SSE.LT

Preamble

I have never seen a country where political wings are formed according to nationality. Yet, Latvia has succeeded in this field with right-wing parties being comprised almost completely by native Latvians and left-wing parties – by native non-Latvians. Using nationalistic slogans, twisting the truth and playing on the dreadful memories of Latvian folk, right parties have accounted for the major part in Saeima (state parliament) for already 15 years. The global financial crisis gives Latvian citizens a unique chance to check if the ruling parties are seeking prosperity for the state or just personal welfare.

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Encouraged by a message from Bank of America with precise projection of Baltics devaluation I have decided to summarize why the analysts could be right in their estimations. Apart from inflation, economic recession and credit crunch, as stated by the BoA, I would like to stress other interrelated macro economic phenomena, which theoretically should be ended by a change in currency rates. Mainly, these are:

1. Hot money effect

2. Current account deficit

3. Reserves/ M2 + Gross external debt coverage

4. Low competitiveness

5. Parex Bank… and international relations

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Some comments from Stockholm School of Economics in Riga staff inside.

I also liked Godmanis, Latvian Prime Minister.

Swedbank and Latvia are major friends today. If you listen to someone speaking about Latvia just wait a few moments and you will enjoy expressions about Swedbank. Or other way, if someone is articulating about Swedbank, she will certainly stick few words about Latvia. Causality is uncertain but base is obvious: Swedbank and Latvia are major problems of each other. Latvian currency is losing value, Swedbank – confidence.

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Does corporate governance matter? Here, in Baltics? Particularly, do listed companies of Estonia, Latvia and Lithuania can increase their share prices through better corporate information disclosure practices? These questions were raised last spring in Stockholm School of Economics in Riga with help of Riga Stock Exchange by my partner Inga Zarecka, currently a student of Heriot-Watt University of Edinburgh, and me in Bachelor thesis writing process. Our intention was to evaluate numerically the effect of corporate governance on stock returns of listed companies in Baltic States.

Apart from identification of general links between information disclosure and corporations valuation, one can find stated questions especially interesting under current poor economic environment of the region. Good knowledge about companies is the first step to attract foreign capital to the countries, which is so required today for Baltic economies. But results we have found during the study process are not very promising. As could be expected more transparent companies might gain benefit which is greater than costs of preparing report which is expressed in excess stock returns. However, the opposite effect was observed in empirical analysis of the paper. The group of companies with poor reporting standards significantly outperform the companies with high quality corporate information disclosure.

Research Question

We were interested whether the companies of Baltic stock exchanges gain an extra advantage in their share price values through “best practice” reporting. In order to answer this question the authors investigated  whether investors earn positive returns on a long “high information disclosure level” portfolio and a short “low information disclosure” portfolio.

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A social event recently took place in Vilnius, occupying the entrance of the parlament. As a result of 30% drop in wholesale milk prices during 1h 2008, local farmers decided to arrange a quick protest meeting. All volunteers received milk for free.

During the same time, the price of milk and milk products in grocery decreased by roughly 2%, according to Lithuanian statistics department. In fact, small farmers receive just 12 euro cents for a kg of milk sold to manufacturers. After production, transportation and labour costs as well as related margins it caps to 90 euro cents. An increase of 7.5x

I must admit I don’t have much knowledge in the field of milk processing. But is it a new way to tackle inflation?

Recently Ober-Haus has published a report overviewing the development of real estate market in the first half of 2008 in Lithuania. A few things draw attention, apart from a general downside market trend and a “light depression”, as portrayed by Ober-Haus.

Firstly, as I have already mentioned, residential real estate prices in Lithuania have declined in 1H2008. According to Ober-Haus estimations, Vilnius-based dwellings lost 9% of their value; the second largest city, Kaunas – 10%; the third, Klaipeda – 12%. Land prices across the country plunged 20-40%, depending on a region and infrastructure integration level.

Secondly, according to the company’s March survey, a half of potential real estate buyers with adequate amount of capital would not prefer purchasing flats due to negative price expectations.

As a result, Lithuanian banks do not lend money for land purchases anymore. Building companies are also suffering from tighter credit conditions, as they are obliged to sell flats prior to launching a project and taking a loan. So, according to Ober-Haus, Vilnius will have built only 3,500-4,000 new flats in 2009, down 40% from planned 6,000 flats. Kaunas and Klaipeda will have built roughly 2,000 new flats together in 2009, twice lower than this year. The company does not give any forecast for 2010. However, I believe further decline in real estate demand is the most promising scenario, even under soft-landing scenario, which of course is very questionable.

Panic has started.

Discussed by John Hempton in Bronte Capital, Baltic banks are insolvent. The reasoning is the following:

Well if the Lati devalues (as would seem inevitable) then Hansa Bank has to pay Euro to Swedbank – and as its assets are in Lati it would be insolvent.

If the Lati doesn’t devalue its only because people (ie Swedbank) are prepared to continue to fund it. This is not pretty at all. All in Hansa owes Swedbank over 30 billion Swedish Kroner – all denominated in Euro and which can’t be paid. The equity capital of Hansa (roughly 7 billion Swedish Kroner) is also going to default.

To protect Baltic economies, firstly, central banks should have enough willingness and reserves to long Baltic currency and short Euro with gold. While the rest of the world is doing vice a versa. Any thoughts who is able to spend more capital: hedge funds or Baltic central banks?

Secondly, people must inject more Euros to Hansabank, SEB and other banks to diminish their loan-to-deposit ratios and make shareholders of Swedbank calm. Any one is willing to buy litas or kronas from the bank and give them all your Euro savings?

Yes, we do! Banks have been clever enough to hedge their currency risks by lending in Euro to residents of Baltic States. And we have been borrowing in Euro, protecting banks and exposing our own assets. The great scheme that has been working until recently, when borrowing capacity was more or less sustainable.

Today, it’s not true. Banks’ credit risks are topping due to bad loans coming from the Baltics. Inflation does not allow to reduce interest on domestic currency denominated loans and decrease demand for Euro. People do not funds banks anymore. Contracting GDP growth is pushing away foreign investors. Consequently, to make their shareholders calm, both Swedbank and SEB should closed down their Baltic branches. Until they will be forced to.

It is a common fact for everyone that Lithuanian real estate market has been booming in recent time. Involved parties are eager to stress prosperity and enormous returns of the market. For instance, Lithuanian Development Agency whose aim is “to create the common informational Internet platform for foreign and Lithuanian business” loudly presents benefits of the market for foreign investors and local speculators. Ironically, that platform, which did the Ministry of Economy support (and I assume taxpayers’ money was involved there), has also a direct link to a private real estate company, which can further provide you a number of optimistic market’s “bubble-facts”.

I think it is a good moment to realize the underlying environment of Lithuanian real estate market. I would like to present some fresh ideas, but contradicting to official arguments, about past development of the real estate market; its intrinsic conditions; and subsequent wind up. To begin with, I would offer to take a short look at capitalization rate (cap rate) of private real estate in Lithuania.

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Real inflation in Lithuania reaches 6.0% in first five months of 2008 versus 5.8% officially published. Official data is adjusted by new weights structure introduced in the end of 2007, where food loses some contribution. If we use 1996 initial consumer products percentage contribution to total inflation, YTD CPI level reaches 7.1%, which is 1.3% higher than we are spoke by the department of statistics. This holds if official contributors inflation is taken.

To make matters worse, after conducting a small research on food prices I found another less pleasant number. Real current inflation in Lithuania piked by extra 0.6% during five months of 2008. In total, real inflation in Lithuania gets to 6.6%-7.7% level, depending on one of the several methodologies used by the department of statistics. Somewhat more than 5.8%.

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Today is the first time since September 26, 2007, when Latvian currency returned to its unpleasantly low position against Euro. However, if in autumn momentum was rising, this time it is the sharpest one day price drop of Lat against EU currency. In one day LVL depreciated more than 0.5%. Is it only a mystery happening each Friday the 13th or financial markets started to doubt in Lat?

Technically 0.7060 level is important for Lat, as it is a second 1-year lowest LVL-EUR rate. If it is broken, we should expect further depreciation until another important limit to test – 0.7074, which is 0.2% higher than Friday’s closing price. This point was reached when Latvia was flooded with SMS’s containing rumors about Lat devaluation. On short term-graph, resistance line is broken, and probably does not already play any significant role. Technically, the question is whether another 0.7060 is a strong resistance level. Economically, not necessarily.

Monday’s, opening price shall judge this interesting case.

How beautiful is the country of Gibraltar! This is a welcoming piece of nature full of mountains, beaches, fresh air surrounded by relaxing smiles and Estonian exports. Small, but very loyal UK-owned colony is the 8^th largest buyer of Estonian products: “mineral fuels, mineral oils and products of their distillation; bituminous substances”.

When was the last time when Estonia cared about Gibraltar so much, but today, when year-on-year GDP growth reached 0.4% in Q1, led mostly by exports, inflation flooded at 11.4%, current account stayed at risky height and relationship with its largest neighbour fell to depth. Proud but debatable behaviour of the Baltics states with Russia, selfish and overconfident, is an appealing topic to examine, especially under speculations about the worst financial crisis Tallinn, Riga and Vilnius can face after gaining our independence.
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After spending some time on Delfi, I have once again faced an eye catching idea: Sampo Bank (one of the banks, operating in the Baltic states) offers its clients an amazing 18% annual rate on their half-year deposits, while regular time deposits for the same period earn around 4.3%. However, as a rule, there also should be some nasty things, which the bank takes for additional privileges it grants. And I was prepared for that. This time, it was an obligation to invest 75% of your portfolio in Danske Fund Global Emerging Markets, and the rest into the amazing deposit.
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The recent report by McKinsey has identified new financial markets participants, which might unexpectedly affect its development. Petrodollars, Asian center banks, hedge and private equity funds – these institutions, as the report mentions, have obtained a great ability to influence financial markets during the last 6 years. Besides, even under optimistic assumptions, in the same period ahead, the new power brokers might reach the size when other investment funds will have to adopt their behavior according to the new brokers’ actions.
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