The rating agency Standard & Poor's yesterday stripped the tiny Baltic country of its 'A' standing, citing an “increasing risk of a hard landing” and the failure to slow runaway spending. Latvia’s sovereign debt was cut to BBB+, with warnings of further relegation to come. Credit growth reached 78% last year.
Riga property prices have doubled since early 2005, driving prices in the old city above levels in Berlin. The current account deficit was 26% of GDP in the Q4, the world’s highest. “The government does not seem to have a sense of urgency in tackling the mounting imbalances,” said the agency. Instead it is building 'mega-projects' such as a lavish new concert hall. The central bank belatedly raised interest rates to 6% yesterday, a move damned as too little too late for an economy with 8.9% inflation. S&P said Latvia could ultimately face ejection from the European exchange rate system. “This would have a devastating effect on the private sector balance sheet,” it said.
Carsten Valgreen, chief economist for Danske Bank, says much of Eastern Europe is looking vulnerable, with back-sliding populist leaders and a dangerously high mortgage debts in euros, Swiss francs, and lately yen. “All the red lights are flashing. The region looks very much like East Asia before the crisis in 1997, and by some measures it' worse,” he said. Over 85% of all household and corporate debt in Latvia is contracted in foreign currencies, a proportion similar to Argentine dollar debt before the collapse of the peso peg in 2001.
Hungary, Poland, Croatia, Romania and the other Baltic states have all been snapping up foreign loans, accounting for much of the outstanding $138 billion (£79 billion) of Swiss franc debt outside Switzerland by the end of 2006. Fitch Ratings said credit growth last year reached 68% in Kazakhstan, 64% in Azerbaijan, 55% in Estonia, and 46% in Romania, all far above their sustainable speed-limits. The region needs $217 billion in external financing this year to plug deficits. “Cheap and plentiful capital inflows have fuelled the economic boom Eastern Europe. This begs the question how well the region will cope in the event of a marked increase in risk aversion and tightening liquidity,” it said.