Estonia’s Neck Goes Into A Latvian-style Noose

Well, today is the 30 of June, and still no news from the IMF on releasing the next tranche of the Latvian loan. Perhaps this is one of the reasons why (via Ott Umelas at Bloomberg).

Estonia’s fiscal deficit under European Union terms more than doubled in the first quarter from a year earlier, indicating the Baltic country may not be able to adopt the euro in January 2011. The deficit, including social security and state and municipal spending, rose to 5.57 billion krooni ($502 million) from 2.06 billion krooni a year earlier, according to data published on the statistics office’s Web site today. The gap corresponds to 2.5 percent of gross domestic product, according to Bloomberg calculations based on the Finance Ministry’s forecast for Estonian GDP for 2009.

The first-quarter figure means the government will have to keep the deficit at 0.5 percent of GDP for the rest of the year to meet euro-entry criteria. Finance Minister Jurgen Ligi has said he sees no improvement in the economy before the third quarter. The minority Cabinet of Prime Minister Andrus Ansip has cut the 2009 budget deficit by 16 billion krooni, or 7.3 percent of GDP, in recent months to avoid depleting state reserves and keep the fiscal deficit at last year’s level of 3 percent of GDP, the same as the EU’s budget-deficit threshold. This would allow Estonia to adopt the euro in January 2011, the government’s main economic goal.

So why a “Latvian-style” noose? Because these countries have built for themselves a sort of “paradox of fiscal thrift” connundrum, whereby the more you cut, the more GDP falls, the more revenue rises, the more spending grows, the more the fiscal deficit goes up, the more you have to cut, and so on. In the end, as Kenneth Rogoff said yesterday, it simply becomes too painful. There seems no way Estonia can achieve a 3 percent deficit this year at this point. And remember what IMF First Deputy Managing Director John Lipsky said last week.

“If there is a solution it begins with macro policies,” Lipsky said. “No single exchange rates solution, or exchange regime represents a solution to these kinds of problems. What is important is that the currency regime is credible and coherent”.

Estonia now has no exit strategy, at least not to join the euro in 2011 it doesn’t And then we have Lithuania and Bulgaria to think about. Basically, the ECB and the European Commission should never have drawn a line in the sand across the original Maastricht criteria. But it’s too late for that now.

For Background Reading and Arguments on All This, See:

Why The IMF’s Decision To Agree A Lavian Bailout Programme Without Devaluation Is A Mistake
Why Latvia Needs To Devalue Soon – A Reply To Christoph Rosenberg
Latvia – Devalue Now or Devalue Later
The Long And Difficult Road To Wage Cuts As An Alternative To Devaluation
Why You Need Devaluation – An Open Letter To The People Of Estonia< Devaluation, Euro Membership And Loan Defaults – Some Thoughts For My Critics

And For Why It Is The Baltics Have The Problem In The First Place, See

Is The Latvian Economy Running Out Of People?

The Clock Is Ticking Away Under Latvia

Taking Solow Seriously – Does Neoclassical Steady State Growth Really Exist?
Latvian Population Dynamics
Hard or Soft Landing in Latvia?
Latvian Fertility

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

10 thoughts on “Estonia’s Neck Goes Into A Latvian-style Noose

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  2. The origin of problems is different for Latvian and Estonia. Latvia has been hit hardly by its accidental banking crisis. The Estonia is suffering from structural weakness of its production.

    Latvia is producing chemicals and pharmaceuticals which are much more stable during recession. Estonia is assembling mobile phones. Which idiot will purchase a new 500$ mobile phone during recession?

    It is a very big “?” where the recovery will come for countries which are addicted to exports – as Germany and Estonia. Who needs a new car and/or a new mobile phone when most do not have enough money for food? At time now the only means of restoring the purchasing power for such goods are governmental stimulus. How many cars and handys can the government afford?

  3. Hi govs,

    I’m sure you are right that the origins of the problem are different in the two countries, although both had huge borrowing financed consumer and housing booms. Unfortunately, the outcome in both cases is likely to be depressingly similar.

  4. Yes, I agree – the convergence theory holds here. Until now Estonia was trying to distantiate from Latvia and complained that Latvia spoil the common Baltic image. However, the evidence shows that outcome in Estonia is the same as in Latvia, only with a lag.

    Regarding perspectives there is a very high structural risk for Estonia. Production fell Apr 09/ Apr 08 -33.7% in Estonia, Apr 09/Mar 09 fall was -2.8%. In Latvia production grew Apr 09/Mar 09 was +4.8%.

    The big overall slump in Latvian GDP is caused by extremely undergoing added value in finance and retail trade sectors, which are, however, structurally not so important.

  5. Pingback: Global Voices Online » Estonia: Budget cuts and GDP decrease

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  8. 1) “the more revenue rises, the more spending grows, the more the fiscal deficit goes up”

    The transition from step 1 to step 2 in this sequence obviously wouldn happen in a “paradox of fiscal thrift” situation with pre-existing debt.

    2) The Estonian fiscal deficit is less than one third of the profit the boss of hedge fund Renaissance Technologies made a wile back. How exactly is there supposed to be no possible exit from the current mess?

  9. “wouldn” is supposed to read “would not” (as I assume to be obvious anyway).

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