The health of Sweden’s banking system is increasingly coming under the microscope given its exposure to the rapidly contracting Baltic economies (Estonia, Latvia, Lithuania). Swedish banks’ outstanding lending to the three Baltic states is around 20% of GDP (US$ 60 billion), mostly in foreign currency. In June, Sweden’s central bank and the financial supervisory authority (FI) both released stress test results, which showed all the Swedish banks weathering the Baltic malaise. However, the central bank and FI’s stress test scenarios were not especially stressful and may soon start looking more like base case scenarios.
Bottom line: While Swedish banks should all meet minimal capital requirements (4% Tier 1 capital ratio) in a stressed scenario, spiking defaults in the Baltics will significantly erode the capital positions of Swedish banks exposed to the Baltic region. Such erosion will tighten lending both domestically and in the Baltics, further cutting into Sweden’s already negative growth outlook for 2009.
The collapse of the Thai baht in July 1997 helped spark the Asian financial crisis. Could events in Latvia spawn a similar contagion? Eyes are focused on this small Baltic economy, amid growing talk of a devaluation, due to the potential for spillover effects into its fellow Baltics, Sweden and the broader Eastern European region.
Strong trade and financial linkages, not to mention similar macroeconomic vulnerabilities, mean a Latvian crisis would almost surely have knock-on effects on neighboring Estonia and Lithuania, as detailed in this RGE EconoMonitor post in early May. A Latvian crisis would also have negative spillover effects into Sweden via Swedish banks’ heavy exposure to the Baltic trio. The wildcard is how a Latvian crisis would affect the greater Central and Eastern European (CEE) region. Direct trade and financial linkages between Latvia and CEE economies, outside of the Baltics, are limited. Nevertheless, many of these countries – particularly Bulgaria and Romania – share similar macroeconomic vulnerabilities with Latvia, meaning a crisis there could ‘wake up’ investors to the potential for crises in the rest of the region.
There is no question that growth is deteriorating across Eastern Europe, but are these countries facing outright financial crises? Hungary and Latvia have already turned to the IMF for rescue packages, and other countries in the region exhibit similar vulnerabilities.
The IMF, which recently announced a $2.4 billion agreement with Latvia, has said the ailing Baltic country will not be required to give up its currency peg (the lat is currently pegged to the euro with a ±1% fluctuation band). This is quite an unusual move and is reportedly controversial even within the IMF.
After a protracted period of deflation from 1999 to 2005, Japan appears headed for falling prices yet again. Japan’s core CPI (which excludes fresh food prices, but not energy prices) rose 1.9% yoy in October – a drop from September’s 2.3% yoy rise. The consensus forecast is now that Japan will dip back into deflation (as measured yoy) in mid-2009, with many seeing a return to positive territory in fiscal year 2010/11. Nevertheless, there are reasons to believe deflation this time around might not be as temporary a phenomenon as some now believe.
Until last week, some analysts still believed Japan would escape recession, but the release of the Q2 GDP numbers forced most to change their tune – real GDP in the second quarter (Apr-Jun) fell -0.6% qoq (-2.4% yoy). Consequently, the consensus now seems to be that Japan is experiencing a shallow, short-lived recession, with recovery […]
Romania’s economic prospects seemed bright as it entered the EU to great fanfare in January 2007. Just over a year later, massive imbalances have clouded Romania’s sunny economic picture. Danske has classified Romania in the ‘danger zone’ for a hard landing, while Fitch downgraded its outlook on Romania to ‘negative’ from ‘stable’ earlier this month.Analysts, […]