Baltic reboot: Is Baltic 2.0 around the corner?

In the six years leading up to the Great Recession of 2007/8, the Baltic states along with Nordic neighbors were the leading performers in Europe. Estonia, Latvia and Lithuania were dubbed the “Baltic Tigers” because of their GDP growth and “can do” attitude especially for tech-based startups, which encourage FDI (Foreign Direct Investment). But after the onset of the economic downturn, the Baltic’s are trying to scratch back, with an economic reboot - an economy more diverse than the original. But the challenge is inherently more difficult as global conditions are more severe. Challenges The Eurozone itself is part of the challenge. The problems in Greece (and many of the other south Euro zone economies), economic dominance of Germany, slowdown in China, potential exit of Britain and the U.S. and the commodity glut, are particularly impacting Nordic neighbors like Norway. But perhaps the greatest challenge to the Baltics is Russia. Relations with Moscow have grown chillier in the wake of events in the Ukraine. A Russian trade embargo hasn’t improved relations with Moscow. And relations are unlikely to warm any time soon. In December 2015, Lithuania connected its electricity market to Poland and Sweden. But Baltic states are already in talks on the next step toward energy independence from Russia: synchronizing their electricity networks with EU grids. For Lithuania, the step is a big one in the process out of Moscow’s orbit. The country was the first Baltic state to declare independence from the Soviet Union but the sector, as part of its conditions of EU entry, had to decommission a Soviet-era nuclear plant. Overnight the nation went from being the main electricity producer in the region, to being almost entirely Russia-dependent. The new links offer an alternative but the Baltic states remain integrated with the old “IPS/UPS synchronous area” - the power ring of Belarus, Russia, Estonia, Latvia, and Lithuania (Brell). The bottom line is Russia still controls operational parameters regulated by a Central Dispatching Unit in Moscow. The planning of operational reserves is done by reference to hydroelectric plants on Russia’s Volga River. The price of disconnecting from the Brell is a hotly debated topic. The EC (European Commission) has said it would cost around Euro 800 million to disconnect from the system. And Moscow isn’t happy about the prospect. Putin has said that Russia would seek compensation from the Baltic states should they decouple from Brell. The Russians say the pullout would force them to undertake a costly rebuilding of the grid. Lithuania has said that changing grids doesn’t necessarily mean ending the Brell connection, although it means Moscow central will have a great deal less control over the grid. But the controversy of the Brell is part of a wider discussion of what sort of relations can the Baltic nations have with Moscow? While it is clear that the Baltics need to get back to some sort of “export” based model to build up FDI and reduce national burden, the boom bust cycle with Russia has forced the Baltics to look to other partners. The Nordic nations are a natural fit albeit much smaller demand than Russia. Nordic Model Subdued The Nordic nations have had slow growth in 2015 and little indication that they will emerge in 2016 with any appreciable improvement. In the case of Denmark, the country posted narrow GDP growth in the first three quarters of 2015 before only expanding at 0.2% in the fourth quarter. On the positive side, the country has low unemployment, low public debt, and a fiscal deficit of less than 3% GDP. The main difficulties were in private fixed investments, domestic consumption and exports. Both problems of global making. Will Denmark recover in 2016, probably not but it is likely to be the first nation in the Nordic/Baltic range to emerge from the slump. Finland’s GDP grew by 0.1% in Q4 and while not large it was an improvement over the 0.2% contraction in Q3 and brings 2015 year growth to 0.4%. Economic growth has been flat since the financial crisis as major industries have collapsed and trading partners have undergone drastic slowdowns, while the country’s labor market remains one of the least competitive among European nations. After the government failed to implement labor reforms over the past 12 months due to staunch opposition from unions, the government requested that unions put forth a proposal for increasing competitiveness, otherwise the government stated that it would go ahead with cuts to welfare and benefits. On 29 February, union leaders agreed upon a proposal they say will meet the government’s demands and could resolve the issue. Norway’s economy posted a 1.2% quarterly contraction in fourth quarter which was up from the revised 1.6% expansion registered in third quarter and brought full year 2015 growth to 1.6%. Like other countries in the region, weak exports and falling investment in both the mainland and offshore energy related sector have stifled growth. The economy is undergoing a difficult adjustment to lower oil prices, which are not expected to recover to pre-2015 levels. Offshore investment in the oil sector makes up over a quarter of total investment, however, it declined last year, taking the momentum out of growth. Moreover, Statistics Norway’s Oil Investment Survey data released in late February suggest that oil investment has further room to fall in 2016, thus restraining growth going forward. The Swedish economy expanded 1.3% in the fourth quarter 2015, which was almost double analysts’ forecasts and is well ahead of Germany and the United Kingdom in terms of the strength of its recovery since the global financial crisis hit these economies in 2009. The reading marked a notable improvement over third quarters 1.0% expansion and brings full-year 2015 growth to a solid 4.1% increase. In Iceland The Central Bank revealed the first set of measures that it will implement prior to removing capital controls later this year. In order to stem a potentially destabilizing flow of foreign currency rushing into Icelandic banks, the Bank plans to impose taxes on foreigners who purchase bonds and to remove certain interest rate privileges. The Bank fears that the country’s significantly-higher interest rate of 5.75% compared to European countries near-zero rate could compel foreign investors to flood the country’s financial market. The Bank is taking all measures necessary to avoid a repeat of the 2008 crisis. Meanwhile, Fitch credit ratings agency affirmed Iceland’s BBB+ rating and stable outlook. Fitch commented that the fiscal balance of the country will improve notably going forward as the country starts to remove capital controls.