Latvia is the 18th country to make up the European Union. This country, bordering on the Baltic Sea, composed of approximately 2 million inhabitants and 64,500 square kilometers, has historically had a very high level of GDP growth, principally consumption-driven. But it too, in its turn, suffered from the 2008 crisis. As the old saying goes, happy families are all alike. Every unhappy family is unhappy in its own way. So will Latvia's entry into the EU make the EU family - currently grumpy at best - unhappy in the Latvian way? Here are six facts to consider for 2014 and the prospects for Latvia becoming, as Krugman has prognosticated, "Europe's Argentina", or maybe, more realistically, Europe's Cyprus.
Before considering the usual suspects (debt, banking structure, overall economic health), it is worthwhile considering the history of Latvia's integration into the eurozone. Latvia joined the EU in 2004. It sustained a healthy growth rate in its transition to a market-based economy; however Latvia's main problem was the simultaneous growth of foreign currency debt - consisting primarily of the gross liabilities of corporations and households to domestic and external creditors.
In order to facilitate the complete integration into the eurozone, Latvia underwent an internal devaluation between 2007 and 2009. The net effect was that, while maintaining the fixed exchange rate with respect to the euro and implementing pro-cyclical fiscal policies, unemployment grew from 5.3% to 20.5% in early 2010, while the country lost about 24% of its GDP. Was it worth it? The following six indicators should be a good predictor on the prospects for 2014.
I. The bad news is that Latvia is starting from a lower level than Cyprus.
It's worth providing some salient comparative statistics between Latvia and Cyprus. The following table provides comparative statistics on the two countries.
2012 GDP per capita
Government debt per capita (2012)
Government debt as % of GDP (2012)
Government deficit (2012)
Unemployment rate (Sep. 2013)
Corruption index (2013)
1.14 million euros
292 million euros
On a number of parameters, Latvia is comparable to Cyprus. Government debt is lower - this theme of lower debt is echoed when examining household debt as well (see below). Per capita GDP is lower in Latvia, but corruption is a problem in Latvia (see below).
II. The bad news is that the credit boom from West to Latvia led to a growth in household debt to income.
The expansion of Western European banks (and in the case of Latvia, several prominent Scandinavian banks) led to a growth of bank loans and thence a credit boom. As the following graph shows, there was an expansion of household debt to income, but overall, the levels are lower than the euro average.
III. The bad news is that Latvia has an alarmingly high level of non-resident claims to its MFIs.
As the above table indicates, Latvia's corruption index is relatively high. Part of the problem is the suspicion that the country's banks have been used as a conduit for stolen money, as in the recent case of Hermitage Capital involving the now-deceased Russian lawyer Sergei Magnitsky. This case involved the alleged transfer into Latvia of tax rebates stolen from Hermitage. The bank involved in this transaction has not been revealed, and there is widespread skepticism that Latvian regulators have the will to effectively deal with the use of Latvian banks in possible fraudulent activities. Here is a graph that shows the importance of non-resident deposits in Latvia's monetary financial institutions (MFIs), a pattern reproducing uncomfortably that of Cyprus.
IV. There was a run on Latvia's second largest bank, but short-term deposits remain at a stable level.
In 2008, there was a run on Parex bank, then Latvia's largest bank. Customers then lost 85 million euros in deposits. The government was forced to take over the bank, which was subsequently transformed into Reverta, a distressed asset manager.
As the following table shows, the rate of change of the shortest-term deposits, redeemable upon notice remains stable, and has in fact decreased recently.
% of deposits redeemable upon notice long-term
Rate of growth of deposits redeemable upon notice
V. The good news is that although Latvia's credit boom shares many attributes, with the East Asia crisis of the late 1990s, household debt in Latvia remains current for the most part.
Certain characteristics of the Latvian economy hearken back to the East Asian crisis of the 1990s. For instance, there has been a rapid build-up of private sector indebtedness, most of it in foreign currency. The debt of the East Asian countries succumbing to the 1990s crisis was short and unhedged for the most part. By contrast, Latvian household debt is mostly owed to foreign banks, and as the following graph shows, relatively current.
VI. The good news is that restructured loans remain low, and are not in primary mortgages.
A restructured loan is defined as any concession to a borrower in financial difficulty - capitalization of interest, and grace periods. The share of these types of loans remains low for both the corporate sector and for households. Mortgages are relatively unimportant, with total household debt in housing being concentrated in loans for housing purchase and repair, given that Latvians still live in Soviet-era housing transferred to occupants. In addition, there have been new measures put into place to facilitate resolution of individual insolvency or super-indebtedness, in an attempt to help both corporations and households in risk of outright default.
Perspectives. It is not clear that the entry of the Latvian economy will do anything to strengthen the eurozone, given the potential for a new Cypriot-style inflammation of the banking sector (primarily due to the heavy concentration of bank deposits in non-resident MFIs). However, due to the relative strength of the balance sheet of the household sector, investors might consider a play on one of the largest Nordic banks to operate in Latvia, Swedbank (OTCPK:SWDBY). With a P/E of 17.6, it has a third of the market share of the private loan market in Latvia, and a 31% share in the mortgage market. Given that a complete overhaul of Latvia's decaying housing stock will likely be necessary, Swedbank seems well-positioned to take advantage of this opportunity, if Latvia can develop a sound basis to protect property and contract rights.