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Learning Financial Lessons from Baltic Nations

Troubled eurozone countries could learn lessons from Baltic nations that were able to turn around financial imbalances after the 2008-9 economic crisis, Fitch Ratings has claimed. In a report released today, the rating agency examined the parallels between the experience of Estonia, Latvia and Lithuania and peripheral countries of the single currency – in terms of economic adjustment during an economic downturn and how to return to growth.

"Estonia, Latvia and Lithuania faced severe economic crises in 2008-09 and have shown that although it was painful to correct large macroeconomic imbalances and return to growth with a fixed euro exchange regime, it was not impossible," said associate director of Fitch's sovereign team Michele Napolitano. "However, parallels appear overall to be much closer with Ireland than Greece or Portugal - due to its more flexible labour market, open economy and attractive business investment environment."

In the Baltic and eurozone states, current account deficits soared in the years prior to the crisis - as a result of rapid growth in credit and domestic demand combined with a rise in labour costs relative to main trading partners in emerging countries – according to Fitch. But the Baltic States unwound their economic imbalances through a contraction in domestic demand, falling inflation and slower wage growth. The "internal devaluation" was a painful process with Estonia, Latvia and Lithuania suffering a cumulative gross domestic product contraction of 18 per cent in 2008-09. Although, in 2011, their economies have recorded fast rates of GDP growth - driven by a strong export performance. External competitiveness and confidence in their solvency was also restored, claimed the rating agency.

"With a fixed nominal exchange rate, the peripheral euro area countries can only gain competitiveness over the medium term if they allow price and wage levels to decline," stated the Fitch report. "Indeed, the International Monetary Fund-European Union programmes advocate this type of adjustment to restore competitiveness in those countries. This will be extremely challenging. Some of the lessons from the Baltic States are that severe macroeconomic adjustments are more likely to succeed where economies are open and flexible, the authorities undertake decisive and early fiscal austerity measures including cuts in public wages, there is strong social cohesion and political consensus behind austerity, and external support is provided to underpin confidence in banks where necessary."

Meanwhile, Standard & Poor's issued a statement warning of a consistent slowdown in the US and European economies. A spokesman for S & P's pointed to continued "weak economic data", adding: "Eurozone GDP grew a modest 0.2 per cent in the second quarter, down from 0.8 per cent in the first quarter. German GDP grew only 0.1 per cent during the second quarter, increasing the uncertainty about Germany's ability to support the bail-out of weaker eurozone countries." Opinion among investors and traders as to whether there will be a double-dip recession in Europe and America - or, even, a global depression - remains split.    This item was originally posted on Public Service Europe.