Exchange rate hostages

The Russian rouble has regained some ground but it is still down by 24% against the euro compared to a year ago due to tumbling oil prices and continued capital flight.

And currencies in its vicinity have not escaped this fate either: Over the same period the Belarusian rouble has depreciated by 17%, the Moldovan leu by 12% and the Ukrainian hryvna by no less than 50%. The latest victim was Azerbaijan, which devalued by a third on 22 February – just a few days after the central bank chairman had “assured” people that there was no need for such a devaluation….

For these countries Russia is a major trading partner and devaluation might be necessary to maintain suitable competitiveness but it has also left currency markets in some turmoil with devastatingly high interest rates as the result – the key policy rate in Russia is 15% and in Belarus 40% (8 March 2015).

Partly because of less trade with Russia but certainly also due to having the euro as currency, nothing similar has happened in the Baltics. In fact, not just nothing similar; nothing has happened in terms of currency or interest rates, of course.

But Russia is of course an important trading partner (in particular for Lithuania) so there will be some negative impact and altogether from three sources: 1) the depreciated rouble which makes Baltic goods more expensive in Russia, 2) the recession Russia is facing in 2015 and 3) the Russian sanctions against the West. All three will have a negative impact on exports to Russia, most importantly 1) and 2), and this will obviously have a negative impact on economic activity here in 2015.

By how much is still hard to say, I think, so I am mostly thinking about how Latvian and other Baltic firms will react. During the financial crisis 2008 – 2010, when domestic demand collapsed many firms were very fast in reorienting production from domestic to foreign customers. A similar thing happened in 1998-1999 after the collapse of the rouble (which lost about three quarters of its value then; much more than what has happened in 2014-2105) – Latvian firms quite quickly reoriented exports away from Russia to markets in the west and the impact on growth in Latvia was rather short-lived and lasted just four quarters (Q4 1998 – Q3 1999), see Figure 1.

Figure 1: Latvian growth rates, quarterly data, 1996-I – 2002-IV

Source: Central Statistical Bureau

While we wait for more data to appear to evaluate the impact on the Latvian economy of the developments in Russia it will be interesting to see if Latvian firms can once again prove flexible in terms of reorientation. The task this time is tougher, given weak demand also in the Eurozone but let us see.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and member of the Latvian Fiscal Discipline Council