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Wednesday, July 22, 2009

Hungary Struggles To Apply Its Own Unique Version Of "Internal Devaluation"

by Edward Hugh: Barcelona

Just what the hell is going on in Hungary? This is the question which even the most cursory inspection of the latest round of data coming out of the country leads me to ask myself. What the hell is going on and just what kind of correction is this the IMF are presiding over here?

In May, according to the latest data from the Hungarian statistics office, in the Hungarian private sector real wages were up, and employment was down. Meanwhile in the public sector, real wages were down, but employment was up (contrary to what was supposed to be happening). A recent programme to get workers off the unemployment roles and back to work seems to have had the perverse and contradictory impact of offsetting the fall in private sector employment by giving a sharp boost to public sector employment. So while total employment has remained more or less stable, the balance has shifted, and in the wrong direction. Meanwhile, in an attempt to stem the bloodletting in public finances (the economy remember will probably contract by about 7 percent this year) VAT was raised - by the significant margin of 5 percent (from 20% to 25%) on July 1st, giving consumption, which was already falling sharply, another sharp jolt downwards. Not only that, the Hungararian economy, in order to maintain the value of the forint more or less where it is (all those forex loans) was supposed to be having a major downward correction in wages and prices, yet inflation (which was already at an annual 3.7 percent in June) will surely now be given a hefty kick upwards. So, I ask myself, how does any of this actually make sense, and to who? And meantime the problem of the forex denominated loans remains, and goes jangling around (like any good jailor does) in the background, putting an effective stop on monetary policy just as fiscal policy switches over to complete contracton mode. This is why I talk of "internal devaluation", since the Hungarian authorities (with the agreement of the IMF and the EU Commission) seem to have decided that, rather than resolving the issue of the CHF loans once and for all, they will down the same road that is proving to be so disastrous in Latvia, even though they have their own currency to devalue, should they choose to do so.

At the end of the day, the big question which we are all left with is, whether this structural shift in employment, away from the private sector and towards the public sector, and the increase in the consumer price index to be caused by the sharp VAT hike, plus the ongoing rise in real wages, really is the outcome the IMF support programme was intended to achieve?

Wages Up, Employment Down

Amazingly, with an economy contracting at at least a 7% annual rate, Hungarian real private sector wages aren't falling, they are still rising. They were up (over and above inflation) by 1.7% in May. Evidently those who are still in employment say, crisis, what crisis?

Unsurprisingly Hungary’s consumer confidence index rose in July for a third month (to minus 63.1) after hitting a record low in April.

“Consumers’ perception of their ability to save in the short-run is what improved the most from June,” GKI said in their statement. Well certainly a 5 point hike in VAT is unlikely to encourage them to spend. In fact, paradoxically, saving is what Hungarians collectively really need to do, to reduce the ballooning government debt and pay down the level of net international indebtedness. But all this simply means is that to get the economic growth necessary to do all the required saving Hungary is going to need to export, and a lot more than it was doing previously, which is why the shift towards public sector employment is so serious.

As I say, private sector employment is down in Hungary, by 4.8% y-o-y. While industrial output was down 22.1% in May over a year earlier. Something just doesn't seem to be working as it should be here.

On the other hand, public sector employment is on the up and up in Hungary, due to job creation under the short term stimulus programme, courtesy indirectly of the IMF, who have permitted a large than anticipated budget deficit. Don't get me wrong, it's not the stimulus I am quibbling about, it is what it is being used for. The outcomes we are seeing at present don't seem to me to be producing a large structural change in the right direction.

Actually the rise in public sector employment is not a direct result of the increase in the IMF permitted deficit, but rather comes from restructuring funds earlier used to finance social assistance payments. The same ammount of money (at about 100 billion HUF) was used to provide public work opportunities for people who before April were entitled to receive social assistance for staying at home. Now those considered capable of working can only receive benefits if they are registered as public workers and if they are offered a job opportunity by local governent they are compelled to accept it. Thus, like so many things in Hungary, the intention was good even if the execution wasn't.

Meanwhile, far from the current recession leading to a significant downward shift in wages and prices, real wages are - as we have seen - still rising, and Hungary's consumer prices were still running year on year at 3.7% in June, down it is true from 3.8% in May, but still far to high to start restorting competitiveness. And of course, the July 1st VAT rise will give consumer prices another stout kick upwards, with some analysts suggesting that year end inflation could be running as high as 6%. If this is anywhere near accurate, and the HUF stays in the region of its current euro parity, then Hungary's agony looks set to continue unabated into 2010.

And in case you had forgotten, here is what is happening to Hungarian GDP: while wages and prices are rising steadily, GDP is in freefall. Year on year it was down 4.7% in Q1 and Hungary’s government currently expects the economy to contract 6.7 percent this year, the most since 1991. My view is a total policy trap is in operation here, since neither monetary (interest rates are currently 9.5%) or fiscal policy are available, so there is little support to put under the economy at this point. The only way to break the circle in my opinion is to let the forint drop, bring down rates, and restructure the CHF loans.

The result of all this botched policy - Hungary’s unemployment rate rose to the its highest level in at least a decade in May. The rate rose to a seasonally adjusted 10.2 percent, the highest since at least 1996. And the situation is more likely to deteriorate than improve, with the central bank forecasting lay-offs of around 180,000 in 2009-2010, nearly 5% of the total number of employed.

One of the important things to grasp about the current situation in Hungary is that this is not a constant size wheel running constantly around the same spindle. The long run outloook is steadily deteriorating as population falls and ages. The same is also true of the working age population, which has now been falling steadily for some years (see chart below).Unsurprisingly therefore the NBH now project that employment will fall by 3.2% this year, followed by a 1.7% contraction in 2010, notably primarily due to layoffs in the private sector.

Hungary’s industrial output fell at a slower annual pace in May than it did in April as stimulus plans in the European car industry added to demand, but production was still down 22.1 percent on May 2008 (following a 25.3 percent annual decrease in April). Output rose 2.6 percent over the month.

Hungary's contraction seems to be more or less moving sideways at the moment, and the June PMI came in at 45.8, a slight uptick from 45.4 in May, but hardly a seismic shift. The output improvement was almost all due to the export sector.


Hungary recorded its fourth monthly trade surplus in May, and came in at 497.7 million euros as compared with 430.3 million euros in April and a deficit of 30.3 million euros in May last year.

Now good news is always good news, but it is important to understand that this result was almost entirely achieved via a dramatic drop in imports, which plunged 32.3 percent in May (following a 35.4 percent decline in April). It is impossible to talk of any marked improvement in exports, since these fell by an annual 24.1 percent, accelerating from a 29.4 percent drop in April. While in the short term this substantial drop in imports (and hence rise in the trade balance) is GDP positive, it is very negative for living standards in the longer term, and the whole situation needs to be reversed by a large boost in exports leading imports as the eurozone economy eventually recovers. But to be able to achieve this Hungarian industry needs to do more, much more, to achieve competitiveness.

Investment Activity

Hungary is suffering from a generalised drop in demand - domestic, export, government, and investment - for which it is difficult to see any short term remedy. In the first quarter of 2009 investments fell by 7.7% compared to the same period of 2008, while they decreased by 1.1% in comparison with the previous quarter (according to seasonally adjusted volume indices). Within this fall machinery and equipment decreased by 9.9%, while investment in manufacturing industry was down by 6.8%. Evidently the first sign of any real recovery in the Hungarian economy will come when investments stabilise and even start to increase, since that will be a reflection of the expectation of future demand arriving further down the pipeline.


Construction activity was down by 10.1% compared to May 2008. In the first five months of the year, output decreased by 6.9%. In comparison with April production decreased by 3.3%. Construction output showed a decreasing trend in connection with the global economic crisis in the past months. In fact there was a significant difference between the performance of the two construction branches, with buildings activity falling by nearly a quarter, while civil engineering works were up by 7.9%. On a seasonally adjusted basis, building activity was 8.6% lower in May over April, while civil engineering was up one percent on the month.

Retail Trade

Retail sales fell 3.4% year-on-year in the first four months of 2009. In April the fall in retail sales accelerated, and the volume index was down 4.1% compared with April 2008. Retail sales decreased by 0.3% over March according to seasonally and calendar adjusted data.

But the real problem is that Hungary's retail sales are now in long term decline, and it is hard to see this situation turning round as the population declines. The peaked in mid 2006, and it has been downhill ever since. This highlights the important point that Hungary's economic difficulties - like Italy's, which bear some resemblance, are not of recent origin, but go back to the adjustment process that started following the mini crisis of June 2006, an adjustment which has never, at the end of the day, achieved the results which were expected of it, and the real question is, why not?

Monetary Policy Trap

Back in April, the Hungarian Finance Ministry were expecting a 155 billion forint budget surplus for the second half of this year, but since then the economic outlook has continued to deteriorate, and according to their latest estimate there will actually be a 149.6 billion forint deficit in H2. This anticipated shortfall is the principal reason why the IMF and the European Commission recently agreed to let Hungary raise its deficit target to 3.9% of GDP for 2009 from the 2.9% previously agreed. They did this in response to the larger-than-expected economic recession, thus avoiding the additional fiscal tightening measures which would have been needed to hold the deficit below the Maastricht 3.0% target level. The gap in 2010 is now expected to come in only a tad lower than this year at 3.8% of gross domestic product (although this number is subject to considerable revision given the levels of uncertainty facing the economy and hence government revenue and spending). As a result, the EU Commission in their latest forecast suggest gross government debt to GDP will reach 80.8% in 2009, and 82.3% in 2010, way above the 60% euro adoption level.

Nonetheless the Hungarian government is in bullish mood. According to Finance Minister Peter Oszko in a Bloomberg TV interview “Recently there has been a turning point......Financial risks are very quickly decreasing in terms of the whole budget. The Hungarian government is committed to implementing a reform program quite quickly.”

Capital Economics' Neil Shearing isn't so convinced:

But is this new-found optimism justified? Possibly. The National Bank will certainly take heart from the fact that the bond market is functioning once again following a complete freeze late last year. This adds weight to the case for interest rates to be gradually lowered, with a 50bps cut to later this month looking increasingly likely. But amongst all the euphoria, it is important to keep some sense of perspective. First, while the government managed to complete the bond auction successfully, it came at a price. At 6.79%, the yield on the new bonds is around 90bps higher than what existing 2014 euro-bonds currently trade at.
There is indeed a general feeling in the air that monetary easing is coming, and in fact three members of the central bank's Monetary Council voted even at the last meeting to lower the key policy rate by 50 basis points, according to minutes of the 22 June rate setting meeting. The MPC is set to hold its next policy meeting on 27 July, and is widely expected to start a monetary easing cycle. My view: just watch out what happens next.

Basically the problem is the value of the forint. My opinion is that the recent recovery in the currency value (see chart below) has been almost entirely driven by yield differentials, and by self-fulfilling expectations (traders expect the currency to rise), rather than by any change in the underlying economic fundamentals, which as we have seen, has not taken place.

And if you are in any doubt about the extent to which Hungary has lost competitiveness since the start of the century, just take a look at the comparative REERs for Germany and Hungary below (REERs are trade weighted, and take account not only inflation but also movements in unit labour costs, ie productivity).

The problem the central bank and the Finance Ministry have to address is the ongoing issue of the mountain of Swiss Franc denominated mortgages (see chart).

These have stopped increasing in recent times, but still constitute a serious obstacle to any devaluation of the HUF, due to the non performing loans issue this would create for the banking sector. Not only has money been borrowed against homes for to fund house purchases, it has also been loaned for consumption (see chart below), so indeed the fact that even these loans are stagnating hardly bodes well in any way for domestic demand.

The thing is, as long as the interest rate differential remains as it is, there is no possibility of convincing people to take out HUF denominated mortgages. So domestic rates have to come down, but as they come down the forint will fall, and the number of distressed loans will spiral up. So the authorities are stuck in a real policy trap, where they have to wriggle uncomfortably around, carrying out what can only be described as a weird variant of voluntary internal devaluation, an intenral devaluation which again, as we have seen from the wage and price data, just isn't happening.

Obviously the whole idea IMF idea here was some sort of long term "play" - moving the focus of taxation from employment to consumption (addressing the tax wedge issue). Initially this shift was supported by the argument, that, amidst a deflationary backdrop, businesses wouldn't be able to pass the tax increase on to consumers in its entirety. At this point it would seem the Hungarian government has no real room for manouver and are desperate to implement the tax restructuring, therefore they opted for the significant VAT raise.

Part of the thinking which lies behind the present approach seems to be some new concept of financial orthodoxy. The IMF put it like this in the Hungary Standby Loan Report

In emerging market countries with debt overhangs, the “Keynesian” effect of fiscal adjustment is likely to be outweighed by “non-Keynesian” effects related to expectations and credibility. Non- Keynesian effects have to do with the offsetting response of private saving to policy-related changes in public saving. In particular, if fiscal adjustment credibly signals improved public sector solvency, a fiscal contraction could turn out to be expansionary, as private consumption rises based on the view that future tax hikes will be smaller than previously envisaged.
IMF - Hungary, Request for Stand-By Arrangement, November 4, 2008

So from Tallinin, to Riga, to Budapest, to Bucharest, the same sonata on a single note is being played, and the message is a clear one - cut spending and you will expand.

But with consumption sinking, government spending falling and exports insufficiently competitive to drive the necessary surplus, the whole thing is now becoming rather a mess, with no clear economic policy objective in the short term (except, of course, maintaining a strong exchange rate) and while in the long term the emphasis is rightly on export. But no one has any idea of how exactly to correct prices sufficiently with the CHF mortgages stuck in the middle.

And the new bond issue only makes things worse here, since as Neil Shearing emphasises:

it is worth noting that the latest euro-bond issue only adds to the mountain of foreign currency denominated debt that lies at the heart of Hungary’s current woes. With the banking sector still in deep trouble and fiscal policy set to tighten, the recession is likely to intensify over the coming quarters.

So, with the Hungarian government currently forecasting a GDP contraction of 6.7 percent,this year, and the likelihood being of further contractions next year and possibly even in 2011, something somewhere is going to give here.

And among the casualties, well why not Hungary's unborn children, the ones she needs to start turning round that population decline I started this post with.

According to preliminary data from the stats office, in the first five months of 2009 38,964 children were born, 1.9 percent less than in the first five months of 2008. But that isn't all, if you look carefully at the chart you will see that the number of children born fell substantially from about March 2007, just nine months after the first financial shock hit Hungary in June 2006. So here's a nice prediction, if economic conditions do work as a short term influence on fertility, then we should see another sharp drop in Hungarian births starting in from July, just nine months after the last financial crisis hit the Hungarian economy. There, I bet you never imagined that the collapse of Lehman Brothers could have such far reaching consequences, now did you?

Thursday, July 16, 2009

Another election, another government in Bulgaria

by Manuel Alvarez-Rivera, Puerto Rico

Bulgaria will be having a new government after President Georgi Purvanov formally asked Sofia mayor Boyko Borisov to form a cabinet on Thursday, July 16. Voters in the Southeastern European nation gave a clear victory to Borisov's right-of-center Citizens for European Development of Bulgaria (GERB) in a parliamentary election held last July 5. While the election to choose members of the Bulgaria's unicameral Parliament, the National Assembly, was the country's second vote in less than a month - last June Bulgarians elected their representatives in the European Parliament - the parliamentary poll nonetheless had a 60.9% voter turnout rate, up from 55.8% in 2005.

Bulgaria's general election - the seventh since the country peacefully moved away from single-party Communist rule in 1989-90 - was held under a new electoral system which established 31 single-member seats, chosen by plurality voting. First-past-the-post seats were ostensibly introduced to make the National Assembly more accountable to voters, although the remaining 209 seats continued to be filled separately by closed party list proportional representation (using the Hare/Niemayer variation of the largest remainder method among parties and coalitions with at least four percent of the vote, initially on a nationwide basis and then at the multi-member constituency level, the latter stage under a complicated procedure that insures that seats are allocated without changing the nationwide distribution of mandates among competing lists or multi-member constituencies). Moreover, single-member seats were filled in a manner contrary to the principle of one person, one vote: each one of Bulgaria's existing 31 multi-member constituencies was assigned one seat, irrespective of population; the distribution of multi-member constituency seats is also skewed in favor of the smaller provinces, but the differences are considerably less pronounced.

At any rate, while the electoral reform may have amounted to little more than window dressing as far as parliamentary accountability is concerned, the introduction of single-member plurality seats has had a distinct impact on the distribution of legislative seats: GERB won a sweeping victory with 26 of 31 first-past-the-post seats, which along with 90 of 209 list seats gave the party a total of 116 National Assembly mandates - five short of an absolute majority; under the previous, fully proportional electoral system, GERB would have only had 105 seats (assuming of course that voters would have cast their ballots in the same manner).

Elections to the Bulgarian National Assembly has detailed 2009 election results and an overview of Bulgaria's electoral systems since 1991.

As in previous elections, corruption and the economy were salient campaign issues. Bulgaria joined the European Union in 2007, but it has the dubious distinction of being rated the poorest EU member - and the most corrupt as well. In fact, Bulgaria's inability to deal effectively with corruption and organized crime cost the country hundreds of millions of euros of EU aid in 2008. On top of that, Bulgaria has been hit exceptionally hard by the global economic crisis, and after twelve years of growth, the Bulgarian economy is in recession, contracting at a rate which the IMF forecast could reach seven percent this year.

Not surprisingly, the big loser in the election was the ruling coalition government, headed by the post-Communist Bulgarian Socialist Party (BSP): the BSP-led Coalition for Bulgaria lost 42 of its 82 its National Assembly seats, and its coalition partner, the National Movement for Stability and Progress (NDSV; originally the National Movement Simeon II) sank below the four percent threshold and lost its parliamentary representation; meanwhile, the third party in the outgoing coalition government, the Movement for Rights and Freedoms (DPS) - which represents Bulgaria's sizable Turkish minority - slightly improved upon its 2005 result both in terms of votes and seats. Nonetheless, the outcome of Bulgaria's 2009 parliamentary election follows a pattern common to every general election since 1991, in that once more Bulgarian voters have voted out of office the parties running the country.

However, Bulgaria has yet to develop a stable party system: as in 2001, a newly-established party has upset the existing political order, and GERB's convincing victory on its first parliamentary contest strongly resembles that of the National Movement Simeon II eight years ago; interestingly, constituency-level results show a very strong correlation between GERB's share of the vote in 2009 and NDSV's in 2001 and 2005 (0.83 and 0.77, respectively). That said, the rise and fall of NDSV should serve as a cautionary tale for GERB: after the NDSV-led 2001-2005 government of Simeon Saxe-Coburg-Gotha (the former king of Bulgaria) proved unable to fulfill its campaign promises to deal with corruption and improve living standards, the party quickly went into a steep decline, which culminated in its wipeout last July 5.

It was originally expected that GERB would form a coalition government with the center-right Blue Coalition headed by the United Democratic Forces (UDF) and Democrats for a Strong Bulgaria, which won fifteen seats in the election (down from thirty-seven obtained by its two major constituent parties two years ago), but Borisov has chosen to preside over a minority government, supported from the outside by smaller right-wing parties such as Order, Lawfulness and Justice, which won ten seats in the National Assembly, or even the far-right nationalist Attack Coalition (21 seats). Bulgaria hasn't had a minority cabinet since Filip Dimitrov's UDF government in 1991-92, which lasted just over a year in power - hardly an encouraging precedent. All the same, it appears unlikely the remaining five parties represented in the National Assembly will join forces against GERB, at least for the time being.

Wednesday, July 15, 2009

IMF Imposes New Conditions On Latvia

by Edward Hugh: Barcelona

Izabella Kaminska at FT Alphaville has the story (via Reuters):

The International Monetary Fund has put forward new, difficult conditions for Latvia to receive further loans, the prime minister said on Wednesday in a further sign the Fund is being tougher than the European Commission.

It isn't clear at this point what these conditions are. Rumour has it they may be an end to the flat income tax, or a hike in VAT. A hike in VAT would be more hari-kiri, since this would again hit consumption AND would boost inflation at a time when they are trying to deflate to carry through an internal currency correction. It also isn't clear whether this is a serious attempt to add new conditions (which I find unlikely, given how advanced the distemper is) or whether this is a way for the IMF to get themselves off the hook (ie leave the EU Commission to stew in its own juice) without having a public and potentially damaging break with the EU. The IMF need to find some sort of exit strategy I think (since Latvia evidently at this point doesn't have one), or it risks losing its own credibility if it puts a seal of approval (by granting the next tranche) on something which most external specialists now think could end up in a very messy grande finale. Argentina ghosts are stalking the corridors in Washington, not because of the similarities between the two countries (they are, at the end of the day pretty different), but because of the way giving a final "kiss of death" loan to a country can ultimately come back and haunt you.

Update One

The local Latvian news agency is saying that if Latvia and the IMF do not sign the new agreement by Friday, Latvia may not see the next chunk of the IMF loan and it could jeopardize the further funding from the EC. This could be brinksmanship, but even brinkmanship can go badly wrong if the other party can't concede. And who is the other party here? Latvia or the EU Commission, since they already said they are happy with progress. What a muddle!

Update Two - Thursday Afternoon

Bloomberg's Aaron Eglitis reports this afternoon that Friday may in fact not be any kind of deadline. He quotes Caroline Atkinson, head of external relations at the IMF, in Washington, to the effect that the head of the IMF mission in Riga is returning to Washington this weekend as scheduled, while the mission itself would “continue its work.” This suggests there will be no final decision this week. She also said there was “broad consensus among all the parties involved” about the goals for Latvia, declining to go into specifics.

Rumourology has it that the IMF wants the government to become more effective in revenue collection, with the fear that the current contraction may be so strong due to the fact that part of the economy is disappearing back into a "grey area" as a backdrop. Various proposals are being floated around, but perhaps it would be better to wait for some concrete information before speculating about this.

Latvian central bank Governor Ilmars Rimsevics has also been holding a press conference in Riga today, and he took the opportunity to suggest that the country’s budget deficit was likely to grow to between 9.5 percent and 10 percent this year. If this is the case, then this would obviously put Latvia outside the 60% gross debt to GDP criteria by 2010, which would make euro membership as an exit strategy non viable over the relevant horizon in my view. Just a long shot, but maybe that is what they are all arguing about. The EU clearly has to offer the four peggars more in the way of a carrot, although they themselves need to remember - looking over at Slovakia and Slovenia - that mere euro membership is no panacea to cure all ills.

Russia's Contraction Eases But Knife-edge Risks Remain For 2010

by Edward Hugh: Barcelona

The Russian ruble strengthened the most in more than three months against the dollar yesterday (gaining 1.7 percent to 32.2247 per dollar at one point) as oil rebounded above $60 a barrel and OAO Sberbank reported better-than-expected earnings. Sberbank shares jumped 5.1 percent after first-quarter net income turned out to be above analyst estimates. But the rise was also helped by the fact that Russia’s central bank spent approximately $2 billion from reserves to try to stop the ruble from falling yesterday, taking central bank reserve spending over the two working days since they lowered interest rates half a percantage point on Friday to around $4 billion, according to reports in the newspaper Kommersant.

Russia’s central bank cut its main interest rates for the fourth time in less than three months at the end of last week after the government estimated the economy contracted an annual 10.2 percent in the January-May period. Bank Rossii lowered the refinancing rate to 11 percent from 11.5 percent following on initial reduction on April 24 and two further cuts on May 13 and June 5.

But the striking thing here is that today's ruble surge followed seven consecutive days when it fell - including yesterday when it dropped 0.5 percent against the euro and 0.1 percent against the dollar to hit the lowest close against the central bank's currency basket since May 4. Indeed only last week the ruble posted its steepest slide against the euro and dollar since January as oil prices fell and Russia's budget deficit contined towiden. And to top it all, as I say, the central bank reduced interest rates for the fourth time in less than three months.

Indeed just after the rate cut Alfa Bank’s Chief Economist Natalia Orlova commented that she was seeing a “very fragile trend” in the ruble, with a lot of downside potential: and I completely agree with her. What we have is a lot of volatility and a lot of market nervousness. Just this morning Bloomberg cited a research report from the ING Group warning that "the ruble may drop as much as 5.8 percent to the weakest end of Russia’s target exchange-rate basket as the central bank aims to revive credit by lowering key interest rates by up to 4 percentage points.” (research note here).

My feeling is that a 400 basis-point reduction would have an even bigger impact than even ING expect. Basically central banks in a number of central and east European countries are caught in a kind of trap, where the high level of forex borrowing both households and companies have engaged in makes local monetary policy rather impotent, and worse, this impotence itself becomes a self perpetuating situation. The trap perpetuates itself since people become reluctant to take out local currency denominated loans due to the high interest rate they carry, so they take out either dollar- or euro-denominated ones and thus make matters even worse, making the possibly erroneous assumtion that end game of all this will be either a dollar collapse (the Russian view) or eventual euro membership (in places like Hungary and Romania). Those doing the borrowing thus feel themselves to be completely covered, and fail to take into account the capital loss that could follow a large correction in their own local currency.

Slowly monetary policy makers in the most affected countries are coming to recognise that they need to address the issue, and somehow or other to get rates down, since the problem is not going to simply go away, and the meanwhile the respective economies keep on shrinking, with no positive boost from local monetary policy. But it is just when they start to lower rates that things start to turn nasty on them, since the whole situation is non-linear. Supporting a currency with high interest rates works for as long as it does on the win-win dynamic of yield differential AND a rising currency, but once the so called carry trade "punters" get the idea that political pressures to address the economic contraction may force substantial rate cuts on the government and the monetary authorities, and that the expectation of such rate cuts may lead the other "punters" to sell local instruments and exit the market, then the "thinking punter" finds he or she also needs to sell, and this is how we get to see that "will the last one out of the door please turn the lights off" type of self fulfilling herd behaviour.

I would say Serbia, Ukraine, Hungary, Romania and Russia are all vulnerable to this kind of outcome. Of course, from a macro economic viewpoint they can all start to bring interest rates down as inflation steadily drops, but I'm not sure that the inflation element is an important consideration for the short term carry-trade people, since it is the absolute yield differential, and the currency dynamics that would seem to matter most.

Sharp GDP Contraction

Evidently the background to all this nervousness is last week's announcement from the economy Ministry that Russia’s economy may shrink by as much as 8 to 8.5 percent this year. Gross domestic product probably contracted by an annual 10.2 percent in the first six months and may slump at a 6.8 percent annual rate in the second half, according to the latest Ministry forecast.

Behind this drop in GDP lies the fact that Rusia's exports were down by 47.4 year on year in the January to May period, largely due to falling prices for oil and raw materials. The economy ministry also said it expected capital investment to fall by around 21 percent this year as utility and energy companies, which account for about a third of total investment, cut spending programs. The ministry forecast is based on an oil prices scenario of an average $54 a barrel in 2009.

Further, industrial production is expected to shrink between 11 percent and 13 percent as manufacturing falls by as much as 17 percent. Inflation of between 12 percent and 12.5 percent is forecast, down from last year’s 13.3 percent. And retail sales are expected to suffer an annual contraction of 5.8 percent.

For the 2010 to 2012 period the ministry currently predicts a 1 percent expansion next year, followed by a 2.6 percent one in 2011 and 3.8 percent one in 2012. This “moderately optimistic" scenario would produce a deficit of 6.5 percent in 2010, followed by further deficits of 4 percent and 3 percent over the following two years. Government officials have recently stated they expect Russia to have a budget deficit of around 9% of GDP in 2009, up from an earlier 7.4% estimate.

Short Term Indicators Show Continuing Contraction

Industrial production shrank a record annual pace of 17.1 percent in May, while capital investment fell the most since December 1998, dropping an annual 23.1 percent.

Russian unemployment fell back for the first time in 10 months in May, but despite the positive effect this may produce on confidence the rate is sure to rise further in the months to come.

Retail sales fell the most in almost a decade in May, sliding an annual 5.6 percent, the fourth consecutive decline and the biggest since September 1999. The average monthly wage decreased an annual 3.3 percent in May, while real disposable incomes dropped 1.3 percent.

From Inflation To Deflation?

After all the inflation which seems to have become endemic in Russia, deflation would seem to be the most unlikely of scenarios, and indeed it is not the most likely of out comes, given the capacity of the authorities to allow the value of the ruble to fall. However, downward pressure on producer prices is evident at this point, and the cost of goods leaving Russian factories and mines dropped an annual 6.5 percent in May after falling 4.1 percent in April, according to the Federal Statistics Service. Prices rose 0.6 percent from April.

Russia’s inflation rate - which fell to an 18-month low in June - is still far too high. The rate dropped to 11.9 percent from 12.3 percent in May. Consumer prices rose 0.6 percent in the month, the same rise as registered in May. Russia’s inflation rate has averaged more than 14 percent a year since the country’s 1998 default and is certainly one of the biggest headaches facing the country.

Some Rebound In June

Russia’s manufacturing industry shrank last month at the slowest pace since September, and VTB’s Purchasing Managers’ Index advanced to 47.3 from 45.3 in May. So the rate of contraction is easing.

Further Russia's service industries shrank in June at the slowest pace since the contraction began in October, according to the VTB Capital Purchasing Managers’ Index which rose to 49.7 from 46.6 in May.

As a result the VTB Capital GDP indicator showed an annual 6.4 percent rate of contraction in the second quarter following a 5.4 percent decline in the first three months of the year. But output was shown shrinking at a 4.8 percent rate in June (from a year earlier) as compared with 6.8 percent contraction rate in May.

“The GDP indicator suggests that the economic decline in the second quarter of 2009 is likely to be similar to, or slightly worse, than in the first quarter,” Aleksandra Evtifyeva, an economist at VTB Capital, said in the report. “However, the prospects for the second half look brighter.” The pace of Russia's economic contraction eased to a 5-month high of 4.8 percent year-on-year in June, compared with a 6.8 percent shrinkage in the previous month, VTB bank's GDP indicator showed on Monday. The June reading "suggests that the economic decline in the second quarter is likely to be similar to or slightly worse than in the first one," VTB Capital senior economist Aleksandra Yevtifyeva said in the report.

2009 Contraction In Double Figures?

According to the latest report from the World Bank collapsing industrial production, rising unemployment and ongoing capital flight will reduce Russia’s gross domestic product by 7.5 percent this year and restrain “intraregional trade flows and transfers,”. The Bank also highlighted that “Remittances to the broader CIS region are expected to decline for the first time in a decade, by 25 percent”.

Neil Shearing of Capital Economics forecasts a contraction of 10% this year, zero growth in 2010 and fears that Russia may be facing a kind of "lost decade", since it may well not recover the 2008 level of output till 2014, and there are still clear downside risks attaced even to this estimate.

Shearing identifies three main factors which may contribute to the lost decade. First and foremost, he notes, the banking sector remains under enormous strain. While official estimates put bad debt at around 12% of total loans this year, Shearing thinks the true figure is likely to hit something closer to 20%. On this basis, he estimates that the banking sector could require up to $60bn in additional capital – far more than the $30bn that has so far been allocated by the government.

Second, by using so much ammunition this year, authorities leave little scope for further policy stimulus. Monetary policy is somewhat hamstrung as we have seen earlier, and fiscal policy will have to be tightened over the coming years in order to rein in a ballooning budget deficit. Indeed, Laura Solanko of the Finnish Central Bank's Transition Economies Centre calls this "the largest fiscal stimulus ever" in the Russian context.

As Solanko points out, the current crisis has hit oil and gas exports particularly hard, leading to a 47% decline in export duties and a 53% decline in proceeds from taxes on natural resource extraction during the first four months of 2009. The drop in general economic activity has further reduced proceeds from all revenue sources. General government revenues in January–April were 20% lower than a year earlier. If current trends continue, Solanko estimates that general government revenues may drop to close to 35% of GDP this year - down from around 50% in 2008.

Meanwhile, government expenditure has increased dramatically at all levels. In January–April this year, enlarged government expenditure increased by 23% to RUB 4,140 billion. The expenditure at the core of the Russian fiscal system, the federal budget, increased by an astonishing 37% compared with the same period a year earlier. Even taking the fairly high inflation into account, this equals a 20% increase in federal expenditure in real terms. Relative to GDP, general government expenditure has risen to 37% and federal expenditure to 23% of GDP, against 28% and 16%, respectively, a year earlier.

To sum up, public sector expenditure has nominally increased by 23%, and relative to GDP by a whopping 9 percentage points compared with the first four months of 2008. The sheer magnitude of such a fiscal stimulus is huge. During the 1990s, Russia’s public sector shrank dramatically, its GDP share decreasing by 12 percen-tage points to 26% of GDP in 1999. The current fiscal stimulus has shot public expenditure back to the level of the early 1990s.

As the automatic stabilisers in the Russian fiscal system are small, the expenditure increase largely reflects expenditure on anti-crisis measures and advance transfers to the regions by the federal government. The government’s anti-crisis measures announced by mid-March 2008 alone would increase federal expenditure by some RUB 2,000 billion, or 15%, in 2009. Roughly half of that is directed to strengthening the financial system, and the other half to supporting the real sector.

The current federal budget foresees a deficit of 7% of GDP, a figure only slightly larger than last year’s surplus – and only slightly smaller than the total assets of the Reserve Fund. This im-plies that most of the Reserve Fund will be exhausted by year end and the Russian government will have to reenter the domestic and external bond markets in 2010 at the latest.

And we should never forget that Russia remains in the grip of a pretty vicious credit squeeze. Bank lending to companies fell 1.5 percent in May compared with April, while retail loans dropped 1.9 percent. Overdue bank loans reached 4.6 percent of the total in May, versus 4.2 percent a month earlier. And while many Russian corporates may be restructuring their debt, the only deepening their longer term exposure to currency correction risk. As in the case of Moscow-based steelmaker OAO Mechel, who, according to Bloomberg, just agreed to refinance $2.6 billion of loans in the biggest foreign-debt restructuring by a Russian company since the credit crisis began. Such refinancing is not coming cheap - the rate was 6 percentage points over the London interbank offered rate - but even more to the point this type of restructuring may only to a certain extent postpone the inevitable, since the new debt now becomes due in December 2012. This is fine if everything is all hunky-dory come 2012, but if it isn't.....

As the OECD put it in their latest report on Russia

“The main threat to credit growth now appears to be solvency problems, arising from the declining capacity of borrowers to repay bank loans,” the bank said in an economic report released today. “The challenge is to maintain capital adequacy and prevent a sharp curtailing of lending flows.”

Lastly, Neil Shearing points out there remains little external support for the economy. With the global recovery likely to disappoint, export demand will remain weak. Oil could fall to $50pb by early-2010. As ING say:

"Oil price dynamics pose additional risks to RUB. Last week, oil prices plunged below the technically important EMA-200 level of US$63/bbl, indicating a potential further drop to US$47-54/bbl. If this happens, the RUB looks destined to weaken as well, given its greatly strengthened correlation with oil prices over the past two quarters".

And if oil does drop back to this range, and the ruble does weaken, and non performing loans rise above the 20% mark (pushed by that very same ruble weakening, and the rising unemployment), and the Russian Federal Government has to start issuing bonds in 2010, well watch out, is all I can say, since trouble will surely be in store. This is very much knife edge touch and go stuff from here on in. Grit your teeth everyone.

Tuesday, July 14, 2009

To The Finland Station And Back Again

by Edward Hugh: Barcelona

This post accompanies my recent piece on Sweden. I have been scratching my head and trying to see what could be learnt from making a comparison between Finland and Sweden. Some of the differences are obvious - one is in the euro, and the other isn't, once can adjust monetary policy and currency values, and the other can't. Others are less so. Finland's goods trade surplus has been declining steadily since joining EMU while Sweden's has remained relatively constant. And Swedish males live on average three years longer than their Finnish counterparts. So what is important here, and why? And if convergence theory has anything positive to be said for it, shouldn't we be able to observe so sort of convergence going on here.

First, and just to remind ourselves, here is the chart from Claus Vistesen which shows what the relation between population ageing and current account balance might look like. The key point is that as populations age beyond a certain point, a tendency to run a current account surplus emerges, as domestic demand steadily weakens, and becomes insufficient to drive growth. Evidence for this phenomenon can be found in Germany, Japan and Sweden.

The idea is that as median population age rises the current account dynamics of a country change. The last ageing phase shown to the right of the diagram is purely speculative at this point, although theory suggests that if the underlying momentum of ageing is left unaddressed it may well be what happens. But it is a development which is to be strongly avoided since although we do not yet know what happens when a society starts to dis-save at an advanced median age, the longer we can put off finding out, the better.

Which is why looking at Finland is important, since unlike the three aforementioned "ideal type" agers, Finland has in fact seen a deterioration in its external position over the last decade, and even though it has, up to now, remained a surplus country, the trend is certainly towards deficit, and this trend needs to be halted and reversed. Indeed this is the most pressing policy problem facing the Finnish authorities during the current recession.

Now, as in Finland, Sweden's external position underwent a structural shift in the mid 1990s, just as Claus's model predicts. First positive balance - the submarine breaks water - in 1994, meadian age 38.4 (quite young in international comparisons so interesting). So so far so good.

So Sweden is a sort of normal case, now let's look at Finland. Once more the mid 1990s "transition" is clear. Finland moves from deficit to surplus. But unlike the Swedish case the surplus peaks around the turn of the century, and since then has been steadily weakening.

There can be a number of explanations for this. The pattern of ageing could, for example, be different in Finland. Or the euro might be a factor, with the loss of control over monetary policy leading to a steady deterioration in the level of international competitiveness. As we will see below, some part of the explanation may be provided by each of these, but first, lets take a look as some of the empirical aspects of Finland's present recession, since it is evident that Finland, like many other countries, has entered a strong recession on the current back the global crisis.

Strong Decline In Finland's GDP

In the first three months of this year GDP was down by 2.7% when compared with the last three months of last year (an 11.2% annualised rate of contraction).

And it was down by 7.5% when compared with the first quarter of 2008 (Eurostat data).

One significant difference which can already be noted between Sweden and Finland is that while the last three months of 2008 were definitely much worse than the first three months of 2009 in Swedan, in Finland, as in many other Eurozone economies, Q1 2009 was definitely much worse than Q4 2008. And indeed, while Sweden's economy shows some definite signs of small green shoots in Q2 2009, as far as we can see, Finland's economy still remains deeply mired in recession. Finland does not have a local variant of the ubiquitous Purchasing Managers Surveys, but the statistics office does maintain a monthly gross domestic product (GDP) indicator. Now, while the methodology is very different (the PMI composites are survey based and qualitative, and much more reliable) for what it is worth Finland's GDP indicator fell 9.2 percent in April in comparison with April 2008, that is to say, the year on year contraction was greater than in the first quarter, but it is difficult to draw any definitive conclusion from this, since there are many statistical factors at work here.

According to Statistics Finland building and manufacturing industry were the hardest hit.

The April data showed production in construction and manufacturing - both key contributors to the Finnish economy - down around 17 percent year-on-year. Production in April was down 0.6 percent from March. Output in agriculture and forestry showed slight growth on an annual basis of just below two percent, while services fell six percent.

And the outlook for the rest of this year does not look much brighter. The OECD forecasts growth in the Finnish economy will fall by 4.7 percent in 2009 with a return to 0.8 percent growth next year. Significantly the OECD also stressed that uncertainty in the evolution of international trade poses the greatest risk in the outlook for the Finnish economy.

The IMF currently expects the economy to shrink by 5.2 percent this year and again by 1.2 percent next year, while the latest finance ministry forecast is for a 6.0 percent shrinkage this year followed by 0.3 percent growth next year. All the 2009 forecasts seem to be subject to downside risk, while the 2010 ones are no better than guesses, since the level of uncertainty is so high, and Finland is so dependent on external trade, but further contraction seems more probable than growth at this point.

Short Term Indicators

Industrial output fell again in May (year on year) for the seventh consecutive month, and was down by 23.2 percent over May 2008. This follows a revised fall of 21.3 in April.

Month-on-month, industrial production also fell - by 2.2 percent from April when it fell by 3.8 percent over March. So the industrial situation is deteriorating, not improving at this point. Output fell in all main sectors, with metal industry reporting the biggest decline around 28 percent, while the paper industry production also shrank by nearly 28 percent year-on-year.

Over the January to May period, industrial output decreased by close on 22 per cent from the corresponding period in the previous year. And there seems to be little improvement on the horizon. According to Statistics Finland, the value of new orders in manufacturing was 39.6 per cent lower in May 2009 than in May 2008, slightly above the January to May average decrease of 38.9 per cent year-on-year.

As in earlier months, the decline in new orders was strongest in the metal industry (47.5 per cent). In the chemical industry new orders fell by 30.7 per cent, in the textile industry by 28.5 per cent and in the manufacture of paper, and paper and board products by 19.4 per cent.

Construction activity is also well down, falling by 14.4% year on year in March (the latest detailed data we have), and by around 17% in April according to the GDP indicator.

Finland did not have a massive construction boom. The construction of new dwellings shows no obvious surge in the first decade of the century.

On the other hand rate of household indebtedness is up, with the ratio of debt to disposable income rising to 101.4 percent in 2007, from 70.3 percent in 2002. Significantly, the rate of indebtedness among households composed of persons in the key 25 to 34 age range reached 189 percent in 2007. House prices seem to be a story of one long steady march upwards since 1995, but prices did start to fall in 2008, and this trend now seems set to continue.

Retail sales, which give us a measure of domestic demand, are also falling, if still only moderately. According to Eurostat, retail trade sales fell by 2.99 percent year on year in April. According to the Finnish Statistics Office, sales between January-April were down by 1.6 percent over a year earlier. During the same time period, motor vehicle trade sales were down 31.8 percent and wholesale trade sales down 17.5 percent.

Finland's unemployment rate continues to rise, and at an accelerating pace. The increase in those unemployed from April to May alone was greater than that in the whole of last autumn, according to Statistics Finland. From January to May the seasonally adjusted jobless rate was up by two percent and there were more than 300,000 people recorded as without work in May, 60,000 more than in May 2008, taking the national unemployment rate as measured by Finland Statistics to 10.9 percent.

Using the EU (ILO compatible) methodology, Eurostat report the May unemployment rate as 8.1 percent. The OECD expect unemployment to continue to rise in Finland, and forecast an unemployment rate of 8.7 percent this year, rising to 10.8 percent next year (ILO methodology).

The OECD is also worried about employment in Finland in the longer term, and point out that while the country has taken important steps to remove the barriers to employment of older workers (see the OECD publication Ageing and Employment Policies in Finland) more needs to be done. Since the early 1990s, Finland has introduced programmes to support the employment of older workers, notably the National Programme on Ageing Workers. It has also recently undertaken a major reform of the old-age pension system and will phase out early retirement schemes.

However, Finland’s median age is rising steadily (see chart above) and the old-age dependency ratio (population aged 65 and over as a proportion of the population aged 20-64) is projected to increase from 25% in 2000 to 43% in 2025 compared with an OECD average of 22% in 2000 and 33% in 2025. This is a very steep rise, and raising employment rates among the older population is going to be the key to meeting the challenges presented by the need to find export lead growth.

According to the OECD, only around 30% of people aged 61 are currently working – a drop of more than 50 percentage points compared with 51 year olds. This steep drop in employment rates can primarily be explained by the fact that Finland has too many pathways to early retirement, notably unemployment benefits, unemployment pension, disability pension and individual early retirement pension. Already at the age of 50, 18% of individuals are receiving either unemployment or disability benefits, increasing to more than 46% by the age of 60. Moreover, in the age group 60-64 most unemployed persons transfer to the unemployment pension with a further 20% relying on disability benefits and about 10% rely on the individual early retirement pension.

Deflation dynamics

Like Sweden, the inflation data also throws into the limelight the disparity between the EU HICP measure (which does not include housing interest) and the national CPI (which does). Year-on-year inflation, calculated by Statistics Finland dropped to 0.0 per cent in May, while in April it was still 0.8 per cent. According to Statistics Finland the drop was primarily due a fall in food prices and interest rates. Between April and May, consumer prices fell by 0.2 per cent. On the EU HICP index, however, year on year inflation is currently running at 1.5 percent. Thus, in a time of falling house prices and lowered interest rates, the HICP totally underestimates the deflation danger.

It is important to remember here that two-thirds of Finland’s housing stock consists of owner-occupied homes, and home ownership is widespread in all forms of housing, including apartments as well as detached houses and row houses. Normally falling interest rates would produce rising house values, due to the affordability effect, but under current conditions we are observing the opposite. I can't help feeling that European monetary policymakers need to think more about this type of thing.

More evidence for deflationary headwinds is offered by producer prices for manufactured products, which fell by 8.1 per cent year on year in May. Export prices were down 9.8 per cent and import prices fell by 11.7 per cent. The year-on-year change in the wholesale price index was -8.9 per cent.

So Where Are We?

Finland's economy faces important challanges in both the short and long terms. Finland's state debt is low at the present time, which gives the capacity for short term stimulus and bank bailouts. But it is rising, and reached a record high of 70.6 billion euros by the end of the first quarter of 2009. General government debt, calculated according to Eurostat methodology, grew by 7.5 billion euros in January-March, and reached 38 percent of 2008 gross domestic product (GDP). Still, there is plenty of stimulus ammunition left, the important thing is to use it wisely, and try to engineer an economic transition.

The severe contraction in the Finnish economy is also likely to take its toll on bank credit fundamentals, according to the credit rating agency Moody's. The agency recently reaffirmed its negative outlook for the Finnish banking system. Up until now the Finnish banking sector - lead by Pohjola Bank and local branches of Nordea and Danske Bank - appear to have been weathering the storm without undue difficulty due to minimal exposure to toxic assets and a focus on traditional banking activities, according to Moody's. However:

"Given that the crisis on financial markets has now spread extensively into the real economy, Moody's expects Finnish banks to be adversely affected," according to the latest report. Moody's said an increase in bankruptcies was indicative of the weakened credit environment.

Corporate bankruptcies increased 33 percent in January-May from a year ago, according to Statistics Finland.

The Finnish government has already approved one supplementary budget for 2009 including a special stimulus package. The overall impact is estimated at around €2 billion (although new spending is estimated at only €1.2 billion), and includes about €140 million in transport infrastructure projects. The government has committed itself to implementing a guaranteed pension from the beginning of March 2011. This will cost around €111 million a year, and will raise the lowest pensions by about €100 a month - affecting about 120,000 people.

There have also been a number of measures aimed directly at helping corporate finance. The government now offers banks operating in Finland both deposit guarantees and capital, and will also invest its pension funds in corporate bonds, offer companies financial support through the specialised state-owned finance company, Finnvera, and provide partial financing for the construction of thousands of new homes through the state-owned credit institution Kuntarahoitus (Municipal Finance).

Overall, the government has pledged about €60 billion in guarantees, loans and investments, and is expecting a boost of €45 billion in corporate financing. Prime Minister Vanhanen described the decisions as ‘massive, even gigantic’. The largest sums of money are in the bank support package, which aims to secure the continuity of corporate credit. In fact, the Finnish parliament has already approved guarantees of €40 billion to help banks to raise capital.

But in the longer term the issues raised at the start of this post need to be addressed. Competitiveness needs to be restored to the Finnish economy, and exports boosted, as illustrated by the REER chart below. In particular the situation pre 2007 needs to be restored. The change is not massive (maybe only 5% or so), so it is doable, and it needs to be done, especially since the Swedish Krona has been significantly devalued.

As mentioned previously, the goods trade balance has been deteriorating, and the earlier positive balance now needs to be restored.

One of the things that stands out is Finland's differential preformance vis a vis Sweden. Using data prepared by Eurostat which shows the volume indexes of GDP per capita as expressed in Purchasing Power Standards (PPS) (with the European Union - EU-27 - average set at 100) it is apparent that a gap exists (see below) and that it is not being closed. In fact, after 1998 the two lines move tantalisingly in tandem, but with Finnish per capital GDP stuck just short of the Swedish level. Any reading on these indexes of over 100 implies that the country's level of GDP per head is higher than the EU average and vice versa, and relative movements in the indexes imply that the rates of change in GDP per capita are either improving more or less rapidly than the EU average. The basic data behind the charts is expressed in PPS which effectively become a common currency eliminating differences in price levels between countries making possible meaningful volume comparisons of relative GDP per capita. Since the index is calculated using PPS figures and expressed with respect to EU27 = 100, it is only valid for cross-country comparison purposes and not for individual country inter-temporal comparisons, nonetheless charts based on such data are extraordinarily revealing.

So the real reason is why (given some sort of loose convergence expectation) this gap is not being closed. There can be several explanations. One may be differences in institutional quality (education systems, for example), another might be the impact of euro membership: it could be, for example, that, as OECD economists Jorgen Elmeskov and Romain Duval argued in a suggestive paper (Structural reforms in product and labour markets) presented at the 2005 ECB conference "What effects is EMU having on the euro area and its member countries?", that membership has up to now slowed down rather than accelerating the reform process. Thirdly, the issue could be differential demographics. Few economists seem willing to investigate this possibility in any depth, despite mounting evidence that it may be important.

One demographic indicator that springs to mind immediately when I think about these two countries is the differential in life expectancy. Swedish males live on average around 3 years longer than Finnish males (see below). Now this may be important, although no one has started to calibrate this effect yet. The economic intuition for the importance would be, think of investment in a machine (physical capital), then obviously the value of the investment is greater (other things being equal) if the machine keeps running five years longer.

Things cannot be that much different with human capital. The education and on the job training costs are similar, but the person is able to work three years less. Is it mere coincidence that labour market exit at 61 is so typical if the health outlook is worse? Here are the relative labour force participation rates for me between 55 and 65. It is my contention that this alone accounts for a substantial part of the GDP per capita difference between the two countries.

But the solution to this problem is not an easy one, and the OECD and others really need to think much more seriously about this phenomenon when they indisciminately propose raising higher-age participation rates across the board as a solution to the declining workforces problem.

What is involved here is a complex mix of health provision, lifestyle and genetic differences, and any response needs to take account of all of these.

Raising the health and life expectancy of the Finnish population would be one sure way to raising GDP per capita, another way (in the longer term) would be raising fertility back up to replacement levels, and a third path would be extending the younger labour force by encouraging immigration (which interestingly has been on the rise in the Helsinki area in recent months, although if many of the newcomers simply arrive from equally affected Estonia this is nothing more than moving the deckchairs around). Whichever way you look at it though, in both the short and longer term the deterioration in Finland's trade surplus needs to be addressed. If it isn't the outcome will not be a pleasant sight.