A further deterioration in global credit conditions could push Baltic property markets – the primary driver of regional growth – over the edge, as investors look to exit a market already in decline, analysts warned this week. "The positions taken by bankers and investors on [the region’s property markets] look mad now,” said Lars Christensen, senior analyst at Danske Bank. “The sub-prime [mortgage] mess in the US relates directly to the region, in terms of over-leverage and over-optimism.”
“I am very worried about what will happen to the region,” said Kristjan Kivipalu, who manages the Explorer Property Fund, a joint venture between Estonia’s Arco Real Estate and the Sweden-based investment firm East Capital.
He warned that a sharp economic contraction is on the cards for the region, as the global credit conditions deteriorate. “The external indebtedness of the region’s economies, over-leveraged households and tightening global credit - all these factors are coming together,” he said.
Frank Gill, director of European sovereigns at Standard and Poor’s, observed that the credit-driven bubble could now burst, since capital in many cases has been provided by foreign parents who are not compelled to act as lenders of last resort.
“Under the worst case scenario of a property crash, foreign banks could decide to shut down credit lines to the region to protect their own balance sheets,” Gill said, pointing out that Scandinavian banks in particular have been financing much of Baltic credit boom in recent years. “They are practically the region’s central banks because they determine the pace of monetary growth.”
“Scandinavian banks have the power to do everything in the region,” noted Kipivalu.
Gill warned that a property crash would lead to a massive liquidity shock for the region that result in an increase in non-performing loans, high unemployment and a deterioration in public as well as private finances, as governments are forced to step in and assume potentially large contingent liabilities.
Latvia's finance minister, Oskars Spurdzins, last month reassured the IMF it would do more to tackle imbalances, but its currency came under pressure this week as fears grew over the country’s current account deficit - 21.3% of GDP, compared to 15.7% in Estonia and 10.8% in Lithuania.
Furthermore, households in the region are significantly over-leveraged, Estonia’s primary mortgage debt stands at more than 30% of GDP, compared with Latvia’s, at 23%. But property prices have already dropped around 10% over the last two quarters in Estonia, while Riga has seen a 5-8% price reduction in the last two months, as developers freeze projects on fears that investments will not generate sufficient returns to service the floating rate debt. Although Lithuania’s property market remained relatively steady, the three Baltic states are linked economically, so prices are also likely to fall in the coming months.