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Mr. Yuan Xiao, Mr. Robert M Burgess, and Ms. Stefania Fabrizio

Abstract

Large current account deficits in Estonia and Latvia, and the continued real appreciation of the exchange rate in Lithuania, have prompted concerns about the competitiveness of the Baltic economies, and called into question the sustainability of their current fixed exchange rate arrangements. Recent external performance, however, appears to be explained more by temporary or cyclical developments than by a deterioration in the underlying competitive position of the Baltic economies. This book assesses the competitive position of the Baltic countries and focuses, in particular, on the viability of the countries’ strategy of maintaining their fixed exchange rates on joining the European Union, participating in its exchange rate mechanism, and then adopting the euro at the earliest possible date.

Mr. Yuan Xiao, Mr. Robert M Burgess, and Ms. Stefania Fabrizio

Abstract

Concerns about the competitiveness of the Baltic economies have reemerged, as current account deficits have widened in Estonia and Latvia, and the real exchange rate has continued to appreciate in Lithuania. Annual current account deficits in Estonia and Latvia are currently running at about 14¾ and 8¾ percent of GDP, respectively (Figure 1).1 Current account deficits of this magnitude are clearly unsustainable over the medium to longer term. While foreign direct investment (FDI) inflows remain substantial, net external indebtedness has increased.2 In Estonia, this has been accompanied by persistently strong growth in wages over the last couple of years, in excess of productivity growth. Other indicators, however, including strong enterprise profitability, tend to mitigate concerns about competitiveness. In Lithuania, the current account deficit is 5¼ percent of GDP, and net external debt has fallen. But the litas has continued to appreciate following its repegging from the U.S. dollar to the euro in February 2002, raising concerns about the future competitiveness of Lithuania’s exports to countries outside the euro area.3 Inflation, however, has been low, which has helped to offset (but not fully eliminate) the appreciation in the nominal effective exchange rate.4 Wages also remain subdued, with real wages declining in 2001 and growing only moderately since then.

Mr. Yuan Xiao, Mr. Robert M Burgess, and Ms. Stefania Fabrizio

Abstract

Since 1999, real effective exchange rates in the Baltics have been quite stable compared to the strong real appreciations experienced earlier in the transition process. REER indicators based on measures of relative prices or costs that are more representative of the traded goods sector have been even more stable. A more direct assessment of competitiveness based on export performance is complicated by the importance of electronics subcontracting in Estonia and oil processing in Lithuania, which are important in terms of trade flows but much less so in terms of value added. Aside from this, exports have generally performed quite well despite the global slowdown.