Baltic Household Outlook

Transcription

1 Baltic Household Outlook September 2010 Summary After sharp decline over the past two years a weak increase in total income of Baltic households is expected next year along with rising expenses Private consumption is likely to grow next year as Baltic consumers become less pessimistic regarding future A higher average income and euro adoption will make Estonians more optimistic than their neighbors Net financial position of Baltic households will improve further nevertheless net asset value of Estonian and Latvian households remain negative Low interest rates will enhance intention to keep money in current accounts and not transfer to time deposits Edmunds Rudzitis Socioeconomics Expert, SEB Latvia Telephone: edmunds.rudzitis@seb.lv Julita Varanauskiene Household Economist, SEB Lithuania Telephone: julita.varanauskiene@seb.lt Hardo Pajula Economist, SEB Estonia Telephone: hardo.pajula@enskilda.ee

2 The Baltics The road to recovery In past two years the financial situation of households in Baltic countries has been worsening more than in other European countries. Latest quarterly GDP growth rates of all three Baltic countries suggest that the bottom of the economic downturn has passed. Despite GDP improvements and stabilization of economy, households financial situation has deteriorated further in the first half of 2010: total income of households decreased while prices of some necessary goods and services increased as well as unemployment rate jumped to record high. Only after some time lag households will perceive more money in their pockets through employment and wage growth. Unemployment still remains one of the biggest problems in all three Baltic countries. Unemployment (job seekers) rate currently is much higher than the average for the European Union as a whole. Latvia has the highest unemployment rate in the Baltic countries (approximately 20 per cent) Unemployment (job-seekers rate) in Baltics (%) During the second quarter the job seekers rate as well as registered unemployment shows signs of improvement, albeit unemployment statistics is improved also by wave of emigration. There is currently no need to hire many new employees as increase in the workload of the existing employees could be realized. Thereby it is hard to expect significant improvements in the labour market in the near future. 3% 25.0% 2% 15.0% 1% 5.0% % -5.0% -1% Average gross wages and salaries (%, YoY) % 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q Latvia Lithuania Estonia Source: National Statistics Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 Latvia Lithuania Estonia 3Q09 4Q09 1Q10 Source: CSB Significant growth of unemployment rate registered also in Estonia (18.6 per cent at the end of June) and Lithuania (17.3 per cent). 2Q10 Some positive signs have shown up during the second quarter. Both number of employed persons and average salary increased in Latvia and Lithuania. Decrease in the number of the employed slowed in Estonia in second quarter. The biggest increase of average gross wages on quarterly basis registered in Estonia. Of all Baltic states, wages on an annual basis have been increasing only in Estonia, discontinuing previous falling trend. Average monthly gross wage rose an annual 1.2 per cent in the second quarter to EUR 822. At the same time, average monthly wages in Lithuania and Latvia fell 5.4 per cent and 6.3 per cent, respectively. According to statistics, Estonia has the 2

3 highest monthly gross wages in the Baltics, followed by Latvia (EUR 632) and Lithuania (EUR 595). Besides, gap between Estonia and other Baltic countries in wage statistics is widening Average gross wages (in euros) was unconstitutional. As the amount of newly granted old-age pensions still remains higher than the average sum of existing pensions the average pension in Latvia continues growing. The average old-age pension in the second quarter of 2010 in Latvia has reached EUR 250 level showing growth by 1.6 per cent compared to 2Q In Lithuania retirement pension is the lowest among the Baltic states (EUR 216), falling by 8 per cent compare to second quarter of Due to pension cuts seniors in Lithuania have experienced economic downturn more than old people in Latvia and Estonia. 350 Average old-age pensions (in euros) Q08 2Q09 2Q Latvia Lithuania Estonia Source: National Statistics Similar differences appear in statistics of old-age pensions. Estonia has the highest old-age pension in region (EUR 305) unchanged compared to the second quarter of Faced with rising budget deficits, Latvia and Lithuania cut pensions. However, in spring 2010 Latvia s seniors were paid previously withheld pensions since Constitutional Court in Latvia ruled that the government's decision to reduce pensions Q08 2Q09 2Q10 Latvia Lithuania Estonia Source: National Statistics Consumption recovers slowly Substantial income fall due to wage and benefits cuts and unemployment growth has affected household consumption. In recent years the largest income decline were experienced by Latvian households, followed by Lithuanians and Estonians. The deeper fall in households incomes, the larger the drop in consumption. Latvia experienced largest drop in private consumption by 24 per cent last year, 18 per cent and 17 per cent decline saw in Estonia and Lithuania, respectively. After significant drop in previous year the latest two quarters shows signs of stabilization in private consumption. Latest data indicates that Baltic households have adapted their spending to the new changed economic situation. Household consumption has recovered in Latvia and Estonia after taking a nosedive in previous years, decrease trend slows also in Lithuania. Private consumption figures remain negative due to the base effect. Next year household consumption could grow in all Baltic states, albeit growth will be only a few per cent. Household spending in the Baltics will remain comparatively weak due to high unemployment, low 3

4 incomes and growing expenses (food prices and housing expenses). 15.0% 1% 5.0% % -5.0% -1% -15.0% -2% -25.0% Household consumption expenditure (%, YoY) strongest pessimists in the Baltics Financial situation over next 12 months (balance of respondents, %) Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10-3% -40 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10-45 Latvia Lithuania Estonia Source: National Statistics Private consumption recovery was driven by improved consumer confidence. Households are not as pessimistic about their financial situation as at the beginning of According to consumer surveys, significant jump in pessimism was noticed in autumn Since last summer sentiment of households regarding economic situation and their financial future improved significantly in all Baltic countries. Households are more optimistic than they were a year ago, however expectations of households in most cases remain negative. Estonians are quite optimistic about employment growth over next 12 months, while Latvians and Lithuanians anticipate further deterioration in employment in the nearest future. Consumer surveys indicate that Estonians are more optimistic than neighbors in Latvia and Lithuania. Regarding future Lithuanians still remain the Latvia Lithuania Estonia Unemployment expectations (balance of respondents, %) Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Latvia Lithuania Estonia Source: Eurostat Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Source: Eurostat Net financial assets increase due to or despite of the economic slowdown Baltic financial markets are dominated by the banking sector. Banking deposits are still by far the most important instruments in Estonia, Latvia and Lithuania and form the largest part of household financial assets. Lately, investment and pension funds 4

5 have become much more visible in the financial landscape Net financial assets per capita (in euros) 3300 Financial assets per capita (in euros) Q Deposits Pension funds Other Latvia Lithuania Estonia 314 Source: SEB estimates However, net financial position in Lithuania is different. While Estonian and Latvian households financial obligations exceed their claims (by EUR 2 billion in Estonia and EUR 2.5 billion in Latvia), net asset value of Lithuanian households has remained positive and is increasing (up to 2 billion EUR). There have been non-trivial movements in the position during the latest episode of macroeconomic adjustment. The observed improvements in the net financial assets of households have been brought by a simultaneous increase in the value of financial assets and a decline in the value of liabilities. At the first glance, the most positive trends in households net asset value are observed in Lithuania. Positive trends are also observed in consumer surveys. The assessment of financial situation has improved the most in the southernmost Baltic country. Estonian households are the most indebted, at same time, however, they have the largest amount in terms of financial assets. Also, trends in net financial assets show that Estonians tend to decrease their indebtedness level close to Latvia. Lithuanian households are the least indebted, although with lower financial assets than in Estonia Latvia Lithuania Estonia Source: SEB estimates Lithuanians have the least amount of savings for retirement. Latvians have the least financial assets and their net financial assets are improving at the lowest pace Current financial status (balance of respondents, %) Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Latvia Lithuania Estonia Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Source: Eurostat 5

6 Household savings behavior determined by movements of interest rate During the first half of the year 2010, Baltic households savings increased mostly due to growth in deposits and pension funds. 20% 15.00% 10% 5.00% 0% -5.00% -10% % 1Q2008 2Q2008 3Q2008 4Q2008 Household deposits (%, change Y-o-Y) 1Q2009 2Q2009 3Q2009 4Q2009 Latvia Lithuania Estonia 1Q2010 2Q2010 Source: Central banks Deposits in Latvia approached the level of 2008, although the total volume was still 10 per cent below the pre-crisis levels. Whereas in Lithuania deposits reached a record level of EUR 7.6 billion. Regardless of growth that was observed in demand deposit accounts, the volume of time deposits decreased in all the three countries. A drop in interest rates decreased the former attractiveness of time deposits. In Latvia interest rates on 1-2 year maturity deposits in national currency decreased from late in the 2009 to 3.35 per cent in June, In Lithuania the drop was not so prominent. The interest rate decreased only from 8.13 to 3.92 per cent. In general, in all the tree countries growth in demand deposits is a result of household wealth redistribution. The perspective of accession to the eurozone is accompanied by movement of households money from time to demand deposits in Estonia. In Lithuania money to demand deposits are also transferred from security markets where private individuals sell their securities. In Latvia demand deposits also grow at the expense of time deposits. It is also important to note an impact on Latvian household deposits growth - transfers of earlier withheld pensions into pensioners accounts. A tribute should also be paid to recovered trust in banks and in local currency as well. Households expectations about new savings are still negative. Although there are some positive signals in Estonia and Lithuania. Lithuanians may have adjusted their expenditure levels to the new reality of decreased income and enjoying seasonally contracted heating bills. Unfortunately, expenses of Baltic households will rise. Larger heating bills and increasing food prices will affect household finances and restrict to meet other household needs Savings over next 12 months (balance of respondents, %) Jūn.08 Aug.08 Okt.08 Dec.08 Feb.09 Apr.09 Jūn.09 Aug.09 Okt.09 Latvia Lithuania Estonia Dec.09 Feb.10 Apr.10 Jūn.10 Aug.10 Source: Eurostat The second largest group of households financial assets in all the countries is II pillar pension funds. Compared with the end of 2008 the value of assets managed by Estonian pension funds has climbed up by EUR 280 million, i.e. by 74 per cent. Latvian II pillar pension fund participants also enjoyed increase of their pension value by EUR 491 million, or 64 per cent. The growth of II pillar funds in Lithuania was 57 per cent or EUR 372 million. 6

7 II Pillar pension funds (EUR million) However, Lithuanian II pillar pension funds value per capita is the lowest in three Baltic (see graph Financial assets per capita). The pension reform here started three years later than in Latvia and two years later than in Estonia. The contributions during the economic growth years were the lowest ( per cent compared to 2-8 per cent in Latvia and 2-6 per cent in Estonia). Unfortunately (for the future pensioners) the governments of the Baltic countries decided to cut contributions to 2 per cent in Latvia and 2.5 per cent in Lithuania in order to cover current social insurance expenditures. Nevertheless it is the most steadily growing asset group. 300 Estonia Latvia Lithuania Source: National Statistics 7

8 Latvia Total income of households continue falling down; however, overall sentiment and evaluation of future is not so pessimistic any longer Consumption has stabilized, households direct less percentage of their income to savings and coverage liabilities and more for consumption, including acquisition of durable goods The volume of household savings has increased in first half of year; however, this growth has taken place for account of increased volume of short-term savings and still does not evidence the existence of a stable trend Trust in commercial banks grows, a part of money which had been withdrawn in returned to the banks Deposit interest rates have decreased both for deposits in lats and in foreign currencies; however, they still remain higher compared to inflation, i.e. real interest rate are positive Households demonstrate growing appetite for investment risk with the purpose to gain higher profit; investments into mutual funds also grow Volumes of household loans continue decreasing since the amounts of newly issued loans are lower than amounts of repaid loans Incomes continue decreasing, the decline rate slows down During first six months of this year total income of Latvia s households continued falling, which was primarily affected by reduction in the number of employees within first quarter as well as by continuing tendency towards decrease in remuneration of labour. Unemployment has reached its peak in first quarter of this year while second quarter showed a little reduction of unemployment and growing number of employees. Thus, in second quarter the volume of labour income slightly increased compared to first three months of the year. Total labour costs in first half of this year has decreased by about 20 per cent compared to respective period of last year. In second quarter the average gross wages dropped by 6.3 per cent compared to respective period of 2009 down to EUR 626 while in first quarter the average gross salary was EUR 615 or by 8 per cent lower than in respective period of Drop in total labor costs in early 2010 was higher than reduction in gross wages due to the introduced increase in personal income tax and to lower nontaxable minimum for wages as well. In second quarter of the year the average net wage was EUR 450, which is by 11 per cent lower than in respective period of last year, while in first quarter it reached down EUR 438, thus showing 12.4 per cent drop compared to the first three months of I II III IV 2008 I Wages and salaries (%, YoY) II III IV 2009 I II Gross Net Real III IV 2010 I II Source: CSB Taking into consideration deflation processes that were observed in first half of the year, the percentage drop in real wages is less than reduction in net labour wages. Still, in second half of the year along with exhaustion of deflation forces and appearance of slight inflation the curve of real wages could be directed contrary to the net wages of which curve will go upwards with slowing decline. The average net 8

9 wages and salaries could rise in 2011 when a little increase in gross wages is expected. Likewise, growth in net wages and salaries would be favoured by the increase in the amount of nontaxable minimum. Within year time the distribution of employees by their labor incomes has changed. The increase in the numbers of low wages not exceeding the minimum wage is explainable both by the drop in enterprise turnover so employees are not hired for full time, and by optimization of taxes. Such registration of employment for a part-time job is sometimes carried out for purposes of tax amount optimization. These processes were affected by the previously introduced reduction in nontaxable minimum amount and rise in personal income tax from 23 up to 26 per cent, resulting in growing shadow economy and increasing number of envelope salary receivers, thus corrupting the statistics of labour market. Total amounts paid out as benefits in first half of this year were lower than in first six months of 2009, which was affected by establishment of benefit ceiling amount and changes in procedure for calculation of benefits. With lower average benefits the amounts reduced also which were paid in disability, state family, unemployment and other benefits. The number of unemployment benefit receivers has reached its maximum (more than 82 thousand) in this year s January and since that time the number of benefit receivers has reduced as well as the average volume paid out as unemployment benefits. If in more than half of registered unemployed persons received unemployment benefits, then in this year s June unemployment benefits were only received by 35 per cent of registered unemployed. The only group of population whose incomes in first half-year have actually grown are the pensioners since by resolution of the Constitutional Court they were paid a part of previously withheld pensions. For that reason total expenditures for pensions in first half of this year were by 15 per cent higher than in first six months of previous year. Taking into consideration that the amount of newly granted old-age pensions still remains higher than the average sum of existing pensions (average amount of newly granted pensions was over LVL 200 or EUR 285), the average pension amount also continues growing and thus the average old-age pension amount in this June has reached EUR 259. Growth in payouts for pensions has stipulated that the total expenditures for benefits and pensions in first half of this year have increased by about 6 per cent compared to respective period of previous year. However, growth in amounts paid out as benefits and pensions could not compensate a considerable drop in volumes of labour costs and thus total income of households in first half of this year have considerably: approximately by 13 per cent compared to first half of previous year. Sentiment improvement makes consumption stable Both data on gross domestic product expenditure and retail trade turnover evidence stabilization of household consumption. Notwithstanding the lower incomes, in first half of this year households did not cut their consumption any longer and even demonstrated the growing interest also in acquisition of durable goods (for example, a car). Growing consumption with the same or lower incomes shall be in no way considered as a paradox and is explainable by more factors. First, growing specific weight of shadow economy and hiding the real labour incomes by paying a part of salaries in envelopes is not reflected in labour income statistics; however, this content of envelope salaries earlier or later show up in expenses of population. Lower burden on employees and redistribution of tax burden from income part to consumption is one of solutions how to reduce shadow economy, reduce growing popularity of envelope salaries and push business in direction of salaries legalization thus reducing also the distortions in labour income statistics. Second, the dynamics of consumption in Latvia is presently influenced also by attitude towards liabilities and debts. Record-breaking amounts of debts to providers of public and other services, considerable delays in loan repayments to commercial banks not always are associated with the lack of money. A part of bill non-payers choose to firstly 9

10 satisfy their consumption needs and not settle down their debt liabilities Household consumption and income (labour costs, social benefits); million EUR savings (both in local and foreign currency) which traditionally have higher specific weight in total financial assets in Latvia compared to Western Europe and also other Baltic states Financial situation Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug Q05 4Q05 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10-6 Consumption Income Source: CSB, SSIA, SEB estimates Besides, the existing system of penalties is not the one that would discipline the persistent non-payers while high specific weight of shadow economy and opportunities to be employed on a semi-legal basis is like a honey pie for such people. Third, the most important factor that has contributed to stabilization of private consumption in this year is the consumer sentiment. With improving future expectations households become ready to spend more money and less save, both in percentage and numeric expression. Sentiment improvement in relation to economic situation in the future was observable since last year summer and now the sentiment of people climbed back on the level of summer Even less households are considering that the situation has considerably deteriorated. Similar dynamics is observable also in evaluation of changes in household financial situation during last year. Other indexes of consumer sentiment have also improved, for example, on making bigger purchases presently and especially in the future (growth since beginning of the year by 10.4 and 11.3 per cent points, respectively). More positive look into the future allows opening purses of households, especially it relates to their cash Financial situation over last 12 months Financial situation over next 12 months Major purchases at present Major purchases Major purchases over next 12 months Source: Eurostat Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Source: Eurostat Data on private consumption and savings witness that in this year a part of cash savings that were kept at 10

11 home under the mattress or in bank safes are spent for everyday expenses and acquisition of durable goods Savings Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Savings at present Savings over next 12 months Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Source: Eurostat Households evaluate as negligible the possibilities to create savings at present time or within the nearest 12 months. Still, it should be noted that also during the period within 2005 and 2007 when a comparatively fast growth in labour remuneration was observed, Less negative value of net financial assets Financial assets of Latvia s households (bank deposits, securities and other financial instruments, private pensions and life insurance savings, II pillar pension volumes) in first half of this year continued growth, having increased by EUR 219 million and thus reached EUR 5.9 billion. II pillar pension accumulations which are not inheritable in Latvia in contrast with neighbour countries are still considered as a property of a particular person at retirement age. Almost a half of the increase in the value of abovelisted financial assets in first half of this year was due to the growing volume of deposits while one third part of total increase relates to rising value of II pillar pension assets. Insignificant increase was demonstrated also by savings of private pensions and most households did not see the possibility to make savings, this index fluctuating more or less around minus 50 mark which is only slightly better than today. Population sentiment in second half of the year could go down slightly which will be affected by budget consolidation measures projected to be taken in the next year as well as by growing expenditures for goods of prime necessity, including food and dwelling. In first half of this year the deflation still ruled in Latvia and therefore due to price decline households even at lower incomes was able to acquire an unchanged number of goods and services. There are considerable differences between price changes in different groups of goods and services. Prices for particular goods and services were reduced considerably while there were also goods and services of which prices did not drop and even sometimes grew. Current trends evidence that already in nearest future deflation will be replaced by inflation: at the end of 2010 the inflation rate could approach 2 per cent level with the average annual inflation still showing minus values. Growing expenditures and dropping incomes bar from anticipating a fast growth in household consumption during the next year. life insurance as well as by financial instrument portfolio. Meanwhile, household financial liabilities continue reducing: drop in first half of this year by EUR 158 million down to EUR billion. Reduction in financial liabilities was influenced by falling total amount of loans since the volume of newly granted loans for private persons was lower than repaid by the households for previously received loans. Thus, the value of household net financial assets has increased by EUR 377 million while Latvia s households are still far from being proud of a positive balance of their net financial assets. 11

12 Financial assets and liabilities of households (EUR billion) IVQ 08 IVQ 09 IQ 10 IIQ 10 Financial assets Financial liabilities Source: SEB estimates Negative difference between household financial assets and their financial liabilities amounts to EUR 2.56 billion though since late 2008 decreasing trend has been observable in this difference (during yearand-half period the financial balance of households has improved by approximately EUR 1.08 billion). Distribution of Latvia s household financial assets has not essentially altered in this year: approximately 70 per cent of financial assets are made up by deposits in financial institution, 18 per cent relate to pillar II pension capital, 7 per cent are formed by securities and other financial instruments owned by households. Meanwhile, only about 5 per cent of total amount are formed by private pensions and life insurance savings. Though the volume of deposits in first half of this year has grown mostly, the percentage increase of financial instrument portfolio within this time period was faster than the rise in deposit volumes: 7.8 and 2.5 per cent, respectively. Also data on life insurance savings witness growing risk appetite, i.e. persons are willing to take higher risk in order to earn more. In first half of 2010 the amount of unit-linked insurance premiums subscribed of SEB insurance company has tripled compared to respective period of 2009 while total savings into unit-linked policies have increased up to 21.9 per cent of total clients insurance savings.. More deposits in banks In first half of this year household deposits in have increased by EUR 97.7 million or by 2.5 per cent. Meanwhile, in a year s time the growth in the volume of household deposits was EUR 73 million or 1.8 per cent. Data for first half of 2010 evidence that the volume of household deposits has approached a level registered at the end of 2008, though still falling by approximately 10 per cent behind the pre-crisis level. Though a gradual growth in volumes of household deposits in commercial banks can be observed since autumn of 2009, still this growth is not associated with the increase in volumes of long-term savings since amounts on time deposits have even reduced. Growth in deposit volumes was due increase of demand deposits (money on current account): increase by about 13.5 per cent within six months in contrast with approximately 5 per cent reduction in term deposit volumes. As a result of such changes the share of demand deposits in total amount of household deposits has grown from 38 per cent in late 2009 up to 42 per cent in June While at the end of last year the growth in term deposit volumes was promoted by high interest rates on time deposits in lats, then with a fast drop in RIGIBOR interbank index the interest rates on time deposits in lats have also decreased considerably. Household deposits in lats were applied to by annual interest rate per cent in late 2009 while in late June of 2010 annual interest rate on newly deposits has reduced down to 3.35 per cent. Interest rates on deposits in euros and US dollars also fell: in June average interest rate on up to one year time deposits in euros was 1.86 per cent and 1.47 per cent on deposits in US dollars. At the end of 2009 average interest rates on deposits in euros and US dollars were 3.17 and 1.68 per cent, respectively. 12

13 Jun-08 Dynamics of household deposits (EUR million) Sep-08 Dec-08 Mar-09 Jun-09 Demand deposits Termdeposits Savings accounts Sep-09 Dec-09 Mar-10 Jun-10 Source: Bank of Latvia Keeping money on current account and not directing it for longer-term savings is associated with unawareness of the future and comparatively high unemployment level as well as with the expected increase of expenses (for dwelling etc.) Growth in total volumes of deposits in first half of this year was furthered also by repayment to seniors of previously withheld pensions: a part of this returned money was directed for consumption while another part was left on current accounts for some projected bigger purchase or for everyday expenses expected in the future. In second half of 2010 a part of money kept on current accounts could be directed for consumption and therefore the total amount of private deposits could remain on current level or even slightly reduce Deposits of households by currency (EUR million) Further drop in interest rates on deposits in euros and dollars is not any longer anticipated; however, in the nearest future the depositors will hardly have serious hopes for considerably higher fixed-term deposit interest rates. If no surprises will be brought by forthcoming parliamentary elections and their results, RIGIBOR index will remain on comparatively low level and therefore interest rates on deposits in lats in the nearest time could even closer approach the rates on deposits in euros. Notwithstanding the reduction in deposit interest rates, the real deposit interest rate (adjusted according inflation) still remains positive, i.e. money deposited in a bank does not lose its purchasing power. However, with lower deposit interest rates and deflation-to-inflation transformation the real profitability of deposits demonstrates a descending tendency. Because of lower time deposit interest rates a part of depositors choose to wait or are looking for earning more profit, thus contributing to growing interest in risky investments. In general the households give preference to place their savings for very short fixed terms meanwhile long-term deposits are still unpopular in Latvia Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Deposits in lats Deposits in currency Sep-09 Dec-09 Mar-10 Jun-10 Source: Bank of Latvia Growth in the volume of deposits in Latvian commercial banks evidences also the increasing trust in Latvian banking sector in general, growing trust in local currency is observed as well. Diminished concerns about devaluation of local currency results in considerable deposits growth in lats: since December 2009 the volume of deposits in lats has increased by 10 per cent with simultaneous 2.6 per cent decrease in the volume of deposits in foreign currencies. Drop in foreign currency deposit volumes 13

14 was influenced also by events in Greece and other countries within euro zone, which brought doubts about stability of euro in the future. As a result of these changes the share of deposits in lats has grown from 38 per cent in the year beginning up to 41 per cent in late June of this year. Low interest in credits Already since fourth quarter of 2008 a reduction is observable in total volume of household loans: the volume of newly granted loans is less than depreciation amounts of previously granted credits. Dynamics of household loans (%) mortgage loans are still lower that average volume of credits granted in previous years Mortgage loans (number and volume) % % % % % % % % 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 4Q2008 1Q2009 2Q2009 3Q2009 4Q2009 changes over previous quarter changes YoY 1Q2010 2Q2010 Source: FCMC Number of mortgage loans Mortgage loans (EUR billion) Source: FCMC Also in second quarter of 2010 households loan portfolio continued falling: a drop by EUR 51.2 million or 0.6 per cent against previous quarter is the smallest drop, both in numerical and percentage expression, within a quarter since late Total volume of loans to residential households since beginning of the year has dropped by EUR 158 million or 1.8 per cent. In annual terms the rate of decline in the volume of credits granted to households has reduced down to 4.5 per cent. Volume of mortgage loans in first half of this year has dropped by EUR 108 million or 1.6 per cent while in annual terms 4.1 per cent drop was registered. The number of mortgage loans has also reduced along with a slight decrease in average amount of these loans since average amounts of newly granted The volume of consumer loans continues reducing faster in percentage expression than the volume of mortgage loans. The total amount of consumer loans granted to households has reduced approximately by EUR 71 million or 7 per cent while compared to June of 2009 the drop in volume of consumer loans has reached 12.8 per cent. Notwithstanding the growing interest of households in opportunities to receive loans, the volumes of newly granted credits also in second half of 2010 will still be comparatively low and will not be capable to compensate the loan portfolio depreciation process. Thus, in 2010 the total volume of household loans could reduce by 5 per cent, with gradually slowing down the decline rate by the end of the year. The debt burden of households continued growing also in first half of this year since the volume of loans has reduced less than the amount of disposal income. 14

15 Reduction in the debt/income ratio will be possible in the next year when it could take place at the expense of both growing incomes and continuing trend for reduction in total volume of loans. Financial assets and liabilities of households (EUR million) 4Q Q Q Q Q 2010 Financial assets Deposits Bonds, equities and other financial instruments Life insurance and private pension funds* II pillar pension funds Financial liabilities Mortgage loans Consumer loans Other loans Net financial assets * SEB banka estimates Sources: Bank of Latvia, FCMC, LIA, SEB dzīvības apdrošināšana. 15

16 Lithuania Total incomes of households continue falling down; however, overall sentiment and evaluation of future is not so negative any longer Households income and expenditure balance has worsened further: constant income decreased while prices of necessary goods and services increased Households asset liabilities balance has improved mostly to the decrease of liabilities or obligations During the first half of the year, net value of the financial assets of households with the financial institutions grew by EUR 103 million mostly due to decrease in the total household loans portfolio Inflows to the household accounts with the financial institutions were higher by EUR 59 million compared with outflows Total debt of households decreased by EUR 99 million as the volume of outstanding loans exceeded repaid loans Although interest rates of deposits have decreased they are still higher than inflation. However people prefer to keep money in payment accounts to transferring it to saving accounts Negative changes in securities markets forced back intentions to invest in mutual funds. Though payments to insurance and pension accounts remain stable Positive signs for income too diffident During the first half of 2010 Lithuanian households experienced controversial changes. Households income decreased. Labour income (calculated as conditional number of employees multiplied by average salary) decreased by 2.1 per cent (12 per cent on an annual basis) mostly due to the decreased number of employees or working hours. Social transfers also decreased at the beginning of the year. The average retirement pension, as compared with previous year, decreased by 9.3 per cent, maximum unemployment allowance decreased by 60 per cent. Positive trends have shown up during the second quarter. There are some positive news in the light of the unemployment. On the 1st o f September there were thousands of unemployed people compared to million of the employed (average number for the Q2). But during the last quarter both number of employed and average salary increased. Conditional number of employed increased by 1.3 per cent and average salary increased by 1.1 per cent. However number of working hours (and salaries) increased mostly in those sectors that are oriented towards export (textile, furniture), industries where foreign capital dominates (pharmaceuticals, computer, electronic and optical equipment production, chemical production), and average salaries also increased in the utilities (electricity and water supply) sector. Based on SEB customers data we may identify that the constant inflows to household accounts during the Q2 were higher compared to Q1 by 18 per cent, but still lower compared to last year s respective figure by 8 per cent. Unfortunately, prices during the first half of the year slightly increased. The CPI was 2.18 per cent. The most significant increases in prices were these: electricity prices increased by 33.3 per cent - mostly due to the closing of atomic power electric plant. Also prices of pre-school education increased significantly (20.61 per cent), transport fuels by per cent, heating energy by 9.35 per cent. Prices decreased for renting a living place, audio, video and photo equipment (by 7.88 per cent each). As one can notice, price and expenditure increase rather than decrease was experienced by much larger number of households. At this point of view we can state that financial status of Lithuanian households has worsened during the first half of the year 2010, despite the more optimistic second quarter. SEB experts forecasts aren t optimistic regarding household economies. It is forecasted that average salary at the beginning of the next year will be lower by one per cent compared with the beginning of However prices should increase on average by 1 per cent. 16

17 Net value of financial assets increased, albeit not because of asset side During the first quarter, net value of the financial assets (financial assets less liabilities) of households with the financial institutions grew by EUR 103 million. The greatest impact was made by decrease in the total household loans portfolio by EUR 99 million Financial assets and liabilities of households (EUR billion) accounts with banks; 2) investment in bonds; 3) investment in the investment funds being managed and offered by banks; 4) premiums under life insurance agreements; 5) funds accumulated with II pillar pension funds. During the first half of the current year, the new savings transferred to the deposit accounts, investment funds, life insurance accounts, II pillar pension funds amounted to EUR 274 million. However investment by households in bonds after redemption thereof by banks shrank by EUR 215 million. 9 Households new savings (EUR million, 1H2010) Q Q Q Q Financial assets Financial liabilities Q Q Q Q Source: SEB estimates Deposits Investment funds Life insurance and private pensions II pillar pension funds Bonds Compared to first quarter of 2010 net assets value growth was only half of it. This was mainly determined by different development in securities markets. Due to market fluctuations value of assets in mutual funds, pension funds and insurance funds decreased. Household savings in this review are distributed by type of the financial assets: 1) funds in deposit Sources: Bank of Lithuania, LBA, ISC, CSD -215 The most significant increase was observed in payment accounts Increased growth of deposits was determined by several factors: as in 1Q2010 households received invested money after the redemption of bonds. Also several hefty transactions where private individuals sold their company stocks. Instead of looking for a new trend of growing income, it s more rational to consider this increase as a seasonal phenomenon, which was also determined by temporarily lower expenditure on housing. The balance in time deposits is however decreasing. Since the beginning of the year it has decreased by 2.8 per cent or by ЕUR 140 million. Some of depositors who have accumulated their savings earlier are spending them; those who acquire new income do not rush to transfer money into time deposits. Savings in time deposits is demotivated by decreased interest rates. 17

18 Dynamics of time deposits and demand deposits (EUR billion) January February Demand deposits March April Time deposits May June Source: Bank of Lithuania However real interest rates (adjusted according inflation) still remain positive. During economic growth real interest rates were negative. Although even then a stable share of savings per cent was kept in time deposits. Since the beginning of this year a share of time deposits (compared to all amount of deposits) has decreased from 68 to 64 per cent. A new trend of increasing amounts in current accounts and decreasing amounts in time deposits can be observed. Such a situation may be determined by several conditions: 1) wealth redistribution when money from securities markets are transferred to deposit accounts; 2) unstable situation in securities markets when household are more cautious with new investment decisions and prefer to wait; 3) decreased interest rates when interest rate on deposits in national currency have decreased thrice compared to the rates a year ago; 4) seasonally decreased housing expenditure (on heating and electricity) which allows to leave more money in personal accounts; and 5) households expectations regarding price movements in the future that are also supported by households opinion regarding suitability of time to buy new durables. Mutual funds appeal volatile as the weather While during the first quarter of the year 2010 we observed a regained popularity of investment funds, Q Net inflows into investment funds (EUR million) Q Q Q Q Q Q Q Source: Lithuanian bankers association 3.7 during the second quarter, investment by residents in the investment funds being offered by banks (established and registered in Lithuania for public and non-public offering) exceeded divestment only by EUR 4 million. It is a fourfold decrease compared with the first quarter of this year. Negative trends in securities markets encouraged investors rather take back their money and not to buy them at a decreasing prices. According to data provided by SEB Bank, the investment funds investing in stock markets and especially in the emerging markets (Russia, Eastern Europe) remain the most popular. Those who are willing to invest, as a few years ago, select such financial instruments, which involve higher risks but in favourable circumstances such instruments ensure higher profits. Drop in equity prices may result not only in decrease in value of the financial assets related to price fluctuations but may again stimulate divestment of funds. On the other hand, caution of investors is grounded as there is still much hesitation about double dip recession. 18

19 Most stable inflow of funds to II pillar pension funds and life insurance During the first half of the year, recovery in the life insurance market was strengthening. Number of new agreements increased by 33.6 per cent, insurance premiums were higher by 10.6 per cent compared to the period a year ago. Investment life insurance remains the most popular form of savings in insurance. Funds transferred to II pillar pension funds during the 2 quarters made EUR 47 million. If the government hadn t changed the percentage of transfer, the amount would have been larger by EUR 29 million. Unfavourable changes in securities markets didn t bypass households assets accumulated in life insurance or pension funds. Due to decreased prices in most markets, asset value of investment life insurance and pension funds increased far less than new net inflows amount. But because most of households are saving long-term, this value decrease is the most important for those who are approaching the term to take out accumulated money. Loan repaid by households exceed new loans Since the beginning of last year, a positive impact on net value of financial assets of households is made by shrinking loan portfolio, i.e., residents continued repayment of loans but did not obtain new loans or the number of loans was considerably lower. During the first half of the year, the loan portfolio of households decreased by 2.6 per cent, or by EUR 218 million. Rather than decreasing loan amount, decreasing interest rates were the condition to take a breath. Especially for those who have loans in national currency. Most of debtors had chosen variable interest rates. While interbank interest rates decreased, interest rates for old loans were recalculated. Interest rates in Lithuanian banks since the beginning of the year decreased by 3.04 p.p. (decrease from 7.38 to 4.34 per cent). A loan payment for average loan (EUR 53 thousand) decreased by EUR 85). Interest rate decrease for loans in euros was less significant only 0.14 p.p. (from 3.52 to 3.38 per cent). Household expectations still negative though improving To evaluate change of household financial situation we may state that households income and expenditure balance has worsened further: constant income decreased while prices of necessary goods and services increased. Households asset liabilities balance has improved mostly to the decrease of liabilities or obligations. However only one fifth of households have liabilities to financial institutions. On the assets side a big impact of large numbers (large deposits) should be mentioned. Thus changes in assets-liabilities balance was less relevant to an average households financial status. SEB experts are quite tight regarding households financial future. No salary increase or unemployment decrease is forecasted for this year. The economy will have first to revive in business sector. Now we can observe a sustainable growth of export. Only after some time lag increased income will start to flow into households pockets as salaries or social transfers. The negative change of the financial situation is reflected in households confidence surveys: 61 per cent of households stated that their financial situation had worsened and 35 noticed that it remained the same. However current financial status is evaluated slightly better than half a year ago. Here the distribution of positive and negative evaluations is almost equal. Looking at these data we may assume that households have adapted their spending and saving habits to the changed situation. However households are more optimistic than they were half a year ago. Estimations about their financial future improved significantly (from -28 in January to - 16 in August). Nevertheless, Lithuanians still remain the strongest pessimists in the Baltics. 19

20 Financial assets and liabilities of households (EUR million) 4Q Q Q Q Q 2010 Financial assets Deposits Bonds (Lithuanian corporate bonds and Government bonds ) Equities (Lithuanian equities) Units of investment funds offered by the Bank Savings under life insurance agreements* II pillar pension funds Liabilities Mortgage loans Consumer loans Other loans Net value of financial assets ** Data for the previous periods are adjusted taking into consideration amendments to the list of insurance companies submitting data to the Insurance Supervisory Commission dated IQ2010 Sources: Bank of Lithuania, Lithuanian bankers association, Insurance supervisory commission, Central securities depository 20