Both Latvia’s and Estonia’s debt ratings were downgraded by Standard and Poors. Estonia was cut from A to A-, while Latvia was cut to BB+ to BB – its considered high yield securities aka junk bonds. This should come as no surprise as both countries have been in the news due to severe economic dislocations as they attempt to maintain currency pegs in the face of a severe debt deleveraging.
Latvia has been having severe difficulties getting its IMF monies disbursed due to the lack of fiscal belt tightening. Just today Latvia released dreadful economic news with statistics revealing a19.6% fall in gross domestic product. As macabre as the figures were, they were better than analyst expectations of a 22% fall. Nonetheless, S&P has decided to use this backdrop as an occasion to downgrade the country’s debt along with northern neighbour Estonia.
Win Thin, an analyst at Brown Brothers Harriman, had this to say about the downgrades (emphasis added):
Somehow, Lithuania escaped this time but it should have been cut from the current BBB, as we rate it BB- vs. actual BBB/A3/BBB. The only surprise to us was that the downgrades weren’t deeper, as we see eventual junk status (below BBB-) for all three. As we noted in our most recent FX quarterly, the ratings agencies have been overly generous with Eastern Europe, particularly the Baltics. Our sovereign rating model puts Estonia at a BB/Ba2/BB rating, way below actual ratings of A-/A1/BBB+. For Latvia, we rate it B- vs. actual BB/Baa3/BB+. Others that are overrated in the region include Bulgaria (we rate it BB vs. actual BBB/Baa3/BBB-), Hungary (we rate it BB- vs. actual BBB-/Baa1/BBB, and Romania (we rate it BB vs. actual BB+/Baa3/BB+).
We fully expect Estonia, Lithuania, and Bulgaria to follow Latvia and Romania into IMF programs. Our negative view on the Baltics still underscores our bearish calls on SEK given the high levels of Swedish banking exposure to the region, and helps explain why SEK was the worst performer today vs. USD and EUR… Just look at Latvia. It just reported Q2 GDP as contracting 19.6% y/y vs. an 18% drop in Q1. The banking regulator has reported that all overdue loans rose to 23.5% of total loans in June... Those numbers will only get worse, as we see little relief in sight for the economy…
The long and short of it is: expect more pain in Latvia and Estonia, but also across Eastern Europe as well. As the global recovery seems to within reach, particularly in emerging markets, expect Eastern Europe to underperform.
Originally published at Credit Writedowns and reproduced here with the author’s permission.