Potential To Benefit From Cyprus Debacle
BMI View: Concerns that Latvia will become "the next Cyprus" are exaggerated in our opinion, as Latvia's banking system is substantially smaller than Cyprus' (relative to GDP), a smaller contributor to economic activity, and has stronger liquidity and capital requirements. While Latvia will remain an attractive destination for foreign capital, the government will likely ensure that foreign deposits do not rise to levels that could potentially threaten Latvia's eurozone accession bid.
In the wake of the Cyprus bailout, concern is growing over the stability of other regional economies with oversized banki ng systems relative to GDP and high proportion s of foreign depositors. Latvia, frequently described as the "Switzerland of the Baltics", has attracted special attention recently , as similar to Cyprus, its banking sector is heavily funded by deposits of Russian origin. Latvia's position as an offshore banking centre for Russia has been long-established and the country increased its attractiveness for foreign depositors by passing a law in 2009 allowing anyone who invests 100,000 lats to get a residency permit. However, c oncern s that depositor outflows from Latvia could trigger a similar crisis to that experienced in Cyprus were significant enough to prompt Latvia's Prime Minister Valdis Dombrovskis to pub lically assuage investor's concerns, reassuring them that they had seen no indications to suggest deposit outflows were occurring .
|Non-Resident Deposits Comprise Around Half Of Total|
|Latvia - Banking Sector Deposits By Ownership, %|
While it is true that Cyprus and Latvia's banking sectors share some similarities, we think concerns over a potential run on Latvia's banking sector are overdone. In fact, we believe that Latvian banks may even stand to benefit from the situation in Cyprus. As the chart below shows, the size of Latvia's banking sector relative to GDP is a relatively modest 133 % - substantially smaller than the eurozone aggregate of 357 % and dwarfed by Cyprus at almost 900%. As a result, Latvia's banking system is implicitly more stable than those where assets are between 3x to 20x annual GDP. Furthermore , Latvia's economy is far less skewed towards the financial sector, which accounts for just 3% of total economic activity - versus 9% for Cyprus. Also , those Latvian banks which hold a high level of foreign deposits are subject to more stringent regulation with regards to liquidity and capital requirements.
|Latvia's Banking Sector Is Reasonably Proportioned|
|Latvia & Cyprus - Banking & Financial Sector Metrics|
Latvia's macroeconomic outlook is also considerably more attractive than Cyprus': we are forecasting Cypriot real GDP to contract by 1.5% in 2013 against growth of 4.3% for Latvia. In addition to an impressive growth outlook, Latvia's public finances are also in considerably better shape, with the 2012 fiscal deficit estimated at just 1.5%, while Cyprus' budget shortfall widened to 6.6% of GDP in the same period. Finally, Latvia remains on track for eurozone accession in 2014, which should bolster its appeal for investors seeking a safe haven in a relatively stable political and economic environment.
As a result , we believe that Latvia's deposit base is actually more likely to experience capital inflows from foreign depositors in the wake of the Cypriot crisis, as investors seek alternative destinations to safeguard their capital. However, we are also sceptical of claims that Latvia is set to experience a tidal wave of foreign capital inflows. This is primarily because we note that despite previous efforts, the government is increasingly wary of attract ing foreign capital. Following the Cyprus debacle , Latvia's Capital Markets Commission was quick to issue a press release stating " There are no grounds to expect large inflows of unknown origin funds entering the Latvian financial sector in the nearest days, as requirements for non-resident customer assessment in Latvia are among the highest ones, including duty to apply enhanced customer due diligence. "
|Is Russian Capital Already Moving To Latvia From Cyprus?|
|Latvia - Deposits By Residency Status, LVL000|
Indeed, we believe that concerns over foreign capital inflows are likely to surpass the threat of deposit flight, as the government is likely to become increasingly concerned over the level of non-resident deposits (NRDs) in the banking system - one of the few potential pitfalls that Latvia faces in its eurozone accession bid. Several EU officials have already expressed serious reservations over the high level of NRDs in Latvia's banking sector, which they believe could pose a systemic risk to the system. Accordingly, we expect that if Latvia were to start experiencing a sharp influx of NRDs, the government would likely introduce greater regulatory barriers. Accordingly, while we expect the outcome of the Cyprus crisis to be beneficial to Latvia, the net impact is likely to be relatively modest.