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Baltic blues disperse as strength returns

SINCE the start of the financial crisis, the Baltic states have cast a long shadow over their Scandinavian and Eastern European neighbours. Swedish banks, which lent heavily to the Baltic states in euros, now find themselves running a high risk of loan default. <br /><br />Sweden&rsquo;s Swedbank, which is the Nordic bank most heavily exposed to the Baltic countries, says that says up to 30 per cent of its mortgages in Estonia are in negative equity. It warned last week that business in Ukraine and the Baltics was still on a downward trend, albeit at a slower pace.<br /><br />Even more concerning for investors, recent loans to Estonians have been made in euros, rather than in the local kroon, which exposes borrowers to currency fluctuations. If the euro strengthens against the kroon then the real value of their loans surges and they are more likely to default, adversely affecting the issuing bank. <br /><br /><strong>UNDER PRESSURE</strong><br />The Swedish central bank, the Riksbank, has highlighted that the problems in the Baltic states remain a cause of concern, which will also put the krona under pressure, especially if the currency pegs in the region come under the spotlight again.<br /><br />However, there have been two trends recently which suggest that the outlook for Swedish banks, and consequently for the krona, is improving. Firstly, ratings agency Moody&rsquo;s said yesterday that Latvia, by far the worst affected of the Baltic states, is now in a state of &ldquo;fragile stabilisation&rdquo;. Moody&rsquo;s reports that the country&rsquo;s economic output appears to be levelling out and key economic indicators are no longer falling at the dramatic rate observed six months ago. &ldquo;These developments have also been mirrored in the countries&rsquo; financial markets, suggesting that negative pressure may be diminishing,&rdquo; Moody&rsquo;s said.<br /><br />Secondly, the appreciation of the Swedish krona against the euro and dollar had helped reduce banks&rsquo; exposure towards the Baltics. The Swedish krona had suffered badly against the single currency last winter, but since late February it has strengthened 12 per cent against the euro. With European banks also potentially at risk from Eastern European loan defaults, better-than-expected news out of the Baltic could see the Swedish krona continue to strengthen in the short-term against the single currency. <br /><br />However, for those traders still too concerned about Baltic exposure to go bullish on the krona, an alternative could be to go long on the Norwegian krone-Swedish krona. Norway is fiscally very stable and its oil reserves mean that it will benefit from an upturn in the price of crude oil. <br /><br />The Baltic states&rsquo; long shadow might be receding but despite improvements, the krona will remain a potentially volatile currency for some time. <br />