The Baltic Republics and Putin

For the first time since 1991, when the Baltic republics – Estonia, Latvia, and Lithuania – emerged from the Soviet Union, these states are again fearful of Russia’s intentions. After gaining their independence, these countries swiftly reoriented both economically and politically towards the West, joining both the European Union and NATO in 2004. Estonia, the wealthiest of the three, also became the seventeenth member of the Eurozone, adopting the euro as its currency. Latvia joined the Eurozone in January of this year. In view of Putin’s seizure and annexation of Crimea on the pretense of protecting the Russian-speaking elements of the population, the Baltic States, on the northwestern doorstep of Russia, are keenly aware that the same rationale could be used against them. In Latvia, Russian speakers make up some 35% of the population, and in Estonia the figure is 25%. The possibility generates less concern in Lithuania, where only 6% speak Russian and there is no border with Russia.

Given the history of these countries – in particular their experience as “captive nations” – and the weakness of the West’s responses to Putin’s moves against Ukraine (along with his earlier moves against Georgia), the fears of the Baltics are understandable. Their military forces would be no match for the Russians. Their defense would have to depend on NATO, which is committed by the North Atlantic Treaty to come to their aid, and their now-strong political ties with the European Union. I do not think Putin wants to take on NATO; to do so would be a disastrous move for his country. But he may think that the US and its NATO allies would fail to come to the defense of these small countries of little strategic importance. That would be a tragic miscalculation, in my view; but he is a gambler. It is important that the NATO members take steps to demonstrate that they stand together on this matter.

Should the Russians, contrary to our expectations, move against one or more of the Baltic States, the implications for international investors would not be attributed primarily to the effects on these three small economies. Rather, the effects, which would be very substantial, would reflect the impact on European and global markets caused by an exchange of serious economic and financial sanctions and a military confrontation between nuclear powers.

On the other hand, should the current crisis gradually de-escalate, which is our base case, global risk premia will decline and some buying opportunities could arise. There are no US-listed ETFs that provide access to the Baltic equity markets. There are MSCI equity market indices for Estonia (-6.42% so far this month) and Lithuania (+1.09% so far this month). The closest neighbors of the Baltics to the west are the Nordic countries: Finland, Sweden, Norway, and Denmark. The MSCI Nordic Countries Index is down 4.02% so far this month. There is a Global X FTSE Nordic Region ETF, GXF, which does not appear to have been affected by the tensions with Russia. It is up 1.56% over the past month, and its 12-month return is a healthy 19.9%.
Poland appears to be a better regional emerging-market proxy. Its equity market experienced a sell-off when Russia moved against neighboring Ukraine. The iShares MSCI Poland Capped ETF, EPOL, is down 5.17% so far this month and could represent a buying opportunity if the crisis de-escalates. Poland’s economy is doing relatively well, indeed better than most of Western Europe, with GDP growth approaching 3% this year. Its economic ties with Ukraine are limited.

About Bill Witherell 24 Articles

Affiliation: Cumberland Advisors

William Witherell joined Cumberland Advisors as Chief Global Economist in November 2005 and became a Portfolio Manager in December 2005. He is also a Senior Consultant for Finance and Corporate Governance to the Organization for Economic Cooperation and Development (OECD). From 1989 through September 2005, he was OECD’s Director for Financial and Enterprise Affairs. He joined the Secretariat of the OECD in Paris, France, in 1977.

Dr. Witherell is a graduate of Colby College and holds M.A. and Ph.D. degrees in economics from Princeton University. Dr. Witherell began his career as a business economist with Exxon and Esso Eastern, from 1967 to 1973, where he held positions in the economics, treasury, and corporate planning functions. He moved to the international economic and financial relations field in 1973, with positions first in the U.S. Department of State and then in the Department of the Treasury, from 1974 to 1977, as Director of the Office of Financial Resources and Energy Finance.

Dr. Witherell currently resides in North Grafton, Massachusetts. He is a past Chairman of the International Roundtable of the National Association for Business Economics, and a member of the Boston Economic Club and the Westborough, MA Rotary Club.

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