For investors, the Baltic countries of the EU beat Europe. But geopolitics is not in their favor

The three Baltic states of Estonia, Lithuania and Latvia have been part of the European Union for 18 years now. And over the past six years, investors have fared better than they have in a slow and crisis-ridden Europe.

Since then, the OMX Baltic 10 index has beaten FTSE Europe. This is always the case, even in a bad year like this, if you look at the year-to-date. This proves that emerging economies can still beat developing economies.

This winning streak is coming to an end.

Geopolitics and a high-profile corruption case at a well-known Latvian company threaten to dull the shine of what has been euro investors’ best-kept secret for years.

Saber Rattling, a definite headwind

There’s too much saber rattling. The Baltic states, far from being supporters of Moscow after decades of Soviet rule, want Russia to succumb to Ukraine.

Krišjānis Kariņš from Latvia and Ingrida Šimonytė from Lithuania told the FT Global Boardroom Conference on June 8 that it was becoming more difficult to keep Europe united on the sanctions due to inflation. But they added that the EU must continue to pressure Russia, or risk Russia turning to other countries. “Our goal must be for Putin to lose the war,” Kariņš said.

Not to be outdone, on June 21, the Lithuanian leader then ordered a blocked transit route between Kaliningrad, a small territory belonging to Russia on the western border of Lithuania, and Belarus. For two countries warning that Russia could turn aggressive against other weak ex-Soviet states, Latvia and Lithuania seem to be pecking a hornet’s nest.

A week after the blockade, Russia and Belarus threatened Lithuania with military action if they kept the transit route blocked, according to the Kyiv Post reported June 27. They’ve said that almost every two weeks since.

“Any talk about a blockade of Kaliningrad is a lie. Lithuania respects the sanctions imposed by the EU on Russia for its aggression and war against Ukraine,” Simonyte said.

There are sanctions against this transit routewhatever Simonyte says.

The Baltic 10 market is down around 1.58% since Simonyte’s June 21 comments on transit route sanctions. FTSE Europe is up 0.98% since then. The market is worried.

Big companies, big concerns

With the brain war, now is not the time for emerging market business stories to start turning people off.

Earlier this year, the Economic Affairs Court of Latvia acquitted all defendants in the so-called “Digital Gate” criminal case – a fight against corruption that has been going on since the mid-2000s.

Lawyers familiar with the case said the government still holds millions in seized funds.

John Sandweg, a partner at Nixon Peabody in Washington and former general counsel for the Department of Homeland Security, and former acting director of ICE in the Obama administration, said it “fails to strike the right balance between the general interests and the fundamental right of investors to its property”. .” He is not familiar with the Digitalgate case. But similarly, people whose assets were frozen in white-collar criminal investigations never got them back or, when they won a case, were sent back to a new court for a retrial.

The fight against corruption is still one of the main tenets of membership of the European Union. This will probably be one of the biggest obstacles to allowing Ukraine to join.

Regarding the Latvian courts, Olav Gutting, member of the Financial Committee of the Bundestag in Germany, noted that “the Latvian judicial and judicial systems require urgent reforms. The repeated failure of Latvian courts to prosecute local oligarchs and corrupt senior officials, choosing instead to prosecute foreign direct investment leaders, is damaging Latvia’s reputation.

Gutting said local prosecutors and judges were too “aggressive with asset seizures” and had a “complete disregard (for) the fundamental principles of prosecutorial discretion, fairness and respect for criminal procedure and rules of evidence”.

Many cases in which private property has been illegally seized in Latvia over the years will soon be tried in European and British courts. It could damage the image of Latvia, a country that is one of three Baltic sisters that have since outclassed continental Europe.

“The Russian threat makes it even more important for Europe to stick together,” Gutting said. “We cannot tolerate any cracks in the European house when it comes to rule of law issues,” he said.

In a letter dated June 23 to Didier Reynders, European Commissioner for Justice, Marion Walsmann, Member of the European Parliament in Germany and Vice-Chair of the Legal Affairs Committee, wrote that Latvia was setting a “dangerous precedent” in some of his recent white-collar criminal cases where – after no wrongdoing was proven in a higher court, a lower court was given the power to overturn the decision and start over.

“The Latvian authorities (are) in blatant contradiction with European primary and secondary law, including the rule of law, the right to a fair trial, the presumption of innocence and the right not to be retried for a crime already acquitted or punished,” Walsmann wrote.

When the Baltic countries joined the EU in 2004, markets were slow to mature. Breaking free from the state-controlled lanes of the former Soviet Union would take time.

The change of its currencies to the euro was accompanied by growth difficulties. State-controlled enterprises have been privatized; parts sold. New mini-empires were built. Within the framework of the European Union, it was essential to ensure that these remnants of the old Soviet system did not remain intact.

It’s a generational issue, and the Baltics, like much of old communist Europe, still have growing pains.

“I applaud Latvia’s commitment to combating money laundering, but the reality is that Latvian courts are failing to hold the government to account and are allowing funds to be seized based on little or no evidence of wrongdoing,” Sandweg said. “The courts have allowed the government to simply refile the same case and take another bite of the apple.”

He said that in a case that Nixon Peabody was involved in, they demonstrated the legitimacy of the seized funds in a trial court and won. The government appealed the decision. “We won again when the Court of Appeal upheld the verdict of the trial court. Rather than accept the verdict, the government simply referred the case to another trial court,” he says.

Strange twists and turns in the rule of law have spooked emerging market investors. War only adds to it. Over the past four weeks, the Baltics have slipped below Western European stock markets. If the clang of sabor continues and a real firefight ensues, things will turn very quickly for the three Baltic states.

Yet within the confines of Europe, these are the stories of growth. Latvia has grown 3.6% in the first quarter of 2022; Lithuania has grown 1%. Estonia is in the worst shape and is almost flat at 0.1% growth in the first. In comparison, France’s GDP fell 0.2% in the first trimester. Italy and Germany have progressed to the same level as Estonia.

On June 28, the Organization for Economic Co-operation and Development said Estonia has coped well with the economic shocks caused by the pandemic and is expected to experience continued economic growth. The economic risks are mainly geopolitical, namely the Russian risk and the impact of the war in Ukraine on inflation.

In Lithuania, the largest of the Baltic states, the CEO of Civinity, one of the largest facilities management and engineering groups in the Baltics, has reportedly been charged in Latvia for suspected money laundering earlier this month.

And in Latvia, according to the Ministry of Economyprices for electricity, natural gas, thermal energy and oil are expected to increase by 39% this year, with petrol prices expected to increase by 40% due to the European policy aimed at sanctioning oil and Russian gas.

This is another headwind that the market does not seem to have taken into account. Year-to-date, the OMX Baltic 10 isn’t even in a bear market yet, unlike the FTSE Europe. It’s only a matter of time now.

Mary I. Bruner