Bank of Latvia says inflation, ultra-hot economy are long-term risks

  • 2005-11-23
  • By TBT staff
RIGA - The Bank of Latvia raised the mandatory reserve requirement by 2 percentage points in an effort to limit the abundance of cash in the economy and prevent inflation from further spiraling out of control.

The bank announced that it had raised its 2005 inflation forecast to 6.7 percent, and the bank's president, Ilmars Rimsevics, fired a shot at the government and Parliament when he told journalists last week that much of the country's inflationary woes were due to internal factors, not external ones, as many politicians repeatedly suggested.

Explaining the new forecast, Rimsevics said, "The increase can be partly explained by the growing prices of energy resources 's fuel and natural gas 's on the world markets, which are influencing price levels also in our country. But these price shocks are influencing inflation dynamics in all EU member states in a quite similar way."

"So it would not be right to say that the high inflation rate in Latvia is determined mainly by external factors, that are beyond the influence our governmental institutions. Our analysis suggests quite the opposite - that it is the internal factors, brought about by strong domestic demand, that are having an increasing influence on Latvia's high inflationary rate," Rimsevics said.

Finally, the central banker warned, "If the government fails to act to curb inflation as soon as possible, inflation expectations will materialize and the process of inflation will grow more and more uncontrollable."

Indeed, along with prices, the bank's economists raised their forecast for economic expansion to 9.3 percent.

"Judging by the current trends and favorable conditions fostering dynamic growth, this year the growth of Latvia's gross domestic product could be above 9 percent 's our forecast is 9.3 percent," Rimsevics said. "If GDP is in line with the forecast, our country will not only be able to boast the fastest developing national economy in the European Union, but also the steepest growth since the restoration of its independence."

Still, with ultra-high growth rates come serious risks, the banker warned. "Such a pace, as well as the fact that there are no considerable changes observed concerning the factors that provided the growth, raise doubts about stable long-term growth of the national economy," Rimsevics said, which is another reason why the bank felt compelled to raise mandatory requirement rates.

The bank said in a statement that the current "macroeconomic situation requires certain actions from state institutions to secure the balanced and long-term growth of the economy. Considering the limited influence of interest rates in Latvia after pegging the lat to the euro, the Bank of Latvia decided to increase the mandatory reserve requirement for Latvian banks from 6 to 8 percent, stressing the necessity for stricter financial policy in the situation of limited political decisions and fixed currency rate."

This was the second time this year the bank raised the requirement rate. Central bank officials said commercial banks' aggregate mandatory reserves would grow some 135 's 145 million lats (192 's 207 million euros) after the decision.

The bank left interest rates alone, since it is only able to influence rates in lats, the national currency, whereas many Latvian banks lend in euros and U.S. dollars.

The last time the Bank of Latvia raised the refinancing rate was in November 2004, by 0.5 percent. The current rate 's 4 percent 's has been in effect since then.