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Inflation set to soar in Estonia, state content with budget surplus

Mar 28, 2007
By TBT staff

TALLINN - Citing growth in wages and administered prices, the Finance Minister last week revised its inflation forecasts upward for this year and next, casting a long shadow over Estonia's ambition to join the eurozone anytime soon. The ministry said the consumer price index would rise 4.9 percent this year and then 5.2 percent in 2008, up from earlier estimates, due to exceedingly intense wage pressure and the need to raise regulated prices. In 2009 inflation should slow to 4.4 percent, the ministry said, and then decline further in subsequent years.

Price increases would continue in 2010 's 2011 so that the Baltic state would be unable to meet the Maastricht criteria and begin preparing for adoption of the euro, the ministry said.
The dream of introducing the common currency, in fact, has become so elusive that Prime Minister Andrus Ansip was forced to admit last week that it was impossible to predict when Estonia might be able to become a member of the eurozone.
He went further and said the next coalition government wouldn't make inflation control a priority. "We are not going to take any special steps to join the eurozone," Ansip said March 20.
The prime minister said that the government would continue running a significant budget surplus, and for now this was enough to restrain excessive inflationary growth.

As in Latvia, a labor market crunch and rapid credit growth have conspired to propel prices to new highs. Higher commodity prices and the need to phase in higher excise taxes are also facilitating price growth.
On the bright side, Estonia's economy grew 11.4 percent in 2006, the second highest in the EU. This, in turn, helps whittle away the divide in wealth between the Baltics' most developed countries and older EU member states.
But at the same time the specter of economic overheating is hanging over the Baltics 's particularly Estonia and Latvia 's and there has been more talk of a hard-landing scenario (with economic growth slowing to nearly zero) or the need to devalue the local currency to help local producers remain competitive.
Andrus Saalik, an analyst at the Finance Ministry, said 5 percent inflation should not be regarded as traumatic for an economy that was still undergoing rapid economic development.

The ministry has forecasted that GDP would expand 9.2 percent in 2007 and 8.3 percent in 2008, up from previous estimates of 8.3 and 7.7 percent, respectively.
According to the ministry's forecast, private consumption will be robust, supported by salary and wage increases and the overall euphoria that the good times are here to stay. Unemployment will continue falling and reach 4.8 percent this year, the ministry said.

Meanwhile, economists and analysts have cast more doubt on the government's lackadaisical app-roach to tackling inflation.
Kalev Kukk, an economist with Estonia's ruling Reform Party, said that inflation was primarily due to the sharp increase in money supply and that inflation was set to spiral out of control.
For instance, cash pumped into the real estate market is beginning to flow out and fuel inflation, Kukk argued in the Aripaev daily. This is demonstrated by the fact that the rise in nonregulated prices was 5.9 percent annually in February. A year ago it was 3 percent.

"If inflation makes saving pointless and begins to generate inflationary expectations things are more than serious. The Latvians appear to have seen the light, although how they intend to combat inflation is a different matter," Kukk says.
Mikael Johansson, an analyst at Swedish-owned SEB, which owns the second largest banking group in the Baltics, said Estonia and the other two Baltic states needed to rein in the over-exuberant lending boom.
"Latvia and Estonia continue to exhibit clear signs of overheating after several years of excessively fast, domestically driven growth. Economic policy should have been tightened earlier, but this has not happened," he said.
Johansson said SEB is predicting a soft-landing approach for Estonia and Latvia's economies 's meaning a gradual reduction to 5 's 7 percent GDP growth, though this foresees putting the brakes on the current credit boom.
Banks, therefore, must lead the campaign to restrict lending growth, the analyst said.
Latvia's government recently adopted a series of measures to bring down inflation, which at 7.3 percent is the second-highest in the EU. Measures include forcing regulated bank-lending through a more stringent application of criteria as to whom and how much banks can lend.

In Tallinn, government officials have so far denied that Estonia needs to adopt a similar batch of measures, claiming that the situation is "not as critical" as the one in Latvia.
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