World Bank: Inflation in Latvia could derail euro plans

  • 2004-10-20
  • Staff and wire reports
RIGA - World Bank economists said this week that Latvia's high inflation could derail the country's plans for introducing the euro, while public and private sector officials debated the merits of a loan-based tax to stem the runaway growth in consumer spending.

Thomas Larssen, chief economist of the World Bank, told a gathering in Riga on Oct. 18 that the rise in prices in Latvia was dramatic and should be the government's biggest concern since it undermines the country's efforts to join the Exchange Rate Mechanism II, the transition period for all countries preparing to adopt the common currency.

Raita Karnite, director of Latvia's Academy of Sciences' Institute of Economics, said that she did not see how Latvia could curb inflation.

According to the latest statistics, year-on-year inflation is pushing the 8 percent threshold, far beyond the 3 percent territory where it needs to be for countries joining ERM-II. Latvia is set to join the EMR on Jan. 1, 2005, when the lat is to be pegged to the euro.

Larssen said that the government's draft budget for next year, which calls for a deficit of 2 percent of GDP, does not promote economic stability at a time when the economy, in the words of the economist, is overheated, which is evidenced by its high current account deficit and inflation rates.

Gundars Berzins, chairman of the Parliament's budget committee, last week suggested applying a tax on loans to curb lending as a way to combat inflation, since efforts by the Bank of Latvia - i.e., raising lat-denominated interest rates - have had no effect on the lending boom.

"I believe the policy of the Bank of Latvia is wrong," Berzins said on Oct. 13. "By changing the refinancing rate restrictions are imposed only on the market of lat-denominated resources whereas resources in foreign currencies still are cheap."

He said lending growth could be curbed through a "highly unpopular solution" - a credit tax that would apply to loans in all currencies.

Uldis Cerps, chairman of the Finance and Capital Market Commission, the market watchdog, agreed with Berzins, saying that the higher refinancing rate is only pushing up costs for lat-denominated resources, while relatively cheap loans in foreign currencies remain available.

"This issue should be discussed by politicians. The idea is not wrong," Cerps said.

A Bank of Latvia spokesman, Martins Gravitis, said the possibility of introducing such a tax was raised earlier in the year during a meeting with the prime minister. "The Bank of Latvia alone cannot balance the macro economic risks. Therefore, the readiness of the government to use the tools available for it, carefully assessing its effects, should be praised," Gravitis said.

Finance Minister Oskars Spurdzins said the loan tax should be assessed in consultations with banks.

Meanwhile, bankers defended the status quo, saying the rapid growth in lending was a normal phenomenon for Latvia given its current development pace, and that fears regarding lending and high inflation were exaggerated.

Teodors Tverijons, president of Latvia's Commercial Banks Association, said that the current 40 percent growth in lending would be a fantastic figure if posted by Sweden or Germany but not by Latvia. Moreover, there is no expertise as to what growth rates in Latvia should be.

"What's not normal for others may be normal for us," said Tverijons.

Hansabanka board chairwoman Ingrida Bluma said, "Latvia's economy has not been analyzed - there is no analysis saying the present growth rate of lending is too fast."

Latvijas Unibanka Chairman Viesturs Neimanis said certain concerns old exist since the good times would not stay forever.

Loans to individuals in Latvia skyrocketed by 47.6 percent in the first eight months of 2004 year-on-year. As on Aug. 31, banks had issued 1.1 billion lats (1.6 billion euros) in loans to individuals, up from 758.1 million lats at the end of the last year.

Despite the high rate of inflation, the Finance Ministry confirmed last week it would not lower the budget deficit planned for 2005, which is based on a 4.3 percent rise in the consumer price index.