Latvian inflation: the tiger hiccups

  • 2005-10-19
  • By Ben Nimmo
RIGA - Latvia has often been called the "Baltic tiger" for its record-breaking economic growth. With the shocking news that inflation in September reached 7.2 percent, the highest monthly gain since January 1997, it is beginning to look as if the tiger has heartburn.
At the beginning of October, Ilmars Rimsevics, president of the Bank of Latvia, greeted the news that GDP growth in the second quarter had reached the record-breaking level of 11.6 percent with the words, "Although we view this rapid growth as a positive development, it strengthens our fears regarding the economic system on which it is based. Such rapid economic growth brings the risk of higher inflation."

Sure enough, within a week the statistics bureau announced September's inflation figures. All eyes have now turned to the government.

Martins Gravitis, press secretary at the Bank of Latvia, said, "The government should think whether it isn't the right time to activate its secret anti-inflation plan." As yet, however, the secret plan remains exactly that.

On Oct. 10, Prime Minister Aigars Kalvitis was quoted in the daily newspaper Diena as criticizing the lack of competition in the country's food and fuel retail sectors and recognizing the need to strengthen the Competition Council. On Oct. 11 he went further, saying that the government was ready to adopt radical measures, if necessary, introducing new taxes in order to curb demand. But so far, government reaction has not stretched to unveiling an effective plan.

Media attention is currently focused on the question of how inflation will affect Latvia's adoption of the euro, scheduled for 2008. According to Gravitis, however, this is a secondary issue.

"Our main concern is whether our economy will be able to sustain the growth levels it needs to reach EU standards of living if inflation remains so high," he said. "What's really worrying about the current situation is that the figures can't be blamed on fuel and food prices: core inflation is creeping up. We're also seeing signs of an incipient price-wage spiral: people are starting to expect high inflation, and therefore ask for higher wages, which itself leads to rising prices. We're therefore urging the government to consider applying its plan as soon as possible."

Indeed, both inflation and growth figures point to an uncomfortable situation in the Latvian economy. According to Rimsevics, in an announcement made before September's inflation figures were known, "In the second quarter the fastest growth was seen in the service and construction sectors, although industrial production also saw a significant rise after its first-quarter decline. The figures strengthen the Central Bank's fears that an increasing proportion of GDP growth is based on domestic demand, which can strengthen the economy in the short term, but which cannot provide a sufficiently stable basis for long-term growth if it is not matched by a growth in domestic production backed by strong foreign demand."

In other words, Latvia's spectacular growth is mainly based on Latvians' eagerness to spend, leaving it vulnerable to any kind of local shock.

The government now faces a delicate balancing act. On the one hand, if it moves too vigorously, it might create exactly the kind of shock it needs to avoid. On the other, if it acts too slowly, it could be accused of ignoring the experience of other economies who tried to achieve rapid growth while ignoring inflation, and failed.

Latvia's long-term development is now at stake. Unless the appropriate action is taken soon, 2005 may come to be known as the Year of the Hiccupping Tiger.