Inflation spins out of control

  • 2005-11-09
  • By Aaron Eglitis
RIGA - Latvia's annual inflation rate hit a staggering 7.6 percent at the end of October, the Central Statistics Office announced on Nov. 8, confirming fears that the Baltic state might not achieve its much-anticipated goal to adopt the common currency in 2008.
The new data showed that month-on-month consumer prices rose 0.8 percent, while the year-on-year rate 's 7.6 percent 's was far beyond the rate required by the European Union for new member states to join the eurozone.

Inflation for the year is likely to approach 7 percent, while the total rise next year could be as high as 6 percent, analysts said, significantly higher than the 4.5 percent the government has written into the 2006 budget.

The news sparked renewed concern among leaders, with President Vaira Vike-Freiberga bringing up the issue in a discussion with Prime Minister Aigars Kalvitis.

Central Bank officials repeated their appeals to the government to enact an anti-inflation strategy proposed earlier this year. The plan has so far been kept secret.

But the government appeared unwilling to act. Aigars Stokenbergs, economic advisor to the prime minister, was quoted as saying, "The government is doing everything in its power."

Recently the Economy Ministry proposed reducing the value-added tax on foodstuffs from 18 to 5 percent, but Kalvitis rejected this.

The Bank of Latvia has complained that the government's fiscal policy is too lax, and that the deficit should be trimmed in the current high-growth environment. But with a number of public sector workers threatening to go on strike if their paltry wages were not increased, the government 's a coalition of four parties, including two right-wing 's proved unable to trim spending next year even further.

But a worsening in the trend could materialize even before the New Year. With heating prices expected to rise in November, consumers may see another percentage point added on the monthly rate.

For its part, the Bank of Latvia has little in its arsenal to combat the rise. The lat is now pegged to the euro, and the bank can also raise rates on lat-denominated borrowing, which only accounts for a small percentage of commercial loans.

The bank did, however, raise the reserve requirements, or the amount of money that commercials banks must keep on hand, to whittle down the money supply. But with Latvia's super-hot economy, which posted nearly double-digit growth in the second quarter of the year, the move proved to be too little too late.

Some economists have blamed external factors for the crisis 's e.g., high energy costs 's while others have pointed to unbridled domestic demand.

Regardless, there is a danger that inflation will become entrenched. To keep up with the cost of living, budget workers 's teachers, doctors, policemen 's will demand more pay increases, which will facilitate a wage spiral and further inflation.

Alf Vanags, director of the Baltic International Centre for Economic Policy Studies, said that the inflation rates make euro entry by 2008 "very problematic." He added that the boom in property prices and the decrease in the inflation rates may be indicators that the economy is already experiencing some overheating.

The rise in Latvia's inflation has been attributed to the timing of the lat's peg to the euro. The peg was announced a year in advance, in 2004, but during that time the euro fell considerably in value. By the time the peg took place in January 2005, the lat was fixed to a weakened euro, which then proceeded to rise in value, making products from the eurozone more expensive in Latvia.