Latvia finally tends to runaway economy, but measures may be 'too little too late'

  • 2007-03-14
  • By Gary Peach
RIGA - The government finally approved a plan to combat runaway inflation last week, though international analysts, while welcoming the move, said the measures may be too late to prevent a painful "hard-landing" that would bring annual economic growth close to zero.

The measures, approved on March 6, include balancing the budget, regulating and taxing real estate transactions, taxing motor vehicles, and curbing bank lending by introducing stricter criteria in the industry. Other, softer measures such as increasing productivity and competitiveness will also be encouraged.

Government ministers commented later that the plan's aim was not to slow Latvia's economic growth 's the highest in the EU 's but to stem inflation, which has spiraled out of control.
On March 8 the Central Statistics Office announced that annual inflation was 7.3 percent as of the end of February, up from 7.1 percent at the end of July. Worse, with the rise in public transportation and other regulated prices, the upward trend is unlikely to reverse anytime soon.

Finance Minister Oskars Spurdzins told the government that adopting the inflation-busting measures would reduce growth of consumer prices to the 2 's 3 percent range by 2010-2011.
The measures were greeted both at home and abroad, but analysts were cautious about being optimistic, since the government will have to pass amendments to laws in order for the measures to go into effect. That will take time, and Latvia's super-hot economy has none to spare.

"While we welcome the plan, which is long overdue, we fear a case of 'too little too late,'" wrote Danske Bank in a comment on March 8.
"We think the plan will contribute to reducing domestic demand and hence inflationary pressures, but only very moderately," the bank wrote. "Furthermore, we find the government's projections for inflation overly optimistic and… do not believe the plan will in any significant way reduce the risks facing the Latvian economy and markets, nor will it reduce the risk of rating downgrades of Latvian sovereign debt."

In recent weeks Latvia has been under siege by international credit agencies and financial institutions, all of whom have chided the government for not doing enough to address the borrow-and-spend binge that has been ongoing for several years now.
Standard & Poor's, a credit agency, gave Latvia a negative ratings outlook, and FitchRatings later said it would consider doing the same.

Remarkably, Prime Minister Aigars Kalvitis said on Feb. 20 that the working group on inflation was still meeting and had yet to introduce any proposals. Spurdzins said the same day that the working group was scheduled to have two more meetings.
But after the deluge of criticism from international quarters, which included persistent rumors of a possible devaluation of the lat and a fall in the share price of Swedbank, which owns the largest banking group in the Baltics, Hansabank, the government was forced to take immediate action.

Danske Bank said initial reaction to the plan has been "muted" and that the lat 's Latvia's national currency 's is "still flirting with the weak end of the fluctuation band." The lat is pegged to the euro as part of the ERM-II plan necessary to join the eurozone. But the euro, experts agree, is at least five years away from Latvia.
Several analysts have compared the situation in Latvia with that in Portugal in the late 1990's, when the country was experiencing double-digit growth on a wave of easy money. However, by 2000 the Portuguese economy burned itself out and growth was taken out of the equation. Economists described it as a "hard-landing," and should the Latvian government neglect to implement the above measures, the country's economy could fall hard.

The alternative would be a "soft-landing," which economists roughly describe as steady annual growth in the 5 's 7 percent range.
In Estonia, where the economy is no less under threat of overheating as Latvia's, outgoing Economy Minister Edgar Savisaar said Estonia's financial situation is better than that of Latvia. "I wouldn't overdramatize our situation" concerning inflation, he said, according to the Baltic News Service.

Estonia is also seeing a steady rise in consumer prices due to a consumption boom.
The statistics office also announced that the economy rose a staggering 11.9 percent last year. Fourth quarter 2006 growth was 11.7 percent, higher than Estonia's (11.2%) and Lithuania's (6.9%).
The office has estimated that Latvia's economy would grow approximately by 10 percent in 2007.

Anti-inflation measures
- Balance the 2007 budget by using additional revenues to pay off the deficit. Budget surpluses planned for 2008, 2009.
- Deflate the real estate bubble by imposing an income tax on capital gains on real estate that the seller owned for less than three years.
- Control banks' lending by requiring banks to issue loans "exclusively" on clients' legal income.
- Minimize effect of upcoming energy price increases by boosting energy efficiency and restricting consumption.
- Minimize current labor market crunch by raising economic activity and boosting productivity, particularly in the retail and construction sectors.