RIGA - Inflation continued its unrestrained tromp through Latvia and Estonia in March, as consumer prices surged over the month and further tainted both countries' macroeconomic outlook.
In Latvia, inflation soared 1.4 percent in March, a full percentage point above expectations. The result baffled economists, who had predicted 0.4 - 0.5 percent. On closer analysis, however, it became clear that the culprit was the lat, which had lost a portion of its value against the euro as more forex traders sold the Latvian currency in favor of euros.
For over two years now the lat has been allowed to fluctuate against the euro in a narrow corridor between 0.6958 and 0.7098 lat per euro, or about 2 percent.
So as a result of the lat's slide against the euro in March, imports of clothes, shoes, meat and other items imported on the basis of euro contracts became more expensive, and retailers raised their prices accordingly.
As the Central Statistics Office reported April 11, prices for goods increased 1.6 percent over the month, while those for services rose 0.9 percent. Analysts said the unexpected jump in inflation was a one-time event and that consumer prices would stabilize as soon as the lat strengthened.
Still, the result placed Latvia's year-on-year inflation near the stratosphere, with March 2007 prices surpassing those in March 2006 by a whopping 8.5 percent. At this level, Latvia may overpass Hungary and resume its initial position as the EU member state with the highest annual inflation.
Even prior to the inflation data, Latvia's woes continued, as Fitch Ratings, one of the leading international ratings agencies, downgraded the Baltic state's local currency outlook.
"The outlook change reflects the increased risk of an abrupt adjustment in capital and financial flows or a prolonged, painful slowdown in economic growth," Fitch said in a statement.
The agency also threw cold water on the government's anti-inflation plan, saying it "may not be sufficient to restore the economy to a sustainable path."
International bankers seconded the assessment. "We completely agree with Fitch on the concerns raised," said Danske Bank in a written comment. "We do not believe that the measures presented by the Latvian government are enough to do the trick, and further measures need to be implemented as soon as possible."
Last year Latvia's economy grew 11.9 percent, the best result in the EU27, though for months now economists have warned that such rapid growth is unsustainable and fraught with a "hard landing" scenario that would bring the economy to a virtual crawl.
The government, faced with a rising chorus of international criticism, finally approved a series of measures to combat inflation, but it is unclear how fast it will be able to adopt them and how long the measures will require to slow down GDP growth.
In Estonia, the statistics department announced that March inflation grew 1 percent month-on-month, while annual inflation has soared to 5.7 percent, the highest level in years. There domestic demand was blamed for the higher-than-expected result, as economic activity continues to be robust across the board.
The Bank of Estonia predicted that pressure on prices would slow as the year wore on. Although inflationary pressures will persist through the year due to robust economic growth, prices are expected to decline in the long term, Martin Lindpere, an analyst at the bank, said.
The bank said it would not take any extraordinary steps to simmer consumer demand.
"Admittedly, inflation is somewhat higher than we'd like, but it's nothing that would require taking urgent extraordinary steps," Janno Toots, a bank spokesman, said.
Toots said Estonia would stick to its successful policy of economic openness, a fixed exchange rate and a surplus budget.
Many Estonians, however, are calling for tougher measures to cool down the economy. Olari Taal, former banker and parliamentarian, wrote in an opinion piece in the Eesti Paevaleht that inflation is a serious problem and is being fed by "our stupidity, arrogance, superficiality and selfishness."
"It is a widespread belief that the best means of combating inflation is the knowledge of the existence of a very good plan to curb inflation," he wrote. Taal suggested the Bank of Estonia cease paying interest on mandatory reserves, and that the state stop refunding taxes on interest on loans. What's more, he called for devaluing the kroon by 2.9 percent to the bottom of its fluctuation limit.
"This will cause a little trouble of a few billion kroons only to commercial banks whose assets are in euros and liabilities, in kroons (they've protected themselves against devaluation)," he wrote. "But this loss will be smaller than commercial banks' annual profits."
