Latvia's inflationary struggle becomes self-fulfilling prophecy

  • 2007-05-16
  • By TBT staff
RIGA - Inflation in Latvia continued to run amok in April, reaching 0.9 percent for the month and 8.9 percent year-on-year, defying analysts' forecasts and propelling the Baltic state further into unstable macroeconomic territory. The Central Statistics Office said that food prices were mainly to blame for the higher-than-expected inflation, though prices for services also scored considerable gains. Vegetables, fuel and catering services led the charge, with vegetable prices soaring 12.3 percent over the month, while fuel prices jumped 3.7 percent.

Consumer prices for goods and services both increased 0.9 percent for the month. Annually, goods were 7.5 percent more expensive and service 12.7 more than a year ago, the statistics office said.
The annual 8.9 percent result was the highest since 1997, and underscored Latvia's increasingly tenuous economic situation, with high inflation distorting consumers' expectations and undermining exporters' competitiveness. Many Latvian analysts have revised their 2007 forecasts to approximately 8 percent, while their international colleagues warned of an overheating economy.
"The inflation rate in the European Union's fastest growing economy is accelerating more than four times faster than in the euro area," Danske Bank said in a note. "Needless to say, this is clearly not a sustainable situation, and urgent policy action to dampen growth and inflationary pressure is needed to avoid a hard landing in the economy and potentially financial distress."
Fitch Ratings put Latvia top among a list of 20 European countries most susceptible to external economic events, which the agency published last week. In April Fitch also downgraded Latvia's outlook due to overheating risks.

At home, the Bank of Latvia commented through its spokesman, Martins Gravitis, who said, "Such an inflationary rate continues to eat away at the competitiveness of Latvia's exports and challenges economic policy makers to act fast by implementing and, if necessary, modifying the plan for curbing inflation and stabilizing the macroeconomic situation approved in March."
Gravitis said the inflation reflects surging domestic demand. "Unfortunately, no significant slowdown is expected in the nearest future. So it is important to consistently and fully implement the government's anti-inflation measures that should come in force at the beginning of the summer," said Gravitis.

Finance Minister Oskars Spurdzins said the April jump in food prices could be explained by the agricultural situation last year, while those of services, such as a hike at hairdressers, would have to be analyzed.
He said that inflation is influenced by expectations, as well as the inflation-curbing plan that could have prompted residents to make last-minute purchases before anti-inflation amendments went into effect.
Spurdzins added May inflation was likely to remain on the same level.

Meanwhile, the statistics office reported that, according to preliminary data, GDP in Latvia grew 10.7 percent year-on-year in the first quarter of 2007, compared to 13.1 percent in 2006. For the whole 2006 Latvia's economy expanded by 11.9 percent.
Analysts welcomed the result, since it indicated that the pace of economic growth was beginning to slow down. As Andris Vilks, chief economist at SEB Latvias Unibanka, told the Baltic News Service, "There is no doubt that it was again driven by domestic demand and service industries. I think we will succeed more in curbing economic growth than inflation."
Dainis Stikuts, chief economist at Hansabanka, Latvia's largest bank, said the bank expected consumption to fall in the following quarters. He also said that the situation in the real estate sector, which has attracted considerable financial resources, is changing fast.

"The number of transactions with standard-design apartments has decreased considerably in recent months, while at the end of the last year it was evident that the rate of construction development is falling due to insufficient capacities," he said.
He added that the rapid salary increases suggests that industries are having difficulties boosting production. "Latvia's economic development cannot be based on further gains in employment, because unemployment is already very low. [It] is possible only by increasing productivity," said Stikuts.

Vilks pointed out that the economy would be cooled down both by the inflation-curbing plan, as well as stabilization of property prices. "Inflation should stop rising then, because consumers will no longer accept such price levels, and producers will have to sustain their competitiveness on foreign markets," he said.
The Bank of Latvia's Gravitis said that the first fruits of the anti-inflation plan could be reaped at the end of the year at the earliest.