'Banana republic' of Latvia losing competitiveness at 'dramatic rate'

  • 2007-06-13
  • By TBT staff
RIGA - Annual growth of gross domestic product and inflation backtracked slightly in May, though the dark cloud of economic uncertainly continued to hang over the Baltic state due to the prospect of wage increases and a persistent current account deficit. A top economic think tank even issued a report last week warning that the government's room for maneuverability is narrowing and that a devaluation of the national currency may be necessary to rectify runaway inflation and the current account deficit.

The statistics office announced June 8 that GDP expanded 11.2 percent in the first quarter of 2007, led by trade (up 15.7 percent and accounting for 23.1 percent of GDP) and transport and communications (up 7.6 percent and accounting for 11.3 percent of GDP). Gains in the trade and communications sectors, in fact, accounted for half the economic growth in the country.
Still, the quarterly result is down slightly from 11.9 percent annual growth registered for the last three months of 2006, a trend analysts welcomed.

As of the end of May annual inflation amounted to 8.2 percent, down from 8.9 percent in April. It was the first time in six months that consumer prices have slowed on a monthly basis. Month-on-month inflation was 0.6 percent.
Analysts welcomed the inflation data since they were below expectations. Most banks have revised their 2007 estimates based on April data and are predicting that inflation this year will be in the 7.5 - 8.5 percent range, which is likely to be the highest in the EU.
But the seven months remaining will see a range of pressures on the lat. For instance, Latvia has yet to feel the full effect of a rise in gas tariffs and other utilities.
"Soon Latvia will see another fuel price increase. In the middle of the year a significant rise in the excise on cigarettes is expected, and new gas tariffs will leave an impact on the next heating season," cautioned Ieva Veja, an analyst at DnB Nord Banka.

A fresh study by the Baltic International Centre for Economic Policy Studies put the inflation debate into perspective. The report, issued June 7, stated that wage growth and inflation are depriving the economy of its competitiveness and "recent surges in producer prices and wages point to further inflation in the pipeline and to the possibility that the Latvian economy has shifted from a position of simple overheating to something more serious in structural terms."
By keeping the lat pegged to the euro, the government "has too few instruments to achieve its policy targets" of cutting inflation and the current account deficit, the BICEPS report stated. "Through a policy of 'neglect' the government has arrived at a situation where all realistic options will be painful."
Latvia has been at the center of a maelstrom of international criticism since March due to its record-breaking economic growth, which many say indicate an overheating.

Alf Vanags, director of BICEPS, pointed out that Latvia's current account deficit of 21.3 percent in 2006 was one of the highest in the world and that most of those countries with a higher indicator were Caribbean islands renowned for exporting a particular agricultural commodity 's bananas.
The near future holds more of the same 's consumer and producer inflation, wage growth 's for Latvia despite the government's anti-inflation plan, the report said. "This means that the external competitiveness of the Latvian economy can also be expected to worsen, and with it the trade balance and the current account," the report said.
Finally, the analysts, including Morten Hansen of the Stockholm School of Economics, concluded that the government's plan, involving fiscal measures, will likely "require a long and costly process of deflation," the one thing it is trying to avoid at all costs due to the drastic political consequences.
"Latvia may eventually find itself in a situation where the pain of a long and costly period of deflation may be weighed against the cost of altering the peg to strengthen competitiveness 's and where the latter may be the rational and less painful choice," the report concluded.

Commenting the latest economic data, Prime Minister Aigars Kalvitis decried the "insufficient" level of production in the nation's GDP and that the state needed to boost efforts to increase manufacturing volumes.
Latvia's gross domestic product per capita in the first quarter was 904 lats (1,286 euros) in constant prices, up 11.8 percent from the first quarter of 2006, the statistics office reported.