RIGA - The EU's monetary commissioner visited the union's hottest economy last week, telling government ministers that while the anti-inflation plan was a welcome development, more action was needed to prevent the economy from undergoing a hard-landing.
Joaquin Almunia's visit came three days after Latvia announced annual inflation in June, which at 8.8 percent once again placed the Baltic state at the top of EU's inflationary summit.
Almunia said he was "impressed by the dynamism of the Latvian economy," particularly with the fall in unemployment and the rise of investment. "This shows that membership in the European Union has been a [good] option for consolidating the strategy of the Latvian economy," he told reporters on July 12.
But the rapid growth "has created imbalances that need to be tackled," the commissioner stressed. As an example, Almunia said that one-third of consumption in Latvia is financed through credit, which has given the country the highest current account deficit in the EU, a trend that urgently needs to be reversed.
"This [current account deficit] is the other side of the coin of financing growth, but we need to take account that this deficit should be financed not only today but in the future also," he said.
The commissioner also pointed out the rapid growth in wages. "We strongly recommend that wages increase in line with productivity, not to create inflationary pressure," he said.
Almunia said the commission was "very happy" to hear not only about the government's anti-inflation plan that was adopted in March, but that it was being implemented.
"But we need to say that this [anti-inflation plan] is not the end, that more efforts are required to put inflation under control over the mid-term," he said.
Almunia's strongest recommendation was to use a "counter-cyclical" budget policy 's i.e., to decrease public sector demand and create a larger budget surplus. After several years of small budget deficits, in 2006 Latvia posted a 0.4 percent surplus, which, according to the commissioner, is inadequate as a measure to curtail demand.
He refused to say how large the surplus should be.
Latvian Finance Minister Oskars Spurdzins, speaking alongside Almunia, agreed that a larger surplus was needed but that it was questionable that a 3 - 4 percent surplus could be attained.
"We are on the same page with the commissioner about what needs to be done," Spurdzins said.
Asked about a possible devaluation of the lat, the finance minister ruled it out. "There are no grounds to speak about devaluation," he said. "There is no basis that this could take place this year."
In recent weeks Latvia has come under fire from foreign analysts for having done too little to combat its macroeconomic imbalances, and some have raised the specter of a devaluation of the local currency in order to correct these imbalances. Currently the lat is pegged to the euro.
Other recommendations voiced by Almunia included establishing dialogue with banks to moderate credit growth and continuing structural reforms in order to foster competition in key industries.
At 11.9 percent, 2006 GDP growth in Latvia was the highest in the EU 's including Romania and Bulgaria, which joined in January. The growth, however, has been fueled by rampant consumption, which Bank of Latvia chief, Ilmars Rimsevics, has described as a "spending spree that cannot go on forever."
High inflation has also led to expectations of rising wages, which in turn forces employers to raise the price of their goods and services. Also, the competitiveness of Latvian goods on international markets has also suffered as internal prices soar, though Rimsevics is quick to argue that the situation with exports is fine.
Exports grew 22 percent in the first quarter year-on-year and 30 percent in May, according to Rimsevics.
Yet monthly inflation continues to defy analysts' expectations. In June the rise in Latvia's consumer price index surpassed the EU's inflation-leader Hungary, where annual inflation based on June data was 8.6 percent.
While in Latvia, Almunia declined to say when Latvia could possibly join the eurozone, saying only that membership in the euro was the best guarantee of macroeconomic stability.
"Experience shows that the efforts required to fulfill the criteria for joining the eurozone pay off in terms of more stable growth, less inflation, low interest rates, more financial stability and more investor confidence," said the commissioner.
Prime Minister Aigars Kalvitis told reporters on June 12 that the Baltic state would target 2012 - 2013 for adopting the euro.