RIGA - Inflation at the producer level in Latvia continues unabated in the second quarter of 2007, increasing by 4.4 percent compared to the first quarter, and showing an increase of 17.8 percent year-on-year, according to Latvia's Central Statistics Office.
The largest increase in costs from the first to second quarters of this year was in the production of non-metallic goods, registering an increase of 11.5 percent; next came water cleansing producer prices which rose by 6.1 percent, followed by rubber and plastic goods production prices up by 5.6 percent, and production prices for timber and timber products, except furniture, increasing by 5 percent. Producer prices declined in garment manufacturing and fur processing and painting as well as in the printing and sound recording industries by 2.2 percent and 0.8 percent, respectively.
In the second quarter of 2007, the sector with the fastest year-on-year rise in producer prices, at 33.9 percent, was timber and timber products, excepting furniture. Considerable growth, by 26.3 percent, was registered for production of non-metallic goods, while water cleansing producer prices grew 21.2 percent and electricity, gas, steam and hot water supply producer prices grew 19 percent.
Compared to May 2007, the overall month-on-month producer price level rose by 0.4 percent for June, while the year-on-year increase for the month was 17.7 percent. Compared to May 2007, the overall month-on-month producer price level for domestically sold goods grew by 0.9 percent but for goods exported to foreign markets a decline in producer prices of 0.2 percent was registered. The year-on-year increase in March at the producer price level for domestically sold goods reached 18.8 percent but for goods exported to foreign markets, by 16.1 percent.
According to a recent BICEPS report by economists Alf Vanags and Morten Hansen, the high wage inflation that we are currently experiencing in Latvia tends to work itself into producer prices generally over a time lag of up to 15 months. Consumer price inflation, which last month came in at an annual rate of 8.8 percent, can expect to see further pressure from producer price inflation.
These numbers will continue to negatively impact the Latvian government's anti-inflation plan, in which the two economists say that "linkages between wages, prices and price expectation suggest that there is considerable inflation already in the pipeline and that inflation is likely to increase further in the short to medium term."
Latvian construction firm Merks has seen its costs go up by about 20 percent this year, though company chief Ivars Geidans says that in his opinion, the 29.1 percent hike in construction costs the Central Statistics Office reported for the second quarter of 2007 was an exaggeration. The Merks chief says that construction materials have not shown steep price climbs so far this year, but labor costs have kept surging. His own estimate is for overall construction costs this year to climb by 18-20 percent.
In a sign that control of Latvia's inflation problem could be beyond its own devices, a paper presented at the International Conference of Commercial Bank Economists in Madrid this month by the chief economist at Danske Bank, Carsten Valgreen, promotes the idea that small, open economies such as Latvia, even those with fixed exchange rate regimes, are experiencing a loss of monetary control over their economies. Lending in both local and foreign currencies has the effect of crowding out lending in the local currency, he suggests.
"Fast growing Latvia has been seeing aggressive domestic expansion fueled by credit from foreign-owned banking in a fixed exchange rate environment. Monetary policy has become increasingly impotent as the central banks' money monopoly is getting increasingly hollow."
He's arguing that Latvia's central bank is hampered by the fixed exchange rate, though even if it were freely floating, "it would not help much if [the bank] could change interest rates more freely, as credit decisions in Latvia are overall decided by large foreign banks, whose capital costs, balance sheets and ability to extend credit are insensitive to Latvian interest rates."
Building firm Skonto Buve's director Guntis Ravis predicts that construction costs might also grow rapidly in the second half of the year. The increase in costs, he says, is driven by the rapid growth in workers' salaries and that these still have the potential to double in the future.