Brussels alarmed at Latvia's economic imbalances, runaway inflation

  • 2008-02-13
  • By TBT staff

TIME TO GO ON A DIET: Food prices have consistently outpaced general inflation, and in January increased 20 percent year-on-year.

RIGA - As expected, Latvia's inflation went from bad to worse in January, jumping 2.8 percent for the month and skyrocketing 15.8 percent over the year and leaving everyone 's from politicians to consumers 's wondering when the nightmare would end.
Alarmed by the situation, the European Commission intends to issue a warning to Latvia's leadership that the threat of an economic hard-landing 's or a sharp drop in GDP growth to 2 percent or less 's was still a reality if urgent measures weren't taken to tighten the state's belt and public sector wages, according to reports. 
"The program's economic scenario is attended by extremely high risks for macroeconomic stability, with a harder landing being a distinct possibility," the Reuters news agency quoted the commission's report as saying.

A hard-landing is typically used to describe a red-hot economy where growth suddenly plummets to less than 2 percent. For over a year now economists have debated the possibility in Latvia, with a vast majority maintaining that the country could avoid such a worst-case scenario.
The commission, in the meantime, wants the government to go the extra mile to ensure that it doesn't happen by increasing the budget surplus. "The key to addressing internal and external imbalances will be a more ambitious fiscal stance," the draft stated.
Last year Latvia managed a 1 percent budget surplus.

The warning, if it materializes, will come at a time when the Latvian economy, for nearly three years the fastest growing in Europe, is beginning to cool down. The nation's statistics office announced on Feb. 8 that fourth-quarter GDP expanded 9.6 percent year-on-year, according to preliminary results.
By comparison, in the last three months of 2006 the economy grew 11.9 percent year-on-year.
Still, inconsistencies remain, including excessive wage growth (making Latvian products less competitive) and a current account deficit. Inflation continues to accelerate and has now risen eight months in a row.
Worse, analysts in both the private and public sectors agree that prices will continue to rise, particularly in light of planned increases in gas and heating tariffs.

What remains a matter of debate, however, is how serious the repercussions will be for the economy.
"In March it is expected that prices for electricity will increase by around 40 percent and in May natural gas prices might rise by almost 50 percent," wrote Danske Bank in a note. "Thus acceleration in the rise of consumer prices would start to dampen private consumption growth, and the slowdown may be very sharp."
Latvia's new government, however, is convinced that last year's 1 percent budget surplus, the continuing decline in real estate prices and a sharp fall in bank lending point to macroeconomic stabilization. But financial experts in Brussels apparently see things differently.

"From mid-2007 some slowdown has become visible in the housing market and in domestic consumption but insufficient to remove the downside risks of a potential hard landing," according to the draft report compiled by the commission. "Restraining public sector compensation is critically important."
Few would argue that Latvia's economy is cooling down. The question, however, is how fast, and to what extent, it will slow.
The fourth quarter GDP indicator, although preliminary, seems to suggest that the economy is not slowing enough. "This level of adjustment is clearly insufficient to remove the downside risk of a hard-landing for the economy," Danske Bank, one of Latvia's loudest critics in Europe, wrote.
The bank's analysts said it was critical that the government "maintain a tight fiscal policy and keep wage growth under control."

No doubt wages will be crucial. As food prices continue to climb at an annual rate of 20 percent, public sector workers are bound to become more disgruntled and may start to demand pay increases. The previous government put a freeze on salary and wage hikes, but there's no telling if that dissatisfaction may spill over into demonstrations and strikes as inflation marches upward.
And prices can only go up. According to Zigurds Vaikulis, chief analyst at Parex Asset Management, inflation could hit 17 percent in February. Other analysts have gone on record as saying 18 percent is a possibility in upcoming months. All agree that the consumer price index will eventually start to fall in the second half of the year.

"The scenario of a subsiding inflation in the second half of the year is still in force," Vaikulis told the Baltic News Service.
To be sure, Latvia, where the prices a year ago rose by 7.1 percent, is not alone in its inflationary woes. Prices are climbing inexorably across the region, and the world. Inflation in Estonia hit 11 percent, while in Russia monthly price gains in January amounted to 2.3 percent (annual 's 12.6 percent).
A combination of higher energy prices and a poor harvest conspired to propel costs of heating, electricity, motor fuel and food upward, and could accelerate a recession in some countries.