Bank of Latvia raises interest rate

  • 2004-03-18
  • Baltic News Service
RIGA - The Bank of Latvia raised its refinance rate for lats by half a percentage point to 3.5 percent on March 11 in order to calm a rising tide of inflation.

The move, which will force commercial banks to raise their prime rates, should help stem the current borrowing binge in Latvia.
Bank President Ilmars Rimsevics said that no immediate effect was expected from the rise, but he hoped the move would cut down on consumer demand for loans. Both the Bank of Latvia and independent experts have warned in the past that the commercial loan market risked overheating.
Indeed, the Bank of Latvia announced March 15 that inflation was the only criteria in which Latvia failed to meet the Maastricht criterion for in 2003. The requirement for Latvia last year was set at 2.7 percent, but the actual inflation rate turned in at 2.9 percent. By contrast, at the end of 2002 the rate for Latvia was only 1.9 percent, well below the 2.9 percent requirement for that year.
Other criteria - such as budget deficit, state debt, issue of state securities - were easily met.
Analysts had warned that Latvia might not meet all the Maastricht criteria, especially given the higher-than-expected rate of inflation. The criteria must be met in order for a country to join the euro-zone, which Latvia is striving to do.
The criteria, however, will only be binding starting in 2005 since prior to joining the European Monetary Union Latvia must first take part in the so-called currency exchange rate mechanism 2, which is a transitional period for countries that want to adopt the euro.
Still, Hansabank Markets senior analyst Liene Kule said that inflation could remain in the 3 percent - 4 percent area over the coming years, which would complicate Latvia's euro-ambitions.
Analysts say that prices will rise further this year and next due to both EU-related expenses - e.g., administration costs - and other economic factors - e.g., higher energy prices and VAT on services that were once VAT-exempt.
In February consumer prices were up 0.7 percent over January, mainly due to a jump in food prices. Year-on-year, prices were up 4.3 percent, including a 4.4 percent increase for goods and a 4 percent growth for services.
Uldis Osis, an economist at the Economy Ministry, said that the level of inflation could be managed.
"It is possible to control the inflation on the national level if there is no budget deficit, the Bank of Latvia raises credit rates, and so on," he said.
Osis said that in order to contain the growth in consumer prices the budget deficit should be reduced "at least to the zero level," considering that money supply and prices move up in correlation to budget deficits.
Still, demand for consumer loans is unlikely to fall much even after a half-point rise in rates.
Kule stated that she did not expect demand for loans to decrease, since homeowners and businesses could still borrow dollars and euros, the rates for which will remain unchanged.
She explained that since the lat was pegged to a currency basket, the Bank of Latvia didn't have much room for maneuver in regulating inflationary pressures, even more so since demand for loans depends more on global loan rates, which are currently "very low," she said.
Since the mid-1990s, the Bank of Latvia has gradually reduced its refinancing rate for lats, with the last cut occurring in September 2002 when the rate was lowered from 3.5 percent to 3 percent.
Latvia intends to peg the lat to the euro by 2005 and would like to introduce the euro starting in 2008.