On May 1 Latvia will become a member of the EU and is therefore supposed to benefit from the freedoms existing within the union: the free flow of capital, labor, goods and services. Let us review what each of these will mean for Latvians in the short- and midterm.
The free flow of goods presumes a relative equality of prices within the EU. Currently Latvia imports all major consumer durables, transportation vehicles, clothes and a good deal of foodstuffs. This means the prices of the latter are already in line with those in the EU. Only locally produced goods, which are in the minority and primarily consist of foodstuffs, will add to current prices. Therefore, we see no danger of a price boom in the goods sector.
At the same time one should take notice of the expected increase in electricity, gas and gasoline prices, which currently are significantly lower than those of the EU. A 20 percent - 25 percent price rise in energy prices is expected over a relatively short period of 1 - 2 years. As a result, a gasoline price surge should add to overall transportation costs and therefore the general price level. An energy price increase will in turn lead to an increase in the costs of all public utilities.
Considering the above, Latvia will come under inflationary pressure in the following years, and the Bank of Latvia has already taken steps to curtain inflation by increasing the basis interest rate for the lat by 0.5 percent in March. Unfortunately, the latter policy will be undermined on Jan. 1, 2005, when the Latvian lat will be pegged to the euro. After that, the euro and lat interest rates are bound to converge, which will boost the monetary base in the country and further boost inflationary pressures.
On the other hand, Latvia is a service-oriented economy, and services are provided by a local workforce and are significantly less expensive than those in the EU. Due to relative immobility, growth in service prices will be much slower and will restrain inflation to a good extent.
Regarding labor mobility, one should still keep in mind that almost all of the current EU member countries have placed significant restrictions on the new member countries' citizens for periods of several years. That is why we should not expect much of a migration from Latvia, especially one involving the country's highly qualified workforce. It is obvious that disposable income will grow, though in a very gradual manner; it will take years to bring local income levels to comparative equality with those of the EU. The positive news is that the imbalance in wage levels between Latvia and the EU will attract smaller processing and other labor cost-sensitive enterprises from the EU to Latvia, which will gradually decrease the level of unemployment.
Capital inflows in the coming years are imminent. The Latvian economy is expected to see major acquisitions on the part of larger international groups. Even though the market is small, all of the larger industries players in EU are expected to enter it by setting up representative branches. Financial intermediaries are expected to benefit the most when servicing those activities. As to the real estate market, there are several contradictory factors that will influence it. On the one hand, disposable income growth and increasing construction costs will stimulate real estate prices; but on the other hand, growing utilities costs, as well as global growth in interest rates that is accompanying the current economic recovery worldwide, are expected to influence the market conversely. o
Peteris Antropovs is head
of the investment department
at LATEKO Bank