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Thursday, June 28, 2007

Latvian Ministers Change Their Tune on Economic Outlook

From the Baltic Times:

Ministers change tune on economic outlook, but are they two years too late?

RIGA - Finally, a top government official has come out and said what many – from the erudite analyst to the bewildered consumer – have been waiting to hear about Latvia’s irrational economic boom, which is threatening to propel the country into a prolonged cold spell. “Salaries have been growing at a cosmic speed during the rule of the present government,” Prime Minister Aigars Kalvitis told a public private council on Aug. 15, referring to the current 33 percent annual rise in gross salaries. “If pay rises continue at the same rate, we will simply blow up this country,” he said.

Such illustrious hyperbole – Latvia “blowing up” thanks to a time-bomb of skyrocketing wages, high inflation, a labor market crunch and easy credit – is a far cry from official rhetoric as recently as a year ago. Previously ministers bragged about Latvia’s double-digit GDP indicators and shrugged off eurozone membership deadlines, reiterating that the primary economic goal was to raise living standards to average EU levels as quickly as possible. As Finance Minister Oskars Spurdzins said last December, “If we do not maintain the growth rate [of 7 - 10 percent], then of course we will not reach the average EU living standards that soon, or we will probably never reach them at all.” And so the ruling coalition continued to compile growth-stimulating budgets at a time when drastic fiscal restraint was in order.

As Valdis Dombrovskis, a member of the opposition party New Era, told the Russian language Telegraf recently, the government’s economic policy has been “to push the pedal to the metal.” The results are well known – and continue to haunt Latvia. On Aug. 17 Fitch, a major international ratings agency, downgraded several of the Baltic state’s ratings. “The Latvian economy is severely overheating, and Fitch considers the policy reaction of the government to be insufficient to restore the economy to a sustainable growth path,” the agency said in a statement. The criticism echoes sentiment in other agencies, banks and international finance institutions such as the IMF: Latvia’s government hasn’t done near enough to combat overly high economic expansion.

Arguably, the Kalvitis government, which has been in control since December 2004, made its biggest mistakes when it compiled pro-growth budgets for 2006 and 2007. On Nov. 14, 2006, the Cabinet announced a budget plan with a 1.4 percent (of GDP) deficit, which Parliament eventually passed. With that stroke the government’s primary lever of economic regulation – fiscal policy – was thrown to the wind. In fact, as of last year a balanced budget wasn’t even seriously considered in the country’s medium-term plans. Finance Minister Oskars Spurdzins said on Dec. 11 that a zerodeficit budget “could be achieved by 2010.” In the meantime, average annual inflation reached 6.5 percent last year, considerably above the government’s target of 5 - 5.5 percent set in December 2005. The Finance Ministry, in fact, has consistently been way off mark.

In December the ministry predicted inflation in 2007 would be 5.9 percent. It is now clicking along at 9.5 percent and breaking records on a monthly basis. Past mistakes aside, the question now is whether the government has the will to make the painful decisions to prevent a meltdown. One idea that is being floated is to link all wage increases for state-sector employees with productivity. But this is likely to trigger a further exodus of doctors, teachers, policemen, postal workers and public transportation drivers and intensify Latvia’s labor crisis. Shelving state-subsidized building projects is another idea, and perhaps the most crucial since public demand is “squeezing out” private demand, particularly in the construction sector. Kalvitis told the council last week that the government could no longer invest in new development projects, since budget money is going to salary hikes. Yet the Castle of Light, the grandiose library project, is proceeding as planned and will soak up some 11 million lats (15.7 million euros) this year.

Even Bank of Latvia Chairman Ilmars Rimsevics has warned about the macroeconomic repercussions of this project, but the demiurge behind the library, Culture Minister Helena Demakova, is a fellow party member of Kalvitis. Construction is slated to begin Nov. 18. Transport Minister Ainars Slesers is as equally keen on a new international airport for Riga, though the government has yet to decide how to finance this. Meanwhile, ministers also seem to be changing their tune on guest workers. In December Kalvitis said the government did not plan to open the country’s doors to foreign workers and that employers should be encouraged to raise productivity and to raise salaries. “If borders are opened up, all this [present growth] will be destroyed, so the borders will not be opened,” Kalvitis said Dec. 13.

On Aug. 20, however, Slesers was quoted as saying Latvia should attract guest workers to fill the yawning labor deficit. “In such an intensive phase of development we simply don’t have the resources,” he said, suggesting that foreigners could be invited to work on specific construction sites. Slesers, in fact, seems to have taken the opposite standpoint from Kalvitis on the question of rising salaries. In an interview with Baltic News Service, he said that the salary increases are the only way of stopping people from leaving Latvia, and conversely, to get them to return. “We have to create workplaces enabling people to earn good money,” said the minister, predicting that Riga would become one of Europe’s most expensive cities.

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