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Friday, February 8, 2008

Latvia Inflation January 2008

Latvia's January inflation rate rose to the highest level in more than 11 years as prices for food, alcohol, tobacco and gas advanced, adding to concern not that the economy is overheating, since we just saw in the GDP estimate that it is now cooling - but rather that someone is in the process of applying a large dose of "super coolant" - since these rates of price rises even as the economy slows only serve to act like shovels of sand thrown into a rather delicate piece of machinery. In other words, watch out for the rate of the slowdown!

The rate, the highest in the 27-nation European Union, rose to 15.8 percent from 14.1percent in December, the Statistical Office said today in the capital Riga. Consumer prices rose a monthly 2.8 percent, compared with an gain of 0.7 percent in December. So as the economy decelerates, inflation accelerates.

Inflation is now almost five times the pace of the average price growth in the 15 nations that share the euro, making it more likely the Baltic nation will be unable to adopt the euro currency for many years to come.

Quite a lot of fuss is being made about the weighting given to food in the calculations of the local price index, but if we look at the european harmonised reading - which we don't yet have for January - which uses a more standard methodology, then inflation in December was 14% as opposed to 14.1% on the Latvian index, so the difference isn't that large (indeed it has always been within 0.1% over the last 6 months, so even using the harmonised index the reading is unlikely to be less than 15.7 - ie this isn't all about food by any means).


hcpi said...

Has anybody seen some comments on these inflation figures from central bank?

Edward Hugh said...

"Has anybody seen some comments on these inflation figures from central bank?

Interesting question. They are notably silent about what to do about all this. But then again they effectively practiced self-castration when they went for the Lat-euro peg. Monetary policy effectively stopped there. All they can do is sit back and watch. They can urge the government to run a bigger fiscal surplus, but it may well even be too late for that to have any effect, and by the time it did impact it might well strike in just the moment that the Latvian economy started seriously deflating - last March would have been another matter entirely - so what we have now is just one huge mess.

For what it is worth here is the relevant extract from the January "Recent Economic Developments and Banking in Latvia" statement.

In December 2007, inflation surged to 14.1%. The rising costs of previous periods, to a great extent driven by higher expenditure on energy and labour, made some administered prices soar (those of house maintenance and transport services in particular), and a stable domestic demand brought about a particularly steep rise in non-administered service prices (13.5% per annum on average). Moreover, in the second half of 2007, the pressure of the global food market trends on grain and dairy product prices in Latvia intensified. Fluctuations of oil prices were in part offset by depreciation of the US dollar, hence fuel price rises were less pronounced and contributed a mere 0.2 percentage point to inflation. With costs on an upward trend (driven also by projected escalation of energy costs) and due consideration of lagged effects, inflation rate is likely to be the very last indicator to respond to the national action plan for stabilisation of macroeconomic situation and moderation in the economic growth. The current upward inflation trend is likely to continue at the beginning of 2008, with easing anticipated only in spring or even mid-year. This assumption builds on administratively regulated price rises, both already in effect and to be approved by the Public Utilities Commission in the near future, on excise tax increases (substantial for tobacco products, moderate for fuel) and on the impact of energy prices on the components of core inflation. With the high inflation rate of the first half of the year heading for a gradual slowdown, inflation may be down to around 9% by December 2008, according to the Bank of Latvia forecasts. Turbulence in the oil market and global food market fluctuations do not suggest a more dynamic price stabilisation scenario, with the average annual inflation rate at around 13%.

In other words platitudes.

Of course they do also say,:

Following Latvia's accession to the EU, the Bank of Latvia's policy is based on the strategic goal to prepare the country for a full-fledged participation in the Economic and Monetary Union. In the light of its commitment, Latvia is aiming towards both nominal and real convergence with the EU member states. Though real convergence is a long-term objective, Latvia is well on its way of achieving it.....Although Latvia complies with the majority of the Maastricht convergence criteria necessary for joining the Economic and Monetary Union already now, the initial plan for the adoption of the euro in 2008 has been revised due to the high rate of inflation.


In September 2007, the Latvian Government revised the initial plan for the adoption of the euro and decided to specify the target date at the latest 24 months prior to the actual changeover to the euro when the three-year forecasts of Latvia's Convergence Programme come close to the compliance with the Maastricht criteria. According to the Ministry of Finance, Latvia's changeover to the euro might tentatively take place in 2011-2013. The introduction of the euro in Latvia will be an issue of the EU multilateral relations affecting common interests of all EU countries. Therefore, the projected timeframe for the introduction of the euro is merely tentative and will gain an official status only after the completion of all negotiations and other formal procedures.

This all looks completely pie in the sky now.Even the central bank suggest that inflation may still be at 9% entering 2009 so 2011 looks completely unrealistic, especially given all the things which may well pass between now and then.

Obviously the EU are about to start using much stronger language. Accoring to the Guardian on Friday:

The European Commission will warn Latvia next week its fast-growing economy might face a hard landing and urge the country to tighten fiscal policies and keep wages under control, a draft report by the EU executive showed. The Commission's draft opinion of Latvia's mid-term fiscal plan said the Baltic country seemed to be underestimating the risks to its economy from high inflation, overheating domestic demand and external imbalances.

Edward Hugh said...

Of course those who can still manage to retain a sense of humour in this rather bleak environoment might like to consult the Monetary Policy of the Bank of Latvia page on the bank's website. There you will find:

Pursuant to the Law "On the Bank of Latvia", the primary objective of the Bank of Latvia's monetary policy is likewise to maintain price stability in the country.


Why was a fixed exchange rate strategy chosen? A fixed exchange rate strategy is one of the most effective instruments for reducing inflation, stabilising the macroeconomic environment and strengthening the public's confidence in the national economic policy during the initial phase of the economic reforms in transition economies. Therefore Latvia, like many countries, chose a fixed exchange rate strategy at the initial stage of the economic reforms.

So the fixed rate was adopted to try and contain inflation. And has the policy been effective? Has the experiment worked? I think at this point Latvians may have a right to know the banks opinion on this.

hcpi said...

it's actually quite obvious that 'experiment' hasn't worked not only for Latvia but also for other ERM2 countries with hard pegs. But the economy of Latvia is in a very poor shape, and hard landing is a very likely scenario