Inflation in Latvia will decrease this year, but will continue to be above the European Union (EU) average, Uldis Rutkaste, Head of the Monetary Policy Department of the Bank of Latvia (LB), said on Tuesday, January 24, at the meeting of the Saeima’s Budget and Finance (Tax) Commission.
According to the forecast of the Bank of Latvia, inflation will be around 20% at the beginning of the year, and around 5% at the end of the year. Rutkaste explained that Latvia’s high inflation can be explained both by global factors and local characteristics. The prices of food and energy resources are one of the causes of inflation, but Latvia spends more of its income on food and energy than in the EU.
Likewise, the transmission of world prices to local prices occurs faster, Rutkaste pointed out, explaining that Latvia has more flexible price formation mechanisms, for example, administratively regulated prices grow faster. Elsewhere in Europe, fixed tariffs are not so transparent.
Among the reasons for higher inflation, Rutkaste also pointed out that Latvian food producers are much more fragmented,
there are many small businesses whose profit margins cannot absorb global price increases.
“Inflation is also largely influenced by an opportunistic approach – companies price possible future growth in their production, and also act according to the principle “If everyone’s prices rise, we will also rise”, said Rutkaste.
Meanwhile, LB President Mārtiņš Kazāks emphasized at the commission meeting that the highest point of inflation in the Eurozone was reached last year, and it is gradually starting to decrease. In Latvia, inflation also slowed down in December. He emphasized that inflation slows down economic growth, so monetary policy will have to be used to free the economy from this problem.
Kazaks also pointed out that the European Central Bank (ECB) has started rapidly raising interest rates to curb inflation. “If high inflation persists for a long time, it appears in biased wage and price increases, so the rates will be raised in the future – expectedly up to 3.25%,” said Kazaks.
The head of the LB emphasized that long-term and excessive fiscal support can also make it difficult to limit inflation, so the support should be timed, targeted and proportionate. Kazak also added that already
next year, the European Commission could return to the requirement to comply with fiscal discipline norms.
Rutkaste informed the deputies that a moderate economic decline is expected in Latvia this year, and Latvia will be one of the few EU countries where a recession is expected. Although the recession will be weak and shallow, Rutkaste stressed that the decline in consumption will be sharper, possibly exceeding 5%. However, the recovery from the recession will also be rapid.
Rutkaste explained that Latvia’s slower progress through the crises is determined by a weaker starting position – insufficient investments and low growth potential. Latvia’s growth has slowed down, so it is much easier to fall into recession. Rutkaste emphasized that investments in Latvia have been very weak, especially in recent years, that’s why
capital accumulation was much more “anemic” than the rest of the Baltic countries.
Also, Rutkaste pointed out that labor productivity in Latvia is starting to fall behind in recent years, there is a greater difference between the dynamics of wages and the dynamics of productivity, which is growing much more slowly. The labor shortage in Latvia is still significant, and it drives wages up.
Rutkaste noted that the amount of support in the crisis has been sufficient so far, but in the medium term, the emphasis should be placed on investments financed by EU funds. In the future, the flow of EU funds should increase, and if Latvia continues to not use this money, it will simply disappear. Also, the budget deficit in Latvia in recent years is among the largest in the EU, so additional fiscal stimulus is not relevant from a macroeconomic point of view. He also added that it will become more and more expensive to stimulate the economy in the future, as the cost of servicing the national debt will increase quite rapidly compared to the beginning of the Covid-19 pandemic.
In order to increase productivity and labor productivity, crediting is necessary, Kazak emphasized, adding that the promotion of crediting requires the consolidation of the small bank segment in order to increase the ability to lend. Also, LB must improve credit risk regulation to facilitate lending and look for new market participants. LB should also continue the dialogue with market participants to promote lending.
Santa Purgaile, the deputy president of the LB, also admitted that macroeconomic forecasts and the rise in interest rates do not contribute to the availability of financing – both housing and consumer lending have slowed down. She emphasized that uncertainty does not stimulate active borrowing. Also, Purgaile pointed out that it is necessary to think about how to inject additional investments, how to develop the capital market. According to her, a strong stock exchange is needed, so state capital companies could make a partial public offering on the stock exchange.
Read also: Banks reduce the Latvian GDP growth forecast for this year
