July 11, 2006

RIGA/TALLINN : The Baltic states of Estonia, Latvia and Lithuania have recorded the fastest economic growth in the European Union since they joined in 2004, but economists are now questioning their ability to sustain it.

“We cannot maintain this growth rate for long. The Estonian economy is already seeing capacity problems, and price pressures are growing,” Maris Lauri, economic analyst at Hansabank Estonia, told DPA.

The Baltics’ record is remarkable. In the first quarter of 2006 Latvia recorded annual GDP growth of 13.1%, Estonia achieved 11.7% and Lithuania scored 8.8%, the highest rates in the EU.

However, commentators have wondered whether their economies are not going too far, too fast.

“Overheating is obviously a risk in an economy which experiences double-digit growth rates, and the longer the rates continue, the higher the probability,” said Silver Vohu, spokesman for the Bank of Estonia.

“We are beginning to see signs of a wage-price spiral, which could push up wages faster than productivity, harming competitiveness,” said Martins Gravitis, spokesman for the Bank of Latvia.

Latvia’s neighbours are on the alert for similar problems. Lithuania’s inflation is predicted to reach 3.5% this year, while Estonia’s stands at 4.7%.

Both are well above eurozone levels, although they are below Latvia’s.

“The wage-price spiral is definitely a risk, especially in those fields where productivity increase is limited. However, wages are, as a rule, determined by productivity growth,” Vohu said.

Both Lithuania and Estonia have already been forced to postpone their ambitions of joining the euro, with the European Commission in May rejecting Lithuania’s application on the grounds of inflation.

The housing market is another area of concern. Both Latvia and Estonia have seen explosive growth in property transactions since EU accession, and some fear that this growth, too, is unsustainable.

“Since current real estate prices are high in ratio to average gross wages, price stabilisation could be expected,” commented Vohu.

For the moment, however, opinion is divided over whether the trio are in danger of overheating.

Despite recent growth, they have barely 50% of the EU’s average GDP per capita, and some argue that the numbers are natural results of accession and modernisation.

“I think we have such rapid growth because of the legalisation of the grey economy? About 8% actually comes from economic growth, and 5% from legalisation,” Economics Minister Aigars Stokenbergs told the Telegraf newspaper last week.

“Therefore, (the government) does not need to take any extra measures to prevent possible overheating,” he added.