Eastern Europe becomes victim of own economic success as inflation spirals out of control

The Associated Press
February 19, 2008

RIGA, Latvia: Artur Arushanov dreads shopping these days. A truck driver and father of three, he can’t bear to watch how food prices in Latvia are climbing relentlessly, with inflation raging at almost 16 percent annually.

“I wanted to buy my daughter granola cereal, but I can’t afford it anymore,” said Arushanov, 41. “I now spend about 60 percent of my income just on food, so I really have to think about what I buy.”

Not just in Latvia, but across Eastern Europe, inflation has descended like a nasty winter virus in the newest EU member countries, hurting household budgets and causing countries to see their long-term goal of joining the euro slip farther into the future as governments struggle to get prices under control.

Economies across the globe are grappling with inflation, thanks to costlier energy and food, but prices in Eastern Europe are soaring on a wave of economic growth as the former communist countries that joined the EU in 2004 and 2007 race to catch up with richer Western European nations.

Natalya Kiselyeva, 40, a Riga public school chemistry teacher, moonlights at a private school to afford Latvia’s food prices, which have soared 20 percent over the past 12 months.

“I don’t even bother trying to save money,” she said. “It’s practically losing value by the week.”

The average monthly wage in Latvia was 400 lats ($835) as of September, the latest figures available. And with a liter of milk costing 0.56 lat ($1.17), consumers are feeling the pinch. Last year, cheese prices jumped 44 percent, according to official statistics, and a recent survey found bread prices have soared 30 percent over the past three months.

Strong growth plays a role since increased economic activity means more demand for goods and raw materials. In 2006, Latvia’s GDP grew 11.9 percent and Estonia’s 11.4 percent ? the two best results in the EU. So in 2007, the two countries’ consumer price indexes jumped 14.1 percent and 11 percent, far beyond official forecasts.

Lithuania, Latvia and Estonia, EU members since 2004, got into what is called ERM-II, the union’s official two-year waiting room for euro hopefuls ? but have had to postpone the long-cherished dream because the inflation shows they do not have their economic houses in order.

Ministers now say 2012 will be the earliest that common currency will appear in the three Baltic countries. To get in, countries must meet strict standards for low deficits, debt and inflation; last year the “entry bar” on inflation was 3.4 percent.

Bulgaria’s chance of reaching the waiting room soon “has decreased considerably,” said analysts at RZB Group, and while targets of 2008-9 for ERM-II and 2011-12 for euro adoption “seemed too pessimistic a year ago, they appear somewhat optimistic at present.”

In Bulgaria, which along with Romania joined the EU in 2007, prices ended the year up 12.5 percent, even though some disgruntled Bulgarians believe the government is keeping the data artificially low to save face.

“I simply don’t believe the official statistics. When I calculate my household’s expenses for last year, I come up with an annual inflation of more than 20 percent,” said Angel Kuzmanov, a 58-year-old technician.

In Cluj, 250 miles from the Romanian capital, Bucharest, teacher Dorina Pop, 55, said, “I cannot save anything, all my money goes on food, taxes and utilities. I will soon retire and I am horrified about what will happen to me.”

The National Bank of Romania was forced on Feb. 4 to raise the core interest rate to a painfully high 9 percent after 2007 inflation hit 6.6 percent. Higher rates are central bankers’ chief tool against inflation.

But such textbook monetary policy works poorly in the new Eastern Europe, where consumers can take out loans in euros and U.S. dollars, currencies that the national banks cannot so easily regulate. That swells the money supply ? meaning more cash chasing the same amount of goods.

In Latvia, where inflation hit 15.8 percent in January ? the highest in the 27-member EU ? the situation was exacerbated by speculation in real estate, on which there was no capital gains tax before last summer.

The rest eerily resembles the U.S. real estate boom and bust. Soaring property prices inspired optimism, and Latvians went out and shopped with abandon, buying Toyotas, trips to Paris and flat-screen televisions.

Meanwhile, Latvia’s government ran deficits. Government spending piled on top of private sector demand, further overheating the economy. For years, the nation’s central bank chief, Ilmars Rimsevics, badgered ministers to curb expenses, but the government ignored him.

“The good news is that the government is heeding expert advice on maintaining a fiscal surplus despite slower GDP growth,” Rimsevics said. GDP stands for gross domestic product.

Wage growth is another destabilizing element of the inflationary equation. EU membership has allowed people to move to Britain and Ireland for better-paying jobs, leading to labor scarcity that drives up wages. Throughout Riga, Latvia’s capital, there are signs inviting both young and old to come work ? as bus drivers, cashiers and waiters. In neighboring Estonia, the opening of a major hotel last year was postponed for lack of staff.

In the third quarter last year, Latvia’s average wages jumped at an annual rate of 33 percent. But without an equal increase in worker productivity, such wage hikes undermine a company’s competitiveness.

Economists agree Latvia’s prices will continue to grow in the short term as natural gas, electricity and heat are raised to Western European levels.

Maija Krumina, who lives in a village near Valmiera in northern Latvia, said rural residents have switched to survival mode. Many have stopped going to stores and instead are relying on their own milk, eggs and pork. What they don’t consume, they sell to one another.

“It wasn’t like this a year ago,” said Krumina, 56. “Prices just don’t make sense anymore, especially when Latvian bread is more expensive than German bread.”

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