Fears of inflation temper optimism in Baltics

International Herald Tribune – Paris, France
Rick Smith Tuesday, March 2, 2004

RIGA, Latvia Prime ministers and investment bankers are talking about a long-term economic upsurge for Estonia, Latvia and Lithuania, the three Baltic countries churning out some of Europe’s highest growth rates, as they prepare to enter the European Union on May 1.

But among everyday people, the optimism is tempered by a fear of inflation that is likely to occur as companies have to update and retool production to meet more exacting EU standards and as imports increase. Such shifts can jostle price levels considerably in small economies; the combined GDP of the Baltic states is about half that of Finland.

“I think that the main effect of all this on my life is going to be a rise in prices,” said Yuri Afanasev, a 25-year-old Riga resident. “A two-room apartment cost $13,000 two years ago and now it costs $40,000. The economy has been shifting as we get ready for the EU, and this will continue.”

Some of the fears are self-generating, said Ojars Kalnins, president of the Latvian Institute, a research organization in Riga. “The average person probably doesn’t know exactly what they’re afraid of,” he said, “but it is just that uncertainty that makes people nervous.”

But some of the concern appears well founded, said Uldis Osis, a former minister of finance in Latvia. “Certainly prices are going to go up somewhat in the beginning,” he said. After 50 years of a drab but uniform existence under the Soviet Union, which occupied the three nations in 1940, disparities in prices and in living standards have been created by annual growth rates averaging 5 to 7 percent over the past few years.”

Gaps are readily detectable. At Pelmeni XL, a dingy but crowded Russian-style cafeteria on Kaiku Street in central Riga, you can still get all the Siberian dumplings and borscht you want for under $1. Just around the corner at the new country-western restaurant and down the street at the spiffy outlet of TGI Friday’s, a younger and better-dressed set cheerfully pays 10 and 15 times that.

The signs of inflation are already apparent. Since the beginning of the year, for example, milk prices have risen about 20 percent in Latvia as dairies undergo renovations to adjust to the EU’s stricter standards of sanitation in production.

“A rise in milk prices won’t hurt the growing middle class that much, but it’s more difficult for people in the country and on fixed income,” said Paul Raudseps, editor of the editorial page of Diena, Latvia’s largest daily.

Many Latvians, Estonians and Lithuanians are accustomed to uncertainty after a dozen years of independence that has already done much to widen the gap between haves and have-nots. The hardships have been particularly hard on the elderly, the infirm and the uneducated.

“Poverty has clearly increased in these three countries since the collapse of the Soviet Union,” said Willem Buiter, chief economist of the European Bank for Reconstruction and Development, in London. “There has been a loss of various benefits and, crucially, of cheap energy.”

Although inflation predictions vary considerably, the development bank is predicting that inflation will rise to 3 percent in 2004 from 1.4 percent in 2003 in Estonia, to 3.5 percent from 3.3 percent in Latvia and to 2.7 percent from a drop of 0.8 percent in Lithuania. Several private banks predict larger spurts of inflation.

All three countries expect to receive EU subsidies and money for development. Officials in Lithuania, for example, estimate that it will get four times more from the EU than it will pay out over the next few years. The infusion of cash can be hard for small economies to handle.

“This always leads to some degree of waste and corruption, and it did in other EU entrants in recent years,” Buiter said. “There can be a tendency to build things like airports in the middle of nowhere if you suddenly have a lot of funds.”

The effect is magnified in the Baltics and other former communist countries because some of the rulers, carryovers from the Soviet era, are accustomed to divvying up state bounty without any discipline from markets or parliaments.

The problem of corruption remains despite some attempts to root it out. Latvia has a dedicated Bureau for Combating and Preventing Corruption advising the prime minister’s office, and Lithuania is in the process of considering the impeachment of President Rolandas Paksas in a case involving corruption.

Another jolt for the Baltics will probably be the realization of how vulnerable their industries and infrastructure actually are when faced with competition from Western Europe. As East Germany did 15 years ago when it was united with West Germany, the Baltics will have to deal with painful layoffs and bankruptcies for years.

Now that the Baltics are out of the Soviet orbit, their external trade is following a historical pattern by growing most rapidly with the Scandinavian countries. This is a plus because it solidifies links with some of Europe’s most prosperous and stable countries. But it also poses the challenge of standing up to stronger economies that offer formidable competition and the temptation to migrate for high-paying jobs.

Afanasev, the young Riga resident, has gone to work for a Norwegian company, where he earns the equivalent of $2,500 a month rather than the $400 he believes he would be earning in Latvia.

“I’m fortunate and will probably keep doing this while I can,” he said.

International Herald Tribune