Inflation wave hits pockets, policy in east Europe

Patrick Lannin and Anna Mudeva
March 13, 2008

RIGA/SOFIA (Reuters) – Miles apart, pensioners Alexander Ivanov in Latvia and Maria Vankova in Bulgaria are both grappling with the same silent thief: inflation.

Until recently eastern Europe had strong growth, but prices were fairly steady: now, led by food and fuel prices, basic necessities are rapidly being priced beyond people’s reach.

The elderly are feeling the sharpest punishment for their governments’ ambitions in taking the eastern European states into the European Union. But prices surging at double-digit rates also pose a dilemma for officials who are forced to choose between supporting growth and capping prices.

With price rises galloping beyond target levels, the rampant erosion of purchasing power is also delaying some countries’ hopes of adopting the euro.

For people in the east, much poorer on average than their western counterparts and spending more of their income on basics, price rises are a daily dilemma.

The rate of price rises in Bulgaria at 13.2 percent is not far behind Latvia’s 16.7 percent, the highest in the EU.

80-year-old Ivanov’s pension is 120 Latvian lats ($265) a month and his food needs are taking more than half of it. He has started to sell his belongings to find money to live.

“A month ago this cost 2 lats, now it costs 3,” he said holding a bag of curd cheese at the central market in Riga. “For us pensioners it is impossible, I don’t know what the government is thinking.”

In Sofia, 72-year-old Vankova is living off savings, unable to pay for power and medicines on her pension of 102 levs ($80.38) a month: “The situation is getting worse after we joined the EU,” she said.

Governments and central bankers tend to reassure people that the pressure of price rises will ease off in the second half of the year. Latvian Prime Minister Ivars Godmanis has said he sees inflation at between 9 and 9.5 percent by the end of 2008.

But on a policy level the challenges are tough.

“It is a much more testing time now,” said Lars Christensen, senior analyst at Danske Bank. “Some countries will do the wrong thing, and some will do the right thing — the point is that there is no optimal response (to the current inflation rise).”

The Baltic states and Bulgaria have not only had their hands tied by pegging their currencies to the euro, disabling them from adjusting interest rates to tackle inflation. They have also been forced to import low interest rates from the euro zone just when their own growth has been strongest.


Instead, governments use budget policy to rein in demand.

Bulgaria has the tightest fiscal stance in the EU with a surplus last year of 3.8 percent. Latvia and Estonia have also built up surpluses and commercial banks have slowed lending, which helps decrease consumer demand.

The quandary is that such fiscal rectitude is good for fighting inflation, but is not ideal when growth slows, as in Latvia, Lithuania and Estonia: Latvian and Lithuanian growth edged down to 8 percent in the final quarter of 2007 and in Estonia it has slowed to 4.5 percent.

High inflation can also increase political pressures.

In Latvia, the government has had to agree to index pensions twice a year. In Bulgaria, teachers, doctors, miners, pensioners and social workers have all protested to demand higher pay.

For Poland, the Czech Republic and Hungary — with no fixed rate regime enabling the central bank to use interest rates to fight inflation — the challenge is getting the balance right between dampening prices, potentially at the cost of growth.

Some independent forecasts also suggest that as the global economy slows, led by declining demand from the United States which should dampen demand for oil, inflation may calm down.

“In terms of the inflationary picture, we are close to the peak,” said Christensen at Danske.

“Governments have to avoid doing something stupid for the next half year or 7 months and then inflation will start to move down in the autumn and through 2009.”

But with grains prices supported by low stocks and high demand for biofuel use, the dampening effect may only be partial. And people are already alarmed.

In Latvia, a sense of impending crisis has come from daily newspaper reports about how food is now more expensive than in western Europe, even though salaries are much lower.

For instance, milk in a Latvian supermarket is about 0.50 lats ($1.11) at its cheapest, versus 8 Swedish crowns ($1.31) in Sweden, a difference of 18 percent in dollar terms.

At the same time, Sweden’s average salary is about 30,000 crowns ($4,924), five times Latvia’s 398 lats ($880.9), according to data from their statistics offices.

With record wheat prices making bread more expensive, Latvians are buying more potatoes than bread, according to a survey of food producers by business daily Dienas bizness.

Bulgaria’s average monthly wage of 250 euros is the EU’s lowest: many Bulgarians travel to neighboring Greece or even Turkey for cheaper food.

And official figures only tell part of the story.

“I have the feeling that food prices have jumped 100 percent,” said Mariana Petrova in the Bulgarian capital, a mother of four who runs a small business.

“If previously we needed 500 levs ($392) to cover monthly bills and buy food for our family, now we need over 1,000 levs … I often travel to Turkey on business and use the opportunity to buy cheaper vegetables, fish, meat,” she said. (Reporting by Patrick Lannin in Riga, Anna Mudeva and Tsvetelia Ilieva in Sofia; editing by Sara Ledwith)

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