The Latvian central bank has urged the government to consider reinforcing its anti-inflationary measures, just days after Standard & Poor’s downgraded the sovereign, and months after a speculative attack on the country’s currency stemming from fears of a hard landing for the overheated economy.
Helmuts Ancans, head of the Bank of Latvia’s monetary policy department, told Emerging Markets that “the government’s commitment to dampen lending growth with a balanced budget in 2007-2008, and a surplus in 2009-2010, implies a significant step in the right direction. If consistently implemented, the plan could prove sufficiently effective to mitigate Latvia’s macroeconomic development risks in the coming years.”
But Ancans acknowledged that Latvia was not necessarily out of the woods, emphasizing the importance of the open-ended nature of the government’s strategy: “If domestic demand does not show significant signs of abating in the near future, the government stands ready to consider additional measures aimed at macroeconomic stabilization.”
Indeed, he hinted that the ratings downgrade should serve as an additional stimulus for the government to intensify its counter-inflationary measures, which “might include aiming at a budget surplus as early as this year, rather than postponing it to a later date.”
Standard & Poor’s had warned that the government’s anti-inflation plan “will only slowly reverse rapid growth in the current account deficit and external debt, resulting in an adjustment process that is potentially more disruptive than a more comprehensive policy approach.”
With regard to public understanding of the situation, Ancans perceived that borrowers “have become more aware of risks involved in the mismatch of currencies between their borrowings and earnings”, adding that the devaluation scare that spread through the country via text message in February had entrenched this understanding.
The central bank’s own capacity for combating inflation is being eroded by high levels of euro credit, estimated by Ancans at more than 50% of total lending, and by large-scale emigration.
“Our estimates put the figure of those having left for work in other countries at roughly 2.5% of the workforce, which does put upward pressures on wages and adds to labour shortages in a number of sectors,” Ancans told Emerging Markets.
Moreover, repatriated earnings from emigrants, totalling almost 2% of Latvian GDP and about half the value of EU structural funds, fuel already excessive domestic demand and prevent inflation from descending from levels of 6%-8% seen over last couple of years.
Nevertheless, Ancans ruled out any exchange rate adjustment, arguing that “revaluation, or devaluation for that matter, could not solve our current macroeconomic puzzle... In the absence of an appropriate response through fiscal and structural policies, monetary and exchange rate policy alone cannot solve the excess demand problem,” he concluded.