Publication: Monitor Volume: 7 Issue: 145

Estonia’s currency board and tight fiscal policy have been enormously successful in bringing down the country’s rate of inflation, from an average annual rate of 1,075.4 percent in 1992 when the currency board was implemented to 29.0 percent in 1995 and 3.3 percent in 1999. Last year, the rate of inflation rose for the first time since 1992, but only to 3.9 percent. This year, however, data for the first five months of the year suggest that average annual consumer price inflation will easily top 6 percent for the year.

In May, month-on-month inflation was up a higher-than-expected 0.7 percent, bringing year-on-year inflation to 6.9 percent (Stat.ee). Food prices are one of the major upward pressures on the index. The month-on-month rise in prices of services was only 0.2 percent, prices of manufactured goods were 0.8 percent higher, and prices of food products rose 1.1 percent. The prices of food and beverages were 9.5 percent higher than in May 2000. Food and beverages account for 27 percent of the consumer price basket, a larger weighting than any other commodity, so any jump in their prices boosts the overall index significantly. It was no surprise, then, when at the start of June McDonald’s Estonia raised prices in its six fast food restaurants by an average of more than 8 percent (3 kroons, or 16 U.S. cents) (BNS, June 11). The company said the hike was due to an overall rise in the cost of living. The large increase in food prices is at least partly in response to competition from higher quality manufactured food goods from the EU (as well as to the outbreak of BSE and foot-and-mouth diseases, which are driving up the price of meat). While increases in food prices can be expected to fall over the next few months due to seasonal factors, they may very well return to current levels in the fall.

Another reason for the rise in consumer price inflation is higher energy prices. In May, the producer price index was up 5.0 percent year-on-year, including an 11.2 percent increase in prices in the energy sector. This will work through the consumer price basket with a lag. Energy prices are expected to decline slightly over the year, but not enough to drag down overall prices. Increases in administered prices are another important factor: May’s year-on-year CPI growth of 6.9 percent included a 7.8 percent rise in regulated prices and a 6.6 percent rise in free market prices (BNS, June 7). While higher inflation will make it difficult for Estonia to meet the Maastricht criteria for adoption of the euro, authorities have no choice but to liberalize the remaining administered prices. These increases should work through the system within the next few years, so that when the requirements of EMU membership become a priority, bringing inflation back down should not be difficult.