Publication: Monitor Volume: 6 Issue: 48

Inflation rates in Estonia, Latvia and Lithuania all dropped sharply in 1999. In December, consumer prices in December were rising by just 3.3 percent in Estonia, 2.4 percent in Latvia and 0.8 percent in Lithuania (compared to their December 1998 levels). Inflation is likely to increase in 2000, however, as taxes rise and as subsidies for rents and utilities prices grow toward cost-recovery levels.

Although the Baltic economies have recorded low inflation rates since the mid-1990s, last year’s very low inflation was due primarily to one-time external factors. First, the 1998 Russian financial crisis temporarily closed the Russian market for Baltic food exports. Because food exports are not easily re-oriented to highly-regulated, well-supplied West European markets, Baltic markets were flooded with domestic foodstuffs, bringing prices down. Because food makes up around two-fifths of the Baltics’ CPI baskets, lower food prices had a dramatic effect on the overall price index. Second, lower oil prices in the first half of last year lowered production costs. Lithuania’s inflation in particular is sensitive to changes in oil prices due to the importance of the Mazeikiai oil refinery.

The recovery of food exports plus higher oil prices in 2000 are expected to reverse last year’s downward trend. But other, more fundamental factors are likely to result in at least moderately higher inflation rates in the Baltics during the next several years. All three Baltic states are expected to continue raising administered prices to cost-recovery levels. Latvia, for example, regulates prices on some 15 percent of all goods and services, including the costs of energy, water and telecommunications. In Estonia, regulated prices (in particular for communications and transportation) rose 7.6 percent in January 2000, while nonregulated prices increased only 1.5 percent (BNS February 7).

The Balts’ desire for EU accession will require raising excise taxes toward West European levels, helping to further boost consumer prices. In Latvia, excise taxes for such goods as beer, coffee, and soft drinks increased on January 1. Along with higher prices for electricity, natural gas and heating, this helped boost inflation to 1.5 percent in January–the largest monthly increase in three years (BNS February 8).

In the distant future, Estonia, Latvia and Lithuania may need to further reduce inflation in order to meet the Maastricht criteria for entering the EU’s economic and monetary union. The Baltics’ more immediate concern, however, is preparing their economies for the rigors of competition on the EU’s single market. This is likely to require further increases in excise taxes and the prices of public goods, putting more upward pressure on prices in 2000 and beyond.