Publication: Monitor Volume: 7 Issue: 28

In contrast to the leading transition economies of Central Europe–where annual inflation rates have generally been around 10 percent–the Baltic states have for years been able to keep inflation rates at or below levels reported in European Union countries. Low inflation rates have helped Baltic governments to claim that their economies are more prepared for membership in the EU’s economic and monetary union than countries like Poland and Hungary. Baltic inflation rates rose in 2000, however, with Estonia reporting the strongest price pressures.

Inflation increased in Estonia last year for the first time since 1992. Average annual inflation for 2000 was 3.9 percent, up from 3.3 percent in 1999. In December 2000, prices were 5.0 percent higher than a year earlier, with the increase largely due to higher fuel prices. Rising prices for food, housing, and transport services provided additional inflationary pressures. Administratively regulated prices climbed 7.4 percent. Free market prices rose 4.1 percent. The Bank of Estonia expects inflation rates to remain above 5.0 percent at least until mid-year, due to strong economic growth and planned rises in administratively regulated prices. In addition to having the highest inflation of the three countries in 2000, Estonia was also the fastest growing: GDP was reported up nearly 7 percent during the first three quarters of the year, following a 1 percent decline in 1999. Inflationary pressures in Estonia would be worse, were it not for the anticipated impact of lower imported energy prices and the weakening of the dollar against the euro, to which the kroon is tied via a currency board.

Latvia last year also saw its first increase in average annual inflation since 1992. Average inflation rose to 2.8 percent, compared to 2.4 percent in 1999. In contrast to Estonia, however, price pressures in Latvia seemed to be moderating at the end of last year: Prices in December were only 1.9 percent higher than in December 1999. Food prices remained depressed, and lower excise taxes reduced the fuel prices by 6 percent during the second half of the year. As in Estonia, however, price pressures in Latvia are expected to accelerate in 2001, especially since many regulated prices remain below cost-recovery levels. Latvian government agencies regulate prices on some 25 percent of the economy–including energy, water supply and telecommunications–and the share of regulated prices for consumers continues to expand. The statistical office has calculated that increases in regulated prices will add 0.5 percentage points to Latvia’s inflation this year. Also as in Estonia, a strong economic recovery could boost inflation in Latvia: GDP was reported up 5.4 percent during the first three quarters of 2000, compared to only 1 percent in 1999.

Last year’s rise in inflation was most modest in Lithuania, where average inflation rose to only 1.0 percent from 0.8 percent in 1999. The strongest inflationary pressures came from prices for fuel, communications and transport, and housing. Food prices, which account for 40 percent of Lithuania’s consumer price index, fell nearly 2 percent last year. Economic growth in Lithuania was also the weakest in the Baltics: GDP growth for 2000 has been reported at only 2.9 percent, following a 4.2 percent output decline in 1999. Lithuania’s current account deficit also continues to drop, falling to only 4 percent of GDP through the first three quarters of 2000. This is a sharp change on 1995-1999, when Lithuania’s current account deficit averaged above 10 percent of GDP.

Because administered prices are expected to rise toward cost-recovery levels in all three countries, inflation is likely to accelerate modestly in the Baltics. Electricity prices are likely to be raised 5 percent in the second half of 2001, and food prices can be expected to recover from their current depressed levels as well. Rising wages will also put upward pressure on prices. But, as in Estonia, Lithuania’s currency board will continue to serve as a brake on inflation. Latvia’s pegged exchange rate regime serves much the same purpose. In any case, Baltic inflation rates are likely to remain well below their eastern neighbor’s: Consumer prices in Russia rose 20 percent last year, and inflation in 2001 is unlikely to fall sharply from this level (Bank of Finland, “Baltic Economies in Review,” no. 1, 2001).