Rampant Inflation Hits the Baltics

High energy costs and competing demand are driving inflation up, and unlike Russia, Baltic governments can't simply freeze prices

If only managing a national economy were as easy in every country as it is in Russia.

The Kremlin's solution to rising food costs and dangerously high inflation that hit citizens in the pocketbook is easy: Freeze prices.

President Vladimir Putin's regime effectively took this step in October on fears that steadily rising prices of staples such as butter, which increased 9.4 percent in September, would spoil voters on Putin's United Russia party in advance of Sunday's parliamentary elections. This would work if the trend, expected to push Russian inflation to 11.5 percent this year, were a temporary, minor annoyance.

Problem is, it's not.

Growing demand in surging economies such as China, floods and droughts that crippled key harvests, and the biotech industry's appetite for grain are driving global food prices higher and, coupled with high energy costs, bringing inflation along for the ride. Rich and poor countries alike are being affected. This fall Italians protested rising pasta prices, and there are intimations of civil unrest in Bosnia and Herzegovina, where butter is reportedly 65 percent more expensive today than three months ago.

Economists are just starting to study "agflation," but already there are signs it represents a global economic shift away from the days of sustained low inflation. Agricultural prices are particularly susceptible to market vicissitudes, but the current trend is unusual because it's affecting all food commodities. And with rapid growth in China and India likely to keep demand high, prices aren't expected to fall soon.

This poses a unique challenge to Russia and many of the region's other post-communist countries, where food comprises a comparatively large portion of the consumer-price basket. In Bulgaria it's 35 percent, for example, compared to the eurozone average of around 20 percent. Many of these countries are already grappling with dangerously high inflation, and year-end projections continue growing, posing threats to their economic modernization that will require action more serious than price fixing to offset.

Inflation is getting so bad in Russia that the country recently had to abandon its early 2007 forecast of 8 percent for a figure in the double digits. The indicator is similarly high in the Baltics, and the Visegrad Four, while in better shape than their neighbors, are nevertheless seeing price growth around 5 percent. Even Armenia, which has been able to marshal inflation in a period of rapid GDP growth since the late 1990s, is battling inflationary pressure this year.

It's important to note that price increases will be inevitably higher in these emerging markets than in old European Union countries, for instance, because their sprinting economies are driving spending, but inflation is started to be felt as the weight around their ankle.


The Baltic economies are in a particularly precarious situation. They're already in danger of overheating, but, because their currencies are pegged to the euro as the initial step to adopting the currency, their central banks are pretty much powerless to reign in inflation by raising interest rates. As a result, they're having trouble joining the eurozone because the European Commission enforces strict limits on inflation in its Maastricht criteria for entering the currency union.

Reducing expenditures could help bring these economies down from the red line, but, without independent monetary control, inflation will remain an impediment -- if not a wall -- to euro adoption. As a result, the Baltic countries are missing out on the increased economic prosperity that comes with joining a currency union.

Also euro hopefuls, the Visegrad countries -- Poland, Hungary, the Czech Republic and Slovakia -- are in a better position because, with the exception of Slovakia, which hopes to adopt the common currency in 2009, they haven't yet linked their currencies to the euro. Their central banks still have an economic toolkit to protect their economies, but at the moment high inflation expectations are making euro adoption look like a distant proposition.

On 23 November, Krzysztof Rybinski, Poland's deputy central bank governor, said eurozone entry could be "mission impossible" for the new EU member countries if commodity prices keep rising.

"The window of opportunity created by the global inflation tailwind might have closed in 2007," he said.

Inflation poses a similarly real threat to Russian and Armenian plans for upgrading their economies. Both are posting high growth but need to make significant investment in infrastructure, education and social programs in the coming years to reduce poverty and remain competitive in the long term, but rising prices will make it harder for them to foot the bill.

At the moment, at least, countries are struggling to find a remedy. Some are trying to combat "agflation" by taxing agricultural exports to keep food in the country. Russia has introduced tariffs on wheat and barley to complement its Soviet-style price controls.


Central banks are somewhat hamstrung because the global credit crunch is forcing them to pump money into their economies, which tends to increase inflationary pressure, but they'll have to step in. This will be a significant test, especially for the Visegrad Four.

"It's a pivotal moment because they've been able to anchor inflation expectations at low levels, but if inflation goes up that will damage that credibility," said Christoph Rosenberg of the IMF.

Economists have been predicting interest rate hikes in Poland and the Czech Republic. The Czech National Bank has been reluctant to take this step, which would likely further strengthen the record-setting crown that is cutting into the bottom lines of the country's largest exporters, but it surprised analysts by raising its rate to 3.5 percent on 29 November, a clear signal to the rest of the region that the bank is concerned about inflation.

Analysts are predicting further rises. This won't be easy on the Czech Republic's largest companies, namely the Skoda automotive group, as further rate increases will likely cut into export revenues by keeping the crown on the ascent. But it's a step central bankers appear willing to take to combat inflation.

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