The Baltics are a warning sign for Europe: Inflation

Residents in rural Lithuania’s south began to tighten their belts after inflation reached an unimaginable 20% this year.

“People are purchasing less. It’s hard. It’s hard.

The same story is unfolding at the Aibe grocery shop across the main road of Sangruda. This sleepy village of 200 people lies close to the Polish border. Gintare, a 32-year old cashier, says that people lost their purchasing power and started saving money after the war. “Fuel, heating, and electricity became more expensive than they used to be, as well as taxes. . . Food was the last thing on our minds. “People take the most important things now, whether they are cheaper or discounted.”

The west has seen an increase in inflation to levels not seen for decades, but few places have seen a rise in prices like Estonia, Latvia, and Lithuania. Inflation rose to above 20% this summer in each of these countries, and it is currently at above 21% in all three.

Although there are some local factors that may explain the rise, the Baltics policymakers warn that this region could be a good indicator of how European price pressures will develop over the next year.

Martins Kazaks is Latvia’s central bank governor. He says that the Baltics are a “canary” in the coal mine for Europe’s inflation wave.

This is a troubling message for other European nations, where inflationary Pressure could continue to be high in winter and spring as rising energy prices feed through. Kazaks adds that “we have already front-loaded most external shocks.” It is still being experienced in other countries.”

Economists from the Baltics describe how experts from other European nations are shocked by the apparent acceptance that the public has shown in dealing with extreme inflation. “Colleagues from overseas ask me why there are no protests,” Greta Ilekyte (economist at Swedbank), the largest bank in the Baltics, says.

According to policymakers, the Baltic countries have two major advantages over other western countries. They have had high inflation over the years, with strong wage growth, as their economies catch-up to the rest of Europe. This means that the sudden leap was less shocking. Second, their decades-long Soviet Union occupation of Ukraine has made them more open to the possibility of populists exploiting the situation.

Ingrida Simonyte (Lithuanian prime minister), says that there is a greater understanding here than elsewhere in the world. It would be difficult to get widespread support for the idea that Russia has imposed sanctions against it, and this is why they’re charging high prices.

The Baltic countries had already seen an increase in inflation well before Russia invaded Ukraine in February. At the beginning of 2021, Estonia, Latvia, and Lithuania had all experienced low inflation rates. However, they rose to 7.5-7.2.3% by January 2019, well above the eurozone average.

The Baltic countries have also experienced high inflation in recent years, as was the case with Latvian inflation which reached 18% in 2008. This means that the most recent price rise has had a less significant impact on national psyches than other parts of Europe.

Kazaks says that inflation reached 950 percent in 1992, just after we had regained independence. It is not like Germans, who haven’t seen double-digit inflation in their lifetimes. It is something we all know is bad, but it’s not like it has never happened before.”

Gediminas SIMKUS, head of Lithuania’s central banking, says that people’s living standard have risen significantly in recent years. This makes it easier to absorb recent declines in purchasing power. This helps explain why the Baltics have not been affected by many of the strikes and protests seen elsewhere in Europe.

Lithuania joined the euro in 2015. Since then, wages have increased by two-thirds in Lithuania. Consumer prices have only increased by 40%. Simkus says that living standards have been rising. “So there’s an economic reason why you don’t still have riots,” Simkus says. Ilekyte points to the fact that Lithuania is now wealther, on a GDP per person basis adjusted for purchasing power, than Spain, Portugal, or Greece, and not far behind Italy.

Simkus says that the recent crisis has increased public support of the euro, despite the criticisms elsewhere on continents about the European Central Bank’s slow response in inflation. “Being part of the euro zone is a safety net. It’s not just about convergence and economics. It also provides a guarantee of our independence. This is how it’s perceived. He adds that it is an additional layer of protection.”

According to the central bankers, inflation rose faster in Baltics because of a variety of differences with Europe. These include the increased use of spot energy prices and less of the fixed contracts that many companies have in Europe. This is why we expect a faster reaction. Kazaks states that the full impact on other countries in the euro area is yet to be seen.

Simkus claims that the Baltics have higher inflation because they earn less than other parts of Europe. This means that people spend more of their income on necessities like food and energy, which has seen prices rise most.

He says that the costs of heat energy are nearly four times higher in Lithuania as a percentage of income than in Europe. “Expenses for solidfuels are almost three-times higher” This difference was calculated by Lithuania’s central bank and resulted in local inflation being 2 percentage points higher than that of the rest.

The local population is still concerned about what will happen during winter. “Inflation has done its work — the materials we need to grow flowers have become extremely expensive. Raimonda Skeberdiene (33), is the owner of a small farm that grows flowers on a dirt track near Sangruda. “Our costs have doubled in comparison to two years ago,” she says.

Vida, a neighboring farmer aged 63, says: “Everybody feels inflation. It’s not easy for everyone to earn a decent salary. Today, there weren’t many people in the shops. They used to buy everything. They now choose what to buy.

Like most European governments, the Baltic governments responded by offering support programs to reduce the impact of rising energy prices. “You have to balance what you can pass on consumers with what you can offset by excessive borrowing by the state. Simonyte says that nobody is content.

There has been relative political unity so far. Most parties are not willing to grant Russia a propaganda win by protesting too much. Gintautas Palauckas, the parliamentary leader of opposition Social Democrats in Lithuania, said that “We cannot play around and use any weapon we get to beat our opponent.” “It’s a matter that we face a common threat and we stand together on important issues. Our political system is still young and we won’t allow foreign agents to enter a fight.

There are concerns about the emergence of more extreme forces. Estonia’s far-right party Ekre, which is second only to the Reform party of prime Minister Kaja Kallas in Estonian politics, has consolidated its position ahead of March’s parliamentary elections. Ekre’s recent gains are largely due to anger at the rapid rise in inflation, according to pollsters.

Margarita Seligyte, director of Vilnius University’s Institute of International Relations and Political Science, said that Ignas Vegele is Lithuania’s most popular politician. He is a lawyer who was criticized for making anti-vaxxer comments about Covid-19. It will have political implications. She adds that there are some radical forces on the rise.

The war in Ukraine is still a powerful antidote for protests in these countries along the frontline, which are dominated by the west, Russia, and Nato, three decades after their independence from Soviet Union.

“There’s this realization: Let’s not be too critical, at least there isn’t war. We could have war in Russia, but the realization is more prevalent here than in other countries. It’s vivid here,” Seselgyte says. Ilekyte added: “Our memories are still fresh from the Soviet Union.” What are you protesting against if you’re going to protest? Ukraine probably.”

Already there are signs that the price pressures on the Baltic economies are starting to show their effects. Estonia and Latvia are the worst performers among the 19 members of the euro area so far this year. Their economies contracted by 2.3 percent and 0.4% respectively in the third quarter compared to a year ago.

The industrial sector has suffered the most, with production falling 5.8% in Estonia and 2.7% in Latvia in the year to Oct. Although Lithuania’s economy has performed better, the 2.5% growth in industrial output during the same period was less than the 3.5% growth in the entire eurozone.

The price of heating in winter is a major political issue. Each government must decide how much financial support they will offer. “I burn mulch. The price has risen, of course. Algis, a 78 year-old worker in Sangruda’s modest thermal power plant that heats local schools, foster homes, and other municipal buildings, says that the price of materials has also risen.

Some politicians in the region believe higher inflation is easier to manage in this region than in other parts of Europe.

It is much easier in this country. Simonyte says that he has seen double-digit inflation in other countries. “It is more pressing in countries where the labour market is stable and wage growth is much higher than what we have in this region of Europe.”

She also said that Lithuania is still being protected because it is still catching up to the European average in terms of economic terms. “We are in a more comfortable situation as a converging nation. It is possible to easily blow the public finances, but you need to be careful.

According to economists, the Baltic region’s high wage growth sets it apart from the rest of Europe in the past decade. It also boosts its ability for the current period of high inflation.

According to Eurostat, the European Commission’s statistics agency, wages in Lithuania have nearly tripled over the past decade. However, they have increased by about 95% in Latvia and 85% in Estonia in the last 10 years. However, wages in the EU have increased only 26% over the same time period.

Jens Magnusson (chief economist at Swedish bank SEB) says that Sweden is fortunate to see 1% or 2% real wage growth each year. “But the Baltics have had 6 to 7 percent real wage growth over several years, which provides a buffer to help them cope with high inflation now.”

Germany, which had not seen double-digit inflation since 1951 until this year, is more affected by such price increases than the Baltics where they are more common.

Magnusson states that 10 percent inflation in Europe is not as severe and damaging as 20 percent in the Baltics. Magnusson points out that the Baltic countries have more fiscal flexibility to support those most affected by rising food and energy prices.

After eurozone inflation fell to its record high of 10.6 percent in October, it was lowered to 10.1 percent in November — its first drop in 17 months. There was widespread relief by central bankers. Simkus states that the inflationary pressures within the euro area resemble what was experienced in Lithuania six month ago. Simkus also believes that the “peak in headline inflation in euro” is just around the corner. Ilekyte still predicts that inflation will reach 8-9 percent in 2023, according to her.

The governor of Lithuania’s central banks adds that, even if European wholesale energy prices don’t return to record highs, many goods and services will continue rising at well over the ECB 2 percent target for a long time. He said that he believes the transfer of these energy impulses to final goods and services remains to be seen. “That is precisely what worries me.”

Officials from the Baltics as well as the rest of Europe are concerned that the inflation surge will leave behind long-lasting traces. Kazaks, Latvia’s central bank governor says that this is not a temporary shock. “This is a permanent shift that requires structural solutions.”

He believes the EU must come up with an ambitious and coherent energy strategy. “If we fail to ensure that our countries have access to affordable energy, then we will lose energy-intensive companies and they will move. This will result in lower unemployment and lower growth.”

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