Deflation replaces inflation as Latvian economy cools off

Jul 8, 2009, 13:04 GMT

Riga - Deflationary pressure in Latvia gathered pace in June, as prices fell markedly in the small Baltic country experiencing the European Union's most extreme economic reversal.

Compared to May, the consumer price index (CPI) fell by 0.5 per cent, according to figures released Wednesday by the Latvian national statistics office.

Annual inflation fell from 4.7 per cent to 3.4 per cent.

The figures represent a remarkable turnaround in Latvia's inflationary fortunes as the previously overheated economy freezes over.

Inflation peaked at 17.7 per cent as recently as May 2008.

The Latvian finance ministry warned that deflationary pressure was likely to continue for some time.

'The Finance Ministry predicts further price falls into the autumn months. ... Increased competition and the sharp correction of the labor market will make an additional contribution to the reduction of price levels,' a ministry statement said.

The Latvian economy contracted by 18 per cent during the first quarter of 2009 with a similar figure predicted for the year as a whole.

The outlook for the small Baltic state is tough with unemployment rising past 14 per cent, tax revenues falling by nearly a third and defaults increasing among people who took out loans during a decade-long credit boom.

'Even after a very significant tightening of fiscal policy in Latvia, the outlook for public finances is very bleak. New data shows that government revenues in June were 15.3 per cent lower than originally planned,' said a commentary from Danske Bank.

However, the Latvian government seems to have satisfied international lenders that suitable structural reforms have been carried out.

The European Commission has promised to pay a 1.2-billion euro tranche of a 7.5-billion-euro (10-billion-dollar) loan by the end of July with the International Monetary Fund (IMF) expected to follow suit with its own contribution of 200 million euros.