Consumer prices in Latvia have risen by 11.3% since March 2021. The rise in prices affects both food and energy resources, and are expected to continue to rise this year, with real inflation to exceed current forecasts at the end of the year. Experts predict a rise in overall prices of up to 50%, so the Ministry of Welfare has proposed solutions to support the population – faster indexation of pensions, one-time support for seniors every December, increase of transport benefit, minimum income reform, revision of housing benefit and increase of minimum wage. Experts consider these support measures to be designed as an “acute solution” and inappropriate for promoting economic reorientation and change in population habits. According to forecasts, at the end of the year, Latvia will face a crisis, which is likely to be more severe than ones previously experienced.
The sanctions on Russia and Belarus will have a long-term economic impact globally, and experts estimate that a crisis is imminent and is expected to be even more severe than the global recession in 2008. This economy briefing will present the current situation in the national economy in Latvia, the offers of the Ministry of Welfare to overcome the expected crisis, as well as the alarming expert forecasts for the population and entrepreneurs for the second half of the year.
I Status-quo of the economy
Inflation continues to rise and consumer prices in Latvia have increased by 2.2% in April this year compared to March, but during the year – in April this year compared to April 2021 – consumer prices have increased by 13%, according to the Central Statistical Bureau. At the same time, the 12-month average consumer price level increased by 6.6% in April compared to the previous 12 months.
Figure 1. Percentage change in consumer prices in Latvia compared to the corresponding month of the previous year (2021-2022).
Source: Central Statistics Bureau of Latvia
The main impact on price changes in April this year compared to March was the rise in prices for food and non-alcoholic beverages, clothing and footwear, housing-related goods and services, transport-related goods and services, alcoholic and tobacco products, restaurant, and hotel services.
As inflation rises, unemployment falls. At the end of April this year, the observed registered unemployment rate in Latvia was 6.5% of the economically active population, which is 0.3 percentage points less than at the end of March. At the end of April 2022, a total of 57,223 unemployed people were registered, which is 2,976 less than a month earlier.
At the end of April, the lowest registered unemployment rate was still in the Riga region – 4.6% of the economically active population, which is 0.1 percentage points less than a month earlier, but the highest registered unemployment rate remained in the Latgale region – 14.2%, which is a decrease 0.6 percentage points compared to the end of March.
II Possible solutions to support the population
The rise in prices has affected both food and energy resources. The Ministry of Welfare (MoW) offers six initiatives to cushion cost increases. The first proposal is a more flexible indexation of pensions. Pensions are usually indexed in October, but MoW proposes to do so one month earlier this year, on 1 September 2022. On April 25, 2022, the Minister of Welfare Gatis Eglitis mentioned that the increase could be 10%. And this increase in pensions would affect around 563,000 people.
The second proposal is a one-off support for seniors each year, i.e. once a year in December, to provide an additional benefit to the recipients of the lowest pensions. For those with a pension of less than € 500, a benefit is planned to be paid in December to reach € 500.
It is also proposed to increase the transport allowance for people with disabilities. Increases in this benefit for people with disabilities are usually made twice a year. This year, MoW is offering an additional third payment of 50 euros, while from next year the benefit could be raised from 80 to 105 euros. 35,000 people receive this benefit.
The fourth proposal is to reform the universal minimum income. This would affect the state’s view of the minimum income and its threshold.
The minimum income level is a reform that is a task for the ministry from both the Constitutional Court and the European Commission. These minimum income thresholds will be updated in relation to the national average income from 1 January each year. So, as the economy grows, so do the thresholds for a minimum pension, a guaranteed minimum income for the poor. If there is deflation, then in essence it would decrease.
A review of housing benefit is also proposed. According to the MoW, state co-financing for housing benefits for municipalities would be 50%. From next year, housing rates for different categories of households could increase, such as people of retirement age living separately or people with disabilities.
The last proposal is to raise the minimum wage. In MoW’s view, the minimum wage has to be half or 50% of the previous year’s average wage. The MoW has already chosen this approach, offering to increase the minimum wage from 500 to 640 euros in 2023, which would be half of the previous year’s average salary – 1280 euros. The Minister of Welfare acknowledged that initially the ministry had developed an offer to raise the minimum wage to 640 or 700 euros next year, but now it has become clear that the increase to 700 euros would be too rapid.
III Crisis is imminent
The rise in the prices of fuel, natural gas, electricity and raw materials is already affecting and will further affect every inhabitant of Latvia. The low-income group will clearly suffer the most, as will families, which, in addition to educating their children, still have the burden of paying mortgages. This autumn will be harsh and will affect everyone – pensioners, teachers, entrepreneurs, politicians, regardless of status and current income levels.
Economic tensions will create a variety of internal security risks, starting with rising crime rates. Experts acknowledge that there is no one-size-fits-all solution to the current crisis, but the government should have launched a crisis management scenario ahead of time. Experts agree that indexation of pensions, raising the minimum wage and one-off benefits will not be enough.
Contingency plans and savings need to be considered not only at the level of businesses, households, but also at the level of public administration. Consideration should be given to where spending can be minimized, and an increase in excise duty on certain products, such as alcohol, cigarettes, and other tobacco products, should be considered.
The majority of the Parliament rejected the recent proposal of the Parliament faction of the Greens and Farmers Union to immediately decide to reduce the value added tax (VAT) rate to 0% for the necessary food products – milk, bread, meat, and eggs – to support the population and local producers’ conditions.
Several food and agricultural organizations have already called for a state of emergency in the sector and for immediate support measures to mitigate the negative effects of the crisis and increase competitiveness, both in the domestic market and in support of exports. One of the solutions considered by food producers is to reduce the VAT rate. The reduced VAT rate on food is applied by several European Union countries, also much more prosperous than Latvia.
An unforeseen crisis is imminent. The rise in consumer prices continues to rise, and inflation forecasts are higher than exceeded, given the rise in energy and food prices that intensified after the start of the war in Ukraine. This will dampen economic growth not only in Latvia but worldwide. On the part of the state, bureaucratic obstacles should be reduced for all energy-related issues, and any obstacles should be removed so that projects to strengthen energy independence can begin as soon as possible. The current high prices are a signal that the situation is changing negatively and dramatically, so it would not be right to dampen the current situation with various tax changes, as this will not allow society to reorganize and change its behaviour. The most appropriate solution would be to change the behaviour of subsidies and the habits of the population. In the autumn, entrepreneurs will struggle with the risks of bankruptcy and many will not endure this crisis. Unfortunately, low-income households and families with children who have mortgages will also lose in this fight. The criminogenic situation in the country could also worsen, as will the population’s disability to supply themselves with basic necessities. Entrepreneurs will face challenges, as businesses operating in successful industries so far could face real bankruptcy risks. This, in turn, will promote the development of the shadow economy, as savings will be made at the expense of taxes. Unfortunately, households could go bankrupt due to the rising costs and the government urgently needs to rethink the support mechanisms it provides to enable its citizens and businesses to survive the crisis.
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This briefing was written by the Institute of Economics of the Latvian Academy of Sciences, in collaboration with the China-CEE Institute, and is the intellectual property of the China CEE-Institute. https://china-cee.eu/2022/05/24/latvia-economy-briefing-latvia-on-the-verge-of-a-major-economic-crisis/