The inflation outlook has increased substantially in the latest Latvijas Banka’s projections published in March 2022. Russia’s warfare in Ukraine has contributed to the soaring global energy and food prices. The uptrend in prices has been driven by several factors, including economic sanctions, disruptions in global supply chains, and concerns with respect to whether Ukraine, which is an important supplier of grain and other agricultural products, will be able to sow and plant. In view of the above, inflation projections for 2022 and 2023 have been revised upwards to 9.5% and 3.7% respectively. Inevitably, the assumptions about the expected development of energy prices have significant effects on inflation projections. Higher oil prices support fuel price rises, which in turn push up transportation costs of both raw materials and finished products, and also affect increases in prices of other goods in the medium term. The rise in natural gas prices means that it is not only the households having gas stoves or gas-fired central heating boilers that pay higher bills. Natural gas is also used for the generation of both heat and electricity. Stagflation is the price of ignoring all active factors in the equation.
Although most of February experienced peaceful concerns only with respect to the impact of the pandemic on the economy, prices in Latvia surged by 8.7% year on year. The rise in food and energy prices underpinned the spike in inflation. Moreover, it is expected that the above price hikes will be felt even more sharply in the coming months, with Russia’s invasion of Ukraine contributing to the already difficult situation resulting from the pandemic management and challenges posed by high energy prices.
At the same time, February witnessed an uptrend in a number of administered tariffs, including those of water, sewerage, and heat in several populated areas. Some cities are still awaiting an increase in these tariffs. However, May is the month when the state support program aimed at reducing energy prices expires. Prices of certain food products and energy resources increased at a more robust pace in late February and early March. Invasion in Ukraine brings eventual supply chain disruptions, economic sanctions, and reluctance from a significant part of traders and consumers to sell/buy goods produced in Russia. The growing demand and concerns about the availability of Russian, Belarusian, and also Ukrainian products on the market lead to an increase in prices of various goods, particularly those of food and energy, on the global stage as well.
The current extraordinary inflation is the result of a tremendous macroeconomic mistake of the state economic policy of developed countries. Supply chains remain degraded because it was not thought through lockdown policies. The deeply interconnected global economy does not have an on/off switch. Idle resources and idle workers don’t simply spring to life and produce goods and services on command. No conception of a structure of production, its temporal elements, or the ravages of malinvestment created by the political decisions to shutter businesses was taken adequately into consideration.
In addition to that, the states decided to stimulate directive-blocked demand in unprecedented amounts. Direct payments to the population led to inflation of exchange-traded assets. Support for loss-making and inefficient enterprises to save jobs and the adoption of huge infrastructure programs were combined with maximum monetary easing through zero-funding rates and large-scale programs of direct injections of liquidity into the banking system through the redemption of public debt.
The final and extremely significant factor in production inflation has been the rise in commodity prices, primarily energy prices. This process has three main causes:
- asset inflation, partly artificial and created by the government
- geopolitical tensions in Eastern Europe
- the forcing of the green agenda and the compression of traditional energy sources without sufficient development of alternative sources.
And the forcing of the energy transition, with insufficient funding and the development of alternative energy sources, has led to vulnerabilities in the energy supply.
It was projected that inflation would follow a downward path in Latvia at the end of the year, but the present situation shows that it will have to put up with the booming prices not only in the coming months, when the price rise might be more pronounced but also in the second half of the year. Currently, while active warfare is ongoing on Ukrainian soil, the projections are associated with a high degree of uncertainty, and the adverse inflation outlook scenarios may materialize. However, regardless of the scenarios that might materialize, Latvia has to strengthen its energy independence and facilitate energy efficiency. This is a costly and time-consuming process but at the same time necessary to stabilize energy prices and cushion the impact of strong price fluctuations on inflation in the future. The soaring energy prices are directly passed through to fuel and natural gas prices, but indirectly to heating, electricity, and food prices. Therefore, people on lower incomes will be most affected by these steep cost increases, since the above goods and services represent a substantial share of their consumption basket.
As a result of the complexity of all the factors and sequences mentioned above, globalization is torn into different parts of the cycle, and this is not a short-term process. This also means that the agenda of economic security and sovereignty will supersede the agenda of efficiency growth. The disruption of global production and logistics interactions and the clustering of production and logistics exchanges will inevitably lead to significant shifts in economies and growth rates. And that means inflationary pressures and lower effective growth rates, i.e. stagflation.