Latvia is considering a plan to combat inflation, possibly including some tax cuts, to get into shape to adopt the euro in two years, Prime Minister Valdis Dombrovskis said, expressing confidence about the shape of the Baltic state's finances. Latvia sees the euro as a source of stability and long-term low interest rates. Its lat is already tightly pegged to the euro and Latvia is in the ERM-2 euro waiting room. Most household borrowings are also already in euros.
To adopt the euro in 2014, Latvia must this year meet the euro zone entry criteria, including low rates of inflation and a low budget deficit. The inflation goal might be the main problem due to rising energy prices. That is why the government is considering an anti-inflation plan, though Dombrovskis said such a plan was good for the economy anyway, rather than just to meet the euro goals.
"We already have experience with high inflation back in 2005, 2006, 2007 and certainly high inflation is a problem for the economy. It's better to act quickly to see this anti-inflation plan in place," Dombrovskis told Reuters in an interview. He was referring to the double-digit inflation Latvia had in the year preceding its crash during the global credit crunch.
An anti-inflation plan could include a cut in excise or consumption taxes, which were hiked as part of the austerity measures, he said. The rate of VAT is currently 22 percent. The euro entry inflation target is a rate no more than 1.5 percentage points above the average of the three lowest rates in the EU.
The 12-month year-on-year inflation rate in February eased to 3.4 percent from 3.6 percent in January and from 4.0 percent in February 2011, but local petrol prices have been rising recently. Annual average inflation was 4.3 percent in February. Dombrovskis said the inflation goal was a moving target and he declined to predict whether Latvia would meet it.
However, he said the Baltic state was negotiating with EU institutions to make sure the judgement was as fair as possible. For instance, Latvia was pressing to make sure countries with falling prices be excluded from the measurement. "We are raising our concerns and there seems to be a degree of understanding. There are also debates about possibly excluding countries which are under IMF programmes in the euro zone," he added.
Dombrovskis' centre-right coalition took Latvia through one of the biggest budget deficit-cutting drives in the European Union over the years 2009-2011, when austerity measures equal to more than 10 percent of output were pushed through. The budget deficit shrank from about 10 percent of output in 2009 to about 4 percent in 2011 and the government expects it to come under 3 percent this year, meeting one of the main Maastricht criteria for adopting the euro.
"The budget is outperforming. I think we can say with a large degree of confidence that it will outperform also in March," Dombrovskis said. "That's certainly the intention (to meet the euro zone entry criteria). So we still stick with the plan to join the euro zone as of January 1, 2014," Dombrovskis added.