Inflationary Pressures

Economic News

22 Jul 2010
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Although most Ukrainians have enjoyed a substantial increase in their real incomes over the last couple of years, many of them do not necessarily feel much better off. One of the culprits is price inflation for basic goods, which is threatening to erode higher disposable incomes.

By the end of the first quarter of 2006, the individual income of the Ukrainian population had risen by 33.9% year-on-year, in nominal terms, with the national total reaching some $18bn, according to the State Statistics Committee of Ukraine. The nominal disposable income per capita was $102 at the end of March, helped to a large extent by higher social transfers and wage hikes, originally initiated by the former prime minister, Viktor Yanukovich, back in 2004.

But inflation came hard on the heels of government-sponsored wage hikes, shaving just over 10% off the value of the local currency, the hryvnya. In part, many economists argue, the higher per capita incomes are themselves to blame for inflation, as more money has been chasing a largely unchanged volume of goods.

This has been reflected in a sharp increase in the price of basic consumer goods such as sugar, meat and potatoes and in an upsurge in imported consumer goods that is changing Ukraine's trade balance in favour of importers. Nonetheless, some analysts argue that higher import volumes actually help to ease the inflationary pressure, despite the negative impact on the trade balance.

Meanwhile, the main source of inflationary pressure in 2006 is expected to be the rising cost of energy - oil, gas and electricity - which threatens to push up the inflation rate into the low double digits.

The cost of fuel rose by some 24.5% in 2005, triggering a significant rise in the cost of transportation, which rose 25.5%, and thus affecting the cost of local production. While the producer price index (PPI) was just within single digits at 9.5% in 2005, it is expected to rise significantly in 2006.

Yet, the Ministry of Economy is hoping that strong domestic demand will help to accelerate the overall rate of production output from 3.1% in 2005 to 9.5% in 2006.

Meanwhile, analysts argue that the biggest enemy of both inflation and growth this year is going to be a significant gas price increase imposed on Ukraine by Russia earlier in 2006 that raised the price of 1000 cu metres of gas from a very low $50 to $95.

Although this is still very cheap by east European standards, notoriously energy-inefficient Ukraine will initially struggle to absorb the impact of this price shock. Further gas price hikes, analysts say, could indeed be damaging for the country's macroeconomic stability.

Nonetheless, the National Bank of Ukraine (NBU), the main guardian of Ukraine's monetary policy, told the local media earlier this week that the actual inflation rate will not exceed 10% in 2006.

The central bank was apparently very impressed by slowing inflation in March-April of 2006, when the State Statistics Committee recorded two consecutive months of deflation and believes that price stability is now attainable.

Critics, however, believe that the NBU is simply trying to anchor people's price growth expectations in order to apprehend the self-fulfilling nature of negative economic scenarios. Such sceptics also argue that the NBU wants to head off any significant currency substitution, as Ukrainians trade in their local hryvnya for dollars.

Others argue that the slowdown in inflation is quite real, but caused by an overall economic slowdown in the country.

"The price pressure in a weak economy cannot be strong," according to Roman Bryl, the Intellinews Ukraine analyst. The market forces that provide price stability, Bryl argues in a report this week, now outweigh the forces that drive up inflation.

Also, the report argues that in there was a significant upsurge in local personal savings, ahead of the parliamentary elections, with risk-averse Ukrainians converting their incomes into dollars - still the preferred savings instrument of choice. Such a drain on local currency liquidity, analysts believe, helps to keep a lid on inflation.

While slowing growth and falling domestic demand due to perceived political risks may help to head off the full impact of sharp gas price hikes, the net rate of inflation is still widely expected to be just under 12% in 2006.

Such relatively high price growth in a slow growth economic environment, observers say, is not desirable. The hope is that the new government coalition that is still in formation will adopt policies that will spur economic policies, while sticking to a prudent monetary policy to ensure price stability.

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