Ukraine: inflation crescendo

Ukraine`s inflation continues to spiral out of control, becoming Ukraine`s most urgent economic worry. Ukraine`s inflation rate hit 26.2% year-on-year in March, up from 21.9% in February and 19.4% in January, according to official statistics.

Ukrainian officials place much of the blame for the current spike in inflation on rising global food prices, higher charges for imported gas and an increase in budgetary spending. The price of bread has risen by more than 20% year-on-year in each of the last three months.

The price of eggs has risen by an average of 68% and the price of vegetables by 57%, though the largest gains have been registered in the price of edible oils and vegetables; the former rose by 115% in March and the latter by 100%. In 2007 Ukraine suffered and exceptionally poor harvest so these issues have impacted Ukraine more so than most countries.

Gas prices have also played a major factor in Ukraine`s inflationary surge. Ukraine buys gas from Russia at the rate of $179.5 per 1000 cubic metres - 40% cheaper than global prices of $250 per unit but a lot higher than the $70 it paid two years ago.

In 2006 Russian gas was $95 per 1000 cubic meters. Combine this with the fact that Ukraine`s fiscal policy has been expansionist over the past few years, it appears that inflation will continue to plague Ukraine throughout 2008.

Annual inflation in 2007 hit 16.6% and the government of Prime Minister Yulia Tymoshenko has pledged to contain the figure this year to 9.6% through measures it has promised to unveil soon.

In an interview on Ukrainian TV, Prime Minister Yulia Tymoshenko vowed to overcome inflation soon. "I made a commitment to the country when I became prime minister that we would overcome the galloping inflation we inherited from the previous government within five or six months," she said.

"This is a realistic forecast. And in five or six months time, I will report to the country on the halting of inflation. In five or six months, there will be no inflation in the country," she added.

Ukrainian and international experts are sceptical about the pledge of Tymoshenko, with most predicting a rate for the year of 12-15%. According to the International Monetary Fund`s (IMF) forecast, average annual  inflation in Ukraine would hit 20-22% in 2008.

"I have to say there is an unusual amount of uncertainty about this forecast," Robert Ford, IMF mission head for Ukraine, was reported as saying. "If you ask me in two months` time, my forecast may be different."

While global food prices and rising energy costs have had a negative impact on inflationary pressure, most of the inflation can be attributed to the dollar falling in relation to the Euro. As of February 2008 the US dollar had decreased in value by 12% against the Euro. As a result, Ukraine imports the inflation of rising international food and energy prices through its

dollar peg.

The Hryvnia rate has been de facto pegged to the dollar since 2000, fluctuating within a narrow corridor between 5.0 and 5.05 Hryvnia per one dollar since 2005.

Although the National Bank of Ukraine (NBU) has plans afoot to relax the band within which the currency fluctuates, the inflation pressure is set to pervade and worsen if the dollar continues to plummet.

Many experts agree that it is time to liberalise the Hryvinia and allow it to appreciate against the US dollar. The IMF, the Organisation for Economic Cooperation and Development (OECD), and a range of international economists have long urged Ukraine to alter its exchange rate policy in such a fashion.

Poland and the Czech Republic have long pursued a policy targeting inflation, which has led to lower and predictable inflation rates.

The Governor of the National Bank of Ukraine (NBU), Volodymyr Stelmakh, told local media, "The pre-conditions for strengthening the Hryvnia are now in place." However, the Governor made similar comments last year and no measures have been introduced.

There seems to be a psychological block preventing the NBU from pushing ahead with the move. Ukrainians have grown accustomed to a stable exchange rate and there is some concern about how economic agents, businesses, households and investors will behave if the Hryvnia appreciates.

Immediate measures must be taken, but as Tymoshenko continues to pursue a populist agenda leading up to the Presidential election in 2010, it is unlikely she will reduce public spending, although the IMF recommends to tighten the fiscal policy and aim for a balanced budget.

By Oxford Business Group, Online Economic & Political Briefings