After months of outpacing salaries, inflation has been grinding to a halt in recent months, dropping to 3 percent in February, the lowest level in nine years.
Yet this is a mixed blessing for struggling Ukrainian households, as a slowdown in cost of living hikes comes with weaker economic growth.
The ongoing debt crisis in the European Union has weighed on global markets for more than two years, and is likely to produce a second bout of recession in the first half of the year. Further abroad, a slowdown in China will weigh heavily on global growth, and thus on the situation in the sensitive Ukrainian economy.
Inflation was initially driven down by last year’s bumper crop. The abundance of food on the market and export bottlenecks that kept much of the harvest in Ukraine maintained the price of the average consumer basket stable.
In this Ukraine’s situation resembles that of its regional peers, said Vitaliy Vavryshchuk, macro-analyst at the Kyiv-based investment bank Concorde Capital. In Russia, Georgia, Kazakhstan and other countries the combination of sluggish consumption and a plentiful harvest kept prices low.
“Take any country in the region, and the situation is generally the same,” Vavryshchuk said.
But while the current price stability is likely to continue until June-July, he noted, the reasons had shifted to the demand side: restrictive monetary policy in the European Union, slower rises in household incomes, and a low levels of lending.
It now appears that it is not just the old continent that is slowing down. Indeed, there is growing consensus that China, a major economic motor in East Asia and the world, is reducing speed. According to a report by Erste Bank, the construction boom in China’s major cities is now petering out, which will reduce demand for steel – Ukraine’s top export and source of hard currency.
Domestic steel output was down 7 percent on a monthly basis in February, though the extreme cold weather was partially to blame.
With no positive results in sight for renewing billion-dollar loans from the International Monetary Fund or lowing the price of Russian natural gas imports, the combination of capital outflows and external debt will continue to put pressure on the hryvnia.
Experts have speculated that further falls in inflation, reflecting the weakening demand, would likely lead to monetary stimulus programs, likely in the form of lower interest rates. This may be difficult, however, given the state’s need to attract capital to cover the year’s debt redemptions.
The big question, however, is what will happen to the exchange rate, with the authorities facing a Catch-22 situation. A strengthening dollar means Ukrainian exports are becoming more expensive. Already a December report by international investment bank Troika Dialog calculated that the gains in price competitiveness caused by the 2008-2009 devaluation had all but worn off.
On the flipside, a new devaluation would be socially unpopular ahead of the October parliamentary elections and could spark a panic among current investors, making this option unlikely but not impossible.
With no positive results in sight for renewing billion-dollar loans from the International Monetary Fund or lowing the price of Russian natural gas imports, the combination of capital outflows and external debt will continue to put pressure on the hryvnia.
Since August 2011 the National Bank of Ukraine has used almost a fifth of its reserves to prop up the currency. In a note to investors, investment bank Dragon Capital estimated that the NBU could lose a third of total reserves this year should the situation remain unchanged.
Ukraine has so far managed to ride out the second wave of the financial crisis, but the ride is far from over.
Kyiv Post staff writer Jakub Parusinski can be reached at [email protected].
