Monday, December 24, 2007
Credit crunch, did someone use the expression credit crunch?
Saturday, December 22, 2007
"The Ukrainian economy has enormous long-term growth potential, as industrial efficiency continues to improve, financial markets deepen, and its structure of production evolves.
"However, there are near-term challenges. First, inflation is on the rise. While much of the increase in 2007 reflects food prices, strong domestic demand growth has intensified underlying inflationary pressure. Moreover, the current account position is eroding, and further deterioration in the years ahead—gas import prices may rise further and world steel prices may fall toward their long-term real average—could raise external financing risks. Finally, rapid credit growth points to rising risks in the financial sector.
Stability-oriented fiscal and monetary policies, a stronger monetary and financial sector policy framework, and progress on structural reform are needed to help Ukraine achieve high growth with low inflation and improve the living standards of all its citizens.
Does any of this sound familiar? It should do, at least to those of you with an interest in economics and what is going on at the moment in Central and Eastern Europe it should, since this profile is very typical of one we have seen extending itself right across the whole region in country after country over recent months. Claus Vistesen has already extensively covered (in this post) the issue of what is called "translation risk" (or what might get "lost in translation" if an effectively "dollarised" currency like the Ukranian Hryvnia is allowed to fall substantially at some point - to tackle, for example, the problem of the lack of export competitiveness which results from the combination of the rise value of the currency and the ongoing above-par inflation which is currently being sustained in many Eastern European countries).
GDP growth in the Ukraine has been "solid" but not "exaggerated" this year (think the Baltics or Bulgaria in comparison), and at this point been slowing slightly, running at a year-on-year rate of 7.2% from January to November.
The Ukraine government now forecasts inflation to stabilise at 9.6 percent next year, having missed its 7.5 percent target for this year. This view may be hopelessly over optimistic. Inflation ccelerated to 15.8 percent in November and will probably atttain 16 percent plus this month, according to a statement from President Viktor Yushchenko's office.
Inflation is the biggest of the "near-term challenges" according to the IMF. I would certainly agree, and while much of the increase we are seeing in 2007 reflects food price rises, strong domestic demand growth and a set of underlying structural demographics which also serve to intensify the inflationary pressure.
The Ukraine Cabinet announced on Nov. 21 that it now plans to run a budget deficit of 1.86 percent of gross domestic product next year, compared with the shortfall of 2.33 percent of GDP which was initially planned. The IMF argue for fiscal surpluses as a means of draining liquidity from domestic demand since, given the strong wave of inward capital flows that comparatively high growth countries like Ukraine are expeciencing, and the widespread availability of low interest non-local currency denominated loans.
The difficulty which comes into operation in a situation like that in Ukraine, where there is considerable dollarisation of the local economy, is that exchange rate and monetary policy become either effectively non-existent (in the former case) or impotent (in the latter) to correct growing competitiveness problems - since given the extent of dollarisation it is not practical to adjust the exchange rate downwards and increasing the interest rate only puts upward pressure on the currency, and encourages the contracting of non-Hryvnia denominated loans. The tightening of monetary policy also serves to attract additional funds in search of extra yield and these only serve to make the excess demand problem even worse.
Thus the only real arm left in the government policy arsenal is the fiscal policy one, whereby the government attempts, by running a fiscal surplus, to "drain domestic demand" from the system, and thus work to effect some form of price deflation (for a fuller discussion of this complex topic in the Latvian context see this post). And this, of course, is exactly the policy that the IMF economists tirelessly advocate that the Ukranian government practices.
But it is exactly here that we hit a problem, since far from running a fiscal surplus as the situation requires, the Ukrainian government has been running fiscal deficits, even if, up to the election year of 2007, these have been reducing.
One of the things we should now be learning from looking at what is happening across Eastern Europe is that in an environment where a number of underlying problems exist - ranging from a lingering and heavy state presence in the economy, a high public sector debt and deficit level, an absence of strong goods exports competitiveness, labour supply shortages due to migration and long term low fertility, and extensive euroization of the banking sector - heavy capital inflows can come to seriously strain the entire macroeconomic framework. This risk becomes even greater if measures are not taken to drain excess liquidity from the system (by running a fiscal surplus for example), to loosen labour supply constraints by facilitating inward migration of unskilled workers, and to accelerate the pace structural reforms - and particularly those which facilitate the development of "greenfield" investment sites which help channel capital flows towards productivity-enhancing uses and in so doing raise exports.
A Declining and Ageing Population
According to data from the Ukraine Statistics Office the national population fell by 232,485 people from January to October of 2007. This was a result of the fact that while there were 397,806 births (up from 383,384 during the comparable period for 2006) there were also 630,291 deaths (down slightly from 631,403 last year). What this means is that Ukraine's population is now falling at an annual rate of 0.675%. This is very fast, for population decline, and remember this is the natural decline, not counting out migration. As we can see in the chart below the Ukraine population peaked in 1993, and has been in some sort of free-fall ever since.
There are a number of factors which lie behind this dramatic decline in the Ukrainian population. One of these is fertility, which is currently in the 1.1 to 1.2 Tfr range. In fact Ukraine's fertility actually dropped below the 2.1 replacement level back in the 1980s.
A second factor which influences population size is life expectancy, and in the Ukraine case the recent evolution of life expectancy has been most preoccupying, since it has been falling rather than rising in recent years. In particular male life expectancy which is currently running at around 64. Apart from stating the obvious here, we should note that the deteriorating health outlook which this low level of life expectancy reflects places considerable constraints on the ability of a society like Ukraine to increase labour force participation rates in the older age groups, and this presents a big problem since increasing later life employment participation is normally though to be one of the princple ways in which a society can compensate for a shortage of people in the younger age groups.
The third factor influencing population dynamics is obviously migration. Ukranian out migration since the turn of the century has been distinguished by two factors, a reduced intensity when compared with the rather dramatic population movements which characterised the 1990s, and by a significant change in destinations. From migrating East the Ukranians are now moving West. Data on this latter movement has not been systematically collected but we have some national data on Ukranians in Portugal, Spain and Italy, and lots of anecdotal information about Ukranian migrant workers in Latvia, the Czech Republic, Poland and elsewhere in the EU 10.
According to information provided by Ukrainian diplomatic missions, 300,000 Ukrainian migrants may be working in Poland, 200,000 each in Italy and the Czech Republic, 150,000 in Portugal, 100,000 in Spain, 35,000 in Turkey, and another 20,000 in the US. According to official information based on the number of permits issued by the Russian Federal Migration Service, some 100,000 Ukrainian citizens currently work in Russia, although the real number of Ukrainians working there is often estimated to be more in the region of 1million.
With Fewer and Fewer People Avaialble For Work
This out migration is very significant from the economic point of view, since all those working abroad send money back (see chart below) while at the same time are not present in the country to offer themselves for the work which this extra money creates. So out migration and the accompanying remittances are one thing in a high fertility, growing population like that which is to be found in Ecuador or the Philipinnes, and quite another in the long term low fertility, declining population environment of Central and Eastern Europe. Hence all that demand driven wage inflation. As we can see from the data in the chart below (which the World Bank Economists themselves recognise if surely a substantial underestimation) the flow of remittances into Ukraine has increased steadily in recent years.
The Litmus Test?
In many ways Ukraine could be considered to be a rather important strategic unit in the whole Eastern labour supply and demographic puzzle, since many imagine that as labour supply runs out across the whole region, then countries as diverse as the Baltics, Poland, Hungary, the Czech Republic and Russia may all - and at one and the same time - be able to leverage Ukraine's population reserve to help them out of their own difficulties. In this sense many live in the hope that outward flows from Ukraine may serve to plug a lot of otherwise increasingly evident holes in the East European labour force. My feeling is that the people who make this kind of projection for the Ukraine tend to forget three things.
1) The corrosive effect that long term lowest-low fertility across all the East European and many of the CIS societies is already having on the numbers of people who are becoming available in the labour market of these countries.
2) That large migrant outflows from one society to help meet the domestic needs of the labour market in another (Poles and Latvians in the UK and Ireland or Romanians and Bulgarians in Spain) produce significant labour shortages in the home (sending) country, shortages which when combined with rapidly growing domestic demand (and especially for new housing) - domestic demand which is fueled by i) globally available non-local-currency denominated cheap credit and ii) a steady and growing return flow of remittances from those abroad, then this whole process only serves to push up sending country wages very dramatically indeed, and potentially feed through to a loss of competitiveness which can make the whole external position of the country concerned (and with this the local currency, and the sustainability of the non-local currency denominated mortgages) very vulnerable indeed. Let's call this whole process - with no perjorative intention whatsoever - the Baltic syndrome.
3) That these sending countries, and in particular as a result of the processes detailed in (1) and (2), themselves start to experience fairly high rates of economic growth, and as a result they themselves start to need migrants. Ukraine is now a classic case of this process at work. The only thing which remains to be seen here is how all this ends up in practice, since at this moment in time we are all basically off on a voyage into the unknown, since we have definitely never been here before.
A much fuller analysis of the underlying problem in the Ukraine economy can be found in this post here.