Ukraine's August Inflation Drops Back Slightly While Stocks Fall Sharply

Ukraine's inflation rate declined in August for a third consecutive month as increased supplies of fresh fruit and vegetables from local farms put a brake on the rise in food prices. Annual inflation slowed to 26 percent, still the fastest in Europe, but down from 26.8 percent in July, and significantly down on May's 31.1% peak, according to the latest data from the Kiev-based state statistics office.




Food prices were up  37.2 percent in August, compared with 39 percent in July. Although headline CPI seems now to have peaked, as external energy prices start to ease and food supply improves, inflation and interest rates will probably stay relatively high. The government’s main core index, excluding unprocessed food, fuel and controlled prices, was up 13.1% in the first seven months of the year, not far behind the food-dominated 14.9% of the headline index, and even the Ukraine President's Office now expects it to exceed 18 percent this year, compared with 16.6 percent in 2007.

Further supply-side rises will be increasingly hard to avoid. Kiev’s subsidized bread prices have finally been increased, and household gas prices are due to rise 13-14% in the coming month. Municipal heating companies still buy imported gas at around 25% below the current border price, building losses for Naftogaz that the government acknowledges will require a combination of continuing subsidy and price hikes. Rail freight tariffs are set to be raised 40% by end-2008.

In fact Ukraine's Producer Price Index was up at a 46.9 y-o-y rate in July, so inflation pressures within the price system are evidently still running very high.




At the same time wage growth pressure looks unlikely to slow significantly, especially given the growing demographic squeeze and strong regional demand for Ukraine’s still-cheap labour force. It is not unreasonable, therefore, to project that CPI will still be running above 20% by the end of 2008.


Stocks Slump and Trading Suspended


Ukraine's stocks continue to remain under pressure. One indication of this is that stock market trading had to be suspended for 2 hours on Friday following  a 7 percent slump in values. According to Andriy Kolomiets, spokesman for the PFTS Stock Exchange, "We decided to halt trading after quotes for more than 75 percent of the PFTS stocks fell in today's session." Ukraine's PFTS Index has been  the world's second worst-performing stock index so far this quarter - only behind Russia - falling by 29.1 percent, as the invasion of Georgia and the feud between President Viktor Yushchenko and Prime Minister Yulia Timoshenko gave a hefty shake to investor confidence.

Credit-default swaps on Ukraine's government debt rose 26 basis points to 501 on Friday, according to CMA Datavision prices, after earlier climbing to a record earlier in the day.

Growth Outlook Positive In The Short Term


In the short term Ukraine's growth outlook looks solid enough, and the FX reserve build-up continues apace. Preliminary real monthly GDP growth dropped slightly to 5.4%Y in June but rebounded to 7.3%Y in July – the strongest level yet seen in 2008. Agricultural output has a lot to do with this rebound, and bath agriculture and exports are likely to surge further in the next few months. The government’s grain harvest forecast is currently for  a 53% increase on last year. While oil import prices are falling, steel export prices have so far been firm (steel has accounted for 38% of exports in the year to date), and Russian demand for machinery exports has been strong up to now. At the same time FX inflows have remained very robust, with  FX reserves were up US$2.5 billion in July, an all-time record.

In the mid-term, however, the outlook is clearly becoming more difficult. Despite continuing terms-of-trade gains and unusually low gas imports in the first few months of the year, the current account deficit is widening rapidly, reaching 7.2% of GDP in January to July. Imports in Q1 were up 20.2% year on year in real terms, against just 0.9% year on year real export growth. Real household consumption was up 22.0% year on year. Real fixed investment growth, on the other hand, slowed to a 14.7% year on year rate. Vehicle imports were up 81% year on year in the first half. However, the consumer boom which lies behind all this looks set to become increasingly difficult to sustain. Nominal wage growth remains very strong, up 36%Y in July, reflecting a shrinking and increasingly internationally mobile labor force. Real retail sales growth was up 27% year on year in July.




By way of contrast, domestic industrial production growth in July was at its slowest level in two years, while industrial output was up by 7.3% year on year in the January July period.

At the same time there is now increasing evidence that Russia's economy is starting to slow, and as it does Ukraine's all important steel sector will be among those worst hit.


Ukraine’s overall external financing capacity is clearly still very high, but the risks of deterioration are growing. The financial account surplus in January-July was an impressive US$12.6 billion, or 11.6% of GDP, 80% up on the same period a year earlier (which was before the credit crunch set in)  and 50% above the current account deficit so far this year. Medium-term loans to the banking sector account for 44% of this and are so far holding up better than we had expected. Net foreign liabilities of commercial banks are up an average UAH 7.6 billion in the past three months, still above the 2007 average. However the combination of tighter European funding conditions, a closure of foreign markets to smaller banks and slower credit demand in Ukraine itself may well slow these inflows. 

Net inward FDI, which has ammonuted to US$6.9 billion so far this year, is likely to weaken without progress on privatization or further major bank sales.  While FDI may slow, it is unlikely to come to a halt. The interest of companies like Evraz in Ukrainian steel, coal and transport assets underlines the scope for private sector non-bank inflows, as property rights in the industrial sector settle and investment needs grow. However, in the context of a widening current account deficit, such inflows may prove less supportive.



At 61.1%Y in July, bank credit growth is slowing but remains relatively strong, and it us importabt to bear in mind that recent growth rates are biased downwards by UAH strength. Half of total credit outstanding, and 62% of household credit, is FX-denominated. Bank credit as a share of GDP, at 60%, is high by regional standards, and smaller domestic banks are facing significant funding constraints.

Ukraine Anticipates Largest Harvest In 10 Years

According to the Ukraine State Statistic Committee, as of August 1, 4,495,000 hectares of wheat had been harvested. This brings production to 16,544,000 tons with a yield of 3.68 tons/ha. The wheat production area is up by 24% and the yield by 47% compared to the same date of last year.

The barley harvested area is 2,857,000 hectares, production is estimated at 8,945,000 tons with a yield of 3.13 tons/ha. The barley production area is up by about 40% with about double the yield obtained last year.

Export

Following the cancellation of grain export quotas, export volumes increased significantly in June and July 2008. Official Ukrainian statistics show grain exports in June 2008 totaled; wheat = 483,000 tons, barley = 413,000 tons and corn = 486,000 tons. Total July-June wheat exports totaled 911,000 tons; barley exports totaled 1,040,000 tons and corn 1,600,000 tons. Official Ukrainian statistics show grain exports in June 2008 totaled; wheat = 600,000 tons, barley = 800,000 tons and corn = 274,000 tons. Please refer to the grain export tables (by month and destination) in the Statistical Tables Section.


June 2008 grain stocks are 44% higher than June 2007 grain stock levels. According to inland silo industry information, silos are currently at full capacity, much higher levels than for an average year. The owners of these silos are also expecting to have some difficulties accommodating grain from the new record high crop. The storage capacity of inland silos is estimated to be approximately 25-28 million tons for all crops, including oilseeds. Total 2007/2008 grain stocks amounted to 6.7 million tons on June 1 and about 0.7 million tons of oilseeds.

Ukraine Consumer Inflation Drops To "Only" 29.3% in June 2008

Ukraine's inflation, the fastest in Europe, slowed in June, as food prices rose more slowly thanks to an increasing supply of fruits and vegetables from local farms. The annual inflation rate fell back to 29.3 percent in June from the 31.1 percent high hit in May according to data released by the Kiev-based state statistics committee earlier today. Food prices, which constitute about 60 percent of the basket used to measure the Ukraine consumer price index, rose 43.9 percent in June from a year ago, compared with a 48.5 percent increase in May.



Consumer prices rose 0.8 percent in June from May, the slowest monthly increase so far this year.

Producer prices on the other hand accelerated in June (a bad sign for the future of consumer inflation) rising 4.2 percent month on month from May, which compares with a 3.7 percent increase in May from April, according to separate data released by the state statistics committee. Year on year the producer price index was up to a shocking 43.7% from 37.6% in May.

Ukraine Central Bank Widens The Hryvnia Band

Ukraine's central bank announced today that it was going to allow the Hryvnia (Ukraine's national currency) to fluctuate more, in a desperate attempt to slow what is far and away Europe's fastest inflation. The Natsionalnyi Bank Ukrainy will allow the currency to rise or fall 4 percent from a midrate of 4.85 against the dollar. The decision was made public by the bank's Governor Volodymyr Stelmakh at a press conference in Kiev today. The bank kept the hryvnia at 5.05 to the dollar between April 2005 and May this year.

Stelmakh indicated that the decision was a reflection of a policy of moving towards a regulated floating hryvnia rate.

Rising inflation recently prompted Standard & Poor's to cut Ukraine's credit rating. Monetary policy makers view the wider hryvnia trading band as a step toward inflation targeting according to Petro Poroshenko, head of the bank's council. At the present time the central bank controls the hryvnia rate by selling and buying dollars.

Ukrainian policy makers had previously strengthened the hryvnia by 4 percent on May 21 in a bid to curb inflation, which accelerated to 31 percent in May.


The bank's 14-member supervisory council, which includes political appointees, reversed the hryvnia revaluation on May 22, the first veto since Ukraine gained independence in 1991, saying a stronger currency will harm exporters. The bank's board, led by Stelmakh, then in turn overturned the veto the next day.

The dispute over the exchange rate echoes a wider struggle between President Viktor Yushchenko and Prime Minister Yulia Timoshenko over economic policies. Timoshenko has welcomed the hryvnia strengthening, while Yushchenko has criticized it.

Ukraine Grain Exports To Triple

Ukraine, which is the world's second-largest barley exporter,has said it expects overseas grain sales to triple in the marketing year that starts next month, easing two years of curbs caused by drought and record prices. Exports are expected to rise to between 13.5 million and 14 million metric tons in the 12 months starting July 1, compared with 3.7 million tons this year, according to Agriculture Minister Yuriy Melnyk in Kiev today. The grain harvest will be in the region of 37 percent to 40 million metric tons, after favorable weather, he said.

Of the 40 million-ton harvest, half will be wheat, 9 million tons barley and 9 million tons corn, the minister said. Melnyk reiterated that grain exports would continue to be subject to state-set limits.

Ukraine is expected to export 4 million tons of barley in the year ending September 2009, up from 1.7 million tons this year, the U.S. Department of Agriculture forecasts. That ranks equal with Australia but behind the European Union. The Ukrainian agricultural ministry set forecasts today of 50 million metric tones of grain harvest for the next two to three years.

Ukraine's wheat exports in the year ending June 2009 will be 6 million tons, compared with 700,000 tons this year, the USDA estimates. Corn exports in the year ending September 2009 will be 2.5 million tons, from 1 million tons this year.

Ukraine Inflation May 2008

Inflation in Ukraine accelerated last month to the fastest in more than a decade. The annual inflation rate rose to 31.1 percent in May from 30.2 percent in April, the highest in Europe, accroding to the Kiev-based state statistics committee yesterday.



Consumer prices increased 1.3 percent in May from April, while producer prices rose 3.7 percent from April and 24.2 percent from December 2007.

The government of Ukraine, where the World Bank estimates almost 3.7 million people live in poverty, has so far failed to reduce the average inflation rate this year from 16.6 percent in 2007. Government and central bank officials have pledged to curb inflation to keep the economy stable as the former Soviet republic strengthens its economic ties with the European Union.

The central bank raised the benchmark interest rate to 12 percent from 10 percent in April and strengthened the hryvnia by 4 percent on May 21 in an effort to curb price increases. The Natsionalnyi Bank Ukrainy earlier predicted inflation this year will be below 20 percent.

Accelerating price growth threatens the credit ratings of Ukraine and other emerging-market nations, Fitch Ratings said May 27. Central bank Governor Volodymyr Stelmakh in April called inflation ``a real threat'' and said the government should cut social spending to help tame price increases.

Monetary Chaos Breaks Out at the Ukraine Central Bank

Does anyone happen to know offhand the "official" dollar rate of the Ukrainian currency, the Hryvnia? I am asking this question since clearly over at the central bank they are having difficulty deciding at the moment, since - like the legendary character Hydra - they seem to be speaking with two "heads" at the same time, and the only question I can ask is: would the real representative of the Ukraine central bank please stand up!

This issue unfortunately is neither a small nor a comic one, since Ukraine is currently running a 30% plus annual inflation rate, and letting the currency rise against the dollar is one of the few serious anti inflation policies anyone has on the table at the present time.

Essentially the story to date is that the Ukraine central bank had been keeping the "official rate" for the national currency - the Hryvnia - at 5.05 to the dollar (within a broader target band of 4.95-5.25) since August 2005 - although traders have generally been saying that the bank effectively stopped intervening around February-March. However during the last 24 hours the "official rate" has become a highly contested issue, with one part of the bank's monetary policy structure suggesting that the official rate has now been revalued to 4.85 to the dollar, while another part is denying this and maintains the rate is still 5.05. Basically one part of the structure is challenging the right of another to take decisions.

Of course the reaction of the financial markets to this state of affairs is not that hard to predict (at least in the immediate term), and Ukraine's hryvnia fell the most against the dollar in a single day in over eight years yesterday, falling 4.01 percent on the day to trade as low as 4.7875 per dollar by 6:04 p.m. in Kiev, down from 4.5550 late Wednesday, making it the worst performer among the 178 global currencies being tracked by Bloomberg yesterday.

The fall at this point may, however, be more part of the internal tussle which is taking place in the bank itself than any knee-jerk financial markets reaction (although that could well be to come as central bank credibility at this point must be tending towards zero), and a according to Agata Urbanska, an emerging-markets currency strategist in London at ING Bank "They (the central bank, or part of it) are back in the market................This is all about the central bank weakening the currency.''


The latest incident is only one more episode in a long term tug-of-war which has been going on inside the central bank (and of course, inside the Ulraine parliament itself, since, it will be remembered, President Viktor Yushchenko was recently physically prevented from giving his state-of-the-nation address before parliament by legislators loyal to Prime Minister Yulia Tymoshenko who blocked access to the speaker's chair). The immediate problem started on Wednesday when Ukraine`s central bank board (note here the key term board) announced that it had decided to strengthen the official rate of the hryvnia to 4.85 to the dollar from the previous level of 5.05.

This move was not entirely unexpected since the bank has been under constant pressure to revalue or liberalise the hryvnia since inflation began rising dramatically in the autumn of last year, and Central Bank Governor Volodymyr Stelmakh had announced back in late April that there would soon be a "move" on the exchange rate front. However in a statement which now assumes rather more significance than it did at the time, the bank`s council (yes, note the COUNCIL - not the board - since the council is the other main player in this game) explicitly repudiated Stelmakh and rejected the idea of broadening the band on the very same day. From that moment on it should have been clear that monetary policy at the Ukraine National Bank was in for a bumpy ride, and so it has been.


Not to be upstaged by the decisions of the Board, Ukraine's central bank council itself met yesterday and formally rejected the hryvnia revaluation which had been decided on by the bank's board only one day earlier, and issued a press release stating that the official rate still stood at 5.05 to the dollar. This was the first example of one body vetoing another since the bank was founded when Ukraine became independent in 1991.

The bank council has 14 members, including the governor, parliamentary speaker Arseniy Yatsenyuk, and a number of parliamentary deputies. Stelmakh himself abstained at yesterday's vote while the other members all backed the veto of the board's decision.

"Today, the action of the board of raising the official rate to 4.85 was rescinded. Therefore, the official rate stands at 5.05/$," Petro Poroshenko, the council's head, told a news conference after a council meeting. He also advised the bank's board to re-examine the issue on Friday and suggested the board could only overturn the council's decision with a two-thirds majority.

Now for those of you who are - like me - a little bit confused by this somewhat Byzantine institutional structure, perhaps I should make plain that the board is effectively the bank's executive, while the council is a body created to formulate a framework for ongoing monetary policy. But now we find the board hold that the hryvnia is valued at 4.85 to the dollar, while the council maintain that the "official" value is still 5.05. So which is it? Well at this point your guess is as good as mine - and this is certainly "pluralist" monetary policy in action - but the board do seem to want to insist that they are going to have the last word, since late last night Reuters reported that the board had decided to overturn the councils veto and had issued a statement saying the hryvnia's rate on Friday would stand at 4.85 to the dollar -- unchanged from the rate it had set for Thursday, revalued from 5.05, before the council imposed its veto.

The Ukraine parliament - the Verkhovna Rada - have however voted to summon central bank of head Volodymyr Stelmakh to give an explanation of his actions (by 382 votes out of a possible total of 447) following a proposal put forward by the parliamentary groups of the Party of Regions, the Block of Lytvyn, BYuT, and CPU.


Anyway, I do know how many of you are able to follow all of this? Personally my head is already whirling. And the whole situation became even more bizarre late last night when central bank officials declined to comment on whether the board had in fact overturned the earlier council veto decision, effectively sidestepping the problem posed by head of the council Petro Poroshenko earlier in the day when he stated only a two-thirds vote on the board could do this.


Basically the background to all of this is that until recently, the central bank had been intervening regularly, buying and selling currency to maintain the hryvnia within a prescribed tight-corridor of 5.0-5.06. As a rseult the hryvnia had been hovering around 4.7-4.8 since the central bank stopped intervening in February-March, but in recent days it had begun to soar, touching at one point 4.6 to the dollar, following comments from various central bank officials indicating a revaluation was coming soon, and pressure from credit ratings agencies and multilateral bodies like the IMF to allow the currency to rise in an attempt to soak up some of the globally imported inflation.

Earlier this week a rapid (and possibly speculative) surge in demand took the market rate to 4.6 leaving a gap of about nine percent between the interbank and the official rates, leading the bank`s deputy chairman, Oleksander Savchenko, to state on Monday that decisions would be taken "in the next few days" to tackle the hryvnia`s "highly volatile rate". Effectively it was the developing gap between the official and the interbank rates which precipitated the move on the part of the bank BOARD.


So the problem here is inflation and what to do about it. Ukraine's inflation rate was once more up sharply in April - passing the threshold of the 30% annual rate - as the bickering continued between Prime Minister Yulia Tymoshenko's government and the office of President Viktor Yushchenko over economic policy and how to handle the problem. Inflation was up 3.1 percent month on month (running at an incredible 37.2 annualised rate), and although this was lower than the 3.8 percent monthly increase registered in March (which was a 9-year record) it was still far higher than most analysts were expecting.

Annually, inflation reached a huge 30.2 percent - aided by an almost 50 percent jump in food prices - and the cumulative price rise for the first four months of this year was 13.1 percent, a 'mere' 3.5 percentage points above the government's whole year 2008 target of 9.6% which the government has yet to revise.

The Ukraine central bank has been trying to soak up hryvnia liquidity since the start of the year, twice raising the refinancing rate (which is now at 12 percent, up from 8 percent at the end of last year) and issuing a large amount of depository certificates.

The bank has also repeatedly said that it sees a strengthening of the hryvnia as a means to combat inflation. And of course the bank has been under continuing pressure to revalue or liberalise the hryvnia after inflation began to accelerate in the middle of last year.

When the decision to change the official rate was announced by the board on Wednesday the ratings agency Standard and Poor`s immediately called the move a step towards curbing price rises.

"Liberalising the exchange rate regime should help to curb inflation of tradeables, and in particular commodities such as gas and food, which are priced in dollars," the agency said in a statement. It has currently a rating of BB- for Ukraine.

However ones the smoke finally clears on all this we will be left with a number of outstanding questions. Not least of these is whether in the mid term the hryvnia is not more likely to move DOWN than up. Certaily Ukraine's economic problems are now substantial ones. This was explicitly recognised by Standard and Poor's in its comments following the decision by the bank`s move board, and they painted a bleak picture for Ukraine, saying inflation was boosted by non-monetary factors and that a stronger hryvnia would ultimately harm exporters, raising the current account deficit.

"In the first quarter of 2008, nominal government expenditures increased just under 50 percent, pushing up public sector wages and sending a highly inflationary signal to the private sector," it said. "Loose income policy continues to affect goods prices via second-round effects."

The agency also lambasted the government of Prime Minister Yulia Tymoshenko in January, calling its fiscal policies "populist" after it began paying compensation to people who`s Soviet-era savings were wiped out by hyperinflation during the 1990s.

Tymoshenko has repeatedly promised that the government would be able to bring inflation under control in just a few months, and some officials had even predicted deflation during the summer months due to bumper food harvests (which are more than possible, the harvests, not the deflation, and this may mean in the short term that economic growth and inflation only accelerate).

Meantime Ukraine is currently running a current-account deficit, a deficit which has widened to $4 billion since the beginning of the year, and many analysts estimate it may exceed $15 billion by year-end. In fact the IMF estimate that it will reach 7.6% of GDP this year.




Conclusion

By way of conclusion I would like to make three simple points about this strange affair. The first of these is that the situation in the Ukraine to some extent parallels the situation in Russia, since both countries are facing a major inflation problem, and both are under pressure to allow the currency to rise to soak up some of the inflation. The political battle in Ukraine also mirrors the one in Russia in this sense, since the Putin/Medvedev group have been making it quite clear that they favour going for growth over the need to tackle inflation, and thus will resist currency revaluation pressures, even though the inflation itself will at some point almost inevitably undo all this solid growth performance due to the instability which will eventually follow, as I attempt to explain in this post.

The second point would be that the ability of simple currency appreciation alone to handle the kind of overheating Ukraine is experiencing is in fact rather questionable. Basically letting the currency appreciate can soak up some of the global dimension in Ukraine inflation, but it will not in and of itself resolve the internal overheating dimension. Ukraine, like Russia, has a declining population and a declining working age population. Unlike Russia Ukraine has out-migration and not inward migration. This means that the labour shortage issue in Ukraine is expecially acute when growth is in the 5 to 7% pa range. Basically Ukraine does not have the human capital resources to grow this quickly, and having a steady stream of remittances from those working abroad fueling consumption and construction only adds to (and does nothing to help resolve) these underlying problems.

Lastly, it is clear that Ukraine is now locked in to some sort of "boom-bust" cycle, but the bust may well not be imminent: that is to say we may well go up further before we finally fall back to earth. The reason for this is the current high in wheat prices, and the fact that Ukraine may well have a bumper harvest this year.

Economic analysts (and CEE specialists) 4Cast are predicting a significant recovery in agricultural performance across the entire East European region this year, driven by a massive rise in crop yields and farming output. They say weather conditions seem favourable in many countries in the region. Gábor Ambrus, analyst at 4Cast in London. believes the effect will be most visible where the share of farming is high, i.e.: Ukraine and Romania, while Poland, for example, may not benefit especially as it was spared from much of the regional draught in 2007.

Ambrus sees Romania and Ukraine as particularly likely to benefit from an agricurally driven boost to headline GDP effect. (The share of Romanian agriculture in GDP is 7-8%, so even a 30% increase in farming output may boost GDP by 2pp above expectations.) The effect on Ukraine is even larger with agriculture having something like a 17-18% share in GDP. The crop estimates being offered by UkrAgroConsult indicate a 35% increase in crops, and this could boost GDP by as much as 6pp over 2008, offsetting much of the slowdown coming from other sources, Ambrus argues. Of course this estimate may well be on the high side, but nonetheless Ukraine should get a substantial GDP boost, which means we should watch out, since this train may well now be about to accelerate before coming to what looks like it will inevitably be a "sudden stop".

Anyone interested in a rather fuller explanation of the underlying human capital resource problem could do worse than read this post I wrote some months ago on the topic.

Update

Well it is less than an hour since I put the post up, and already I am updating. I suspect this may happen more than once in the coming days. The latest news is that - unsurprisingly - Ukraine`s central bank chairman Volodymyr Stelmakh publicly confirmed this morning the bank's change in the official hryvnia rate to 4.85 per dollar from 5.05. The show goes on.

“The bank’s board made decision to confirm the change of the rate. We are confident that we do everything right, and we will defend our position”, V.Stelmakh said. According to him, the bank`s council had no right to decide on economic or legal issues and he saw the bank`s change of the official rate as merely eliminating imbalances in the market, and based on economic factors, rather than a "revaluation".