Inflation is not a threat any more

Preconditions for deflation in Ukraine are currently as good as they
were in 2002 when annual CPI hit -0.5%. Annual CPI has for the first
time in 10 years exceeded 30% in early 2008 in part due to global
food price inflation but also as a result of a number of domestic
factors. Among them were negative harvest yields of 2007 and more
than 10% annual drop in cattle and pork population; retail lending
boom of 2006-2007, which boosted spending; nominal wages rising
by more than 40% annually on the back of expanding economy and
harsh competition for employing the labor force; expansive fiscal
policy of Ukrainian government in 2006 and 2007, aimed at increasing
social spending by 40-45% annually; very low (7.7%) savings’ ratio
pushing the households’ incomes to purchases rather than to
deposits in banks. Last but not least, Ukraine was hit especially
severely by global food deficit as food items dominate its consumer
basket (55% in 2008).

The impact of global commodities boom has been felt by a number of
sectors, in particular by steel and mining industry, fertilizers’
producers. They took advantage from global demand shock and kept
their margins high but they raised prices domestically, thus negatively
affecting the construction sector and certain agricultural enterprises.

We see the inflation as inevitably diving under 10% mark in 2009
based on the following assumptions.
• Food prices will grow rather moderately as 2008 has seen one
of the best harvest yields and increase in agricultural output by
25% y-o-y (8M08). As global food prices are reverting from
their peak of 60% annually in May 2008 to 9.8% in October
2008 (according to Economist Commodities Price Index) heavy
focus of Ukrainian CPI on food will this time be an advantage
for CPI.
• End of consumer lending boom will lead to deceleration in
spending dynamics.
• Reduction in fiscal expenditures are expected as a result of
government’s inability to raise money through traditional
sources of covering the budget deficit (borrowings,
privatization) and interest burden for Ukrainian government will
be especially high in 2009.
• Wage increase will moderate to 20% in 2009 down from 32%
expected in 2008 as current low productivity growth is limiting
further wage bargaining.