Is there a deflation in Ukraine?

Olena Besedina, professor and Senior Researcher at Kyiv School of Economics, tells about deflation and its peculiarities in the Ukrainian economy.

What is deflation and is it true that deflation is happening in Ukraine right now?

 

It is important to differ deflation and slowing down inflation. Deflation is a decrease in prices. Right now, Ukraine has a slowing down of inflation which should have been close to 5% announced by National Bank by the end of the year. Nonetheless, by the forecast of NBU, this index won`t be achieved and inflation will be at 6.3%. The goal for the next few years is still 5%. This indicator will probably decrease in the future, but this will depend on the macroeconomic situation (for example, exchange rate) and GDP growth rate in Ukraine. In summer, we have a short-term deflation (month to month), but these fluctuations are 

 

Why does deflation occur? 

 

The causes for the deflation may be demand- and supply-related factors in the developed countries. Because of the unfavorable expectations of the consumers or strict monetary policy demand decreases, which causes a decrease in prices. Moreover, deflation is happening when the supply of goods and services increases sufficiently. The reason of this increase may be the cheaper cost of consumables or factors of production. Producers make more goods, prices decrease, and these goods become cheaper for the consumers. Also, technological progress affects this process too as some goods are cheaper to produce now than 10 years ago.

 

Deflation – is t good or bad?

 

Deflation is not considered to be a good phenomenon of the economy, but Ukraine isn`t threatened by it right now. Еhis phenomenon is inherent in developed countries. For example, this problem has occurred in Japan in the 1990s and this caused a stagnation of the economy. 

Mechanism is the following: low prices continue to decrease; consumers expect that prices will get even more lower and postpone their consumption to the future to buy goods for the lower price. Thereby, demand continues to decrease, prices get lower and real interest rates may increase. Because the real interest rate is a nominal rate minus inflation. In other words, the real interest rate is an interest rate that has been adjusted for inflation to show the real cost of money for the borrower and the real profitability for the lender or investor. For example, you have borrowed someone 1000 UAH and made a deal that this person will return you 1100 UAH in a year (namely, the nominal interest rate is 10%). In a year, your “income” will be 100 UAH, but if there will be an inflation during this year (and it happens almost always), your real income will be less than 100 UAH, with a 5% inflation, your real income will be only 5%. So, the real interest rate is 5%. In the case of deflation, a real interest rate will be greater than a nominal one, i.e. will increase the real cost of the money in the economy. Of course, it is great news for lenders, but businesses and consumers won`t borrow money with a high real interest rate. All of these hold economic growth even more. The problem that has occurred in Japan is complicated due to the difficulty of launching the economy again as the monetary policy is ineffective. 

 

What are the ways to get out of this situation? 

 

Japan is getting out this situation for 20 years already; in fact, there is even a term “deflation mindset” that interfere in the country`s way of getting out of deflation, and even though the situation has improved after the Japanese central bank used the experience of the USA and EU (especially, UK`s) with overcoming a recession after the crisis in 2008. 

 

What is the reason for moderation of the inflation in Ukraine? Perhaps, it is because of the changes in the policy system?

 

Currently, we must be interested in the yearly inflation, since December last year. And when we are told about the deflation in August, we need to understand that it is about numbers compared with the previous month. Moreover, deflation in summer is a seasonal factor. Food gets cheaper, hryvnia – stronger. By statistics of State Statistics Service of Ukraine, inflation was 2.7% until December 2018. Compared to August last year, an inflation rate was almost 9%. We will see what will happen in autumn as hryvnia is getting “stronger”, a supply of seasonal goods is decreasing and expenditures of state and budget institutions are increasing during this season. All of these speed up inflation by the end of the year and prices increase. 

 

Does an inflation slowdown have its bright side? 

 

Of course, an inflation slowdown is good for consumers, because they can afford more. More importantly, this slowdown shouldn`t turn into deflation, so the expectations of the future decrease in prices won`t decrease consumption. In general, deflation, as well as inflation, is an economic phenomenon that can`t be considered as good or bad. Small inflation is an ordinary occurrence the economy won`t be able to grow without. Short-term deflation isn`t something terrifying but it can be a threat to economic growth, potentially. That is why, it is better to have a small inflation rather than deflation. 

 

In your opinion, will we have a 5% inflation NBU has talked about?

 

By the current forecast of NBU – no. But without any shocks at the currency market, it is possible. 

With inflation decreasing, NBU decreases an interest rate. But can a decrease in the interest rate stimulate a demand since loans get cheaper?  

Not particularly. Of course, interest rates relate to an inflation level. Because when an inflation level increases, the central bank increases an interest rate, and vice versa. But interest rates are connected to more than just inflation. Also, riskiness is common in Ukraine and it may affect interest rates. So, even if inflation slows down today, we can`t expect 2% rates tomorrow. 

 

Perhaps you have some rating of the countries by activity or inactivity of the consumption in times of inflation? What is Ukraine`s spot in this rating?

 

Some countries have a higher level of saving (for example, Asian countries). But I can`t say that Ukrainians differ from the citizens of other countries in this case. The savings level is low in Ukraine because of the risks and instability. Nonetheless, it is not a secret that Ukrainians often don`t keep their savings in the banks (savings “under a mattress”), but these aren`t the saving the economy needs. People usually keep their savings in the foreign currency or invest it into real estate, but it isn`t a productive investment, economy-wise. Of course, this facilitates the construction industry; but an economy is not only a housing construction. For now, investment possibilities are limited in Ukraine due to the high risks and suspicion, which can be easily explained by the difficult experience in the 90s when people lost all of their savings. I hope, this situation will change shortly. 

 

Translated by KSE student Yana Tkachenko.