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Outlook

Driving Inflation – Russia’s Current Curse
The Russian government, which watched its 2007 inflation target go up in smoke, was looking to bring it back under control with a 2008 target of about 8 percent. With less than half the year gone that target too is in shreds, and rising costs are starting to seriously shake the Russian economy.
James Blake looks at some of the underlying causes.

Inflation: It’s on more people’s lips than you can shake a price gun at, from politicians to people on the street, all of whom have an unpleasant shock every time they head to their local shop to buy staple household items.

Russia has long had higher inflation rates than Europe and the United States, but without a doubt the last year or so hasn’t been pretty. In 2007 the government’s original inflation target was about 7 percent. After a few upward adjustments, the final tallied figure was a downright ugly 11.9 percent.

Nobody — local and expat alike — could be unaware of the problem. Regardless of the item, it is sharply more expensive than it was a couple of years ago. Grocery items, food, fuel, and real estate — all are leaving people wondering what on earth is going on.

A chat with local economists and business leaders about the causes of inflation rapidly settles on a few key themes that add up to the fly in the ointment of Russia’s economic success story. If infl ation is simply a matter of too much demand for too little supply, forcing people to shell out more for what they need and pushing prices higher, then Russia is at the center of a combination of factors that point to its present malaise.

First of all is demand itself. It’s growing, fueled by the oilunderpinned turnaround in Russia’s economy over the last eight years. A casual glimpse around Moscow reveals seemingly half the city being repaired, a fair bit of the rest being built afresh, more cars on the road than ever before, and shops of all descriptions packed to the rafters with shoppers. At the same time, significant wage jumps plus a strongly appreciating ruble mean that Russians have much more money to spend.

Russia is also seeing a maturing consumer society. Nearly 20 years of advertising means that those with money in their pockets have different expectations of what they can do with it than their Soviet forebears did. Russia now has a society of people who, arguably for the first time, find themselves with a fistful of money and start thinking about what they want to buy. And the range of things they can spend it on would without a doubt shock those who in the early ’80s were trying to work out demand and appropriate production volumes for Soviet society. Russia’s consumer boom is attracting attention from a wide range of international retail outfits, who recognize a good thing when they see it. What they’re seeing is a shoptill- you-drop ethos.

Th is provides an insight into the second factor that economists point to. Russia is still, in some respects, either trying to address the needs of a radically changed society with infrastructure inherited from Soviet planners or halfway through the overhaul. A good portion of all that construction activity one sees all over Moscow, and to varying degrees across the country, will in the long run help get Russia’s production and distribution systems into gear and lower costs. Factories being created, extended, and upgraded with new production capacity, roads being
widened or relaid, bridges repaired, railways souped up with new tracks and rolling stock, airports expanded, seaports modernized. At the moment it’s all happening and until this overhaul is more mature, the country’s production and distribution systems are effectively trying to bypass a series of cost-increasing bottlenecks left, right, and center. Anyone trying to find quality logistics space and handling facilities will tell you, there simply isn’t enough; those trying to get produce of any description from one point to another send more trucks onto already clogged roads or add to backlogs on the rail, air, and port systems. And that’s without taking into consideration the bureaucratic and regulatory factors that can increase delays and costs.

The other part of the production and distribution equation is the people involved: Th ey too are becoming increasingly more expensive. Russia’s population has declined in a major way since the late 1990s, and demand for skilled employees in particular is now greater than the available supply. This is seeing net salary increases averaging more than 10 percent per year of late. Though it was coming off a low base, it still means ever higher costs being passed on with products and services.

The third inflationary factor adding to the mix is the massive scale of investment all taking place at once to overhaul the production and distribution systems, adding to the money in circulation. With oil seemingly holding steady over the $110/bbl mark, there is an estimated billion dollars per day flowing into the country. All this money is what is adding to demand in one way or another, either in people’s paychecks or in the demand for materials and services. The investment must happen simply to make the Russian economy more competitive in the longer run, but its initial effect is to sharpen demand and short-term inflation. The government, which has been lauded for running a consistently tight fiscal policy until quite recently, has bumped up expenditure by an estimated 40 percent in recent years in response to calls to do something more with Russia’s export earning and to address infrastructure problems as well as to increase pensions, improve education, and upgrade health care. Nobody would deny that this is necessary, but the fact that it is occurring right now is adding to inflationary pressure.

Finally, there is the fourth major factor, the increasing integration of the Russian economy with the rest of the world, which has affected food prices in particular. Russia is a significant importer of a range of foods, and the increasing cost of this is adding to inflationary pressure at home. Grain export tariffs and an industry-imposed cap on price increases have helped limit some of the effects, but these aren’t longterm mechanisms. In the end, the government is left with the double-edged sword of ruble appreciation or the limited effect of interest rate rises.

In the long term, producing more, more efficiently and making sure it gets to where it’s needed more easily represents the path to a low inflation rate Russia. But in the short term, existing demand is increasingly difficult to meet, meaning that when you next head to the supermarket, you should continue to brace for a shock.







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