Eastern Europe’s growth spurt looks unsustainable in the light of spiralling inflation – a glum thought for the Kiev gathering.
Eastern Europe is booming.
The European Bank for Reconstruction and Development (EBRD) estimates a striking 7.8% growth rate for the Commonwealth of Independent States (CIS) in 2007, the best for years. But there may still be some glum faces when the economic policy-makers of those countries meet in Kiev in mid-May for the EBRD’s annual meetings. The growth spurt is looking unsustainable as inflation threatens to spiral out of control in some of the region’s hottest economies.
In the host country Ukraine, year-on-year inflation for March 2008 hit 26.3%. This has provoked a political blame-game but little constructive response so far. In many of the region’s other large economies, the story is the same: inflation of 12.6% in Russia and 18.7% in Kazakhstan, far above target in both cases. Although high inflation often accompanies the process of economic transition, these levels are becoming alarming. Real interest rates in most of the high-inflation economies are negative, undermining public confidence in the banking sector.
Steps against inflation
Combating inflation is therefore vital to make transition a success. Liberalising the tightly managed exchange rate regimes of many CIS states would help. Central banks would be freer to raise rates, and stronger currencies should curb imported inflation. The trouble is that many local banks have significant exchange rate exposure on corporate and retail activities, and their risk management may not be ready for more volatile currencies.
This leaves tackling the sources of inflation: the soaring global prices of food and fuel. Food comprises a large proportion of household expenditure in most developing economies and CIS industries became addicted to the cheap oil of the Soviet era. Investments to cut energy wastage are already under way, with the EBRD recently helping to arrange a €600m financing to raise fuel efficiency at Russian steel giant Severstal.
Transition focus
But agricultural modernisation and legal reform for more efficient land use have perhaps been the poor relations of a transition process that focused heavily on restructuring banks and industries and strengthening corporate law. The growing appetite of increasingly affluent populations is a compelling reason to raise investment in food production and establish better regional markets.
The alternative of introducing price controls, already used in Russia, is a retrograde step that will not solve the long-term problem of supply shortages. Ukraine was once known as the bread basket for the whole region – now is the time to regain that status.
