Caught in an import prices trap

As the world slips into recession, many governments are hoping their spending plans will boost growth and prevent deflation. In contrast, Russia is the only economy in the Group of 20 still struggling with inflation in double figures, with Finance Minister Alexei Kudrin warning that it could reach 14 per cent this year.
Contracting demand due to the financial crisis has increased deflationary pressure, but the rouble devaluation in recent months has caused imported goods to become more expensive.
"The major source for inflation now is devaluation, as rouble-denominated prices for imported goods are going up," said Katya Malofeyeva, chief economist at Renaissance Capital.
Inflation reached 2.4 per cent in January, but it is traditionally high early in the year as a surge of government budget spending takes place in December.
"Every year in December, a huge amount of liquidity comes into the system," said Yevgeny Gavrilenkov, chief economist at Troika Dialog. "This translates into high inflation in January but year-on-year inflation is not accelerating that much."
However, the prices of imported goods have not yet gone up significantly - despite the rouble losing over one-third of its value against the dollar - as many companies are slowly reducing their stockpiles to compensate for shrinking demand.
"This year [devaluation] has coincided with the phenomena working in the opposite direction: as many businesses are conducting liquidation of last years' produce, we have seen the instances of much lower rouble prices for the same goods," said Malofeyeva.
Food produce is the main sector driving inflation, with prices having increased at an annual rate of 15.9 per cent in January, according to Citibank data.
"There are many goods especially in food and agriculture that are not produced in Russia in a large enough quantity to satisfy consumption," said Ovanes Oganesian, Renaissance Capital's vice president for strategy. "Russians depend on imports of these products such as meat, milk and butter."
The Moscow city government said this week that it could release emergency stocks of fruit and vegetables at below market prices to help combat the crisis. This would particularly help people on lower incomes who tend to spend more proportionately on food and be most affected by inflation.
Although inflation is widely expected to hit double figures, prices for some goods, particularly raw materials and commodities, have fallen in recent months. Consumers have benefited from a fall in petrol prices, even though they have decreased less than that of the oil price, which collapsed from over $140 a barrel in July to around $40.
"The lack of competition at the local and regional level" has allowed petrol prices to stay high, said Yaroslav Lissovolik, chief economist at Deutsche Bank.
In the longer term inflation is likely to fall as prices adjust downwards and people substitute imported goods for cheaper domestic goods.
"People are trying to substitute (imported goods for domestic ones) but unfortunately there are some groups of consumer and industrial products which simply cannot be substituted," Citibank economists said in a note.
One example of this is cars, where many Russians are prepared to continue paying the extra money for foreign vehicles which they consider to be better quality.
"It is impossible to find a domestic vehicle with a similar quality to price ratio," Citibank commented. "The same thing is true in textiles, clothes and food."
However, the auto industry is already deflating, with many companies lowering prices to take account of declining world demand.
"The most notable example of [lower rouble prices] was the car market. One can find very good deals on new cars in Moscow," said Malofeyeva.
Inflation has been consistently high in Russia for the past 10 years, but with growth slowing, and possibly becoming negative, the urgency of tackling it has increased.
"These days high inflation will really suppress consumer lending and a lack of external borrowing won't help," said Gavrilenkov. "At some point inflation should come down."
The government is facing a tradeoff between controlling inflation or pursuing deficit spending to protect jobs and fuel growth.
"It is very difficult to ascribe a weight to the two goals but in the short term the priority will be to limit unemployment," said Lissovolik.
Focusing on saving jobs now may help ordinary Russians in the short term, but in the medium to longer term, lowering inflation will help boost growth and create more jobs in profitable sectors.
"The government cannot preserve every job," said Gavrilenkov. "That is why bringing inflation down and unlocking money markets will help to create jobs. Artificial job creation won't help."
However, the Central Bank now has an opportunity to control inflation as the financial crisis has caused interbank lending to decrease and it has become the main lender. The interbank rate in previous years was negative in real terms, but higher interest rates and lower inflation could help banks prioritise their investments.
"When money is cheap and interest rates are negative in real terms, investments don't usually go to the most efficient sectors," said Gavrilenkov.
With higher interest rates in the short term, inflation could be brought down to less than 5 per cent by 2010, he added.

Companies Switch From Rubles to U.E.

In a throwback to the turbulent 1990s, some real estate companies and car dealers are repricing their fees in "conditional units" instead of rubles.While conditional units — known as u.e. in Russian — were originally a euphemism for the U.S. dollar during the period of the ruble's instability in the 1990s, it has since come to represent values ranging from the dollar to the euro to a ratio between the two. The government, fueled by complaints from confused buyers and pride in the then-robust ruble, initiated a crackdown on conditional units from 2004 to 2006. But a loophole provided by two competing pieces of legislation suggests that there is room to maneuver.Companies are maneuvering as they scramble to minimize losses from the depreciating ruble, which has lost nearly 20 percent of its value since November. The Central Bank said Thursday that it had "finished" with the devaluation of the ruble.Real estate developer PIK Group began listing its prices in conditional units at the beginning of January, spokeswoman Natalya Konovalova said. The company calculates the mean of the dollar and the euro based on Central Bank rates, and clients pay the company the equivalent amount in rubles."The use of conventional units was around four years ago, and now because of the economic downturn a lot of builders are using this form of measurement again," she said.Most developers are quoting prices in dollars or conditional units these days, she said.The use of conditional units is appearing in other sectors as well. Advertising agency Begun has started selling online ads for 2 to 50 conditional units apiece. The trend is also popular in the auto sector, where foreign cars produced by BMW, Toyota, Mazda and Mitsubishi are priced in conditional units based on euro or dollar rates, Autonews.ru reported.Natalya Orlova, chief economist at Alfa Bank, said that other sectors were also likely to return to conditional units if the ruble remained volatile."If the ruble exchange rate doesn't stabilize at a level of 30 to 33 rubles a dollar in the coming two or three months, then I think a lot of companies will think about using" pricing such as conditional units, Orlova said.So far, the re-emergence of conditional units appears to have occurred primarily in the real estate sector, one of the hardest hit by the financial crisis. Property firm DSK-1, which like PIK received bailout loans from Vneshekonombank, announced this week that it would begin pricing apartments in conditional units after Feb. 1. DSK-1 refused to comment on the decision Thursday.The real estate sector has a history of pricing in dollars, and it was only briefly during the first half of 2008 that landlords began switching to the ruble, betting that the currency would appreciate, said Alexei Yazykov, a real estate analyst for Renaissance Capital.The practice of pricing in conditional units used to be popular with hotels, airlines, restaurants and supermarkets. In 2006, a U.S. lawyer sued Hyatt, Radisson and Marriott for using unfair conditional unit exchange rates in Moscow. Radisson and Marriott said they had not decided to use conditional unit prices again, but one hotelier said it would be a good idea."Today the hotel is losing quite a bit due to the exchange rate. What the government needs to do is allow [businesses] to go back to either conditional units or euro rates," said Michel Stalport, area vice president for the Rezidor Hotel Group's Russian SAS Radisson hotels.He said he believed that the hotel was required to quote its prices in rubles. Other businesspeople said they could use conditional units. The confusion stems from two separate pieces of legislation: the Law on Protection of Consumer Rights, which states that the price of goods and services must be displayed in rubles, and Article 317 of the Civil Code, which allows parties to agree on prices in conditional units as long as the payment is in rubles. Travel agencies, for one, have never fully switched to rubles."Airline tickets are still linked to foreign currency, even though these are tickets sold in Russia," Orlova said. "This means there is clearly a way to recalculate all prices on a daily basis based on a foreign currency."All International Air Transport Association members fix prices at an international exchange rate set by IATA every Wednesday. This week's rate is 43.5 rubles per euro. The government has long pushed for the demise of the conditional unit. Critics of the conditional unit, such as State Duma Deputy Valery Galchenko, have labeled the use of the measurement unpatriotic, and then-President Vladimir Putin issued a decree in March 2006 forbidding state officials from quoting prices in currencies other than rubles.Oleg Zamulin, assistant professor at the New Economic School, said companies are unlikely to flock to the conditional unit because it would be disadvantageous for them to switch currency rates individually when competitors are still using ruble rates.Entire industries switching to the conditional unit would take years, Zamulin said."It took a long time for companies to switch from using conditional units, and it will take a long time for them to switch back," he said.