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.
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