Deflation trend: Why prices decrease is so dangerous?

Author : Mykyta Sinitsyn

Source : 112 Ukraine

In 2019, there were enough changes in the financial and economic sphere of the country. For example, inflation returned to a reasonable level - only 4.1% per year. It would seem this fact means success, even if we did not feel this low inflation in prices during the New Year’s purchases
21:47, 21 January 2020

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However, the State Statistics Service data on prices in December 2019 forced many experts to simultaneously declare the danger for Ukraine's economy.

Prices are falling. Hurrah?

On January 9, the Minister of Economy of Ukraine Tymofiy Milovanov wrote on Facebook that prices in Ukraine began to fall. Like, last December was the first in the history of independent Ukraine, when in the last month of the year a decrease in prices was recorded - by 0.2%. Previously, the minimum inflation in December was the same at 0.2% in December 2011 and 2012.

Officials explained the “price reduction atypical for December” with three factors:
- revaluation of the hryvnia, amounting to 3.1% for the month, which caused a decrease in prices for imported goods;
- a decrease in natural gas prices by 11.2% for the month, which was caused by a decrease in world prices for "blue fuel";
- saturation of the proposal for certain segments of the food market, which allowed to reduce the price of meat, sugar, butter and a number of other goods.

Related: Ukrainian context of economic protectionism

In general, price increases or inflation for Ukraine remains a more common occurrence.

In 1993, an inflation record of 10 256% took place, that is, prices rose 102.5 times. Then the situation improved and from 1997 to 2014 the official inflation rate in Ukraine reached the 20% mark three times, of which two times occurred during the times of world crises - in 1998 (20%) and in 2008 (22.3%). After a jump of 43.3% in 2015, prices began to decline again. Twice, in 2002 and 2012, deflation was recorded in Ukraine according to the results of the year - 0.6% and 0.2%, respectively.

Why falling prices are bad for the economy

Deflation did not leave experts indifferent. Noting the positive aspects of price reductions, such as the cheapening of some consumer goods and producer costs, the expert community generally negatively perceived this trend.

And that's why:
- There is a risk of a slowdown in GDP growth or even a decrease.

“If we do not change the general economic paradigm, we will face inflation slowdown to almost zero and the decline in economic growth. At the same time, the discount rate can really be at a minimum and the hryvnia will be stable. Only this will not unlock the process of lending to enterprises. There was already a similar period: deflation at -0.5%, GDP growth at 0%, the NBU discount rate at an absolute historical minimum of 6.5%, a stable hryvnia in 2013 ... Does it look similar? Then Maidan, the annexation of Crimea, the war in Donbas took place", informs an expert at the Growford Institute Oleksiy Kushch.

- The risk of a decline in production, because the industry is not interested or cannot afford to maintain production at the current level, not to mention increasing it.

“Suppose the company has drawn up a plan for the production of 100 beds and selling them for 100 hryvnias. But while the goods were manufactured, the price fell to 97 hryvnias, which the manufacturer was not ready for. As a result, he must either sell at a loss or adjust plans, for example, to reduce costs by producing, say, 70 beds. And that means reducing the "extra" workers, reducing the purchase of raw materials, revenue and taxes," adds financial expert Vasyl  Nevmerzhitsky.

According to the State Statistics Service, industrial production in Ukraine in the first 11 months of 2019 has already decreased by 1.2% compared with January-November 2018.

Related: 2020 forecast: Which economies will grow and which will fall?

- The business will not be able to raise employees’ salaries.

"In such circumstances, the growth of nominal wages by 16.4%, in the long run, looks like an inadmissible luxury (at the peak of this year in March it was + 22%)," says financial expert Andriy Blinov.

- A drop in the level of real incomes of the population is possible because the reduction in prices and incomes will be compensated for at the expense of staff.

"The real-wage index for October-November indicates that this process has already begun," proves the Growford Institute expert Oleksiy Kushch

Related: Zelensky to deliver special address at World Economic Forum

According to the State Statistics Service, in September the real salary in Ukraine was 0.7% higher than in August, then in October it amounted to 99.7% of the real September salary, and in November it was already 99.5% of the October salary.

- There may be a drop in consumption with subsequent negative consequences for the economy.

“If a person knows that in 3 months he will be able to buy the same product cheaper, conditionally by 5%, then he will wait. Thus, the manufacturer will be forced to lower the price, which further motivates him to increase production and lead to an even greater drop in prices and will continue to drive the economy into a “deflationary trap.” At the same time, powerful monopolies may form in certain segments of the economy, which will increase prices in their segment of goods or services, but in general, the trend for deflation will prevail,” adds Oleksiy Kushch.

What is the government going to do?

The fall in prices and industry performance provoked a sluggish reaction from officials.

So, the Minister of Economy Milovanov acknowledged the fall of industry, but on the example of National Bank calculations for the metallurgical industry, he said that the reason was the fall in world prices, and not the actions of the authorities, and especially the approach of the deflationary trap.

Related: Ministry of Economic Development to publish inflation data monthly

In the bank, as part of the traditional commentary on inflation in 2019, the management was glad that they could keep inflation at no more than 6%, promising to maintain it in this corridor further.

At the same time, the NBU emphasized that "low inflation will create conditions for sustainable economic growth, de-dollarization of the economy and cheaper credit resources for business and the public."

According to Oleksiy Kushch, Ukraine may enter into a “deflation trap” in 2020, which can hit the economy painfully.

"The experience of Japan (which fell into it in the early 90s after deciding to artificially strengthen the national currency against the dollar) shows that deflation can last very long, sometimes for decades. However, for a developed country like Japan, which has experienced several decades of steady growth it is not so scary. Ukraine does not have such experience," the expert complains.

Related: PM Honcharuk announces 'good news' from Davos

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