Record inflation lows give distorted picture

A DROP in the inflation rate to a record low last month was received with some skepticism by economic analysts, who said the trend reflected the government's desire to boost real wages before September elections by avoiding increases to regulated prices connected with EU integration.
In May 2002, headline inflation, which includes all prices for consumer goods and services, fell to 3.2 per cent year-on-year, down from 8 per cent in July 2001 and 16.6 per cent in March 2000. The rate was the lowest monthly inflation figure in Slovakia since the end of communism in 1989.
The central bank, however, immediately said the figure gave a misleading picture of the direction of the Slovak economy, which faces stiff price increases after elections as well as after Slovakia joins the European Union.

A DROP in the inflation rate to a record low last month was received with some skepticism by economic analysts, who said the trend reflected the government's desire to boost real wages before September elections by avoiding increases to regulated prices connected with EU integration.

In May 2002, headline inflation, which includes all prices for consumer goods and services, fell to 3.2 per cent year-on-year, down from 8 per cent in July 2001 and 16.6 per cent in March 2000. The rate was the lowest monthly inflation figure in Slovakia since the end of communism in 1989.

The central bank, however, immediately said the figure gave a misleading picture of the direction of the Slovak economy, which faces stiff price increases after elections as well as after Slovakia joins the European Union.

Economic analysts, while saying they understood why the government was reluctant to continue raising prices before the ballot, at the same time urged the state to continue deregulation.

"In normal economic conditions inflation would be higher than it is now. Even core inflation [excluding regulated prices] should grow in the future," said Ľudovít Ódor from the Slovak rating agency.

"All analysts predicted record [low] inflation values when they learned that price deregulation would not be carried out to the same extent as in previous years.

"The current inflation figures are unusual for a transitional economy with 4 per cent growth in gross domestic product [GDP]. If you look at other transition economies, you see that they have higher GDP growth [compared to economically more developed countries], and therefore higher demand, resulting in higher inflation," he added.

The National Bank of Slovakia said that the current inflation figures could not be considered a reliable indicator of economic development, and also attributed the record lows to delayed deregulation of utility prices.

"Postponed deregulation has depressed price increases this year by approximately two percentage points," said NBS Governor Marián Jusko, adding that inflation would increase next year with the continuation of price deregulation.

Among other factors, analysts expect that an eight per cent weakening of the Slovak crown against its euro peg since April this year, as well as public sector wage growth, will bring an inevitable rise in inflation.

ING Barings senior economist Ján Tóth estimated that wage increases for civil servants before September elections could stimulate inflation by 0.4 per cent over the next 12 months.

"The 15 per cent planned increase in state officials' wages could increase wages in the national economy by 2.3 per cent.

"Such an increase, not backed up by increased productivity, will be reflected in inflation, with some delay," he said

Ódor, however, saw exchange rate developments as more important than wages for inflation.

"We criticised the planned wage increase even when it was proposed at the end of last year. The government applied restrictive policies during its first two years, and now is trying to compensate for them," he said

"But the most important question is the impact of the weakening crown. The real risk is imported inflation, which would come from price increases resulting from an exchange rate increase," said Ódor.

The NBS has also underlined that EU entry, which Slovakia hopes to achieve in 2004, will give an added fillip to price increases, and urged the government to boost inflation now to cushion the shock.

In the central bank's 2002 monetary programme, the NBS wrote: "Besides the fact that deregulation is a condition for EU entry, the Slovak economy needs to adjust price levels to those common in EU countries. We consider higher price levels in the pre-accession period as desirable."

A study of the impact of EU entry on the Slovak economy by the Slovak Academy of Sciences, which published partial results in May, predicted an inflation jump of 15-16 per cent following admission to the 15-member bloc.

Slávia Capital analyst Pavel Ondriska said that while record inflation lows created the risk that the NBS would miss even its revised inflation target of 3.6 to 4.2 per cent, a weaker Slovak crown could help.

"A weakened Slovak crown could increase inflation figures, thus making it fit into the planned values," said Ondriska.

Ódor emphasized that while the exchange rate and lagging deregulation have kept inflation low, they are not the only factors at play.

"Another factor is increased competition in the retail sector which is preventing great price growth," said Ódor, referring to a massive influx of foreign supermarket chains to Slovakia in the last three years.

"This competition is a guarantee that we do not have to fear significant inflation pressures, either now or in the near future," said Ódor.

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