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bne February 2020 Eurasia I 43
affected by shocks that hit Russia, says Isakov. According to UN Comtrade data, trade turnover between Russia and Ukraine has declined 30-45% over the last five years, with the lower figure reported by Russian customs and the other by Ukrainian customs.
Two other aspects keep the vulnerability high: the important role public employment plays in all the countries and their sensitivity to food prices.
Public employment remains important in all four countries, according to the various statistical services. While the share of public sector employment in Belarus is gradually declining, it was still roughly 40% of total employment in 2018, and exceeds 30% in Kazakhstan.
“This means that discretionary decisions on wage policy in the public sector might create unexpected shocks on the demand side, affecting inflation and interest rates,” says Isakov.
Food prices are also important and
have a large non-monetary impact on headline inflation trends in all the KRUB countries. Food accounts for 54% of Ukraine's CPI, for Belarus it is 45%,
and in Kazakhstan and Russia 39% and 38% respectively, according to VTBC.
Managing the effects of things like hiking public wages is difficult. Kazakhstan successfully reduced the inflationary impact of a public sector
wage hike in 2019 but at the same time cut regulated utilities costs as a counter- balance, but policies like this are quick fixes and don't address the fundamental problems, says Isakov.
The goal of all the governments in
the KRUB countries is to reduce their exposure to these interconnecting shocks, but the Kremlin’s drive to develop the Eurasia Economic Union (EEU) will work in the opposite direction, as it attempts
to build a single market modelled on the European Union (EU) that hosts the free movement of goods, labour and funds. Against that, a larger EEU market will become more dependent on internal demand and that will make it more robust, so external shocks will have less of an impact eventually.
Inflation falling in KRUB counties
Of all the macro indicators, it is inflation that is the most important for the governments in the region. Russia had
a good year in its fight against inflation, which fell faster and further than anyone anticipated in 2019.
Russian inflation fell to a post Soviet low of 2.3% in June 2018 and was on the level of a “normal” country after three decades of elevated price rises. But in the second half of 2018 it started to rise again, partly due to political fears of fresh harsh US sanctions, and finished the year at 5%. The Russian government also gave inflation a boost by increasing VAT by 2pp to 20%, but the effects of this
wore off much faster than anticipated and by the end of 2019 inflation had fallen back to 3.5% – below the Central Bank of Russia (CBR) target rate of 4%. The inflation outlook for 2020 remains modest and below the 4% target.
“In Russia, we expect inflation to drop in 1Q20, but then bounce back in 2H20. We expect full-year inflation to print 3.7% year on year in 2020 on a visible pick up in food inflation, steady services inflation and somewhat weaker non-food inflation, depressed by the strong exchange rate pass-through,” says Isakov.
Ukraine also had a stellar year in fighting inflation, which had been pushed up to crisis levels during its economic meltdown starting in 2015. The National Bank of Ukraine (NBU) has shown its independence and kept interest rates high, even hiking them further in 2018 to curb inflation, which began to tumble in 2019. But the
NBU has been slashing rates in recent months, cutting the prime rate by two full percentage points in December and 150bp in November to end the year with a monetary policy rate of 13.5% after inflation fell to 5.1% in November after starting the year at over 9%.
Despite the cuts Ukraine still has one
of the highest real interest rates in the world, which was causing problems at the end of the year; the high interest rates have been sucking money into the domestic bond market, where foreign
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