Economic Policy Review ISSN 1313 - 0544

Inflation in 2005

Author: Dimitar Chobanov / 26.01.2007
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The National Statistical Institute has released preliminary data about the consumer price index (CPI) dynamics in 2005. These data are the subject of revision but, probably, the final values would not differ substantially of now available and thus enable the analysis of the last year situation according to this indicator.

The change in the CPI in December 2005 compared to December 2004 is about 6.5 per cent and the annual average is 5.3 per cent. Still, end of the year inflation is a point estimate while the annual average value gives better understanding of the whole picture.

Few factors determine the rate of price increase during the last year. The currency board that is adopted in the country sets general framework and the other determinants are the credit expansion and related Bulgarian National Bank (BNB) measures, the government fiscal policy, the international conjuncture, floods and the weaker crops, as well as the change in some administratively set prices.

The currency board arrangement is a monetary policy rule that binds monetary base with the economic agents demand for money. The central bank is not allowed to increase the money emission by own decision but keeps some instruments to control the money supply by setting minimum reserve requirements and applying administrative actions. In fact, the functioning monetary regime can be characterized as a currency board like system because it differs from the orthodox one as BNB keeps some of the traditional central bank features.

The fast rate of credit growth logically leads to analogical development in money supply that, in turn, determines the higher prices of goods and services bought using these credits. Of course, one should consider supply side factors of these goods and services and the presence of competition. Generally, when goods can be provided by many sources this does not allow their prices to rise in case of strengthened demand in a small market, like the Bulgarian one. For example, the household appliances are not more expensive in 2005 than in 2004 (prices in the item “Furnishing, household equipment and routine maintenance of the house” rose by 1.5 per cent) although there is a strong demand and growth of consumer loans.

Supported by the government policy to maintain a large surplus in the consolidated budget the measures directed towards the restriction of credit expansion of the Bulgarian National Bank kept inflation lower. Taking away more money from the taxpayers that is necessary to finance its already huge spending lowers the demand and the upward pressure on prices in short run. However, in longer run it limits the private saving and investment pushing down the supply of goods and services that is an anti-inflation factor.

On the other hand, as a result of increasing the excise on alcoholic beverages, cigarettes and oils their prices are higher (prices in item “Alcoholic beverages and tobacco” have risen by about 7.6 per cent) provided that oil prices indirectly influence almost every price in the economy. This effect is strengthened by the international markets situation where oil prices were high during the year and, logically were passed to Bulgaria. This development has a direct effect on prices in transportation services, which had the fastest growth in 2005 with about 11.4 per cent.

Food prices rose by about 4.8 per cent one of the reasons being the weaker crops due to the floods in the summer. This has an adverse effect on the agriculture sector as a whole. According to the preliminary NSI estimations, the output of the agricultural industry fell down by 5 per cent and the gross value added at basic prices fell by about 16.3 per cent compared to the preceding 2004.

Other sectors where significant increases in prices are observed are healthcare (with 9.9 per cent) and education (6.4 per cent) while the services as a whole went up by 6.9 per cent. Their total contribution to inflation is about 36.7 per cent while the contribution of foods is 34.6% and non-foods about 24.4 per cent. Healthcare and education are two of the government-dominated sectors with delayed or non-occurring reforms combined with steadily increasing costs for them. One can expect that keeping the course of this policy in the future will extend the ineffectiveness.

A positive development can be found in telecommunications and, more precisely, in mobile service pricing. Due to the expanded competition some attractive offers were made and prices went down. Still one should recall that prices had been very high thus enabling the telecommunication companies to make monopoly profits because of the restricted number licenses for mobile and fixed-line operators. Therefore, liberalization of the market directly led to favorable effect to the consumers. This could happen to the economy as a whole if an appropriate policy oriented to expansion of economic freedom is implemented.

The conclusion for 2005 is that the rate of inflation is relatively high (above 5 per cent). It is lower than the annual average rate in 2004 that was 6.1 per cent but it is significantly higher than the rate in 2003 of 2.3 per cent. Keeping such rates of inflation is likely to raise doubts about fulfillment of the Maastricht criterion (inflation rate does not have to exceed by more than 1.5 percentage points the average inflation in the three lowest level inflation countries of the Euro area) which, in turn, could delay the adoption of the Euro as a legal tender in Bulgaria. In 2006, the inflation will be relatively high and likely to be even higher than in 2005. It will impose a downward pressure on the real incomes of Bulgarians causing a deceleration in their growth. Still, the inflation will be in single-digit limits on account of the currency board arrangement.