Inflation is here and it will stay

The rise in consumer prices was expected as most countries have started recovering from the coronavirus pandemic. Improvements to liquidity by central banks also lead to inflation. However, the high prices of electricity and raw materials as a result of disrupted supply chains surprised almost everybody. Thus, in just a few months economists have significantly increased their inflation forecasts for this year and next.

Rates of 3-4% y/y and even 5% y/y, especially while incomes are rising faster, are still not particularly worrying. Prices were rising at this rate even before the Covid crisis. As a reminder, in the years of economic boom before 2009, prices increased by 10-15% on an annual comparison basis.

For now, the expectations are that the inflation wave will recede in the spring of 2022. The point, however, is that there is a risk (and it is not to be underestimated) that this forecast will not come true and higher inflation could stay a little bit longer. This could be due to readjustment of work processes after the Covid crisis and lack of staff, slower recovery of some supplies or delayed withdrawal of incentives by central banks and governments.

All these factors are global. As a small and open economy that in addition has no monetary policy of its own because of the currency board, Bulgaria has a much more limited set of measures to counter the import of inflation. The country is on the verge of new elections and waits for discussions of Budget 2022 and that's why the pressure for a significant increase in incomes (which can also fuel inflation) is growing.

What is driving prices up?

Much of the inflation that Bulgarian statistics is measuring at the moment comes from the outside through the prices of food, fuel, transport. For example, in just a year, the retail prices of the most popular types of gasoline and diesel in the country have increased by one-third, and of propane-butane by almost two-thirds. Another factor is the disruption of supply chains due to the Covid crisis, with the ensuing shortage logically increasing the prices of raw materials and transport not only in Bulgaria.

"For us prices of key raw materials, such as oil, primary and corrugated packaging, foils, dairy products, have risen by about 25-30% and several times over the past year so far, which makes 100% for some of them. The concern is that this process is still going on", comments Mehmet Rafet, manager of Talar Foods.

In the latest edition of its quarterly economic review, the Bulgarian National Bank also said that country's inflation is projected to accelerate to 3.8% y/y at the end of 2021, reflecting the expected significant increase in production costs of companies due to the strong growth in international prices of some basic raw materials as well as increased labour costs and electricity prices.

The increase in the price of natural gas on an annual comparison basis as of October is 280%, in the regulated price of electricity for households the rise is 4%, but for businesses which are buying electricity on the free market prices are up 340% compared to October 2020.

"After the large high electricity bills for August (received and paid in September), businesses began to raise the prices of their products. Therefore, in September inflation reached a nine-year peak," says Georgi Angelov, senior economist at Open Society Institute in Sofia. According to him, this process will continue in October.

How long?

Investment in fixed capital will contribute substantially to GDP growth in the next two years mainly due to the expected significant public expenditure under the National Recovery and Resilience Plan. The BNB noted that it expects domestic demand to have a major contribution to growth in 2021-2023, mainly due to increased private consumption. In the context of strong domestic demand, net exports are set to have mostly negative contribution in the period 2021-2023.

In its report, it also forecasts that Bulgaria's inflation will accelerate to 3.8% y/y at the end of 2021 before slowing down from 2022 onwards. This is the base scenario that major international institutions are currently working on.

"Тhe risk of a further rise in international commodity prices in 2022 is increasing due to the still existing supply chain disruptions. An alternative scenario based on this assumption has been developed to assess its impact on key macroeconomic indicators," notes the Ministry of Finance in its autumn economic forecast. The BNB points out as a risk "the possibility in the medium term to maintain the strong upward trend in electricity prices formed since the beginning of 2021".

"The risk is that a one-off energy price shock can cause constant inflation or even stagflation as the oil shock of the 1970s did. So the central banks have to take action when it's necessary. Some of them have already tightened monetary policy or are considering tightening," says Georgi Angelov.

What about the incomes?

Amidst expectations for continued price growth, voices for income-compensating measures have already appeared. There is a danger of staggering into unhealthy populism as discussions on next year's budget are expected to begin soon after a new parliament is formed. They are traditionally accompanied by requests for more state aid or an administrative increase in some payments, such as the minimum wage. The Confederation of Independent Trade Unions in Bulgaria has already asked for an increase of the minimum wage to 764 levs from next year (from 650 levs now), as well as a new 15% increase in the salaries of employees in certain administrations.

For now, the forecasts are that wages will continue to grow. In 2020, for example, the average salary in the country was rising at double-digit rates, which means it outpaced the reported inflation. Since the end of 2020, the minimum pension of 250 levs has been increased several times to reach 370 levs. Also, a monthly supplement of 120 levs for the last three months of 2021 was added to all pensions. This represents almost 100% growth of pensions within two years and it covers more than one million people.

According to Georgi Angelov, temporary measures are needed, otherwise the budget will have billions in surplus, and at the same time the real income of households will be reduced which "will shrink consumption and put us in a fake recession."

"Inflation is like body temperature - it usually appears as a kind of reaction to clear certain processes," says economist Lyubomir Datsov. "In 2006-2007 there was annual inflation of about 6-7% but it was a consequence of the overheating economy. Now it's different - we have a restructuring of the economy, but also a poor regulatory system, distorted relations in industries, hidden monopoly in some of them. In this situation, you have to make sure that market signals are not distorted," concludes Datsov.