Rapidly Rising Prices

KIEV -- A jump in Ukraine's annual inflation rate to almost 20 percent has piled pressure on the new government -- already under fire from world institutions for "populist" policies -- to prove its economic competence.

Prime Minister Yulia Tymoshenko has set herself the conflicting goals of fulfilling spending promises while cutting inflation to 10 percent, grappling with a steep rise in gas prices and improving the finances of the state energy firm without blowing a hole in the budget.

She may get help if the Central Bank allows the hryvna currency to rise or liberalizes the exchange rate regime, but the bank so far has done little more than talk of such moves.

Within weeks of forming a government in December, Tymoshenko oversaw the first cash payments to people who lost Soviet-era savings, a move that raised the specter of policies deemed populist during her seven months as prime minister in 2005.

Inflation gained momentum throughout last year under the previous government as food prices jumped after a devastating drought. In January, it jumped to 2.9 percent month on month and reached 19.4 percent annually after a 16.6 percent rise in 2007.

"Inflation ... is particularly embarrassing to this government because Tymoshenko made a point about raising living standards for the poorer," said Geoffrey Smith, an analyst at Renaissance Capital.

As pensioners lined up in the snow for the payments, Standard & Poor's reiterated its "negative" outlook for Ukraine's -BB rating and said the government could shoot itself in the foot by undercutting the value of benefits through higher inflation.

The World Bank this month raised its 2008 inflation forecast to 13.8 percent and warned of more revisions should the full $4 billion penciled in the budget be paid out.

But Tim Ash, head of emerging markets research at Bear Stearns in London, reckons criticism may be premature. He says accelerating inflation is a regional trend and a problem inherited by the government.

Analysts said the government should pursue higher tax-collection rates, clamp down on corruption, moderate wage rises and ease a link between pensions and inflation. Tymoshenko, they said, should not impose price controls, as she did in 2005.

But the hardest decision may be on raising domestic gas bills, kept low despite rises in Russian imports to $179.50 per 1,000 cubic meters from $130 last year and $95 in 2006.

An increase there would be keenly felt by the very people Tymoshenko says she represents, but would help state energy firm Naftogaz Ukrainy, which she says is practically bankrupt and for which a $2.4 billion guarantee has been set in the budget.

"Until they have Naftogaz sorted out, it's very difficult to know for certain where inflation is going. The scale and nature of help they have to extend to Naftogaz will have a profound impact on the overall budget," said Smith at Renaissance Capital.