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. Last Updated: 07/27/2016

Utilities Rates to Worsen Inflation

Russia's suppression of utilities costs, a throwback to the old Soviet command economy, threatens an inflationary backlash that could make it tough to get retail price growth sustainably into single digits.

A 14 percent tariff hike on a range of utilities and local services helped push up the consumer price index by 2.4 percent on the month in January, data showed this week, and many economists already predict the authorities will miss their 8.5 percent inflation target this year.

Since the main factor behind high inflation -- a 40 percent rate of money supply growth -- is beyond the government's control, policy makers are curbing gas, water, heating and house repair charges to force down the headline inflation rate.

At the end of 2005, the government pushed through a law capping tariff hikes at 20 percent for the whole year. But experts say the move will starve utilities of investment and store problems for later, when prices will be forced to surge.

"Imposed caps eat into our funds for repairs and investment. The rest of our expenses -- materials and labor -- are fixed," said Mikhail Nikolsky, CEO of Novogor, a company supplying water to the city of Perm, in the Ural Mountains.

"About 70 percent of our equipment is about to collapse, and because of the government cap it is likely to stay this way."

Russians still pay much less for water, electricity, gas and garbage removal than people in more developed countries. But because they are poorer on average, many people have to fork out up to half their income to cover their monthly bills.

As temperatures plummeted to record lows last month, thousands of Russians protested against the tariff increases. People are angry because they feel the hikes do not lead to an improvement in the often-dismal quality of services.

"There is an obvious discrepancy between reported tariff hikes of 14 percent and one's own experience," said Yulia Tseplyayeva, an analyst at ING Bank Eurasia.

This month, the Federal Tariffs Service bowed to pressure from local governments and agreed to raise the limits for many regions, which otherwise would not have enough cash to keep the system running.

Utilities fees currently make up about 9 percent of Russia's consumer price index basket, recently disclosed by the State Statistics Service, and are set to grow further.

"If the population is poor and has just about enough income to cover utility fees, accordingly, the weight of communal fees in the CPI basket is high," said Natalya Orlova, chief economist at Alfa Bank.

Even a minor change in utility charges has an immediate impact on inflation figures, tempting the government to manipulate the prices it can control.

Last year, after having to raise its inflation target twice, the government struck a deal with oil companies for a temporary price freeze for gasoline, which weighs about 2 percent in the CPI basket.

But economic theory states that rapid money supply growth -- a result of huge oil revenues -- should result in inflation much higher than the 10.9 percent posted last year.

Analysts say regulated prices could rebound at a later stage -- probably once the 2007 parliamentary and 2008 presidential elections are out of the way -- meaning Russia may fail to get inflation into single digits sustainably.

"Strict control over tariff growth ahead of the elections will lead to accelerated price growth in 2009," Orlova said.

Local governments set prices for water supply, garbage removal and house repairs while charges for heating and power are set regionally. The aim of sector reforms was to make people pay the full cost of the services and eliminate subsidies.

But many regions chose to carry on subsidizing services for fear of popular discontent. In Moscow, consumers still pay only about 60 percent of the cost, with the rest of the bill picked up by City Hall.

Experts reckon up to 40 percent of all energy used to heat Russian houses is wasted.

Vladilen Prokofyev, an expert at the Institute of Urban Economics, said utilities tariffs would have to at least double to reach the levels in other East European countries and even more to replace Soviet-era equipment.

"Further tariff growth is basically inevitable if we want to finance the ailing sector properly," Prokofyev said.

"The limits set by the government will only lead to further deterioration in the sector."