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Ukraine’s Dollar Addiction

KYIV – Inflation in Ukraine is skyrocketing. By March, it reached 26% per year and continues to rise. Although prices are increasing around the world, Ukraine’s inflation is extreme, twice as much as in neighboring Russia. Amazingly, instead of dampening inflation, Ukraine’s central bank is stoking it.

Ukraine’s prices started spiraling out of control around the time when Yuliya Tymoshenko returned as prime minister last December. Malicious observers suggest that she is to blame for pursuing populist social expenditures. But this is false. Her government actually tightened the budget just before New Year. Indeed, Finance Minister Viktor Pynzenyk reports that the state recorded a budget surplus of 0.6% of GDP during the first quarter of 2008.

This is not surprising, because state revenues expand with rising prices, while expenditures are largely fixed. But Tymoshenko’s government has, in reality, done a solid fiscal job. State finances are generally in good shape, with public debt at just 11% of GDP. According to the National Bank of Ukraine (NBU), international reserves have grown steadily and now stand at $33 billion.

The real cause of Ukraine’s inflation is that its currency, the hryvnia, remains pegged to the US dollar. When the dollar falls in value, as it has, Ukraine’s very open economy imports inflation. In the last year, the dollar’s value dropped by 12% against the euro, which is a more important currency than the dollar in Ukraine’s foreign trade.