Inflation shock and horror

Economic risks for Bulgaria because of the war in Ukraine

11:49 | 28 март 2022
Обновен: 14:55 | 28 март 2022


By Boyan Ivanchev

Before the beginning of the attack over Ukraine, the world was expecting the end of the last wave of Covid pandemic which overtook the planet during the last two years. 

The first and most noticeable consequence of the pandemic was the disrupted supply chain in a globalized economy. Remember how at the beginning of the pandemic there were medical masks and testers missing. Later it turned out that the temporarily closure of different sectors in the most affected countries, led to depletion of available stocks of goods and raw materials. After the Omicron wave passed and the opening of economic sectors began, suddenly the production recovery seemed much more difficult than expected - due to the broken supply chain of raw materials.

We ended up in a situation where ships in all world ports had to wait for at least 10 days before unloading, then we witnessed a disrupted schedule in the docks, and then a further delay in deliveries to the final destination - due to lack of trucks and drivers. In the end, the production of goods and raw materials failed to catch up and meet demand. The paradox came that car production was blocked due to a shortage of computer chips. As a result, behavioral compensation mechanisms have forced wealthier consumers in the United States to bid for and buy cars at a deficit and at prices significantly higher than the recommended retail price of automakers.

Disturbed supply chains unleashed inflationary pressures around the world, which accelerated under the current monetary policy of all major central banks to stimulate the economy and liquidity - known as quantitative easing. Against the background of zero interest rates, supported by almost all leading central banks, additional economic measures to overcome the negative economic consequences of the pandemic led to record inflation of over 5% in 15 of the 34 most developed economies (according to IMF criteria), or in 44.1% of these countries. Such inflation, high above the "health levels" of 2-3%, has not been observed for more than 20 years, and in some countries - such as the United States - for more than 40 years. In developing countries: in 78 of the 109 countries the annual inflation also exceeded 5% - or in 71.4% of these countries, i.e. twice as much as the end of 2020. Meaning, inflation has become a global problem.

In Bulgaria, as a country on a currency board, the functions of the central bank to react in such situations are limited. The country does not have an independent monetary policy, except through a budget deficit (which is a quasi-monetary instrument) it is not possible to determine the base interest rate itself. Therefore, there is a transmission of economic conditions in the country - mostly from the EU, meaning that in our country interest rates and liquidity are similar to those in the euro area. This conjuncture is transferred to Bulgaria due to the fact that its economy is very open - the ratio of exports + imports to GDP is over 80%. This means that foreign trade is an important driver of economic growth - along with foreign investment.

In 2021, domestic demand was also important for GDP growth, which increased due to deferred consumption since the pandemic lockdown period also and due to the low cost of consumer and mortgage loans. At the same time, export-oriented activities are largely dependent on imports of energy and raw materials. Domestic prices and production are also affected by the jump in the price of metals, which in construction fittings and iron reached 2000 BGN / t - from 700 BGN / t in early 2021. Energy also fell into the vortex of serious volatility in late 2021 - especially in the prices of natural gas and electricity.

The most serious risk coming from military actions in Ukraine is connected to the high prices of energy resources, which will lead to an increase of manufacturer’s prices, decrease in our export’s  competitiveness and additional growth of consumer prices. Despite the improved in the last years diversification, natural gas in Bulgaria is entirely imported raw material and the high price will directly induce inflation in manufacturing. Consumer compensation with different government measures can lead to larger-than-expected budget deficits and ultimately disrupt Bulgaria's long-standing macroeconomic stability.

In the case of a general decision to suspend the purchase of energy from Russia and / or its suspension by Russia itself, there is a risk for the entire production and household sector of our country. The latest data show that after 2020 Bulgaria has achieved 24% diversification of natural gas supplies from other sources - other than direct supply from Russia and only about 0.16 million cubic meters per day of natural gas production. The total consumption of natural gas in Bulgaria is about 2.9-3.3 billion cubic meters per year and about 70% of the consumption is for industrial purposes (10% are for the production of construction materials and chemical industry, 8% are for transport needs, and the rest are for other purposes) and about 30% are for district heating plants.

The above consumption is about 11.2-11.6 million cubic meters per day and according to the current regulations Bulgartransgas EAD is obliged to store 70 million cubic meters of natural gas in Chiren and gas companies an average of 290-310 million cubic meters, before the start of winter. In case of an accident, the Chiren gas depot will cover 25-30% of the daily needs of natural gas in Bulgaria.
"The full capacity of Chiren landfill is 550 million cubic meters, and the maximum daily amount that can be used is no more than 4.7 cubic meters per day. But the specifics of the Chiren landfill and the extraction of gas from the underground storage allows the extraction of a maximum of 4.7 cubic meters per day for a period not exceeding 30 days, after which the production capacity drops to levels of 3.5-3 .9 cubic meters per day until the entire gas supply is emptied. The current gas reserves in the Chiren depot could cover the above-mentioned emergency levels of natural gas consumption in Bulgaria for about two months.

Of course, in case of suspension of Russia supplying us with gas, we could seize the quantities in the Balkan stream that are directed to Serbia-Hungary and thus provide a significantly larger amount of reserves than those in the Chiren gas depot. 

There is no risk of wheat and corn lack for Bulgarian consumers. Private sector can even extra profit because of the record stock prices of these basic foor raw materials.

The main challenge, except the above mentioned will be managing inflation and tackling pressure for full compensations of all workers – private and public sector. This does not mean that they will be left alone to handle the specific situation, but the budget deficit should be carefully used, as well as the recovery grants in relation to pandemic and the operational programs. This cannot be done through short-term political purposes and instruments but through middle- and long-term macroeconomic country objectives, which will not put future generations into risk of servicing large debt with an expected increase in interest rates – meaning, higher cost of servicing government debt.