The National Bank of Ukraine held a roundtable discussion involving external experts to discuss the NBU’s updated macroeconomic forecast and the NBU Board’s recent decision to raise its key policy rate to 13.5% per annum.
During the first part of the event, NBU Deputy Governor Dmytro Sologub and Director of the Monetary Policy and Economic Analysis Department Sеrgiy Nіkоlаichuk explained the logic behind the Board’s decision to raise the key policy rate, for the first time under an operating inflation targeting regime, bringing to halt of almost the two-year period of monetary policy easing.
A monetary policy reversal was not a response to supply shocks that caused a hike in prices for meat and diary products, as well as vegetables, in recent months, but rather a reaction to growing risks of further inflation deviations from the target in the future. It is precisely to bring inflation down to the target level that the decision on the key policy rate hike was taken.
Dmytro Sologub called on experts to pay more heed to the NBU’s public statements, particularly press releases on monetary policy decisions issued by the regulator, because they can provide some kind of forward guidance, thus communicating the NBU’s stance regarding further direction of the monetary policy.
Possible tightening of the monetary policy, which came unexpectedly for many experts, was signaled in previous communication of the regulator. In August, the NBU Board pointed out that should underlying inflation pressure mount, the NBU will implement a rather tight monetary policy for a longer term to put inflation back on a downward trend in line with the announced targets. In September, it was underscored that should demand-driven inflationary pressures increase, including due to a rise in social standards that is inconsistent with economic productivity growth, or inflation expectations grow significantly, the NBU may resort to a tighter monetary policy and raise its key policy rate to mitigate inflationary pressures and return inflation to the target level. With the risks of strengthening fundamental inflation pressure and worsening inflation expectation, the NBU has responded to it by raising its key policy rate.
"NBU's communications on monetary policy are aimed at reasoning our decisions and making it possible to predict further steps of the regulator, thus creating the basis for making proper investment decisions," said Dmytro Sologub.
The second part of the event was devoted to discussing the Ukrainian economic prospects in 2018–2019 outlined in the recent Inflation Report (October 2017), which is issued quarterly. In particular, Sergiy Nikolaichuk announced an updated inflation forecast that had been revised down to 12.2% as for the end of 2017 and 7.3% as of the end of 2018. The outlook for 2019 remained at the level of the target range’s central point of 5.0%.
Inflation will be trending down due to a gradual exhaustion of the impact exerted by this year's sharp rise in food prices, moderate volatility of the hryvnia exchange rate over the forecast horizon, as well as through tighter monetary policy.
In addition to updated macroeconomic forecasts, NBU representatives brought forward a number of special topics covered in the October Inflation Report:
Supply-Side Pressure on Inflation: Conditions in the Animal Breeding Sector
Prices on the domestic market of meat and dairy products were driven up by two simultaneous factors: exporters raised their prices against the backdrop of rising global prices for these products, while farmers increased procurement prices due to further decline in livestock and in raw milk output.
The sharp increase in procurement prices for meat and milk lay the foundations for the animal breeding sector to develop and increase production. As increasing production takes time, prices for meat and meat products may continue to go up pushed by high exports and a pickup in domestic consumption. Milk and dairy prices are expected to grow further, especially in early 2018.
- Key features of the pension reform
Current changes in the Ukrainian pension system seek to overcome the inequality in pension payments due to different retirement time and programs, enhance incentives for employment in the formal sector of the economy and carrying out of pension contributions. Accordingly, it will be positive for strengthening the financial stability of the Pension Fund, although the negative impact of demographic and migration trends on the pension system cannot be disregarded.
At the same time, the pension reform has not solved all the challenging issues of Ukraine's pension system. Consequently, further steps in reformation of Ukraine's pension system will be as follows: launching a contributory pension insurance system (from 1 January 2019); implementing a professional pension system; and creating the register of recipients of social payments, benefits, subsidies, pensions, and other payments at the expense of budget and off-budget funds.
- Fiscal multiplier as a factor of impact of the fiscal policy on Ukraine's GDP
The government estimates that the October 2017 initiative to bring pension payments up to date will require an additional UAH 20 billion in Q4 2017. Given that other items will offset the impact of the increase in pensions on the budget (the budget deficit will remain below 2.5% of GDP in 2017 and 2018), the NBU estimates that the pension increase will be neutral towards real economic growth but will put moderate pressure on consumer prices (adding 0.3–0.6 pp to annual headline inflation in 2018).
- Sovereign Eurobonds of Ukraine: recovery of access to capital markets
After restructuring of Ukraine's external debt, in less than two years the country returned to the international capital markets. This became a positive signal for not only those investing in debt securities but potential direct investors.
However, the schedule of payment under external obligations will remain rather tense in the next few years. In 2018 – 2021, the annual payments related to the repayment and servicing of the public and quasi-government foreign currency debt will exceed USD 7 billion. Therefore, it remains essential for Ukraine to pursue structural reforms aimed at improving the business environment and conditions for a long-term economic growth. In this context, continued cooperation with the IMF remains significant.
- Analysis of the yield curve under government bonds of Ukraine
The development of the domestic securities market also ensures the efficiency of the monetary policy transmission mechanism, as it is one of the channels ensuring an impact of the key policy rate on economic processes and making it possible to raise the efficiency of liquidity management in the banking system.
Thus, in order to enhance the efficiency of the monetary policy, in September 2017, the NBU changed the operational design of its monetary policy. Particularly, it resumed placement of three-month CDs. In view of sizable liquidity of the central government, the Ministry of Finance of Ukraine (MFU) did not make the initial placement of three-month domestic government bonds (DGBs) and irregularly placed securities maturing up to one year. At the same time, the maximum maturity in the interbank credit market is two weeks. Accordingly, the market did not have enough short-term DGBs to efficiently build this segment of the curve. Consequently, the purpose of restoring the placement of three-month DGBs was not the accumulation of liquidity for a long term but setting up the reliable point at yield curve.
Pursuant to the Public Finance Management Strategy for 2017 - 2021, further steps in the context of building the yield curve in the medium and long terms are as follows: elimination of bureaucratic and other barriers to investing in DGBs by nonresidents; maintaining a continuous dialog between market participants and the MoF; and improving DGBs’ liquidity via developing the institution of primary dealers.
October 2017 Inflation Report and the previous publications are available at: https://bank.gov.ua/control/en/publish/category?cat_id=16036612.
Read more on the logic of making decision on monetary policy issues by the NBU Board in the column Myths and Reality: Why Did the NBU Raise the Key Policy Rate for the First Time in Three Years?