Dear colleagues,
I’d like to greet all the participants at our traditional meeting following the Board meeting on monetary issues.
I would like to inform you that the Board of the National Bank of Ukraine has decided to leave the key policy rate unchanged at 14% per annum. Our decision was prompted by the need to mitigate inflation risks to enable the NBU to meet the inflation targets for current and following year.
Lets us start with a summary of last year.
We’re happy to inform you that we have met our inflation target - the first inflation target set by the NBU under inflation targeting. Headline inflation considerably slowed down in 2016 to 12.4% from 43.3% in 2015, which is in line with our forecast. Consequently, it was very close to the central point of target range (12% +/- 3 pp) set by the Monetary Policy Strategy.
Last year, fast disinflation was prompted primarily by abating pressure of fundamental factors. This was evidenced by drop in core inflation (to 5.8% pp) against the backdrop of prudent monetary and fiscal policies. Stronger role of the key policy rate and its cautious decrease throughout the year, as well as the Government’s efforts aimed at keeping the fiscal deficit within the target range contributed to significant improvements in inflation expectations especially in the first three quarters of the year.
The inflation pressure has eased also as a result of high supply of raw food. In particular, we refer to high crops in Ukraine and other countries, as well as consequences of foodstuff embargo imposed by Russia on our country and some of our trading partners. All these factors ensured high supply of goods in the domestic market and curbed growth of food prices.
At the same time, the increase in prices was mainly driven by higher tariffs for public utilities, as well as recovery in global oil prices, which made domestic fuel prices edge up.
FX market dynamics supported the disinflationary trend during most part of the year.
External and internal fundamental factors were mostly favorable. Last year, global steel prices grew by 61%, global iron ore prices - by 85%. Grain prices dropped; this was offset by record high crops. Moreover, high crops of sunflower, sugar beet and other agricultural products were observed.
Apart from that, in the reporting year, the NBU smoothed out sharp exchange rate fluctuations. To address heightened FX market volatility, the NBU was selling the currency to smoothen out sharp exchange rate fluctuations. The NBU was buying out FX surplus to replenish the international reserves when it was observed in the market.
As a result, the NBU’s net foreign currency purchases have reached USD 1.6 billion, and international reserves increased by 17% to USD 15.5 billion. Today this amount is sufficient both for mitigating excessive fluctuations in the periods of high volatility and performing obligations by the Government and the NBU.
However, despite favorable fundamental factors, the depreciation pressure on the hryvnia gained in strength in late December - early 2017. This has been caused by a number of situational factors.
First, the interbank foreign exchange market was impacted by weaker business activity, particularly, the decline in FX revenues from agricultural exports. While in November farmers accounted for 52% of total FX sales by exporters, in the last days of December their share reduced to 30%), and in January it is at 24%.
At the same time, amid recovery of global prices of steel and iron ore, these commodities’ exports became a major source of FX supply on the market in January. Against this background, the NBU was able to resume foreign currency purchases to replenish international reserves.
Second, foreign currency supply was restricted due to high hryvnia liquidity held by exporters. In December 2016, they received UAH 16 billion in VAT refunds, twice the average refund amounts in the previous months. In this regards, they were somewhat reluctant to bring foreign currency earnings to the country. Generally, exporters sell about 90% of their FX earnings, with a mandatory requirement of 65%, but in January sales declined to below 85%.
Third, the FX demand rose following high budget expenditures in December. This resulted in an increase in demand of state-owned enterprises in the interbank market and that of the households in the cash market.
Let me emphasize that capitalization of Privatbank by the state had no significant impact on the inflation rate. Although we have monetized domestic sovereign bonds for Privatbank for the amount of UAH 27.2 billion, the funds have not been used to finance deposit outflows, which, just for the record, were only registered for a few weeks before and in the first days after nationalization of the bank. Outflows of corporate and retail deposits since 19 December have only reached UAH 4 billion. Instead, the funds were used for provisioning and replenishing cash desks and ATMs to ensure continuous customer service.
What is our inflation forecast for the future?
The NBU is committed to achieve inflation targets of 2017-2018.
The NBU expects inflation within the announced target band (8% ± 2 pp for the current year and 6% ± 2 pp for the next year). The disinflation trend will be ensured through prudent monetary and fiscal policy and substantially lower rates of administered tariff growth.
At the same time, inflation forecast for 2017 has been revised from 8.0% to 9.1%.
Revision after minimal wage rise up to UAH 3200 By our estimates, due to this measure of the Government, the inflation will exceed our forecast by 1.1 pp.
On the one hand, this decision of the Government will have an effect on inflation directly through bolstered consumer demand (mainly for foods) and higher production costs. Consequently, this year, the core inflation will rise from 5.8% to 6.3% while raw food inflation - from 1.2% to 7%.
On the other hand, minimal wage increase has an indirect impact on inflation through inflation expectations of Ukrainians.
As we have already warned, year-on-year inflation is expected to remain high in the first three quarters, reflecting the sharp rise in administered prices that took place during last months of 2016. It will return to one-digit figures only in Q4 of the current year.
At the same time, the NBU does not consider reasonable to implement monetary policy instruments to reach inflation projections of 8.0% (central point of target range). It could lead to the undue volatility of market interest rates and inflation in the future and might slow down the economic growth that is currently at its recovery phase.
The NBU did not change its 2018 inflation projections of 6.0%.
The NBU has revised its 2017-2018 economic growth projections
GDP growth is expected to speed up to 2.8% this year and 3.0% next year, versus growth of 1.8% in 2016.
Stronger consumer demand driven by higher minimal wages is expected to foster economic growth in the current year.
Exports are also projected to return to growth, due to terms of trade improving and last year’s good harvest.
A rise in export earnings will make it possible for export-oriented enterprises to increase their investments at a relatively high pace. However, imported goods will be largely used to meet higher domestic investment demand.
Higher demand for imported goods was a key driver of the past year current account deficit expansion up to USD 3.4 billion, as per our estimates, compared with our previous forecast at the level of USD 2.5 billion. The impact of these factors is expected to continue. Accordingly, the NBU revised the forecast for current account deficit for this year to hover by USD 3.5 billion.
This deficit will be offset by capital inflow to the financial account, primarily, through raising direct investment and borrowings. As a result, the overall balance of payments will remain in surplus.
This along with the receipt of planned tranches under the FF program with the IMF will replenish the international reserves. We expect them to increase by the end of this year up to USD 21.3 billion and by the end of the next year up to USD 27.1 billion.
Further accumulation of reserves remains an important task for the NBU and the Government, given high volumes of external payments under public debt starting with 2019.
Key risks for the baseline scenario imply the growth of geopolitical turbulence and its negative impact on the global economy and economy of Ukraine, as well as the risk of departure from the prudent fiscal policy, including raising social standards even more strikingly than the inflation targets justify it.
Therefore, the NBU proposed to the Government to conduct the re-profiling of domestic bonds from its portfolio and issue the new long-term hryvnia bonds where yield will be linked to inflation.
The furtherance of structural reforms necessary to preserve the macrofinancial stability, expansion of economy’s potential, and continuation of the EFF program with the IMF are also important.
In its turn, this year, the NBU will proceed with the prudent monetary policy that will be aimed at decreasing the inflation to meet the inflation targets.
А new detailed macroeconomic forecast will be published in the Inflation Report on 2 February 2017.
The next meeting of the NBU Board on monetary policy issues will be held on 2 March 2017 as scheduled.
Thank you for your attention!