In H1 2021, inflation will temporarily accelerate and breach the 5% ± 1 pp target range. The NBU will use the flexibility of its inflation targeting regime, allowing inflation to temporarily deviate from the target so that the economy can more quickly recover from the coronavirus crisis. As a result, after contracting by 4.4% in 2020, the Ukrainian economy will return to growth of about 4.2% in 2021 and 4% in the medium term. At the same time, the NBU stands ready to raise the key policy rate to bring inflation to the target. This is according to the NBU’s January 2021 Inflation Report.
The growth will continue to be mainly driven by private consumption, which will rise as household incomes increase further. Economic recovery will also be fueled by a revival in investment activity as global economy expands and business sentiment improves.
Following last year's significant surplus, the current account in 2021 will go back into deficit, which will widen further in the years ahead (to 4.9% of GDP in 2023). This will be driven by growing consumer demand and recovering investment activity. After the decline in trade last year due to the introduction of quarantine restrictions, exports and imports are expected to return to pre-crisis levels this year, and to gradual growth in 2022–2023.
Last year's low crop yields, rising energy prices, and further growth in consumer demand will spur price growth. Administered prices will continue to grow rapidly due to increases in electricity rates and excise taxes on tobacco products. An additional inflationary factor will be an increase in the minimum wage (by 20% in January and by another 8.3% in December). In 2021, inflation will be 7%. In 2022–2023, it will settle at the 5% target level.
Based on the above scenario, the NBU projects that the key policy rate may be raised in 2021. However, this rate will remain below its neutral level during 2021 and most of 2022. But if the increase in underlying inflationary pressures from consumer demand is not offset by other factors, and inflation expectations continue to deteriorate, the NBU will raise the key policy rate. The magnitude of the rate increase will depend on the strength of the impact from these factors.
Labor market conditions also are expected to improve further. Following an increase in Q4 2020 amid rising prevalence of disease and the imposition of new quarantine restrictions, unemployment will gradually decline (to about 9%) in 2021. However, rapid growth in labor costs of businesses will restrain the pace of that decline. Continued economic recovery and higher social standards will underpin the growth in household income. Nominal wages will be up by 16.6% in 2021 and by 9.3% in 2022. Real wages will rise by 8.3% and 3.6%, respectively.
The revised macroeconomic forecast is based on the assumption that Ukraine continues to cooperate with the IMF, and that there are no strict quarantine measures imposed in Ukraine and globally.
Apart from the revised macroeconomic forecast, the January Inflation Report also covers the following specific topics:
COVID-19-fueled inflation in Ukraine
During the tight quarantine, some goods and services were not consumed, their sales being prohibited or restricted. In addition, demand for transport services and clothing and footwear weakened as the options for transition to remote work and training expanded. Yet food consumption declined at a slower pace, while the use of communication services, primarily mail, and purchases of household goods increased.
Respective changes in consumption exerted certain pressure on prices, both during strict quarantine restrictions and likely during economic recovery and the pickup in consumer demand. This led to a need to track broader concepts of inflation.
The NBU thus took an alternative approach to calculating inflation, one that accounts for changes in consumption. As a result, coronavirus-fueled inflation in March was slightly lower than official inflation. Meanwhile, in the following months the shift in the consumption pattern caused the adjusted index to exceed official inflation. Overall, adjusted inflation exceeded official inflation by only 0.2–0.6 pp. Other countries yielded similar findings. The indicator calculated this way is no more than an analytical tool that provides useful additional information on consumer behavior, price perceptions, and inflation expectations. Monetary policy decisions of the NBU are based on the dynamics of the official consumer price index.
Pandemic-induced changes in the labor market
Remote work has grown in popularity in recent years, but as the pandemic broke out, the proportion of employees working remotely surged. Yet even in developed countries, more than half of the jobs had to be performed on site. The best employment option to date is so-called hybrid work, where employees spend only some of the time working remotely.
Remote work conditions in Ukraine were similar to those in other countries. Specifically, businesses in the service sector, such as IT firms and financial institutions, were able to fairly quickly put some of their staff to work from home. By contrast, companies in transport and agriculture were unable to do so due to the nature of the technology involved. However, businesses providing courier delivery services during the quarantine actually hired more people who cannot work remotely.
The theoretical cap for those who can work from home is 38% for high-income economies and only 13% for low-income countries, a study by Dingel and Neiman shows. Ukraine was not included in the study. However, assuming there is a linear relationship between the share of people who can work from home and the country’s GDP, this share for Ukraine stands at about 20%.
Parameters of Ukraine’s State Budget in 2021
The approved law on the state budget for 2021 envisages a deficit of UAH 246.6 billion, or 5.5% of GDP. Although the deficit is set below the level planned for 2020 (UAH 298.4 billion, or 7.5% of GDP), it exceeds the actual deficit seen in 2020. At the same time, the negative primary balance is set to be reduced to 2% of GDP, which is a positive signal for the market and investors.
In current conditions, macroeconomic parameters indicate that risks to tax revenues are balanced. On the other hand, the main risks lie in financing – same as last year. Large borrowing plans on the domestic market (UAH 497 billion or 11% of GDP) will maintain high yields on domestic government debt securities.
Considering the financing risks, the NBU expects a deficit of 4.5% of GDP. However, the deficit will remain significant enough to provide support households and the economy amid the anti-pandemic struggle.
Capital Markets in 2020: Fear and Greed
A number of shocks marked 2020: the rapid development of the pandemic, quarantine restrictions, profound crisis, and large-scale fiscal and monetary stimuli in response. The coronavirus crisis was not the first crisis that hit Ukraine, but it was maybe the first time the country faced the crisis in a resilient position. As a result, Ukraine’s relative capital outflow indicators were moderate despite the overall capital flight from emerging markets (EMs) and sizeable repayments on external debt.
Large-scale anti-crisis measures taken worldwide made monetary conditions much looser across the globe, which revived interest of foreign investors in EMs against the backdrop of the news on successful vaccine trials and finished elections and announced new fiscal stimuli in the United States. Ukraine was not an exception: in December, it placed Eurobonds with the lowest yields ever offered by the country, and nonresident capital inflows into hryvnia-denominated domestic government debt securities resumed. This allowed Ukraine to finance the budget deficit and increase its international reserves to an eight-year high. However, apart from the optimism on international capital markets, such borrowing was made possible by international support and macrofinancial resilience built in previous years.
Outstanding Loans: What Is Seen from Developments of Recent Years
In order to revive lending and support economic recovery, the NBU continued to pursue accommodative monetary policy, used new instruments, including long-term refinancing and interest-rate swaps, and actively cooperated with banks to improve corporate governance. As a result, banks increased their hryvnia lending in 2020, except in the period of the strict lockdown.
Nevertheless, the NBU’s monetary statistics show that in 2020 outstanding amounts of bank loans have been declining for the second year in a row. It appears as if the stimuli were overweighed by opposite factors: increased uncertainty about the coronavirus crisis, risks of a deterioration in the quality of borrowers and the existing loan portfolio, unresolved issues of creditor rights protection, and so on. A more thorough analysis shows that the decrease was mainly driven by purely statistical effects largely resulting from the continued cleanup of the banking system, banks stepping up efforts to work out problem loans, and the exchange rate revaluation.
Assessments of Reaching the Inflation Target
At the end of the year, consumer inflation accelerated in Ukraine, reaching the midpoint of the 5% ± 1 pp target range. Inflation factors in 2020 were mixed and mutually offsetting. For example, last year price growth was restrained by weaker domestic and foreign demand and the benign price environment on global markets. On the other hand, inflation growth was sustained by volatility on global financial markets and associated capital flight to safe assets, increases in administered tariffs and prices, and smaller harvests of sunflower, grains, and sugar beet.
The NBU took account of the said factors in its decisions. With inflationary pressures subsiding significantly as expected and business activity declining in H1 2020, the regulator sped up the monetary policy easing. The key policy rate was brought to an all-time low of 6% already in H1, which was even sooner than projected in the January 2020 forecast. Along with vanished effects of many disinflation factors, this contributed to reaching the inflation target at the end of 2020.
The NBU will continue to pursue its inflation targeting policy to ensure that inflation remains moderate at the level of the medium-term target of 5%.
Electricity Market Debts
As the new electricity market model was introduced, special obligations to secure public interest were imposed on some of the market participants. However, amid worsening economic conditions in early 2020, drawbacks in the mechanism to compensate for such obligations led to large debts between market participants. Moreover, there is a risk that new debts may arise.
Electricity market debts can be covered by issuing state guarantees and government debt securities – so-called green Eurobonds or domestic government debt securities. However, both options will lead to an increase in the guaranteed or direct public debt. Thus, risks to public finances will rise, affecting country's sovereign risk perception. Therefore, the situation will require a comprehensive solution.
The Inflation Report reflects the opinion of the NBU on the current and future state of the Ukrainian economy, with a focus on inflationary developments, which form the basis of monetary policy decision-making. The National Bank of Ukraine has published its Inflation Report on a quarterly basis starting April 2015.