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The Economy Will Grow in 2021 and Will Fully Recoup Its Losses from the Coronavirus Crisis in 2022 – NBU Inflation Report

The Economy Will Grow in 2021 and Will Fully Recoup Its Losses from the Coronavirus Crisis in 2022 – NBU Inflation Report

Inflation will hit 4.1% over the whole of 2020, temporarily overshooting its target range of 5% +/-1 in 2021. The NBU does not rule out the possibility of letting inflation deviate from its target slightly for a short-time to speed up economic recovery from the pandemic. As a result, after contracting by 6% in 2020, the Ukrainian economy will return to growth of about 4% in the years ahead.  However, by 2022, the NBU will slow inflation to its target level through using the key policy rate. Read more in the October 2020 Inflation Report.

The economy has already started to show signs of recovery. Economic activity has been reviving since May, in step with the easing of quarantine restrictions. The economy is rebounding faster than expected, driven by rapidly reviving consumer demand. The economy is being buoyed by rising household income, a more benign external environment, and increased budgetary spending on road infrastructure. The recovery could have occurred even faster but for unfavorable weather conditions, which will result in weaker performance in the agricultural sector compared to last year. 

Private consumption will remain the main driver of GDP growth of 4% in 2021—2022. While recovering, the Ukrainian economy will require larger imports, including investment imports. As a result, after posting a surplus in 2020, the current account will return to deficit. Price growth will accelerate somewhat, fueled by the rebounding economy, this year’s weakening of the hryvnia, and a rise in the minimum wage. Inflation will come in at 6.5% in 2021, returning to 5% in 2022. 

In light of these developments, the NBU expects to maintain the key policy rate below its neutral level until the end of 2020 and for most of 2021. That said, the central bank will continue to conduct an expansionary monetary policy to support the economic recovery. After that, the NBU will raise the key policy rate somewhat in response to growing inflationary pressures. This will bring inflation back into its target range in 2022. 

Labor market conditions are expected to improve further. After jumping to almost 10% in Q2, the unemployment rate will gradually return to its equilibrium level. After a short pause caused by strict quarantine measures, the income of Ukrainians has returned to growth. Continued economic recovery and higher social standards will buoy income growth. Nominal wages will be up by almost 9% in 2020 and by 16% in 2021, while real wages will rise by 6.2% and 9.5% 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 October Inflation Report also covers the following specific topics:

The factors behind the resilience of Ukrainian goods exports during the coronavirus crisis

In contrast to previous crises, Ukrainian exports were sufficiently resilient to the crisis in 2020. This was due to a number of external and internal factors. More specifically, recent years saw an increase in the share of exports of food, demand for which remains robust even during crises.

Stronger trade relations with China amid its trade tensions with the United States also played an important role. Last year, for the first time in history, China became Ukraine’s second largest trading partner after the EU, and it has retained this status in 2020. In addition, the Chinese economy returned to growth reasonably quickly after the onset of the coronavirus crisis. Ukrainian exporters quickly responded to these developments, by focusing some exports on the Chinese market and in this way compensating for narrower demand from other markets. 

Despite there being an improvement in the resilience of Ukrainian exports, their competitiveness needs to be boosted, in particular through increasing the share of high-tech products. 

Household savings during the coronavirus crisis

In a time of uncertainty, demand for the most liquid assets, such as cash, rises significantly. This was the case in previous crises, and it has also been the case this year. Moreover, a flight to liquidity is happening not only in Ukraine, but in many other countries.

However, in contrast to previous crises, Ukraine is seeing no deposit outflow this year. Household deposits continue to rise rapidly, propelled by an increase in wages, budgetary social spending, and households’ greater propensity to save during the coronavirus crisis.

Household deposits are rising in the face of falling interest rates. This growth is laying the foundations for a faster pick-up in consumer demand when the epidemiological situation improves. At the same time, the surfeit of low-return liquid assets is generating dollarization risks.

The pass-through of a change in global oil prices to consumer prices in Ukraine

Oil markets change rapidly in response to global market conditions. This also affects domestic fuel prices. NBU calculations show that retail petrol prices respond more quickly to increases in crude oil prices than to decreases. But the extent of this impact becomes almost equal with time. 

The pass-through effect of higher oil prices kicks in during the month following a rise, and peaks (0.6 pp) during the second month. Over the next few months, a slight correction occurs. In contrast, the effect of a lower crude oil price, which is hardly apparent during the first month, starts to kick in only during the second month, and peaks during the fourth to fifth month (0.5 pp).

Overall, while showing large values in the short-run, the pass-through effect remains below one even over the period of a whole year. This is largely due to the fact that apart from the cost of petroleum products, fuel prices also include other expenses, such as those related to logistics, distribution, marketing, wages, as well as the marketing margin. 

The impact of COVID-19 on the economies of Ukraine’s trading partners 

The unprecedented quarantine restrictions imposed by countries in response to the outbreak of COVID-19 have significantly narrowed demand and reduced global trade. More specifically, in Q2 2020, the economies of Ukraine’s main trading partners (MTPs) saw the largest fall since the Second World War. After the quarantine restrictions were relaxed, these economies started to recover, sometimes even more quickly than expected. The services sector recommenced operations, while substantial government assistance helped the industrial and construction sectors recover gradually. 

The further recovery of MTP economies will be facilitated by a gradual increase in external demand, the implementation of deferred investment projects, continued positive effects from fiscal stimulus this year, improved labor market conditions, and a revival in consumer demand. That said, the return to pre-crisis performance indicators will not be quick. Rising COVID-19 cases are increasing the risk that overcoming the crisis will take some time. Losses to economic growth will only be offset in 2022. 

The business activity expectations index (BAEI) – a leading indicator of economic activity

In July 2019, the NBU launched a monthly survey of companies, with a view to obtaining up-to-date information about the state of the economy. The business activity expectations index (BAEI), which is a counterpart of the internationally well-know PMI, is calculated on the basis of these surveys. A comparison of survey findings and official statistics shows that companies’ views as a whole reflect the state of the economy and individual sectors.

The value of this up-to-date information increases markedly when the economic situation changes abruptly. In early 2020, when the COVID-19 pandemic was spreading and quarantine restrictions were imposed, the BAEI was an additional source of up-to-date information that informed decisions to speed up an easing of monetary policy.

The Inflation Report reflects the opinion of the National Bank of Ukraine 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 since April 2015.


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