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NBU Projects 5%–6% Inflation in 2020–2022 and Expects Economy to Revive After Quarantine

NBU Projects 5%–6% Inflation in 2020–2022 and Expects Economy to Revive After Quarantine

Inflation in 2020 will accelerate, but will not breach the 5% ± 1 pp target range. Consumer prices will be up 6% for the year. Due to quarantine restrictions to combat the pandemic and the global crisis, the Ukrainian economy in 2020 will decline by 5.0%, but will return to the growth of about 4% in the following years. For details, see the NBU’s quarterly Inflation Report dated April 2020.

The biggest shock will hit the Ukrainian economy in Q2 2020. In April through June, the economy will decline by 11% yoy, unemployment will rise to about 12% in seasonally adjusted terms, and wage growth will stall, the NBU projects. 

The gradual lifting of quarantine restrictions will lead to a recovery of the Ukrainian economy in Q2 2020. This will be facilitated by loose fiscal and monetary policies. Increased government spending on crisis management, as well as the NBU’s measures to aid the banking system, will mitigate the economic fallout of the pandemic.

Both the downturn and the recovery will vary across economic activities. In particular, the services sector, retail trade, and transportation will be hit the hardest by domestic quarantine restrictions. After the lockdown, these sectors will partially recover, but will still suffer from a slow recovery in household incomes. Tourism and related air transport will not be fully restored till next year.

Certain export-oriented industries, such as metallurgy, will take losses, primarily from a narrowing of external demand amid the global economic crisis. Demand for agricultural products will remain high, although grain yields will likely decline as weather conditions worsen.

Wages will rise again in 2021 as the economy recovers, and the unemployment rate will gradually return to the pre-crisis 8%–9%. Consumer sentiment is expected to fully recover, with private consumption growing at a rate of 5%–7% per year in 2021–2022.

Apart from revised macroeconomic forecasts, the April 2020 Inflation Report also deals with the following specific topics:

Macroeconomic conditions at the beginning of the current crisis

As it entered the global economic crisis caused by the coronavirus pandemic, the Ukrainian economy had a greater margin of safety than during the crises of 2008 and 2014. Ukraine’s key achievements ahead of the coronavirus outbreak included moderate inflation, effective floating exchange rate policy, currency liberalization, moderate current account deficits, significant international reserves, prudent fiscal policies, and reformed banking and energy sectors, which had previously acted as crisis catalysts.

These prerequisites make it possible to overcome the current crisis with fewer losses than before. Thanks to the prolonged period of macroeconomic stability in 2016–2019, the government and the NBU are able to pursue stimulus policies and to mitigate negative shocks. However, a new cooperation program with the IMF has become crucial for Ukraine as sentiment in the global financial markets has deteriorated. The program will provide additional resources to combat the consequences of the pandemic.

Inflation developments under the lockdown

The introduction of quarantine restrictions to fight the coronavirus in the first first weeks has triggered significant volatility in the prices of goods and services. Due to surging demand and logistical hurdles that started halfway into March, some food and personal care products increased in price rather sharply. The value of certain goods, including imported products or those made of imported inputs, was also affected by the hryvnia's weakening in March.

Since the beginning of April, however, price growth has been decelerating, while prices for certain commodities have even decreased. This was driven by both a weakening of panic demand from households and a strengthening of the hryvnia. According to preliminary data compiled by the NBU through online data monitoring, annual inflation in April remained low – under 3%.

Exchange rate pass-through to consumer prices

The exchange rate has an asymmetrical pass-through impact on consumer prices. When the hryvnia depreciates by 1%, consumer prices increase by an average 0.22%. If the value of the Ukrainian currency plunges, as happened at the start of 2015, the pass-through effect redoubles to 0.45%–0.50%. To mitigate this impact, the NBU takes active measures to smooth out fluctuations in the FX market. In contrast, every time the hryvnia appreciates by 1%, prices decline at a significantly slower pace of an average 0.08%.

The experience of other countries shows that the asymmetry of the pass-through effect is primarily driven by imperfect competition. Under strong competition, appreciation usually has a greater impact than depreciation. Businesses lower their margins to maintain or increase market share. When competition is low, depreciation tends to have a stronger effect on prices than appreciation. Companies keep their margins unchanged when domestic currency weakens, and raise them without losing buyers as it appreciates. In Ukraine, the asymmetry of the pass-through effect is amplified by the lack of long periods of strengthening of the national currency.

Labor market impacts of the quarantine

Ukrainian companies with the capability to operate remotely have been doing so since the lockdown took effect, and were initially expecting to retain staff. But these plans have declined in viability amid multiple quarantine extensions, mounting uncertainty, and deteriorating economic expectations.

The lockdown, imposed two weeks into March, has had no significant impact on unemployment in Q1, according to NBU estimates. Meanwhile, unemployment in Q2 will rise to about 12% in seasonally adjusted terms.

How the lockdown impacted remittances from abroad

Up until now, the consensus has been that sizable remittances from migrant workers mitigate the effects of crises on migrants’ home countries.But the distinguishing feature of the current crisis, apart from the cooling of global economic activity, is national border closures across the worlds. Experts estimate that about 10% of migrant workers have returned to Ukraine during the quarantine, and another 10% who planned to leave for seasonal work in Q2 will not do so. At the same time, the incomes of those remaining abroad will decline as the economies of the host countries cool off. Subject to these projections, the NBU has revised its forecast of migrant worker remittances to USD 10 billion from USD 12.5 billion. The forecast assumes that most quarantine restrictions will have been lifted by the end of Q2 2020. The fall in remittances, however, will be more than offset by a decrease in Ukrainians’ travel expenses.

Ukraine revised the state budget for 2020

In early April, the Parliament approved amendments to the Law of Ukraine On State Budget for 2020, which specify a significant widening of the budget deficit – to 7.5% from 2.1% of GDP. These changes primarily arose from the revised macroeconomic outlook and the need to take measures to contain the spread of the COVID-19 disease, to support entrepreneurs, and to aid vulnerable demographics.

Temporarily increasing the state budget deficit will not pose a threat to macrofinancial stability. Thanks to reforms in the banking and energy sectors, the wide general government sector deficit as a percentage of GDP will remain substantially smaller than in previous crises.

The budget deficit is to be financed out of borrowed funds, primarily IMF loans and official funding from other international institutions. The main risk to this plan is a delay in cooperation with the IMF, which may also make it impossible for Ukraine to obtain funding from the World Bank and the European Commission.

The Inflation Report reflects the NBU’s perspective on the current and future state of Ukraine's economy, with an emphasis on inflation, which is the basis of monetary policy decisions. The NBU has published the quarterly Inflation Report since April 2015.

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