The Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. With exchange rate stability supported by the key policy rate and the NBU’s additional measures, inflation processes will remain under control.
As expected, inflation has been rising during the war but remains controllable
Consumer inflation in Ukraine was 24.6% yoy in September, and core inflation exceeded 20% yoy. Inflation continued to accelerate in October, according to the NBU’s preliminary estimates.
Consequences of russia’s full-scale war against Ukraine remain the main price driver. This includes supply chain disruptions, destruction of production facilities, reduced supply of goods and services, and higher costs incurred by businesses. Another inflation driver has been the pass-through effect that the adjustment of the official hryvnia-to-dollar exchange rate had on prices. A further rise in global inflation also influenced prices in Ukraine.
At the same time, the actual price dynamics were in line with the expectations and even somewhat below the NBU’s July forecast. Fixing utility rates and the saturation of the domestic fuel market while keeping the preferential tax regime for fuel curbed price growth. The planned reduction in monetary financing of the budget and the NBU’s additional measures to calibrate FX restrictions helped ease pressures on the FX market, restraining the deterioration in expectations.
Inflation will reach around 30% this year, but it should slow in the next years provided that security risks subside as expected and monetary and fiscal policies are well coordinated.
Due to the adverse impact of the full-scale war on supply of goods and economic agents’ expectations, inflation will accelerate to 30% at the end of this year. However, such price growth is rather moderate considering the challenges of the largest war in Europe since World War II and inflation reaching its highest levels over many years in many countries. Price pressures and expectations will remain under control, laying the groundwork for a gradual slowdown in inflation.
The NBU expects that price growth will slow next year thanks to a gradual setup of logistics and production, lower global inflation, and moderately tight monetary conditions. This process will accelerate in the middle of the year in view of the high base effect and expected easing of security risks, which is a key assumption of the new forecast of the NBU. The latter factor will lead to a sizeable decline in inflation expectations and risks to business activities, a decrease in production costs, setup of logistics, including through Black Sea ports, and a recovery in production capacity. All of this will result in further growth in supply and a stabilization of consumer prices. Prudent debt policy of the government and refusal from monetary financing of the budget deficit will be an additional factor for an improvement in inflation expectations.
The relevant factors will drive inflation down to 20.8% next year and to below 10% in 2024. A faster decrease in inflation in the next years will be restrained mainly by high energy prices, which will require to gradually bring utility tariffs to market levels.
After a deep fall at the start of the war, the economy of Ukraine has been picking up. The gradual recovery will continue in 2023–2024.
Economic activity recovered gradually in Q2–Q3 2022 on the back of further liberation of Ukrainian territories, businesses adapting to new conditions, and opening the “grain corridor”. The latter factor made a positive contribution to GDP compared to the July forecast.
However, the existing logistical problems (especially in the metals industry), destruction of production facilities (in the energy sector in particular), and a decline in real household income are restraining economic recovery. A large negative contribution to real GDP change expectedly came from agriculture – due to both this year’s lower yields and considerably smaller sown areas. As a result, the NBU upgraded its estimate of a decrease in GDP for this year only slightly, to around 32%.
A decline in security risks from the middle of 2023 assumed by the forecast will be the key factor in the future economic recovery. In particular, the full recovery in operations of Black Sea ports will enable a significant increase in Ukrainian exports. Large budget support will boost consumer demand and investment in the reconstruction of the country.
At the same time, huge losses of labor force and production capacity, high global energy prices, and large import needs in the period of post-war reconstruction will be a drag on economic recovery. Under such conditions, growth in Ukraine’s GDP will be moderate in the next years, at around 4%–5%.
Exports being limited due to the war, strong migration, and the economy’s large needs for imports to carry out the reconstruction will cause the current account to return to deficit in the coming years.
International financial support and revived exports contributed to an increase in FX inflows to Ukraine. Official financing has reached around USD 23 billion since the start of the full-scale invasion. The lion’s share of the financing came as grants in several past months.
In autumn, exports of goods peaked from the start of the war thanks to the launch of the “grain corridor” and record-high growth in electricity supply to the EU. A correction of the official exchange rate of the hryvnia and the cancellation of the preferential tax regime slowed the recovery in imports of goods. This resulted in a large surplus in the current account.
The current account will return to deficit next year. On the one hand, international financial assistance in 2023–2024 is expected to be large, in particular in the form of grants. The improvement in security assumed in the forecast will favor further growth in exports, and remittances from labor migrants will not be lower than before the war.
On the other hand, the country will need large volumes of imports. Moreover, as security risks remain high, migration will continue to be strong, reflecting in large volumes of imports of travel services.
Continued cooperation with international partners remains an important factor in maintaining the Ukrainian economy during the full-scale war and post-war recovery.
International financial aid has become the main source of meeting significant budgetary needs during the full-scale war. The budget deficit will decrease in the coming years, but will still be substantial due to the need to maintain the country’s defense capabilities, and to ensure the smooth functioning of the economy.
That is why Ukraine’s cooperation with its international partners remains a critically important source for replenishing the budget. International support will also enable the NBU to maintain its international reserves at a sufficient level, keep expectations under control, and to safeguard financial stability.
The key assumption of the forecast is that security risks will start to decline significantly from mid-2023. Therefore, a more extended full-scale war against Ukraine by russia remains the key risk for Ukraine’s economic development.
The NBU has revised its key assumption of the security situation forecast. The baseline scenario of the new macro forecast envisages a noticeable reduction in security risks only from the middle of 2023. Therefore, the full unblocking of sea ports, reductions in Ukraine’s risk premiums, and an increase of investment in the restoration of the country have been delayed.
If the full-scale war lasts longer than is envisaged in the baseline scenario of the current forecast, depressed demand, low investment and logistical constraints on exports will persist longer. Under such conditions, the recovery of the Ukrainian economy will be weaker, and inflation will be higher than currently expected.
Other risks are also relevant for the forecast. When realized, most of these risks will worsen inflation dynamics and hold back economic recovery. In particular:
- despite a certain easing, the risk of state finances becoming unbalanced persists on the back of the unpredictable nature of the war, possible problems with the regularity of international aid provision, and the emergence of additional budgetary needs. Another problem could arise from the formation of large quasi-fiscal deficits in the energy sector, taking into account high energy prices.
- russia’s terrorist attacks on Ukrainian energy infrastructure facilities are increasing the risk to Ukraine’s ability to go through the coming winter smoothly. The lack of capacities would create the need to save energy, through temporarily disconnecting power supply for both household consumers and companies. This would decrease production.
- the duration and intensity of hostilities, together with energy terror attacks, are increasing the risk that a large part of Ukrainians who had gone abroad, will not return, and that some more Ukrainian may decide to leave Ukraine. A potential demographic crisis would slow the post-war recovery due to a decline in consumer demand and aggravated structural problems on the labor market.
- There is still a risk that the “grain corridor” may be terminated and that russia may block Ukraine’s seaports. Should it materialize, it would greatly complicate food exports, reduce FX inflows to Ukraine, diminish the farmers’ financial capability to carry out the sowing campaign, and have an adverse impact on the country’s economy, both at the end of this year and throughout next year.
Instead, the rapid implementation of a recovery plan for Ukraine, generating foreign investment inflows and substantial funding for reconstruction projects could accelerate economic growth to two-digit figures and facilitate faster return of inflation to its target of 5% set by the NBU.
As the inflation dynamics are close to the forecast and the balance of risks is skewed upward over the policy horizon, the NBU Board decided to keep the key policy rate at 25%.
Supporting the exchange rate stability and protecting international reserves require ensuring that yields on hryvnia assets stay attractive in the long run. Among other things, keeping the key policy rate unchanged will be a favorable factor for this.
Interest rates on hryvnia deposits continue to rise closely following the expected trajectory in response to the key policy rate hike in June. The NBU also welcomes the decision of the Ministry of Finance to raise interest rates on hryvnia domestic government debt securities at the latest auction. First, such step enables a sizeable increase in volumes of borrowing compared to previous auctions, which reduces the need of monetary financing of the budget. Second, it gave an additional impetus to other interest rates on the financial market, which is important for ensuring attractive yields on hryvnia assets.
In order to stabilize exchange rate expectations and reduce pressures on international reserves, the NBU developed a new mechanism that will provide households with more options to protect their savings from the risk of exchange rate fluctuations and will help dampen demand for FX cash.
Such an instrument will create economic incentives for banks to introduce a corresponding product for private clients, enhance the effect of monetary transmission, and improve resilience of the fixed official exchange rate regime.
Moreover, the NBU has developed a set of potential measures for reinforcing monetary transmission and optimizing the structural surplus of hryvnia liquidity. The detailed design of these measures is being discussed as part of current consultations of the NBU and the Ministry of Finance with the International Monetary Fund.
The updated forecast, like the previous one, envisages that the key policy rate will be maintained at 25% at least until Q2 2024. If required, the NBU stands ready to raise the key policy rate above its forecast and will further deploy additional measures to protect international reserves, as well as and to maintain control over inflation.
The decision to keep the key policy rate at 25% per annum was approved by NBU Board Decision on the key policy rate No. 505, dated 20 October 2022.
A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 27 October 2022.
A summary of the discussion between Monetary Policy Committee members that preceded the approval of the NBU Board’s decision will be published on 31 October 2022.
The next monetary policy meeting of the NBU Board will be held on 8 December 2022, according to the confirmed and published schedule.