The Board of the National Bank of Ukraine has decided to keep the key policy rate unchanged at 25% per annum and to continue raising required reserves ratios for banks. This will facilitate a further increase in the attractiveness of hryvnia assets, support exchange rate stability, and gradually slow inflation.
Inflation has stabilized in the past months but is still high
As of the end of 2022, consumer prices grew by 26.6%. At the same time, in the past three months, inflation remained almost unchanged in annual terms. The de-occupation of territories, an increase in supply of food products, and consumer demand being dampened by russia’s energy terror helped stabilize the inflationary pressure. Inflation was also restrained by unchanged utility tariffs, the fixed exchange rate of the hryvnia, and improved logistics. The NBU’s measures, in particular to introduce deposit instruments to hedge the FX risk, as well as limited volumes of monetary financing of the budget, contributed to a more stable FX market at the end of 2022.
At the same time, the price pressure remained strong due to consequences of the war, such as the destruction of enterprises and infrastructure and disruption of production and supply chains. Moreover, business costs continued to grow on the back of russia’s energy terror. Despite a stabilization, inflation expectations remained high.
Inflation will decline gradually and will remain under control thanks to measures taken by the NBU and the government and the support provided by international partners
The NBU forecasts inflation will slow to 18.7% in 2023, supported by monetary conditions remaining tight, global inflation declining, and consumer demand being dampened by power outages. Inflows of announced international assistance and joint efforts of the NBU and the government to revive the domestic debt market will help avoid monetary financing of the budget deficit and balance the FX market.
In the next years, inflation will decelerate more rapidly thanks to subsiding security risks, proper recovery of logistics, and larger harvests. The NBU expects inflation to decline to 10.4% in 2024 and 6.7% in 2025. The administered prices component will make a major contribution to inflation during these years due to the need to bring utility tariffs to market levels.
The economic recovery ceased due to russia’s terror attacks against energy infrastructure. As security risks subside, Ukraine will return to steady economic growth in 2024–2025
Russia’s energy terror deepened the decline in Ukraine’s GDP in Q4 2022 (to 35% yoy). Trading businesses and the services sector adapted to power outages rather quickly. The impact on agriculture was also limited. On the other hand, industrial production was affected heavily, especially the metals industry. At the same time, thanks to improved results of Q3 and the rapid adaptation of a part of businesses and households to the new conditions, estimates of the decline in real GDP in 2022 were improved to 30.3%.
The NBU expects growth in real GDP to be weak in 2023, at 0.3%. The deterioration of the forecast compared to the October estimates was primarily caused by consequences of energy terror and the revision of the main assumption of the duration of security risks. The latter will delay the full unblocking of ports, which will limit the potential of recovery in exports. Moreover, the NBU expects harvests will also be weaker this year as a result of accumulated problems with sowing and harvesting amid the war. At the same time, the forecast assumes Ukraine will manage to avoid further significant destruction of its energy infrastructure while businesses and authorities will take effective measures to neutralize the consequences of the damage inflicted earlier.
The economy will grow in 2024–2025, driven by a decline in security risks, along with a resumption of proper operation of ports, an increase in harvests, a gradual recovery in production, an improvement in logistics, and a pick up in domestic demand, including thanks to the return of displaced persons. The loose fiscal policy will also to play an important role. All of the above will push up Ukraine’s real GDP by 4.1% in 2024, and in 2025 economic growth will accelerate to 6.4%.
Limited exports, a large number of displaced persons abroad, and the economy’s large needs for imports to carry out the reconstruction will cause the current account deficit to be high in the coming years
In the past months, exports of Ukrainian goods remained stable despite massive missile attacks and russia’s efforts to disrupt the operation of the grain corridor. On the other hand, imports rose significantly compared to previous periods due to the need to purchase backup power devices and fuel as a result of the energy terror. This led to an increase in the deficit of the trade balance. The trade deficit was offset by inflows of official financing, including grants, and steady remittances from labor migrants. As a result, the current account recorded a surplus as of the end of 2022.
The current account deficit is expected to be large in 2023. First, the deficit in the trade in goods will widen rapidly. Exports will decrease due to weaker harvests and electricity shortages, whereas imports will grow fueled by higher demand for energy and goods needed to ensure the autonomous power supply. Second, spending by displaced persons abroad will be larger than expected as security risks are persisting for a longer time. Exports will start to grow from 2024, and Ukrainians will return home more actively. However, large needs for imports to conduct the reconstruction of the country will keep the current account in the deficit.
International aid, coupled with cooperation with the IMF, will finance Ukraine’s substantial budget deficit, and maintain international reserves at a sufficient level
In 2022, Ukraine received over USD 32 billion in international assistance, of which over USD 14 billion was in the form of grants. This enabled the country to finance a larger portion of the consolidated budget deficit (over 27% of GDP, excluding grants), and to increase international reserves, to USD 28.5 billion by the end of the year. Currently, reserves are sufficient to safeguard the stability of the FX market.
In view of the already announced international aid and progress made in negotiations with the IMF, overall official financing in 2023 could exceed USD 38 billion. This will enable Ukraine to refrain from the monetary financing of the budget deficit in 2023, and to maintain international reserves at a sufficient level even in the face of longer-lasting high security risks. International reserves are expected to hit about USD 27 billion by the end of 2023, and will continue to rise.
The key assumption of the forecast is that security risks will start to decline significantly from early 2024. An extended full-scale war by russia and further destruction of critical infrastructure remain the key risks
The NBU has revised its key assumption of the security situation forecast due to fiercer fighting and escalating terrorist attacks on the country’s critical infrastructure. The baseline scenario of the new macroeconomic forecast envisages a noticeable decrease in security risks from the start of 2024. Therefore, the full unblocking of sea ports and reductions in Ukraine’s risk premiums have been delayed in the NBU’s forecast. More intense hostilities and greater power shortages than expected due to russia’s terrorist attacks could dampen economic activity more significantly, while also increasing inflationary pressures.
Other risks also have a bearing on the forecast. If materialized, they could also require revisions in key macroeconomic indicators. These risks include:
- the emergence of additional budgetary needs and substantial quasi-fiscal deficits in the energy sector on the back of the unpredictable nature of the war
- delayed returns by a large number of Ukrainians and potential additional migration abroad, which will depress consumer demand, while in the longer term, this threatens to aggravate structural problems on the labor market and decrease the country’s economic potential
- the irregular arrival of external financing
- complications in the operation of the grain corridor, even despite this risk weakening in recent months.
That said, the rapid implementation of the recovery plan for Ukraine, supported by the arrival of official and private financing, could markedly speed up economic growth.
In order to bring inflation back to the steady decline trajectory and to maintain exchange rate and macrofinancial stability amid high uncertainty, the NBU Board decided to keep the key policy rate at 25%
At the same time, the NBU has raised reserve requirements for banks, as it said it would do in December. More specifically, from 11 February the banks’ required reserve ratios will be raised by 5 pp for demand deposits from, and current accounts of, businesses and households; for deposits from, and current accounts of, nonresident banks; and for loans from international (other than financial) and other organizations. In particular, from 5% to 10% for hryvnia funds and from 15% to 20% for FX funds.
What is more, from 11 March the banks’ required reserve ratios will be raised by another 10 pp for household hryvnia and FX demand deposits and current accounts. The banks will not be allowed to use benchmark domestic government debt securities to meet these reserve requirements.
The NBU expects that these measures will help decrease the liquidity surplus in the banking system. This, in turn, will encourage the banks to compete more actively for term deposits, which will push up interest rates on hryvnia assets and increase the share of term deposits. This will make the FX market more resilient to situational factors, while also enabling the NBU to ease administrative restrictions for businesses and households in future.
The revised forecast envisages keeping the key policy rate at 25% at least until the end of Q1 2024. If required, the NBU stands ready to deploy other tools to avoid the monetary financing of the budget deficit, make hryvnia assets more attractive, increase the resilience of the FX market, and lay the proper foundations for easing administrative restrictions
А new detailed macroeconomic forecast will be published in the Inflation Report on 2 February 2023.
The decision to keep the key policy rate at 25% per annum, was approved by an NBU Board Decision on the key policy rate No. 36, dated 26 January 2023.
A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 6 February 2023.
The next monetary policy meeting of the NBU Board will be held on 16 March 2023, according to the confirmed and published schedule.