The Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. This will support the effects of previous measures to improve attractiveness of hryvnia assets, help maintain sustainability of the FX market, and form proper conditions for the continuation of steady disinflation trend and for easing the most burdensome FX restrictions.
Inflation is declining rapidly, including thanks to the NBU’s measures to support exchange rate sustainability. However, the price pressure remains high because of the war
From the start of the year, inflation has been declining faster than expected. The growth in consumer prices decelerated to 21.3% yoy in March. The decline in the inflationary pressure was facilitated by sufficient supply of food and fuel and by a rapid recovery of the energy system from consequences of russia’s terrorist attacks. An important factor was the improvement in inflation expectations from the start of the year on the back of ceased monetary financing, stronger hryvnia exchange rate on the cash market, and improved attractiveness of hryvnia assets, at which the NBU had been targeting its measures.
However, the inflationary pressure remains high. The year-on-year decline in inflation was largely driven by the high base of last year and enhanced by the mild winter. On the other hand, businesses’ production costs remain under pressure, in particular, due to difficulties of running business and setting up logistics during the war.
Inflation will decelerate to 14.8% in 2023 and will return to a single-digit level in the next years
Inflation will continue to decelerate, including due to lower global energy prices, restrained domestic demand, and the effect of the NBU’s monetary policy. Having considered the combined effect of the above factors and the situation in the energy sector, which was much better than expected, the NBU revised its 2023 inflation forecast, from 18.7% to 14.8%.
Easing of price pressures in the coming years will primarily be contributed by a decrease in security risks, which is the main assumption of the NBU forecast. Under such conditions, inflation expectations are forecast to improve and supply of goods is projected to increase thanks to a recovery in optimal logistical routes and production capacity. Therefore, the NBU expects inflation to decline to 9.6% in 2024 and 6% in 2025.
Already this year, the economy will return to growth, which will accelerate in the coming years on the back of a decrease in security risks assumed by the forecast
In view of the rapid recovery in the energy system and the loose fiscal policy, the NBU improved its economic growth forecast for 2023, from 0.3% to 2.0%. Provided that the assumptions about the security situation materialize, no significant shortages of electricity are expected, except for some local and situational shortages that might occur in H2. At the same time, an increase in budgetary spending on the back of large volumes of international financial assistance will support economic activity and consumption.
Security risks starting to subside next year, as assumed by the baseline scenario of the NBU’s forecast, will boost economic growth to 4.3% in 2024 and 6.4% in 2025. The de-occupation of territories and complete unblocking of Black Sea ports will enable a gradual increase in industrial production and crop harvests. Moreover, domestic demand is expected to increase thanks to the return of some of displaced persons.
Net FX inflows to Ukraine continue thanks to large volumes of international assistance
The current account deficit is expected to be large in 2023. Among other things, this will be driven by an increase in imports on the back of a gradual recovery in domestic demand, a large number of migrants from Ukraine spending money abroad, and exports remaining modest due to weaker harvests and limited logistical routes. At the same time, inflows of international assistance will offset these factors.
Overall, inflows from international partners could exceed USD 42 billion this year. The inflows from partners will, among other things, contribute to the growth in international reserves to about USD 35 billion as of the end of this year. This will strengthen the NBU’s capability to further maintain exchange rate sustainability and gradually ease FX restrictions.
Starting in 2024, rising export flows and the gradual return of forced migrants to Ukraine will help reduce the current account deficit, which will continue to be offset by substantial external official financing. This will maintain international reserves at a relatively comfortable level.
Significant official financing, coupled with the further development of the domestic debt market, will prevent the need for monetary financing of a large budget deficit.
Despite an increase in the government’s tax revenues and domestic borrowing, these funds are not enough to finance the considerable expenditures of the state budget in wartime and during the post-war recovery. International assistance will remain an important source of financing to meet state budget needs.
That said, after reaching a high this year, the deficit and official financing are expected to gradually decline from 2024.
The key risk to this forecast is that the full-scale war lasts longer and is fiercer than anticipated.
The full-scale war continues. As before, the key assumption of the forecast is that high security risks will persist until early 2024. Longer-lasting and more intense hostilities could have a significant adverse effect on economic activity, while also worsening inflation and exchange rate expectations. This will pose additional challenges to the country’s macrofinancial sustainability.
The war is also generating other risks. They include:
- the emergence of additional budgetary needs and substantial quasi-fiscal deficits in the energy sector
- difficulties with, or the halt in, the operation of the “grain corridor” and greater problems arising from the limitations imposed on imports of Ukrainian food by some European countries
- further damage inflicted by aggressor on energy infrastructure, which could again cause substantial power shortages, restraining economic activity and exports, and driving demand for imported equipment and energy and, consequently, FX
- a slower decline in global inflation than expected.
Conversely, the rapid implementation of Ukraine’s recovery project, together with European integration reforms, could significantly accelerate the pace of economic growth. The arrival of substantial financing for recovery could also provide Ukraine with greater opportunities for easing FX restrictions.
Taking into account the risks outlined above, high uncertainty, and a significant amount of expected budget expenditures, maintaining exchange rate sustainability amid a pursuit of currency liberalization plans will require the NBU to continue to take a monetary policy approach that makes hryvnia-denominated savings highly attractive. With this in mind, the NBU Board decided to keep the key policy rate at 25%.
Keeping the key policy rate at 25%, introducing additional instruments for preventing household savings from being eroded away by inflation, coupled with measures to increase competition among the banks for time deposits, contributed to greater exchange rate sustainability. These measures among other factors boosted demand for hryvnia instruments, while cutting demand for FX. This is evidenced, among other things, by the considerable strengthening in the hryvnia’s cash exchange rate seen from the start of 2023, which had a positive effect on expectations, while also supporting a downward trend in inflation.
At the same time, exchange rate sustainability is primarily being ensured by tight currency restrictions. Their effectiveness wanes over time, while their restrictive effect on business activity grows in intensity. It is therefore becoming increasingly desirable to liberalize FX restrictions in the foreseeable future.
To this end, the NBU is making policy efforts to establish appropriate preconditions for an easing of FX administrative controls. With uncertainty still being high and the risks of current account balances growing further amid significant budget expenditures, the key prerequisite for preserving exchange rate sustainability and sustaining the decrease in inflation is to make sure that hryvnia savings are attractive. Which makes it necessary to keep the key policy rate at the level of 25% per annum.
To maintain exchange rate sustainability, improve expectations, and steadily reduce inflation, the NBU will continue to sustain the needed monetary conditions.
Keeping the key policy rate high will support the effects of the NBU's previous measures and leave room for further growth in the investment appeal of hryvnia savings. At the same time, the improved macroeconomic situation, including a deeper decline in inflation and the accumulation of a comfortable amount of international reserves, is creating prerequisites for revising the key policy rate forecast.
The updated macro forecast envisages the launch of a cycle of key policy rate cuts in Q4 2023. Even if such a scenario materializes, monetary conditions will remain fairly tight over the forecast horizon as inflation continues to slow, inflation expectations improve, and real returns on hryvnia instruments remain high.
The NBU stands ready to adjust the time and pace of changes in the key policy rate in view of FX market developments, inflationary dynamics, the sustainability of international support, and the effectiveness of measures to make hryvnia instruments attractive.
The decision to keep the key policy rate, at 25% per annum, was approved by NBU Board Decision on the key policy rate No. 161, dated 27 April 2023, which will come into effect on 28 April 2023.
A new detailed macroeconomic forecast will be published in the Inflation Report on 4 May 2023.
A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 8 May 2023.
The next meeting of the NBU Board on monetary policy issues will be held on 15 June 2023, according to the confirmed and published schedule.