Date of the meeting: 11 March 2020.
Attendees: All ten members of the NBU Monetary Policy Committee (MPC):
- Yakiv Smolii - Governor of the National Bank of Ukraine
- Kateryna Rozhkova - First Deputy Governor
- Roman Borysenko - Deputy Governor
- Dmytro Sologub - Deputy Governor
- Sergii Kholod - Deputy Governor
- Oleg Churiy - Deputy Governor
- Vitalii Vavryshchuk – Director of the Financial Stability Department
- Volodymyr Lepushynskyi - Director of the Monetary Policy and Economic Analysis Department
- Yurii Polovniov - Director of the Statistics and Reporting Department
- Serhii Ponomarenko - Director of the Open Market Operations Department.
The spread of COVID-19 is the main risk that has materialized since the NBU made its macroeconomic projections (January 2020 Inflation Report). The MPC meeting focused on how the global commodity and financial markets had responded to the coronavirus outbreak, its potential economic fallout for Ukraine, and the necessary monetary policy response.
The spread of the infection has as of 11 March had a limited and neutral impact on the Ukrainian economy, the MPC members pointed out.
A longer-term fallout from the spread of the disease may, however, drive the global economy into a recession and cause a significant slowdown in the Ukrainian economy. But Ukraine is better prepared to head off a potential crisis than it was in either 2008–2009 or 2014. The economy and financial system have no accumulated imbalances, meaning that the nation’s margin of safety is greater than in previous crises.
Volatility in the global markets dampened sentiment in the Ukrainian FX market, worsening expectations, triggering demand for foreign currency, and raising pressure on the hryvnia to depreciate. Yet the market has remained under control thanks to the NBU’s efforts last year to replenish international reserves, which are sufficiently large to smooth out excessive exchange rate fluctuations.
Uncertainty over the rate of the coronavirus’s spread throughout Ukraine’s major trading partners remains high, making it hard to assess the pandemic’s impact on their economies, the MPC members emphasized. At this time, it is impossible to tell how COVID-19 will affect the financial and commodity markets.
Given the significant uncertainty over how the situation is going to unfold, the MPC members differed on what the level of the key policy rate should be.
Seven MPC members agreed that the key policy rate should be reduced by 100 bp, to 10%.
Given the significant uncertainty, it makes sense for the NBU to act in line with the projected trajectory of the key policy rate, as this facilitates the pursuit of the central bank’s monetary policy mandate, the MPC members pointed out. Specifically, the NBU should ease its monetary policy to support Ukraine’s economy. A longer-term fallout from the spread of the coronavirus may stall the economies of Ukraine’s major trading partners and dampen demand for Ukrainian exports. This is likely to result in Ukrainian companies cutting back on business activities and delaying investment projects. And it should be taken into account that Ukraine itself has come under threat of being hit by the pandemic, a risk that could bring the country’s economy to a near standstill.
The easing of monetary policy is consistent with the inflation-targeting regime. When inflationary pressure eases faster than predicted, the NBU has to take action to promote economic growth.
The credibility of this approach in an inflation-targeting regime is also evidenced by the experience of central banks (of Poland, the Czech Republic, and Hungary) during the recession of 2008–2009. When they moved to lower their interest rates, those central banks were guided less by exchange rate movements than by the need to ease inflationary pressures amid heightened risks of their economies going deeper into recession. The bottom line is that the monetary policy easing proved to be a right step that helped these nations survive the crisis.
Ukraine is in a similar situation now, the MPC members said.
At the same time, its international reserves are sufficient to tide the nation over potential shocks. The NBU has the power to intervene in the FX market to smooth out excessive exchange rate fluctuations that are fueled by psychological factors.
Statements by the newly appointed government that Ukraine will continue to cooperate with the IMF are another reason to press forward with key policy rate cuts, the MPC members believe. Signing a new agreement with the IMF will make the Ukrainian economy less vulnerable in a time of turbulent global markets and send a positive signal to investors, improving market expectations, among other things.
However, the NBU could switch to a tighter monetary policy stance should risks to financial or price stability increase, the MPC members indicated.
One MPC member argued that the key policy rate should be reduced by 150 bp, to 9.5%. The rise in FX market volatility is primarily driven by psychological factors, he said. With uncertainty mounting over how events will unfold, a more significant reduction of the key policy rate by the NBU will send a positive signal to the market. In addition, this decision will signal to the market that the NBU stands ready to promote economic growth as the economy faces the risk of cooling off.
Two MPC members offered to keep the policy rate at the level of 11%. The NBU should suspend its monetary policy easing efforts, as risks to financial stability have increased, these MPC members believe.
Turbulence in the global financial and commodity markets is going to put pressure on the hryvnia to depreciate, worsening depreciation and inflation expectations, one MPC member said. If the central bank were to cut the key policy rate as an adverse scenario materialized, the risk of a monetary policy reversal would rise. Should economic conditions deteriorate as a result of an FX market shock rippling through the economy, it may prompt the central bank to return to tight monetary policy.
Growing uncertainty and worsening expectations will slow the pass-through of the key policy rate into rates on hryvnia-denominated instruments, these MPC members suggested. The banks will hold back from cutting loan and deposit rates as they watch the situation unfold in the financial market and the economy overall. The linkage between the key policy rate and rates on domestic government debt securities will also weaken in the primary and secondary markets. This may erode the market’s confidence in the effectiveness of the NBU’s monetary policy decisions. The NBU will be able to move forward with its monetary policy easing efforts in April, when fears have abated and the FX market has stabilized and panic has subsided.
The decision to set the key policy rate at 10.0% per annum was approved by the NBU Board at a monetary policy meeting held on 12 March 2020.
For reference:
The Monetary Policy Committee (MPC) is an NBU advisory body that was created to share information and opinions on monetary policy formulation and implementation, in order to deliver price stability. The MPC comprises the NBU Governor, other NBU Board members, and directors of the Monetary Policy and Economic Analysis, Open Market Operations, Financial Stability, and Statistics and Reporting Departments. The MPC meets the day before the NBU Board meeting on monetary policy issues. Decisions on monetary policy issues are made by the NBU Board.