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On the Monetary Policy Committee's decisions

The regular meeting of the Monetary Policy Committee of the National Bank of Ukraine (hereinafter – the Committee) was held on March 25 – 26, 2015.

The first day of the Committee's meeting was devoted to presentations by experts from the NBU's respective subdivisions, who expressed their views about future developments in the money market and provided their insight into the current economic situation and an updated macroeconomic outlook. While hearing presentations by experts, the Committee members expressed their stance and views on the issues in question."

On the second day of the meeting, the Committee members adopted decisions on the following:

1) to keep the discount rate at its current 30% and leave other monetary policy parameters unchanged.

Having considered the current situation in the foreign exchange market and the macroeconomic outlook, the decision was taken to recommend to the Board of the National Bank of Ukraine that the discount rate be kept at its current 30%.

The tension in the foreign exchange market has shown some signs of abating over the past weeks. At the same time, the risks for renewed money market instability remain in place, and so do strong inflation and depreciation expectations. With a view to preventing these risks from materializing and putting inflation firmly on a downward path, the National Bank of Ukraine should proceed with its policy of "expensive hryvnia" by keeping interest rates high.

As the risks to the hryvnia's stability abate, the National Bank of Ukraine is set to gradually lower its interest rates. Whether the monetary policy will be eased will hinge on the successful implementation of structural reforms, fiscal consolidation and the rehabilitation of the banking system, i.e. the fundamental factors underlying the dynamics of the hryvnia exchange rate;

2) to approve the proposals for a new version of the Monetary Policy Fundamentals for 2015, which are subject for approval by the Board of the National Bank of Ukraine.

The National Bank of Ukraine Council held its meeting on February 26, 2015. Following this meeting, the decision was taken to recommend the Board of the National Bank of Ukraine prepare amendments to the Monetary Policy Fundamentals for 2015.

Pursuant to the Law On the National Bank of Ukraine, the macroeconomic indicators calculated by the Cabinet of Ministers of Ukraine shall be used when elaborating the Monetary Policy Fundamentals.

In line with the provisions set forth in the aforementioned law, the projections set out in the Monetary Policy Fundamentals for 2015 are inconsistent with scenario 1 of the revised Outlook for the economic and social development of Ukraine for 2015 approved by the Cabinet of Ministers of Ukraine. This scenario is broadly in line with the projections underlying a new Extended Fund Facility arrangement with the International Monetary Fund (hereinafter – the EFF arrangement).

The Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding lay out the focal points of the monetary and exchange rate policy under the EFF arrangement and provide for the need for quantitative performance criteria to be met. The timely fulfilment of monetary policy commitments is crucial for successful review under the EFF arrangement and the disbursement of next tranches.

In view of the above, the proposals for the Monetary Policy Fundamentals for 2015 are based on the following main principles:

- the fulfilment of commitments under the IMF's EFF, including in terms of meeting quantitative performance criteria;

- the adoption of inflation targeting when the necessary macroeconomic prerequisites are in place;

- achievement and maintenance of low stable inflation rates of 5% a year on the CPI measure in the mid term (from 3 to 5 years), with a permissible deviation of+/-1 p.p.

The aforementioned paper will be sent to the Council of the National Bank of Ukraine to be taken into account when drafting amendments to the Monetary Policy Fundamentals for 2015;

3) to approve the Inflation Report, including its section containing inflation projections, and endorse its publication.

The Macroeconomic Outlook for 2015 – 2016 proceeds from the assumption that Ukraine will stay on track with its commitments under the EFF arrangement, including commitments to undertake energy, fiscal and financial sector reforms and general economic reforms to restore macroeconomic stability and set the stage for robust economic growth.

According to estimates by the National Bank of Ukraine, in 2015 Q1, GDP continued to decline quarter-on-quarter on seasonally adjusted terms amid the ongoing military conflict. Economic growth is expected to resume in Q2 2015, driven primarily by net export growth and the utilization of spare capacity. Overall, GDP is expected to contact by 7.5% in 2015 due to the statistical base effect. A pick-up in investment demand is expected in the second half of 2015 due to stronger import substitution effects and the reconstruction of the destroyed infrastructure in the east of the country. Imports will remain weak due to the depreciation of the hryvnia exchange rate that occurred in the previous periods. Real GDP is projected to rebound as early as in 2016, growing at an annualized rate of 3%.

As a result of contraction in non-energy imports, net exports will contribute significantly to GDP growth.

In 2015, the current account deficit is expected to narrow to about 1% of GDP in 2015-2016 due to the depreciation of the real effective exchange rate by 19.2% in 2014 and by 2.4% у 2015. In 2015-2016, the financial account of the Balance of Payments will run a surplus due to substantial amounts of official external financing and the expected deferral of sovereign euro bond repayments. This, together with the IMF's financing, the lion's share of which is expected this year, will help restore the international reserves, bringing them up to USD 18 billion and covering more than 3 months of future imports.

The deep hryvnia depreciation and dramatic increases in the prices of housing and utilities have led to the outlook for CPI inflation and that for core inflation being revised upwards to 30% and 25% respectively by end-2015. Inflation will peak in the first half of the year, as pass-through from the currency depreciation is the most significant over the first two quarters and frontloaded increases in the prices of housing and utilities are scheduled for Q2 2015. Weak consumer demand and decreasing world prices are among the factors containing inflation. As the impact of exchange rate depreciation dies out and price increases in housing and utilities slow down, CPI inflation and core inflation will moderate to 13% yoy and 8% yoy respectively by end-2016, given the National Bank of Ukraine's strong commitment to anti-inflation policies. 

The full version of the Inflation Report will be published on the NBU's official website on April 2, 2015.

As a side note, the Committee has been revamped to include the newly appointed Deputy Governor of the National Bank of Ukraine Dmytro Sologub and Director of the NBU Financial Stability Department Vitalii Vavryshchuk.

For reference

The next meeting of the Monetary Policy Committee will take place on April 22 – 23, 2015.

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