Dear colleagues,
I’d like to greet all the participants at our traditional meeting following the Board meeting on monetary issues.
I would like to inform you that the Board of the National Bank of Ukraine has decided to leave the key policy rate unchanged at 14% per annum. Our decision was prompted by the need to mitigate inflation risks to enable the NBU to meet the inflation targets for the current and following year.
Let us first look at the recent developments
In January 2017, inflation accelerated to 12.6% y-o-y. The annual inflation reading was in line with the NBU's forecast published in the Inflation Report in early 2017. The slight acceleration of annual inflation was driven by a number of factors:
First, production costs increased, particularly labor costs;
Second, global commodity prices, including oil and food prices, continued to rise; and
Third, the acceleration of inflation was triggered by the weakening of the hryvnia in late 2016 and early January 2017.
As we discussed in detail at our last meeting, the depreciation of the hryvnia was attributed to a seasonal decline in business activity, in particular weaker export performance, as well as high hryvnia liquidity held by exporters.
It is expected that inflation will accelerate further in annual terms in February 2017, primarily due to base effects.
Further economic recovery will also contribute to the acceleration of inflation.
According to NBU estimates, year-end real GDP growth stood at 2.2%. Economic recovery gained momentum in January. This was evidenced by a further rise of the Index of Key Sectors Output (IKSO). In general, the growth of industrial output accelerated to 5.6% y-o-y.
In its turn, a pick-up in economic activity continued to spur labor demand. In January, real wages rose by 21.4% y-o-y, underpinned by strong labor demand and an increase in the minimum wage.
As expected, the growth of real wages could renew demand-pull pressures on prices. Furthermore, inflation expectations of households have remained high in recent months due to these facts.
Obviously, the heightened exchange rate volatility observed in December-January also kept inflation expectations high. However, in contrast to January, the situation in the FX market in February helped contain inflation:
First, inflationary pressures were dampened by a surge in global prices for key Ukrainian export commodities. After remaining flat in January, steel prices picked up by 20%, while iron ore prices rose by 11%, boosted by strong demand from China. Global grain prices also increased despite record high harvests. The rise in grain prices was driven by stronger demand for high-quality grain amid unfavorable weather conditions in Europe and Latin America. In January, grain prices rose by 5%, while in February they surged by 11%;
Second, the FX supply from exports gradually increased during the last month. With FX proceeds from mining and metallurgical exports remaining high, FX receipts from agricultural exports resumed growth. The share of FX proceeds from agricultural exports accounted for about 30% of the total amount of foreign currency sold by exporters.
These two factors, taken together, helped stabilize the situation in the FX market. Furthermore, in contrast to January (when the NBU mostly sold foreign currency to smooth excessive exchange rate fluctuations), the situation reversed in February.
During February, the NBU’s net FX purchases amounted to USD 81 million. As a result, the NBU has remained a net buyer of foreign currency since the beginning of the year.
What is our inflation forecast for the future?
The NBU considers that the inflation targets for 2017 and 2018 (8% +/-2 pp and 6% +/-2 pp, respectively) remain within reach.
Annual inflation is expected to remain high in the first three quarters due to a statistical base effect. It will return to a single-digit level only in Q4 2017.
I would like to draw your attention to the fact that despite the recent changes in the methodology for calculating consumer price indices made by the State Statistics Service of Ukraine, NBU inflation projections will remain unchanged as the inflation forecast published in the latest Inflation Report already incorporated the recent revision to the methodology.
As before, inflation is expected to slow down to 9.1% by the end of 2017, remaining within the target band and decelerating further to 6.0% by the end of 2018.
As we emphasized at our previous meetings, prices will be pressured upwards by private consumption, supported by the minimum wage increase, but the expected pressure will be contained by the NBU’s prudent monetary policy.
However, the risks to further inflation developments have increased since the previous monetary policy meeting. This was yet another argument supporting the NBU Board decision to continue a pause in its monetary policy easing cycle.
First of all, the major risks include intensification in hostilities and a transport blockade in the east of Ukraine. If the blockade is lifted in the nearest future, according to our estimates, its negative impact on GDP growth and the balance of payments will be limited. If it persists for a prolonged period, these developments will lead to the ultimate disruption of production and supply chains and, thus, to a reduction in steel and coke output, as well as mining and electricity production.
According to our estimates, under a more pessimistic scenario, if the blockade remains in place until the end of this year, Ukraine’s economic growth will slow by 1.3 pp to 1.5% in 2017.
Implicitly, this poses risks to the inflation forecast through a negative impact on the balance of payments. The current account balance will be adversely affected by a possible contraction in metallurgical exports and higher coal imports.
According to our estimates, the current account deficit may widen by about USD 2 billion. Consequently, this will have negative implications for the interbank FX market.
Moreover, as a side effect of these developments, inflation expectations may worsen.
I would like to add that this situation is strikingly different from the situation in 2014, when metallurgical enterprises were hit hard by the escalation of hostilities. Today, the NBU has a wide range of instruments at its disposal and a larger stock of international reserves, amounting to USD 15.5 billion as of the beginning of February, versus USD 5.5 billion two years ago. Therefore, if required, the regulator is able to smooth short-term bouts of exchange rate volatility in the FX market.
Currently, the NBU closely monitors the situation and takes into account its potential risk to the current forecast. In any case, the most likely scenario will be reflected in the updated macroeconomic forecast that will be published in the Inflation Report in April.
Given the aforementioned risks and the need to achieve the inflation targets, the NBU Board decided to retain its policy rate unchanged at 14%.
The future key policy rate path will depend on the materialization of the aforementioned risks to price stability and the development of inflation expectations.
However, the NBU deems it possible to move ahead with liberalization of FX regulations after completion of the third review under the IMF EFF. We expect that Ukraine will sign a Memorandum with the IMF in the nearest future.
Last year, the NBU took a series of important steps in this direction, remaining committed to its priorities by relaxing rules governing export-import operations and FDIs.
Moreover, the NBU has recently increased limits on the amount of foreign currency that banks are allowed to purchase from the interbank market (open FX position limits) from 0.1% to 0.5% of a bank’s regulatory capital, and the regulator plans to raise these limits further.
The NBU made a long awaited decision to simplify the rules governing overseas transactions by Ukrainians, primarily for those who work abroad and receive income from abroad.
From now on, individuals will be allowed to deposit foreign currency originating abroad from accounts abroad without individual licenses from the NBU.
They will also be allowed to make investments abroad using funds held on accounts abroad.
We would like to emphasize that a permit to perform such transactions without individual licenses from the NBU does not exempt individuals from the requirement to declare income and pay taxes on these transactions in Ukraine in accordance with applicable laws.
Yesterday, the NBU repealed the requirement for banks’ customers to secure a permit from the NBU to perform the aforementioned FX transactions. Authorized banks will notify the NBU of such transactions following their execution.
The NBU pushes ahead with FX liberalization. As before, we are confident that FX liberalization should not put the still fragile stability of the financial system in jeopardy. Therefore, the pace of liberalization will depend on whether or not favorable prerequisites are in place.
Accordingly, after completion of the review under the IMF EFF, the NBU plans to relax those restrictions that will not have a destabilizing impact on the interbank and cash segments of the FX market. In particular, the NBU intends to ease surrender requirements for FX proceeds and relax restrictions on the sale of FX cash to individuals.
The next meeting of the NBU Board on monetary policy issues will be held on 13 April 2017.
Thank you for your attention!