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Speech by NBU Governor Kyrylo Shevchenko at "NBU FX and Monetary Policies: Summary and Forecasts" Roundtable

Speech by NBU Governor Kyrylo Shevchenko at "NBU FX and Monetary Policies: Summary and Forecasts" Roundtable

Dear colleagues, Dear participants and guests, I’m glad to welcome you to the NBU meeting that will sum up the economic results of 2021.

I think this is a great opportunity for professionals and experts to discuss achievements and current challenges and exchange views and ideas about the design and implementation of the monetary and FX policies.

One of the key macroeconomic issues currently in the spotlight is the record surge in global inflation. Inflation in the U.S. in December last year reached a 40-year high, while Eurozone inflation was the highest since the introduction of the common currency.

Global inflation is the result of several processes. The first is the large-scale monetary and fiscal stimulus measures taken by leading economies. This action restored demand very quickly. The second process was the disruption of production and supply chains due to quarantine restrictions that limited supply.

Speaking of inflation in Ukraine, a large part of it is just a reflection of global processes. However, there also were domestic factors: consumer demand recovered rapidly; and the second-round effects of rising prices for raw materials and labor affected increasingly more goods and services. In addition, the information environment deteriorated at the end of last year amid geopolitical tensions. This started to have a strong impact on prices.

However, the complexity and scale of the current inflation processes is another challenge the central bank has to meet. The wait-and-see approach is not an option here.

At the start of last year, we knew full well that inflation would not go away by itself. It was necessary to take action. The NBU was one of the first central banks to adjust its monetary policy to take into account the macroeconomic conditions and the high degree of uncertainty while pursuing three priorities: policy consistency, predictability, and transparency.

We started raising the key policy rate in March last year and, by the end of the year, increased it by 3 percentage points, to 9%.

During the transition to the monetary policy tightening, we had to give up the nontraditional instruments that we introduced in 2020 to ease Ukraine’s passage through the economic crisis. These measures were no longer necessary, as the banking system had successfully come through the time of turbulence and had quickly increased exposures. However, in order to protect the financial markets from shocks and to ensure that the economic recovery continued, the NBU highlighted the need to roll these measures back in advance and step by step.

The central bank also pursued the floating exchange rate regime. Favorable conditions for Ukrainian exports and the growth in labor migrant remittances generated fundamental revaluation pressures. As before, the NBU smoothed out excessive exchange rate fluctuations, and increased its “safety margin” by accumulating international reserves.

In total, the NBU ended 2021 as a net purchaser of USD 2.4 billion. This boosted international reserves to USD 31 billion (by 6%). At the same time, this did not prevent the strengthening of the hryvnia, which became stronger during most of last year, creating the conditions for a reversal of the inflation trend.

Therefore, thanks to the strengthening of the hryvnia and the monetary measures taken, inflation began to decline at the end of last year. After peaking at 11% in September last year, consumer inflation fell to 10% in December. Therefore, unlike many other countries, in Ukraine the inflation trend reversed last year.

This is precisely why we managed to keep inflation expectations under control throughout 2021. They have increased, but remain in check. The NBU’s rapid response prevented inflation from spiraling out of control. If an inflationary spiral had emerged, our monetary policy would have been much tighter, which would have harmed economic growth.

Our policy over the past year has allowed us to maintain public confidence in the hryvnia. Specifically, the tendency towards dedollarization has persisted. In 2021, the dollarization of deposits declined to 32% from 37%, while that of loans fell to 28% from 37%. Only hryvnia deposits increased last year. The grew by 21%. FX deposits remained almost unchanged.

The beginning of 2022 marks new challenges for the Ukrainian financial market. The build-up of Russian forces on the border has worsened the expectations of market participants. As a result, Ukrainian assets have declined in value (both domestically and abroad), and pressure on the hryvnia to depreciate has increased.

The situation is difficult, but it is NOT an emergency. This is thanks to the safety margin that we have achieved.

Like I said before, we have reserves that we can use to make FX interventions to smooth out excessive exchange rate fluctuations. Specifically, for the purpose of balancing out the FX market, the NBU has already sold USD 1.5 billion since the start of the year. These reserves are sufficient for the NBU to continue to pursue its FX intervention strategy and to level out the volatility. At the same time, I emphasize yet again that the NBU will not repeat past mistakes and will not try to fix the exchange rate to a specific level. We are confident that going forward, the market will stabilize. Actually, there could even be a correction.

Which makes it all the more important that we continue to pursue our monetary policy strategy. In line with this strategy, and taking into account the size of inflation risks, the NBU in January increased the key policy rate by 1 pp. This shows once again that we stand committed to using monetary policy tools to respond to inflation risks.

However, the central bank’s determination to use market-based instruments does not mean a readiness to impose administrative restrictions, which we believe are extremely damaging to economic activity. No restrictions are currently on the table, unlike in 2008 or 2014 through 2015.  As I mentioned earlier, although it’s a difficult situation, we have confidence in our ability to control it. This confidence comes from our accumulated experience, the public trust in our monetary policy, and the available volumes of gold and FX reserves.

Thanks to these advantages, we can see that the scale and consequences of the rising geopolitical tensions are smaller and weaker than the shock caused by COVID-19 in March 2020.

The FX market situation remains under control. Ukraine’s FX market has a sound macroeconomic foundation and is much more resilient to shocks than before. 

The banking system is generally in good shape, with substantial capital buffers that exceed minimum requirements. The stress tests conducted last year showed that the banks were mostly prepared to the hypothetical crisis and risks to the banks’ capital had fallen over the last two years, with credit risk decreasing probably most notably. As of 1 January 2022, even under the unfavorable scenario, considering the approved restructuring/recapitalization programs, regulatory capital adequacy ratios were higher than the required levels for almost all banks.

Furthermore, banks have good liquidity ratios, in particular, all banks meet the LCR, the short-term liquidity ratio, which means the crisis outflows are covered with liquidity.

According to the latest data, the banking system made profit of UAH 77.5 billion in 2021. It is the highest profit in recent years and it can be used to increase capital and expand lending.

It’s likely that such a strong performance of the banking system is why we are not seeing bank runs or a rush to withdraw deposits. Depositors have every reason to continue to trust Ukrainian banks.

In conclusion, let me say that the NBU is committed to pursue its policy on the principles of consistency, predictability, and transparency. Despite significant challenges, this approach will ensure price and financial stability, which is the central bank’s main contribution to sustainable economic growth. 

In particular, the correct monetary policy will reduce the cost of credit in the medium term. We are already seeing this reduction. Specifically, the weighted average interest rate on corporate loans in 2021 did not exceed 10%, despite higher inflation and the cycle of key policy rate hikes. By contrast, in 2012–2013, this interest rate surpassed 20% in some months even as inflation stood at zero. Without a doubt, this policy of the central bank is an important contribution to the revival of investment and economic growth.

Let me welcome you again and thank you for joining our meeting.

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