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Speech by Governor of the National Bank of Ukraine Kyrylo Shevchenko at a Press Briefing on Monetary Policy

Dear colleagues,

Please be informed that the Board of the National Bank of Ukraine has decided to keep its key policy rate unchanged, at 6% per annum. The sustained loose monetary policy is aimed at supporting economic recovery and bringing inflation to the target.

How did prices change in past months?

In September, inflation remained below the target range of 5%+/-1 pp. An increase in food supply curbed inflation to 2.3% yoy. This has offset the opposite pressure on prices from other factors, such as the hryvnia depreciation, higher energy prices, and a recovery in economic activity and consumer demand. 

However, such balanced effect of mixed factors is temporary. According to preliminary data of the NBU’s online monitoring of prices, inflation somewhat accelerated in October. Although the hryvnia depreciation had a minor pass-through effect on prices, inflation expectations of businesses and households also continued to deteriorate. Moreover, the consumer sentiment index improved.  

What will be the future path of inflation?

Inflation will reach the lower bound of the 5% ± 1 pp target range by the end of 2020 and will accelerate further on.

Considering the weak dynamics of consumer prices in Q3, the NBU has revised its annual inflation forecast downward, to 4.1%. The accelerated growth in prices at the end of this year will be primarily driven by a further recovery in economic activity amid sustained loose monetary and fiscal policies and by an increase in energy prices. The last year’s low comparison base will also have a notable statistical effect on annual inflation estimates. 

Consumer inflation will increase to 6.5% in 2021, influenced by the continued economic recovery, this year’s hryvnia depreciation, and a large hike in the minimum wage that will boost domestic demand. However, inflation will cross the upper bound of the target range only temporarily. The NBU may let inflation deviate from the target for a short period of time in order for the economy to turn to steady growth sooner. At the same time, the NBU will apply monetary tools to bring inflation back to the target range in 2022. 

What will be the overall state of the Ukrainian economy?

The economy will contract by 6% in 2020 but will resume growth at the level of around 4% in subsequent years.

The GDP forecast for 2020 has remained unchanged. The main reason behind the year-end economic contraction lies in difficulties faced by businesses in Q2, when the strictest quarantine restrictions were in place. On the other hand, business activity picked up markedly as the restrictions were gradually eased. A recovery in consumer and investment demand in H2 will offset the lower crop harvest and smaller fiscal impulse.

Private consumption will remain the main economic growth driver, boosting GDP growth to 4% in 2021–2022. Fiscal stimuli, the loose monetary policy, and a rebound in foreign demand will support economic growth. This scenario is possible if the quarantine restrictions are not tightened in Ukraine and across the globe. 

After the economy returns to steady growth, it will need less fiscal stimuli from the state. This will help gradually reduce the state budget deficit to around 3% of GDP in 2022. Going forward, the public and publicly guaranteed debt, which grew to 63% of GDP this year, will decline by 2–3 pp a year. The decline will be underpinned by economic growth, prudent fiscal policy, and moderate exchange rate volatility.

Although the current account will record a surplus of about 3% of GDP in 2020, it will return to deficit in the coming years. 

The coronavirus pandemic has markedly decreased energy prices, while also reducing Ukrainians’ demand for imported goods and travelling abroad, and businesses’ demand for investment products. Meanwhile, external conditions were favorable for Ukraine’s main exports. Consequently, over the entire year, exports will fall much less pronouncedly than imports. As a result, the current account will post a surplus. 

The economic recovery is triggering a widening of both consumer and investment imports, a trend which was already apparent in Q3 2020. The rebounding global economy is also pushing energy prices up. In addition, Ukraine’s income from gas transit will fall both this and next year. All of these factors will cause the current account to return to deficit. In 2021, the deficit will be about 2% of GDP, widening to 5% of GDP in 2022. 

Under what conditions would this forecast be realized?

The primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF.

Cooperation with the Fund is the basic precondition for fully financing the state budget deficit. Another important precondition is receiving financing from international partners, which in turn depends on IMF financing. Ukraine needs this support to revive its economy as quickly as possible. 

In contrast, any significant delays in, or suspension of, Ukraine’s performance of its commitments to the IMF could not only slow economic recovery, but also markedly worsen inflation and depreciation expectations. 

A constructive dialogue with international partners is the key to maintaining macrofinancial stability. Cooperation with the IMF will enable Ukraine to continue to meet its external obligations and to increase international reserves to USD 29-30 billion in the years to come. We continue to expect that the next tranche of the IMF loan will arrive by the end of the current year.

As before, a longer-lasting coronavirus pandemic, the further spread of the disease and stricter quarantine measures remain the key risks to macrofinancial stability.

Other risks also remain significant. They include:

  • the negative impact of certain court rulings on macrofinancial stability
  • an escalation of the military conflict in eastern Ukraine or on the country’s borders and
  • the higher volatility of global food prices, driven by global climate change and the risk of stronger protectionist measures.

Given the above balance of risks and expectations that inflation will overshoot its target range in 2021, the NBU Board decided to keep the key policy rate unchanged, at 6%.

How does the NBU intend to change the key policy rate in future?

With the high level of uncertainty, the NBU’s future monetary policy will mainly depend on how the pandemic develops and what budgetary parameters are adopted. 

If the pick-up in domestic demand and business activity fails to persist due to an increase in the number of COVID-19 cases, the NBU will be able to support the economy by cutting its key policy rate further. Conversely, the NBU will also be prepared to raise the key policy rate in 2021 if inflationary pressures intensify. The NBU will continue to keep a balance between stimulating the economy and maintaining moderate inflation. The NBU’s decisions will also be largely guided by the established parameters of fiscal support for the economy. This support is also expected to be significant next year. 

Thank you for your attention!

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