Dear colleagues,
I would like to greet all the participants at our traditional meeting following the National Bank of Ukraine’s Board meeting devoted to the monetary policy issues.
The NBU Board has decided to cut its key policy rate to 13%, effective 14 April 2017. We have resumed the monetary policy easing cycle after a five-month standstill amid abating inflation risks and an emerging necessity to prop up the economic growth in Ukraine. Such measure is in accord with the pursuit of inflation targets set for 2017-2019.
Let’s have a look at inflation tendencies since out last meeting
In annual terms, headline inflation in March accelerated to 15.1%. Such acceleration was expected, while at a lower trajectory than projected in the NBU’s Inflation Report in January 2017. The NBU then projected inflation in March to accelerate to 16.4%.
Price growth has accelerated primarily due to base effects and higher production costs.
At this, the fundamental factors that determine inflation have remained under control. Prudent fiscal and monetary policies against a backdrop of improved inflation expectations restrained acceleration of core inflation (in March, 6.3% in annual terms).
Demand-driven pressure on prices has remained moderate. It is evidenced by the volume of retail goods turnover which grew by a mere 0.5% annually in January-February.
In this manner, the Q1 results showed no significant uptick in consumption in the aftermath of minimal wage increase to a level of UAH 3,200 in early 2017. This decision took by the government prompted the average wage growth. In January-February, the nominal average wage grew by 36%, and real wage increased by 20% yoy. While households’ income from sources other than wages grew at a slower pace. However, unemployment remains at a high level due to labor market mismatches, but the revival of economic activity and the improvement in business outlook of enterprises contributed favorably to a gradual recovery of labor demand.
The situation in the FX market helped weaken pressure on prices.
The external price environment for Ukrainian exporters has become more favorable since early 2017 due to recovery in prices for steel, iron ore, and grains, with an export potential being further bolstered by record high grain and oil crop yields.
In this respect, the halt on trade with certain areas of Donetsk and Luhansk oblasts and the seizure of enterprises in uncontrolled territories in Ukraine’s east did not have a significant effect on the FX market. A shortfall in FX revenues from enterprises, which were severely hit by the blockade, was amply offset by higher earnings of enterprises, whose production activity stood aside of the conflict areas. Although FX supplies from metallurgical enterprises decreased, this decline was offset by FX sales by agricultural enterprises. The share of FX proceeds from agricultural exports accounted for over 40% of the total amount of foreign currency sold by exporters. For reference - in January, it was less than 30%.
Generally, solid export revenues helped underpin appreciation of the hryvnia since the middle of January and enabled the NBU to continue liberalization of FX regulation and make more frequent FX purchases in the interbank market to boost its international reserves. Since the beginning of the year, the NBU’s net FX purchases reached USD 242 million.
What is our inflation forecast for the future?
The NBU forecasts that inflation will meet the announced targets in the current and the next two years.
According to the updated Inflation Report to be published on 20 April, inflation forecast for the current year remains the same as we predicted in January, i.e. 9.1%, staying within the target band of 8% ± 2 pp.
Throughout the current year, the inflation dynamics in annual terms are forecasted to be rather volatile. In Q2 and Q3 of 2017 it is expected to remain in the double-digit range due to the base effects, namely the administered price dynamics throughout 2016. However, in Q4, inflation will return to a one-digit range. Next year, we expect inflation to slow down to 6.0%, and in 2019 - to 5%.
No significant deviations of core inflation from the current level (6.5%) are projected by the end of the year. Recovery of consumer demand and second-round effects from the higher food price inflation will be the inflation driving factors.
Prices for unprocessed foods will rise at a faster pace in the following months driven by a number of factors.
First, global food prices are projected to move on an upward trajectory.
Second, opening of the new markets will result in a lower supply of certain types of domestically produced foods in Ukraine.
In addition to supply factors, there is also an effect of demand factors. Consumer demand is expected to recover gradually due to a quickly growing household income.
The halt on transferring cargo across the line of contact in the eastern Ukraine will have no significant impact on the headline inflation. In particular, owing to the limited effect of the situation on the foreign exchange rate. As we reported in the course of interim update of macroeconomic forecasts, the negative effect of the trade halt on the balance of payments will be compensated at the expense of the favorable situation on external commodity markets. In order to lessen the halt impact on the FX market, the NBU may cut its interbank foreign currency purchases, if needed. This will increase the availability of foreign currency in the interbank market and help smooth out hryvnia exchange rate fluctuations.
In 2017-2019, prudent monetary and fiscal policies will be the key drivers of the disinflation process. Such policies will support a controlled rise in consumer demand and moderate FX rate volatility. Growing investments in agriculture will improve its performance that is still lagging behind leading countries. This will curb the food price inflation in the mid-term.
The NBU has revised its GDP growth projections for the nearest years.
This year economic growth is projected to slow to 1.9%.
This downward revision resulted from expectations that the halt on trade in eastern Ukraine and the loss of the production facilities located in the rebel-controlled areas will decrease the output of some industries. These are the metallurgical and mining industries, coke production, and the electrical industry. However, as it was said before, this negative influence will be partly offset by a more favorable external environment. Therefore, impact of the situation in the east of Ukraine will be less painful for the economy than it could have been under the worse external circumstances.
At the same time, we expect the consumption recovery by the end of the current year. In particular, the stimulating effect of the increased real wages will be visible, among other things, due to the double increase of minimal wages. This will also be fostered by improvement of consumer confidence.
Real GDP growth is forecasted to increase to 3.2% in 2018 and 4.0% in 2019. Consumer and investment demand will remain the driver of economic growth. This demand will stimulate the still high growth in imports of goods and services. However, it will be partly offset by a gradual increase in the country’s export potential in 2018 and 2019.
The balance of payments projections have been revised in response to the halt on trade and a revision of the terms of trade
The projections for a 2017 current account deficit have been increased from USD 3.5 billion to USD 4.3 billion or 4.4% of GDP.
The halt on trade is expected to decrease the export potential of the metallurgical industry. However, it will be partly offset by higher prices in the global commodity markets and bigger grain crops.
As a result, this year, even under the halt on trade, export of goods will demonstrate growth by 11% for the first time since 2012. In particular, deliveries of iron ore abroad will grow due to suspension of iron ore shipment to metallurgical enterprises in certain areas of Donetsk and Luhansk oblasts. Export of foods and machinery will also grow.
Import growth rates will be comparable with export. First of all, due to suspension of shipments from certain areas of Donetsk and Luhansk oblasts, coal and coke import will increase. Second, machinery import will be high due to the increased demand from agricultural enterprises to upgrade their fixed assets. Third, along with the gradual recovery of consumer demand, import of foods will also grow.
The next two years current account deficit will remain unchanged in nominal terms and stay at USD 4.3 billion. At the same time it will gradually narrow to 4.1% of GDP and 3.7% of GDP.
This will be attributed to a rise in the economy's export potential. Metallurgical plants located on the territory controlled by Ukraine, at that time would be able to set up industrial chains and increase deliveries abroad. Also, the supply of food products to Asian markets will keep on increasing. At the same time, imports of products needed for enterprises to upgrade fixed assets will remain active.
The current account deficit of the current year and further years will be counterbalanced by net financial account inflows.
In particular, in the current year, debt inflows to the private sector will resume, while households’ demand for foreign currency cash will continue to fall. Banks’ net FX purchases from households have amounted to USD 457 billion since the start of the year.
Next year, an improved business climate and faster economic growth are projected to increase debt inflows and foreign direct investment in the private sector.
Surplus of the overall balance of payments, together with the planned tranches received under the IMF EFF and other related financing programs, will enable the NBU to further accumulate the international reserves.
At the same time, replenishment of reserves through FX purchases in the interbank market will be less intensive than expected earlier due to the negative effects of the halt on trade with certain areas of Donetsk and Luhansk oblasts on the external trades. Therefore, the international reserves are estimated as USD 21.1 billion as of the end of this year and USD 26.2 billion as of the end of next year.
The major risk for the above scenario might be a failure by the private sector and the Government to efficiently minimize losses from the halt on trade. Apart from that, we still face a high risk of escalation of the military conflict in eastern Ukraine.
A negative impact may be experienced due to departure from the prudent fiscal policy, including raising social standards even more strikingly than the inflation targets justify it. The furtherance of structural reforms necessary to preserve the macrofinancial stability, especially of those specified as Ukraine’s commitments under the EFF program with the IMF, is also important.
Overall, according to the NBU Board, the inflation forecast and the balance of risks are supportive for further monetary policy easing.
Expecting a slowdown in inflation to 9.1% at the end of the year, the Board of the National Bank of Ukraine decided to lower the key policy rate to 13%.
Any further monetary easing will depend on whether or not risks to price stability reduce over the forecast horizon.
Given favorable FX market conditions, the successful completion of the third review under the IMF’s EFF and the above balance of risks, the NBU Board believes that FX market controls can be relaxed further.
As before, the NBU’s main focus is on removing obstacles to foreign economic transactions and inflows of foreign direct investment.
First, the NBU has analyzed businesses’ plans to pay dividends abroad and decided to allow the businesses to repatriate dividends for 2014-2016. Since the NBU permitted businesses to repatriate dividends accrued in 2014-2015, the latter have paid USD 1 billion in dividends abroad. It is worthy of note that businesses’ purchases of foreign currency were equally distributed in time and had little bearing on the exchange rate.
The NBU has also simplified the rules for repatriating dividends this year, allowing each business to repatriate up to USD 5 million every month. These rules will come into effect from May.
Second, the NBU intends to let banks repay their loans to non-resident banks with a rating no lower than A, as well as debts on Eurobonds, before these loans and debts fall due.
Third, the NBU also intends to increase the maximum amount of advance payments under import agreements entities are allowed to make without using letters of credit from USD 1 to USD 5 billion. As is evidenced by the rise in this amount from USD 0.5 million to USD 1 million that took place in September last year, this will not influence the amount of such payments in any significant way.
These steps are expected to improve the country’s investment climate, and make it easier to operate for exporters that import inputs for production with the purpose of exporting finished goods. At the same time, none of these steps will destabilize the FX market.
The next NBU Board meeting on monetary policy is scheduled to take place on 25 May. Since this meeting will be chaired by my follower, I would like to summarize all the monetary policy changes that occurred while I was in office.
There have been 16 monetary policy meetings (including the today’s one) since the NBU Board adopted the monetary policy strategy for 2016-2020 that paved the way for monetary targeting.
Since the adoption of the new strategy, the NBU has been maintaining a flexible exchange rate, has overcome fiscal dominance and met the first inflation target. The NBU believes that it will be able to gradually reduce inflation to 5%, and, over time, set an even lower target, similar to the targets of developed countries.
However, to achieve this goal, the NBU has to remain committed to inflation targeting. Under any governor, the NBU must remain independent and operate a consistent and transparent monetary policy. Only if this condition is met, the NBU will be able to ensure the value of every hryvnia for every Ukrainian.
There is no going back - the only way is forwards.
Thank you for your attention!