The Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. The decision to raise the key policy rate taken in June will continue to push up market rates. Improved attractiveness of hryvnia assets, coupled with the change in the official exchange rate and additional economic policy measures, will dampen demand on the FX market. Taking into account the planned inflows of official financing, this will help support the sufficient level of international reserves and thus maintain the macrofinancial stability.
Inflation soared, reaching 21.5% yoy in June, which was mainly the result of war-driven shocks and global price pressures
The war caused a disruption of supply chains, a decrease in supply of some goods, higher business expenses, physical destruction of production facilities and infrastructure, and temporary occupation of some territories. Persistently high energy prices and record-high inflation in partner countries also fueled price pressures in Ukraine. Inflation expectations of businesses and households increased markedly. This was reflected in deteriorated maturity structure of bank deposits and higher spending on some durable goods, primarily imported goods. As a result, inflation has been growing rapidly over the last months, reaching 21.5% yoy in June. The price growth was unevenly spread geographically: inflation peaked in territories that were temporarily occupied or close to combat areas.
Administrative measures of the NBU and the government – primarily fixing the hryvnia exchange rate and natural gas and heating tariffs – remained the key instruments to curb inflation. Price growth was also constrained by setting up supplies of goods through western borders and by excess supply of raw agricultural products caused by the sea port blockade.
Inflation pressures will persist: inflation will exceed 30% yoy as of the end of 2022. It will slow considerably in the next years, albeit remaining much above the NBU’s target of 5%, primarily due to the consequences of the war.
Supply shocks caused by the full-scale war will continue to strongly affect price dynamics. The baseline scenario of the forecast envisages that Black Sea ports fully recover their operations from the start of the next year. At the same time, the probability remains high that russia will continue its terrorist attacks on infrastructure and production facilities in Ukrainian cities, which will disrupt logistics, increase businesses’ risks, and destabilize expectations. Global energy prices will also remain high. Under such conditions, the NBU will conduct tight monetary policy, primarily aiming at preventing the imbalance of expectations, as well as raising interest in hryvnia assets and reducing the pressure on international reserves. This will support financial stability and somewhat reduce the inflationary pressure, but inflation will keep accelerating and will slightly exceed 30% at the end of the year.
The NBU’s baseline scenario contains a number of assumptions, including the assumptions that in 2023 logistics will recover, businesses will face lower risks, and harvests will increase gradually. This would have a positive impact on expectations and weaken the inflationary effect of supply shocks. A decline in global inflation and the NBU’s tight monetary policy will additionally foster disinflation.
Consumer and investment demand will remain restrained for a long time, which will also slow down inflation in the coming years. On the other hand, persistently high energy prices will be an obstacle to faster disinflation and will require a review of utility tariffs in order to balance state finances. Taking into account the consequences of the war and the large contribution of the increase in administered prices, inflation will drop to 20.7% in 2023, and 9.4% in 2024. Inflation is projected to return to the 5% target in 2025.
The economy of Ukraine will shrink by a third in 2022 but will return to growth in 2023–2024 if the Black Sea ports are unblocked.
The full-scale russian invasion caused a sharp fall in economic activity in Ukraine. A third of businesses suspended their operations at the start of the war, due to physical damage and temporary occupation of whole regions, high uncertainty and risks, disruption of logistical and production chains, and forced massive migration. As a result, GDP plunged in March and fell by 15.1% yoy as of the end of Q1 according to the flash estimate of the State Statistics Service of Ukraine (SSSU). However, the economic activity started to recover in April, and businesses and households gradually adapted to new conditions. This was also due to the liberation of northern oblasts and a decrease in the number of regions affected by active hostilities. According to the NBU’s flash polls, only 14% of businesses remained dormant at the end of the spring. Still, the capacity utilization of operating businesses was much below compared to the pre-war period. As a result, the economy fell by around 40% yoy as of the end of Q2, as estimated by the NBU.
Hostilities in the east and south of the country, destruction of infrastructure in other regions, the blockade of sea ports, and weak demand in the majority of sectors will restrain economic recovery in the next months. A major contribution to the decline in GDP will come from weaker activity in agriculture due to the temporary occupation and laying landmines, loss of equipment and elevators, and occasional untimely and insufficient treatment of land with fertilizers and plant protection products.
This will lead to the economy shrinking by a third this year. When the active phase of the war is over, it is expected that consumer demand will rise moderately, technological and logistical processes will be set up, and investment activity will revive, among other things, thanks to Ukraine’s European integration prospects. However, in view of the large losses of production and human potential and the still-high security risks, the Ukrainian economy will recover at the rate of around 5%–6% per year in 2023–2024.
Despite showing a temporary surplus thanks to international aid, in future, the current account will return to deficit on the back of the economy’s high need for imports, including imports for recovery.
Although slumping at the beginning of the russian invasion, Ukraine’s foreign trade recovered gradually in the following months. Compared to March–April, imports grew faster than exports, due to their less heavy dependence on the blocked sea lanes, rebounding domestic demand, and the expansion of the list of critical imports. This widened the external trade deficit. Large-scale migration has led to significant spending by Ukrainians abroad and increased cash withdrawals in other countries. FX outflows were partially offset by international aid, including grants, sustainable remittances from labor migrants, and a reduction in reinvested earnings. As a result, although the current account posted a surplus in January–May, the overall balance of payments recorded a deficit.
Looking ahead, the current account will return to deficit, driven by the economy’s high need for imports, including imports for recovery. The deficit will be offset by substantial international aid.
Ukraine’s continued cooperation with its international partners will remain one of the key factors in supporting the economy during the full-scale war and contributing to its recovery after the active phase of hostilities ends.
Ongoing military and financial assistance from Ukraine’s international partner countries will enable the country to maintain its defense capabilities, while also meeting a significant portion of its budgetary needs in 2022. Ukraine is expected to continue to actively work together with international financial organizations in 2023–2024, including through the launch of a new IMF program to support the balance of payments and macroeconomic stability. Ukraine’s cooperation with the IMF and the country’s continued European integration will help strengthen state institutions and allow it to implement other structural reforms.
A prudent economic policy is also a necessary prerequisite for delivering macroeconomic stability and ensuring the NBU’s baseline scenario materializes. Among other things, the following measures are important, with their effect taken into account in the baseline scenario:
- narrowing the budget deficit through prioritizing expenditures and raising revenues, as well as through gradually reducing imbalances in the energy sector
- replacing the monetary financing of the budget with market borrowing
- decreasing demand for imports by imposing additional taxes on imports.
The key risk to the forecast is that the war of liberation against the russian invaders will last longer.
If materialized, this risk will delay economic recovery and the return of inflation to its target.
Other risks with differing effects are also important. These include:
- the unbalancing of state finances (in particular due to the lack of measures to achieve fiscal consolidation and to activate market mechanisms for financing the budget deficit), which could pose a threat to macrofinancial stability, including to control over inflationary processes
- increased emigration, which could threaten to reduce the labor force and have long-term negative effects on the labor market and economic growth after the war
- a global economic downturn, which will decrease global commodity prices and, consequently, export earnings, while also stepping up pressure on the hryvnia exchange rate and consumer prices.
The rapid approval and launch of a recovery plan for Ukraine, generating foreign investment inflows and substantial funding for the country’s recovery projects, which could significantly accelerate economic growth and return inflation to its target more quickly than envisaged by the baseline scenario of the NBU’s forecast.
In view of the protracted period of significant pressures on prices and the prevalence of inflationary risks on the forecast horizon, coupled with the need to ensure the attractiveness of hryvnia assets and maintain exchange rate stability, the NBU Board decided to keep the key policy rate unchanged, at 25%. The operational design of monetary policy remains unchanged, in particular interest rates on certificates of deposit and overnight refinancing loans. This will ensure the continued pass-through of the effects on market rates of the June increase in the key policy rate and interest rates on NBU monetary operations. The NBU welcomes the Ministry of Finance’s decision to raise interest rates on annual hryvnia domestic government debt securities at the latest primary auction, and expects that yields on these securities will continue to reach a level that will stimulate demand for these instruments from banks and other portfolio investors. Increasing the attractiveness of hryvnia assets is an important element for stabilizing expectations and ensuring macrofinancial stability.
The baseline scenario of the macroeconomic forecast envisages that the key policy rate will be maintained at 25% at least until Q2 2024. At the same time, the balance of risks to the key policy rate forecast is assessed as having shifted upwards. If these risks materialize, the NBU could raise its key policy rate and interest rates on its monetary operations beyond their current levels in order to safeguard monetary stability and to ensure inflationary processes remain under control.
If required, the NBU stands ready to take additional measures to protect international reserves, improve monetary transmission, and rein in inflationary pressures.
The decision to keep the key policy rate at 25% per annum, was approved by an NBU Board Decision on the key policy rate – No. 363, dated 21 July 2022.
А new detailed macroeconomic forecast will be published in the Inflation Report on 28 July 2022.
A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 1 August 2022.
The next monetary policy meeting of the NBU Board will be held on 8 September 2022, according to the confirmed and published schedule.