The NBU held a scheduled meeting of the Monetary Policy Committee (MPC). The discussion focused on assessing the current economic situation and scenarios of further developments, while the decision on changing the key policy rate was postponed.
Under the current conditions, the impact of the key policy rate on the functioning of the money market and the FX market remains limited. With this in mind, the key policy rate will stay flat at 10% until monetary transmission channels are effective again.
Consequences of russia’s massive attack will raise inflationary pressures, which will be partially offset by measures taken by the government and the NBU
In March 2022, consumer inflation accelerated in annual terms, to 13.7%, up from 10.7% in February. The rise in consumer prices was primarily driven by disruptions of supply chains and production processes, uneven demand, higher business costs, and the physical destruction of company assets due to russia's full-scale assault on Ukraine. Prices for food, pharmaceuticals, and fuel surged the most.
The NBU estimates inflationary pressures to persist due to the consequences of the full-scale war. At year-end 2022, inflation might exceed 20%, but it will remain under control. The reasons for the rise in the prices of goods and services will include:
- disruptions in production processes
- logistical problems due to the temporary occupation of a part of the territory, destruction of the transport infrastructure, and, as a result, the uneven distribution of supply across some regions
- pass-through effects from the weakening of the hryvnia in the run-up to the war
- high global energy prices, which will put pressure on fuel prices and prices of goods and services with energy-heavy production costs.
At the same time, measures taken by the NBU and the Ukrainian government will restrain the price growth. These measures include:
- a temporary fixing of the hryvnia exchange rate, which will limit the probable deterioration in expectations and the rise in prices of imported goods
- a decrease in taxes, including the indirect taxation of imports
- locking in public utility rates
- administrative regulation of prices for some foods and fuel.
Excessive supply of some agricultural crops will be an additional restraining factor due to limited exports.
Moreover, after the monetary transmission channels are restored, the NBU will resume to use its key policy rate and other monetary instruments to control inflation expectations and gradually reduce inflation.
Economic activity is reviving in the regions where it is relatively calm after a shock of the first weeks caused by russia’s massive attack
Businesses are gradually reopening, overcoming the wartime challenges. Results of unscheduled surveys held by the NBU show a decrease in the number of companies that stopped their operations completely. While in the first weeks of March the share of these companies was above 30%, it dropped to 23% in early April. Consumption and production of electricity remains stable, while the number of open restaurants and their turnovers are increasing. The revival in economic activity is also evidenced by resumed sales of train tickets by Ukrainian Railways and the steady demand for them.
At the same time, active combat continues in many regions of Ukraine. Civilian casualties are rising, and infrastructure and production facilities continue to be destroyed. Russia’s large-scale assault on Ukraine has also broken production ties between regions and caused a major increase in forced migration. As a result, losses from the war will be significant.
According to the NBU’s baseline estimates, the Ukrainian economy will gradually recover. Despite that, real GDP could drop by at least one third in 2022.
All GDP components are expected to decline. More specifically, private consumption will contract on the back of the forced relocation of many Ukrainians to other countries, higher unemployment, lower income and decreased spending on non-essential goods. Investment activity will also decline markedly in the wake of considerable uncertainty and high risks.
Decreased consumption and investment could decrease imports compared to the pre-war period. Exports of goods will also drop significantly due to the shutdown of companies, a reduction in sown areas, and farmers’ inability to conduct agricultural work effectively because of fighting, blocked seaports and disrupted supplies of fuel and fertilizers. At the same time, the NBU expects an increase in stocks of goods, which companies will try to export later.
Following the substantial drop in the first month of war, exports and imports will gradually revive
Exports of goods plunged in March 2022 after logistical pathways were severed and production facilities were destroyed. Imports of goods also slumped last month, dragged down by weaker domestic demand, disrupted logistics, and by imports being limited to critical goods.
The NBU expects that exports will gradually rise compared to those in March, thanks to logistical problems being partly resolved. Imports of goods and services will also grow moderately, fueled by gradually rebounding consumer and investment demand.
Financial assistance provided by Ukraine’s international partners will be an important source of FX inflows in the country. Workers’ remittances and the income generated by the IT industry will remain other relatively stable source of FX inflows.
While the economy and the financial system are recovering to normal functioning, the NBU will gradually return to inflation targeting with a floating exchange rate, and will stop financing the budget
A fixed exchange rate and persisting administrative restrictions on FX transactions will remain important prerequisites for supporting macroeconomic stability in Ukraine. However, in the long-run these measures result in macroeconomic imbalances. Therefore, the NBU will strive to resume inflation targeting with a floating exchange rate as soon as the FX market recovers its capacity to self-balance.
The NBU’s financing of the budget deficit, which is being carried out in controlled volumes, is not putting any significant pressure on prices thanks to the fixed exchange rate and FX restrictions. In spite of that, with a view to minimizing risks to price and financial stability, avoiding difficulties with Ukraine’s European integration and preventing the loss of people’s trust in the central bank, the NBU will continue to maintain the stance that its monetary financing cannot be the main source of the budget’s revenues.
In contrast, the NBU will work closely together with the government in order to help the country raise financing from international organizations and partner countries. Among other things, this financing will be used to resolve humanitarian problems, restore destroyed infrastructure, and revive the Ukrainian economy. This financing will also help meet budgetary needs and maintain sufficient international reserves.
The full extent of the economic losses from Russia’s full-scale invasion of Ukraine will mainly depend on the duration of the hostilities. Continued structural reforms, wide international support and Ukraine’s integration into the European Union will pave the way for the country’s rapid recovery.