Ukraine’s central bank releases inflation forecast for 2023

30 October 2022, 04:30 PM
The situation at the front became a key factor in economic recovery. A Ukrainian soldier at the ruins of a school in Lyman, October 5 (Photo:REUTERS/Zohra Bensemra)

The situation at the front became a key factor in economic recovery. A Ukrainian soldier at the ruins of a school in Lyman, October 5 (Photo:REUTERS/Zohra Bensemra)

Author: Petr Shevchenko

Global inflation and war is hitting Ukraine’s economy hard and the National Bank of Ukraine (NBU) hopes that the successes at the front will create opportunities for the start of recovery in 2023.

NV Business has summarized the main points from the NBU’s latest inflation report.

Global inflation is gaining momentum

Global inflation affected different groups of goods and countries. Inflation rates are well above mid-year levels when demand expanded significantly during the post-pandemic recovery. Therefore, about three-quarters of the world’s central banks raised interest rates in 2022.

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More than a decade of “ultra-cheap money” on global financial markets ended in 2022. As a result, real government bond yields have risen to levels last seen nearly a decade ago.

The rising cost of external borrowing and the strengthening U.S. dollar pose significant challenges for EM (emerging market) countries.

Despite a slowdown in August-September, inflation in the United States significantly exceeds the long-term target, while the base level has been consistently above 5% for more than six months. Therefore, the Fed aggressively raised rates (up to 3-3.25% in September).

Inflation in the Eurozone has also increased. First of all, this was due to an increase in energy prices. Moreover, high energy prices were the result of not only of record prices for natural gas, but also of abnormally high margins for processing diesel fuel and distributing fuel for private transport. Therefore, the European Central Bank (ECB) will continue to raise rates, and the tightening cycle may end at 2.25-2.5%.

Inflation in developed and EM countries will gradually weaken as commodity markets stabilize, economic growth slows, and financial conditions strengthen.

The world will plunge into recession

The supply shock will plunge the world into recession for several quarters. Later, global growth will resume, but it will be delayed by the slow adjustment of logistics and weakness in world trade.

The U.S. economy is slowing down. Mortgage rates and costs are rising, which has led to a drop in construction investment.

At the same time, private consumption slowed down against the background of falling real disposable incomes. The adjustment of logistics and rising prices of raw materials will restrain the U.S. economy by late 2023. Additional restrictions will be created by the strengthening of the Fed’s monetary policy.

High inflation and geopolitical consequences of the war in Ukraine also negatively affect the Eurozone economy. These factors will continue to influence things at least until mid-2023.

Oil and natural gas markets in Europe in Q3 2022 had multidirectional dynamics. The slowdown of the global economy significantly reduced the demand for oil and, accordingly, are the reason for its cheaper price. At the same time, the limitation of production volumes by the OPEC+ countries has kept prices from falling even deeper. The introduction of a maximum price for Russian oil by European countries will have an additional impact on the market.

Global steel and iron ore prices eased on weak business activity in most regions amid still oversupply.

The war is the main factor behind high prices in Ukraine

The acceleration of inflation continues to be caused by the consequences of Russia’s full-scale war against Ukraine.

Consumer inflation in September 2022 reached 24.6% y/y.

Cereals became more expensive due to depletion of stocks and reduction of import possibilities. On the other hand, positive expectations regarding the harvest of domestic cereals, in particular buckwheat, contributed to a decrease in the growth rate of prices for them at the end of the quarter.

The growth of fuel prices slowed significantly (to 66.2% y/y in September), although their price stabilized at a high level. This is explained by the decrease in oil prices in the world, and the saturation of the market due to the improvement of logistics and the restoration of competition between gas stations. Fuel prices will rise more slowly further on (up to 20% per year). On the one hand, the gradual decline in global oil prices will restrain prices. On the other hand, the expected return of the fuel tax system to pre-war levels will keep prices high. However, the effects of the transfer of high fuel prices will continue in the future, causing, in particular, an increase in the price of transport services.

The growth rate of administratively regulated prices remained at the level of 14.7% y/y in Q3. The price of alcoholic beverages has accelerated amid rising costs, in particular for energy, as well as a shortage of containers. The growth of prices for pharmaceutical goods also accelerated under the influence of exchange rate adjustments. On the other hand, the growth rate of the cost of transport services decreased after the stabilization of fuel prices. The growth of utility tariffs also slowed over the depletion of benchmarking effects due to fixed tariffs.

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In addition to high current inflation, the deterioration of expectations was caused by the strengthening of devaluation pressure on the cash market.

Inflation will continue to accelerate and reach 30% by late 2022, driven primarily by supply shocks and worsening expectations caused by the war, as well as high global inflation.

However, the expected decrease in security risks from mid-2023 will contribute to lowering the inflationary expectations of economic agents, while the pro-inflationary effect of supply shocks will gradually fade. Relatively tight monetary conditions, as well as the gradual subsidence of global inflation will become additional disinflationary factors.

Ukraine’s GDP is shrinking

According to Ukraine’s State Statistics Service, real GDP dropped by 37.2% in Q2 2022, which turned out to be somewhat better than the expectations published in the Inflation Report for July 2022. According to the NBU’s estimates, the recovery continued in Q3 and the decline in real GDP slowed to 34.4%.

The liberation of the occupied territories and the opening of the “grain corridor” were the most important reasons for this economic revival.

However, difficulties with logistics, especially with the removal of products for export, remains a significant restraining factor, in particular for the metallurgy and mining industry, which operate significantly below the pre-war capacity utilization levels.

According to the results of 2022, Ukraine's economy will shrink by almost a third. The rapid decrease in real incomes of the population due to the war, which is only partially restrained by the expansion of social assistance and high payments to the military, is the main reason for the reduction in private consumption (according to the results of 2022, it is expected to be almost 23% less against 2021).

As a result of the shocks of the war, investments, primarily private, will decrease in 2022 the most among all GDP components – by 50%.

Investments will have the highest growth rates (16-25% per year) in the post-war period due to the need to restore significant losses of infrastructure and enterprise capacities.

The growth of both Ukrainian exports and imports is expected to resume in 2023. Although the risk of a global recession has already materialized, its impact on the real sector of Ukraine’s economy will be limited as long as hostilities continue and there is no full access to sea ports.

Significant losses of domestic demand, a weak labor market, temporary difficulties with logistics, and the loss of export opportunities has led to a more significant drop in real GDP compared to potential. A large negative GDP gap has formed.

Wages and vacancies – the employer’s market prevails

The number of refugees abroad and internally displaced people is increasing. With the reduction of security risks, the return of citizens is expected to increase in Q2 2023. Although, according to the NBU’s assumptions, there will still be about 5 million people abroad by late 2024, which will lead to a corresponding decrease in the labor force and lay risks for post-war recovery.

Despite a certain revival of economic activity, most enterprises are still operating well below pre-war employment levels. A decrease in the output and income of enterprises, as well as the expectation of prolonged hostilities, restrain enterprises in their plans to increase the number of employees, as evidenced by data from job search websites. At the same time, enterprises are not facing a shortage of qualified workers.

As a result, an employer’s market still prevails in Ukraine – although the number of vacancies has increased against March-April, it still remains two to three times (depending on the field of activity) less than it was before the full-scale aggression.

Vacancies in the field of service, labor specialties, and trade are now prevailing. The growth in the number of CVs has slowed due to the revival of labor demand, mobilization, and migration abroad.

Even the workload per vacancy is growing in the IT sector (the number of vacancies is decreasing, while the number of CVs is steadily increasing), which may be related to the relocation of employers abroad. The unemployment rate will gradually decrease but will remain above its natural rate due to the long-term effects of the war.

Real wages will continue to grow due to increased demand for labor force in certain industries, but rather slowly due to sectoral disparities.

Financial and currency markets

Maintaining a fixed official hryvnia exchange rate is contributing to the stabilization of expectations and restrains inflationary pressure.

The adjustment of the official hryvnia exchange rate together with other measures to balance supply and demand contributed to the easing of imbalances in the foreign exchange market.

The value of Hryvnia-denominated assets is gradually reacting to the June increase in the key rate, and its expected maintenance at the current level at least until Q2 2024. The projected continuation of the monetary transmission will contribute to increasing the yield of hryvnia financial instruments and maintaining exchange rate stability.

The discount rate will remain high for a long time to counteract pressure on the exchange rate, which will contain inflation.

Protracting the war is the main risk for the economy

The key assumption of this macro forecast is a significant reduction of security risks from mid-2023 thanks to the successful actions of the Ukrainian army. Therefore, the main risk is a longer duration of the active stage of the war.

Due to the significant number and potential scale of pro-inflationary factors, the balance of risks in the inflation and interest rate forecast has shifted upwards.

Despite some easing, the risk of unbalancing state finances remains. On the one hand, the NBU adheres to the announced monthly budget monetization limits of UAH 30 billion ($820.3 million), and the budget for 2023 currently provides exclusively for emission-free financing of the deficit. Given the unpredictable nature of the war, possible problems with the rhythm of receiving international aid and the emergence of additional budget needs, there is a risk of a recurring need for issue financing of the budget by the NBU. This will further worsen inflationary and devaluation expectations.

The NBU kept the discount rate unchanged in October. It is expected to remain at the current level at least until Q2 2024.

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