NBU Representatives and Experts Discuss the Macroeconomic Projections and Recent Economic Developments

The National Bank of Ukraine has held  a roundtable discussion involving external experts to discuss the NBU’s updated macroeconomic forecasts. During the event, NBU Deputy Governor Dmytro Sologub and Director of the Monetary Policy and Economic Analysis Department Mr Sеrhii Nіkоlаichuk discussed with the participants the outlook for Ukraine"s economy 2017-2019 described in the latest quarterly у Inflation Report (April  2017).

The NBU has left inflation projectionsfor 2017, 2018, and 2019 unchanged at 9.1%, 6.0%, and 5.0%, respectively. The inflation projections remain within the targets previously announced in the Monetary Policy Guidelines for 2017 and the Medium Term (8% ± 2 pp for 2017, 6% ±2 pp for 2018, and 5% ± 1 pp for 2019 and over the medium-term). As in January, the NBU projects the year-end inflation to be driven by a twofold rise in the minimum wage at the beginning of the year. However, as previously mentioned, the suspension of freight transport  across the contact line in Donetsk and Luhansk oblasts will have no significant impact on the headline inflation.

However, the NBU has revised its economic growth forecast given developments in Eastern Ukraine. The NBU expects economic growth temporarily to 1.9% and regain momentum in 2018-2019, accelerating 3.2% yoy and 4.0% yoy, respectively.

In addition to the updated macroeconomic forecasts, NBU representatives presented a range of special topics covered in the Inflation Report (April 2017):

— Маcroeconomic consequences of halted freight traffic between the government-controlled and non-government controlled areas:

The negative contribution of halted freight traffic  to real GDP change in 2017 is estimated at 1.3 pp. In the meantime, in 2018, real GDP growth will accelerate by 0.4 pp due to a lower comparison base and the establishment of alternative production ties. In addition, the negative effect on  economic activity will be mitigated by external environment being more favorable than expected.

However, the macroeconomic effect from halted freight traffic between  the government-controlled and non-government controlled areas may be more significant if actual events deviate from the underlying  assumptions, for example if it takes longer time to secure alternate sources of raw materials or if external conditions get worse.

— Implications of the doubling of the minimum wage for enterprises according to an enterprise survey:

According to enterprises’ assessments and expectations, the main result will be an increase in wages. Most respondents (83%) said they intended to raise wages at their enterprises.

Enterprises expect that the doubling of the minimum wage will increase expenses related to taxes and contributions. Enterprises intend to cover these expenses by increasing the prices of their goods and services. Other negative implications of higher production costs include a decline in working assets and investment. Respondents reported moderate expectations of staff level changes at their enterprises: only about 24% of respondents expect staff level changes, and intend to put their staff onto a short working day schedule.

Some enterprises expect the doubling of the minimum wage to have positive implications. In particular, they project that domestic demand for their products will rise, driven by higher wages in the public sector and increased social benefits. This is also in keeping with the NBU’s earlier projections of a pick-up in domestic demand due to the doubling of the minimum wage, which will contribute another 0.5 p.p. to real GDP growth.

— New Methodology for Consumer Price Index Calculation:

The NBU is positive about the SSSU shifting to the new CPI calculation methodology as it is meant to make reflection of consumer prices in Ukraine more complete and improve its quality. This will contribute to efficient implementation of the inflation targeting policy. 

The methodology review lowered inflation indicators in Q1 2017 as compared to the projected path published in the Inflation Report of January 2017. According to the NBU, the impact of this factor will persist in Q1 only and will be completely offset by other statistical effects as soon as in the second quarter, in particular – due to influence of dynamic weights.

The methodology review has had no influence on the relevance of NBU’s headline inflation forecast which is 9.1% at the end of 2017 and 6.0% at the end of 2018.

— One year after the cut in the unified social tax rate:

The business outlook survey carried out in Q1 2017 showed that most enterprises had raised the wages of their staff members following the cut in the unified social tax rate in p.p. compared to the previous survey, to 65.2%). This is by 9 pp higher compared to the previous survey conducted in Q2 2016. Those enterprises that did not raise wages used freed funds to finance their current operations. The percentage of those enterprises that used freed funds for investment remained small.

Another positive influence of the tax rate cut was a reduction in the tax burden on Ukrainian enterprises, which led to higher profits. Indeed, in the first nine months of 2016, the profits of profitable enterprises were up by 15% compared with the same period a year ago, while loss-making enterprises turned to profits.

— Public sector deficit and structural budget balance:

As expected, in 2016, the general government fiscal deficit widened to  7.5% of GDP, driven by a number of factors: a reinforced support for the Pension Fund of Ukraine to compensate for loss of own revenues amid the reform of UST rate, increasing funds allocated to shore up the banking system, primarily for banks’ authorized capital formation, by means of DGB issue, as well as to underpin the DGF. 

When compared with the previous year, NJSC Naftogaz showed a marked improvement of its financial standing thanks to bringing utility tariffs to cost recovery levels earlier than planned. Therefore, no financial assistance from the budget was required for the company.

Along with the lack of need to give state support for the company, the forecast horizon also projects decreasing expenses on backing the banking sector as the system clean-up was brought to a close.    Coupled with a prudent approach towards GGS deficit, such measures are expected to maintain public sector deficit within specified boundaries, which will gradually bring debt-to-GDP ratio down. 

— Analysis of Ukraine’s External Commodity Trade by Regions: Long-Term Trends

In spite of a big reduction in external exports during the recent years, Ukraine’s economy remains relatively open. Moreover, export of goods became more oriented towards raw materials as a result of decreased export of machine building products (first of all, to the CIS). Along with that, export of food products grew significantly, primarily driven by higher grain crops and seed oil. At the same time, Ukraine continues being dependent on import of raw materials and advanced technology products.

Moreover, Ukraine started entering new markets for some goods (both foods, and industrial goods), thanks to the Association Agreement with the EU. Ukraine continues making efforts to  open external markets further. In such a way, the Agreement on the Free Trade Area has been signed with Canada, negotiations of creating a FTA with Turkey are at a final stage, negotiations regarding the agreements with Israel, Turkey, some African and Asian countries are underway.

Conclusion of free trade area agreements provides no guarantee of trade turnover increase. However, they encourage local producers to improve competitiveness of their products, to include by means of adapting to new standards, certification rules and control procedures, as well as by production modernization.


— NBU’s Measures to Liberalize FX Market and Improve Functioning of Financial Markets:

In Q1 and in early April 2017, the NBU continued to ease restrictions on foreign exchange market and improve operations of the financial market, although this process was more gradual than in the previous periods due to temporary spikes in FX volatility and increased depreciation pressure in the beginning of the quarter.

In particular, the NBU increased the amount of the banks’ net purchases of foreign exchange up to 0.5% (from 0.1%) of a bank’s regulatory capital, cancelled obligatory licensing for individuals to deposit FX funds that originate from abroad on foreign accounts as well as to invest such funds;  eased surrender requirements to foreign exchange proceeds by reducing them to 50%; eased the restrictions on selling foreign exchange to the population by increasing the maximum amount to the equivalent of UAH 150 thousand, and allowed repatriation of dividends accrued to foreign investors in 2014-2015 and simplified the respective mechanism.

— Financial Conditions in Developing Markets:

From a financial standpoint and a minor resumption of capital inflows notwithstanding, 2016 was the worst year for developing countries since the 2008 crisis. The largest bout of capital flight took place after the US presidential election, when the risk of protectionist policies rose and prompted expectations of accelerated growth in the FED’s interest rate. This caused interest rates in developed markets to grow rapidly, which negatively affected investors’ risk appetite.

In 2017, factors restraining capital inflows to developing countries will persist: The current acceleration in inflation in developed markets and expectations of a faster increase in the FED’s rates, which strengthens the USD and continues pushing global long-term interest rates upwards As a result, interest rate hikes in developed markets in 2017 are expected to have only a limited impact on financial conditions in developing markets. Capital inflows to those countries will gradually recover.

Further discussions between the NBU representatives and experts were focused on the blockade impact on the FX market, money transfers to Ukraine in the context of labor migration, as well as other relevent topics to be covered in the next issue of the Inflation Report.

Please follow the link to view  a presentation on the Inflation Report (April 2017) delivered at the roundtable:https://bank.gov.ua/doccatalog/document?id=47667510.

The Inflation Report for April 2017 is available at: https://bank.gov.ua/control/uk/publish/category?cat_id=742185.