Ukrainian central bank cuts rates as inflation falls within target range

NBU is optimistic on economy, but warns government over IMF deal and banking reforms
The National Bank of Ukraine
The National Bank of Ukraine
Oksana Parafeniuk

Ukraine’s monetary policy committee cut rates by 250 basis points on January 30, saying inflation had fallen within its target range much earlier than expected.

The National Bank of Ukraine’s rate-setting body lowered the benchmark rate to 11%, its sharpest cut since 2016. Year-on-year inflation has fallen for five consecutive months in Ukraine, reaching 4.1% in December from 9.1% in July.  

The NBU issued an optimistic assessment of Ukraine’s macroeconomic prospects. But it warned that these could be endangered if the government tried to reverse banking reforms or failed to secure International Monetary Fund financing.

“The NBU thus achieved its medium-term inflation target of 5% ± one percentage point (declared in 2015) earlier than expected”, the central bank said in a statement. It noted that the December inflation rate was a six-year low.

Despite the falling inflation, the NBU forecast GDP growth of 3.5% in 2020, up slightly from the figure of 3.3% in 2019. Growth would accelerate to a level of around 4% in succeeding years, the NBU forecast.

The central bank said the main factor behind the fall in inflation was the strengthening of Ukraine’s currency, the hryvnia. One of the main reasons for this had been the decision by an international arbitrator to award Ukraine’s state-owned natural gas company large damages at the expense of its Russian counterpart, the NBU said.

The Ukrainian central bank moved to an inflation-targeting regime under former governor Valeria Gontareva. It began raising policy rates under governor Yakiv Smolii after an unexpected rise in inflation in 2017, taking the benchmark rate to 18%. In early 2019, the NBU embarked on a series of policy rate cuts, most of them very modest. 

The NBU said it expected inflation to continue slowing for most of 2020, spending “most of the year” in the target zone of 5%, plus or minus one percentage point. It said it did expect an increase in inflationary pressures later, with inflation projected at 4.8% by the end of the year.   

The NBU said the appreciation of the hryvnia would continue to lower the prices of imports, while low global energy prices would limit any rise in domestic fuel prices. The central bank said it also anticipated low food price inflation, as local production of fruit and vegetables was expected to rise.

Central bank warns government

But despite the falling inflation, the NBU used its statement to again warn Ukraine’s government needed to agree a new deal with the International Monetary Fund by trying to reverse the nationalisation of a failed bank. Failure to reach such a deal would be “the key risk” to its optimistic macroeconomic forecast, it said.

The central bank also struck a strong note of caution over the government’s handling of the country’s banking sector. This issue is also closely related to Ukraine’s chances of agreeing a new IMF deal.

The central bank warned that there were “risks to macrofinancial stability” mainly arising from Ukrainian court rulings on the responsibility and liability of the former owners of insolvent banks to the state.” It said that “if materialised, these risks could worsen exchange rate and inflation expectations, and make it harder for Ukraine to access the international capital markets in order to repay the heavy debt load of the coming years.”

Ukraine’s previous funding arrangement with the IMF, which played a key role in supporting its currency, has expired. The IMF and the government led by Ukrainian president Volodymyr Zelensky have reached agreement in principle on a new deal. But IMF managing director Kristalina Georgieva has publicly warned that the new deal will not be authorised if the government overturns the nationalisation of PrivatBank.

The lender, Ukraine’s largest, was nationalised on the advice of the NBU by Ukraine’s then president in December 2016. The central bank subsequently said billions of dollars were illegally removed from the bank by its two main owners.

Governor Smolii and other leading NBU officials have accused PrivatBank’s former main owner Ihor Kolomoisky of having waged a campaign of intimidation against the central bank in an attempt to reverse the nationalisation. Kolomoisky has repeatedly denied all accusations of wrongdoing.

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