INTERVIEW: Ukraine central bank sees single-digit rates in 2017 if base economic scenario pans out

INTERVIEW: Ukraine central bank sees single-digit rates in 2017 if base economic scenario pans out
National Bank of Ukraine in Kyiv.
By Sergei Kuznetsov in Kyiv November 17, 2016

The National Bank of Ukraine (NBU) is looking to cut its key policy rate to single digits in 2017 from the current 14%, provided that its “basic scenario” for the country’s economic and fiscal situation pans out, Dmytro Sologub, the deputy governor, tells bne IntelliNews in an exclusive interview.

In October, the National Bank of Ukraine (NBU) revised its medium-term economic growth forecast downward on the back of worsening expectations about a less favourable external environment for Ukrainian exporters. According to the regulator, the war-torn country's economy is expected to grow by 2.5% in 2017 instead of the previously estimated 3.0%, and by 3.5% in 2018 instead of 4.0%.

According to the central bank, sunflower oil and grain prices are not expected to see any strong rebound after a recent slump that resulted from a record-high global grain harvest in 2016. Iron ore prices are expected to fall further, due to higher supplies from Brazil and Australia, the world’s largest iron ore exporters. And global steel prices remain low amid a high supply in world commodity markets.

“Our conservative forecast reflects the fact that we are not expecting improvements in external trade conditions,” Sologub tells bne IntelliNews in an interview. “Structural changes in Ukraine will also develop at a slow pace.”

The central bank has also taken into consideration the risks of possible political instability in the country, including snap parliamentary elections, as well as a possible deterioration of the security situation in the Donbas region, where a patchy ceasefire exists between state forces and Russian-backed separatists. “However, the possibility of these risks becoming realised is not very high,” Sologub adds.

Therefore, if the situation in Ukraine’s economy and finances develop according to the “basic scenario”, the NBU could cut its key policy rate to single-digits in 2017, he says.

In late October, the NBU cut its key policy rate from 15% to 14%, attributing the move to the further alleviation of risks affecting price stability in Ukraine. This provides some room to ease monetary policy, which was consistent with the need to achieve the regulator’s inflation targets in 2017-2018. The NBU is pursuing an inflation target of 12% +/-3% for 2016 and 8% +/-2% for 2017, which compares with an annual inflation rate of 7.9% in September.

Sologub claims the central bank’s interest rate policy proved “very successful” in 2016, as the regulator’s moves were met by the desired reaction on the markets. “This also applies to inter-bank, deposit and credit rates, as well as rates on the government securities market,” he underlines.

Investor confidence

According to the central bank, accelerating investment activities are expected to be the key driver of economic growth. A lower risk of the military conflict escalating would stimulate economic agents’ appetites to make investments and long-term consumer decisions. At the same time, this would lead to an increase in investment imports, including machinery and equipment. As a result, net exports are expected to make a negative contribution to GDP.

According to the state statistics service Ukrstat, the country's GDP grew by 0.6% q/q and 1.4% y/y in the second quarter of this year in seasonally adjusted terms.

“The negative contribution of net exports to GDP reflects the fact that import substitution and expansion of domestic production in Ukraine are not as fast as we would like. Especially with such volumes of depreciation in the domestic currency,” Sologub says.

IMF loan and Eurobonds

The NBU expects international reserves to increase to $17.5bn by the end of this year, up from the current level of $15.5bn. This figure is expected to be $23.1bn by the end of 2017, and $27.8bn by the end of 2018.

“Our forecasts are based on the fact that there are two wire transfers scheduled before the end of this year: a $1.3bn tranche from the IMF, followed by a €600mn tranche. However, both of them are tied to the implementation of some conditions,” Sologub explains.

Specifically, the EU is ready to provide a new tranche of macro-financial assistance once Kyiv lifts its ban on the export of timber and makes all necessary social payments to internally displaced persons. The IMF will be able to determine the timing of a new package for Ukraine after evaluating its November mission to Kyiv.

Ukraine will be able to re-access international capital markets by late 2017, with 5-year bonds at a yield of 9%, supported by an improved debt profile resulting from successful completion of debt operations and assuming a continued de-escalation of the conflict in the Donbas region, the IMF said in its latest staff report.

Low gross financing needs during the IMF's post-programme period, well below the high-risk benchmark of the debt sustainability framework, would help ensure continuous market access, the multinational lender believes. “Evidence points to an early return to market access in past successful pre-emptive debt operations, with time to re-access at about three years from the start of the operation. Ukraine's time to re-access markets after its 1998 debt restructuring was also about three years,” according to the IMF's document.

Sologub believes that a possible yield of Ukrainian bonds would be “very attractive” for investors. However, tapping international financial markets should not be a replacement for the IMF’s reform programme. “In the past, Ukraine faced choosing between an IMF programme and raising funds on external markets,” he says. “The country has often chosen the second option... However, an IMF programme provides not only cash, it is also aimed at increasing the economy’s sustainability.”

Ukraine’s main donor, the International Monetary Fund (IMF), warned in its latest country report, published in October, that impatience with the speed at which living standards are improving and corruption is addressed could cause the public to lose confidence in the authorities’ reform programme. 

“Indeed, low economic growth brings social risks. Under such a decline in living standards in Ukraine and a significant alignment in tariffs over the past two years, low growth can’t help to improve the country’s social situation,” Sologub says. “This risk should be the main impetus for the implementation of structural reforms.”