Monetary challenges: To print or not to print?
Cooperation has been suspended with the IMF, amid stronger-than-expected economic performance: this is the new Ukrainian reality. The trick question is how the government will cover a fiscal gap of up to 6% of GDP, now that the chances of IMF credits resuming are nearly nil. Meanwhile, calls are growing for a domestic “quantity easing” program.
Economic activity proved more robust than initially expected. By June, GDP had dropped 6.7% y/y, although we predicted a deeper decline of 7.5% y/y. With consumption recovering, a sharply narrowed trade deficit, slower industrial decline, and a smaller drop in grain crops, we were able to upgrade our GDP forecast to -4.5% y/y in 2020, from the -6.5% y/y estimated previously. For 2021, the low statistical baseline will be the main “driver” of growth, and we expect GDP to increase by 3.9% y/y next year.
The COVID-19 lockdown effectively killed a lion’s share of imports, although exports decreased modestly, due to the large proportion of farm exports in Ukraine’s profile. As a result, by August, the current account was reporting a hefty surplus of $4.2 billion, vs. a $3.7 billion deficit a year ago, on the back of a sharply narrowed trade deficit, down to $0.6 billion by August vs. $7.5 billion a year ago, and a substantial decline in investment income outflows: $4.4 billion by August, vs. $6.7 billion a year earlier. In H2 2020, we expect the trade deficit to widen as imports recover, but current accounts are expected to stay in the black for 2020. We project a $2.2 billion surplus, or 1.6% of GDP, in 2020. In 2021, we expect pent-up demand for imports to take the lead, boosting the trade deficit substantially through the year. We expect a CAD of $3.7 billion, or 2.5% of GDP, in 2021.
The national currency is under serious pressure. Since July, the hryvnia has lost nearly 6%, and is moving to new levels, below UAH 28/dollar. With non-residents withdrawing from Ukraine as Ukrainians buy more foreign currency, depreciation pressure is mounting amid scarce investments. This trend is unlikely to change by the end of the year, though we cannot rule out one more Eurobond placement, with global liquidity abundant. Still, there is a noticeable outflow in the financial and capital accounts, so we expect the hryvnia to slip to UAH 29/dollar this year. Next year, depreciation pressure will continue as the trade deficit returns. We expect the hryvnia to hit UAH 30/dollar in 2021.
Despite hryvnia depreciation, we do not expect inflation to speed up noticeably. Energy prices are expected to remain subdued, and food prices will most likely remain stable. Against this backdrop, we expect the CPI to grow 5.2% ytd or +2.8% y/y in 2020. For 2021, we predict that the CPI would rise +2.3% ytd or +4.2% y/y.
Monetary policy is a challenge. Although tax collections are stronger than predicted on the back of hryvnia depreciation, the budget deficit remains a worrisome, at nearly 6% of GDP. Since no IMF support is on the horizon, hryvnia printing looks to be a very likely channel for deficit funding in 2020
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