The monetary policy of the National Bank of Ukraine should be focused not only on inflation, but on all three goals outlined in Article 6 of the Law of Ukraine on the National Bank of Ukraine. They are maintenance of price and financial stability and promotion of sustainable economic development.
On April 15, the National Bank announced another increase in the key policy rate from 6.5% to 7.5%. It cannot be said that such decision was completely unexpected, but there was hope to the last that the regulator’s management would still consider the deplorable state of the Ukrainian economy and refrain from tightening the monetary policy.
However, the NBU even “exceeded” most analysts’ expectations, who had predicted a rise in the key policy rate by 0.5 percentage points.
The reason for the second consecutive rate increase (the previous increase from 6% to 6.5% was in early March) was “reinforcing the underlying inflationary pressure in recent months”.
Annual inflation rates (one month to the corresponding month of the previous year) did accelerate from 5% in December 2020 to 8.5% in March 2021.
However, this acceleration was mainly driven by external conditions and domestic administrative factors.
Half of these 8.5% inflation was due to an 11% rise in food prices. The reason is a poor harvest and higher global food prices.
In 2020, the grain harvest decreased compared to the previous year by 17.6% (wheat – by 12.8%, corn – by 23.5%), sunflower – by 13.9%, sugar beet – by 19.1%.
The natural consequence of weaker harvests was an increase in feed prices and a reduction in livestock (especially poultry).
At the same time, there was a rapid rise in global food prices: over the past ten months (since May 2020), the FAO Food Price Index rose by 27.5 points, or 30%,to its highest level since June 2014.
As a result, for the current year we have higher prices of eggs by 109.1% (more than twice), sugar – by 64.7%, oil – by 48.5%, bread – by 14.9% and so on.
The close dependence of domestic food prices on the condition of external markets on the example of oil is well illustrated by the graph recently published by Professor of KSE Oleh Nivievskyi.
In second place in terms of its contribution to the overall inflation rate is the rise in the cost of housing and communal services by 22% (March to March of the previous year).
The reasons are rising European gas prices and administrative increase in electricity prices.
A significant contribution to overall inflation was made by the annual increase in tobacco products by 20% (due to higher excise duties) and fuel by 12.2% (in particular, due to rising world oil prices).
How can all the above phenomena be influenced by raising the key policy rate? Unfortunately, the NBU does not give an answer.
To be more specific, the NBU persistently adds “growth in consumer demand” to the list of pro-inflationary factors.
As proof of this “growth” is the retail turnover, which in February compared to February of the previous year grew by 5.6%.
However, the use of the aggregate indicator does not seem quite correct since we do not know for sure which goods caused an increase of goods turnover volume.
It is possible that this increase was due to the sale of goods whose impact on the consumer price index was minimal (for example, cars or construction materials).
In addition, frequent restrictions on the functioning of food markets in Ukraine over the past year could simply shift part of consumer demand from the informal to the official segment.
At the same time, the dynamics of consumer sentiment, which are determined by the independent agency Info Sapiens, indicate a lack of excessive demand.
The consumer sentiment index in March was 67.8 points, which is even lower than the corresponding value of the “shock” of March 2020 (73 points).
Inflation should slow down at the end of the year, regardless of the key policy rate.
It is expected that the main factor of lower inflation will be a new harvest and the exhaustion of the low base of comparison (statistical effect).
It is significant that the National Bank of Ukraine actually recognizes it, when in its press release it puts “increase in the key policy rate” only on the third place among the factors of the expected slowdown in inflation (after the above two).
That is, the logic of the National Bankof Ukraine on the impact of the key policy rate on inflation is very “vague”.
However, negative consequences of tightening monetary policy are quite clear and obvious.
In this context, the slip of the tongue of the specialized Deputy Chairman of the NBU is quite symbolic, who during the press briefing on the key policy rate named its increase a “deterioration” of monetary policy.
According to the preliminary indicators of monetary and financial statistics of the NBU, in March interest rates on the corporate sector loans stopped decreasing (the weighted average rate for the month increased from 8.2% to 8.3%).
There is no doubt that after the next rise in the key policy rate, this process will accelerate.
Meanwhile, the “Business Outlook of Ukrainian Enterprises for the First Quarter of 2021” (assessed by the NBU itself) states that “high loan rates remain the main factor that deters businesses from taking out new loans”.
However, the National Bank is obviously not worried about that.
According to the Ministry of Economy, in January-February 2021, real GDP dropped by 2.8% (compared to the same period last year).
That is, in February the decline accelerated, as in January the corresponding figure was 2.6%.
The decline was in most basic sectors of the economy (industry, agriculture, construction, transport), except for retail trade.
These indicators should concern the NBU much more than the increase in prices caused mainly by external circumstances.
The National Bank, however, only revised its forecast for real GDP growth in 2021 from 4.2% to 3.8%, the main driver of which should be consumer demand.
It does not see any conflict between growth in demand and the tightening of monetary policy.
Another unpleasant consequence of the increase in the key policy rate by the National Bank will be growth in expenditures for domestic public debt service, which is already planned in the amount of UAH 103.2 billion in the budget for 2021.
The effect of the interest rate channel of the monetary policy transmission mechanism assumes that changes in the central bank’s key policy rate cause changes in money market interest rates, including short-term government bond rates.
In the future, these changes are “transferred” to the rates of commercial banks on credit and deposit operations, long-term financial market instruments, etc., which at the final stage of the transmission mechanism affect the level of aggregate demand as a whole.
The rise of the NBU key policy rate to 7.5% from April 16, 2021 will lead to an instant increase in interest rates on short-term government issued bonds and to their gradual increase on medium-term government issued bonds.
According to our estimates, the increase in the NBU key policy rate will generate additional annual budget expenditures for the service of hryvnia government issued bonds, which will be placed in April-December 2021, in the amount of about UAH 3.5 billion.
This value exceeds the amount of state budget expenditures planned for sanitary-preventive and anti-epidemic measures, and amounts to 30% of annual expenditures for general hospitals and specialized hospitals financed from the state budget.
Given all these circumstances, as well as the categorical unwillingness of the NBU Board to take into account the peculiarities of inflation, we can but hope that the NBU Council (which is well aware of the non-monetary nature of the main factors of inflation) will find an opportunity to explain to the Board the monetary regime.
After all, according to the Monetary Policy Guidelines, “in 2021 onwards the National Bank will proceed with the use of the monetary regime of flexible inflation targeting, based on a floating exchange rate, with an emphasis on maintaining financial stability and ensuring sustainable economic growth.”
That is, the monetary policy of the NBU should be focused not only on inflation, but on all three goals outlined in Article 6 of the Law of Ukraine on the National Bankof Ukraine.
Founder and Chairman of the Board of the Growford Institute Vitalii Lomakovych for Business.Censor.