NATIONAL BANK OF UKRAINE

Challenges for monetary policy and financial stability

Dmytro Sologub

Deputy Governor

National Bank of Ukraine

OeNB 78th East Jour Fixe

Vienna, 26 February 2016

NATIONAL

BANK OF

UKRAINE

Ukraine: Plagued by the textbook “triple crisis”

2

Macro crisis

Balance of payments crisis

Banking crisis

The situation in Ukraine is not unique:

Mexico (1994/95), Argentina (1994/95);

Thailand (1997), Indonesia(1997), Malaysia (1997), Philippines (1997);

Russia (1998); Turkey (2001); Ukraine (2009).

Run on deposits

Credit crunch

Hiking NPLs and losses

Capital erosion

Mounting bank failures

Severe growth

recession

Surging inflation

Widening budget deficit

Unsustainable CA deficit

Continuing capital flight

Severe confidence crisis

Exchange rate overshooting

1

2

3

2

NATIONAL

BANK OF

UKRAINE

Sluggish economic recovery is underway

The economy is clearly bottoming out, posting positive growth rates (qoq, seasonally adjusted)

for two quarters in a row. As a result, real GDP growth for 2015 as a whole came slightly better

than expected – around -10%

Consequently, business expectations are steadily improving

Regional growth picture remains uneven, as the Eastern regions were hit disproportionately

due to the proximity to the conflict zone and strong economic relations with Russia

3

Industrial Output by Regions, 2015, % y-o-y

Min -66.0

1 quartile -9.3

Median -5.1

3 quartile -1.7

Max 9.8

Ukraine -13.4

0

4.1

-1.4

-8

-34.7

9.8

-20.3

-4.7

-10.8

-7.3

-17

-66

-1.7

-8.9

-4.4

-4.3

0.5

-1.7

-7.6

-12

-2.2

-4.4 -9.4

-1.7

-8.9

Kyiv region

Chernihiv

Sumy

Kharkiv

Luhansk

Donetsk

Zaporizhzhia

Dnipropetrovs

Poltava

Cherkasy

Kirovohrad

Mykolaiv

Kherson

FEZ: Crimea

Odesa

Vinnytsia

Zhytomyr

Khmelnytskyi

RivneVolyn

Lviv

Ternopil

Ivano-Frankivsk

Chernivtsi

Zakar-pattia

-5.5

Kyiv

Source: State Statistics Service of Ukraine

50

60

70

80

90

100

110

120

130

140

150

-20

-15

-10

-5

0

5

10

15

20

II.2

00

6

IV.2

006

II.2

00

7

IV.2

007

II.2

00

8

IV.2

008

II.2

00

9

IV.2

009

II.2

01

0

IV.2

010

II.2

01

1

IV.2

011

II.2

01

2

IV.2

012

II.2

01

3

IV.2

013

II.2

01

4

IV.2

014

II.2

01

5

IV.2

015

GDP, % y-o-y BEI, % (RHS)

Real GDP growth and Business Expectations Index

Source: State Statistics Service of Ukraine; NBU

NATIONAL

BANK OF

UKRAINE

Inflation embarked on the steep downward path

4

Exchange rate stabilization, weak domestic demand, plunging global commodity prices and

prudent monetary and fiscal policies contributed to the strong and persistent disinflation trend,

emerged since mid-2015

On the other side, public inflation expectations remain elevated, which could be traced back to

the persistently high depreciation expectations and adaptive expectations’ structure (i.e. the

general public makes no difference between actual and expected inflation)

17,5

22,5

21,5

13,3

0

5

10

15

20

25

30

35

01

/13

02

/13

03

/13

04

/13

05

/13

06

/13

07

/13

08

/13

09

/13

10

/13

11

/13

12

/13

01

/14

02

/14

03

/14

04

/14

05

/14

06

/14

07

/14

08

/14

09

/14

10

/14

11

/14

12

/14

01

/15

02

/15

03

/15

04

/15

05

/15

06

/15

07

/15

08

/15

09

/15

10

/15

11

/15

12

/15

01

/16

Banks

Corporates

Households

Financial analysts

Source: NBU; GfK Ukraine surveys; NBU staff estimates

Inflation Expectations for the Next 12 Months, %

0,9

40,3

31,3

-8

0

8

16

24

32

40

48

56

6401

/20

13

02

/20

13

03

/20

13

04

/20

13

05

/20

13

06

/20

13

07

/20

13

08

/20

13

09

/20

13

10

/20

13

11

/20

13

12

/20

13

01

/20

14

02

/20

14

03

/20

14

04

/20

14

05

/20

14

06

/20

14

07

/20

14

08

/20

14

09

/20

14

10

/20

14

11

/20

14

12

/20

14

01

/20

15

02

/20

15

03

/20

15

04

/20

15

05

/20

15

06

/20

15

07

/20

15

08

/20

15

09

/20

15

10

/20

15

11

/20

15

12

/20

15

01

/20

16

Inflation Indicators, %

CPI, m-o-m

CPI, y-o-y

Core CPI, y-o-y

Source: State Statistics Service of Ukraine

NATIONAL

BANK OF

UKRAINE

External balance improved amid a sharp drop in imports and strong

official financing inflows

5

In 2015, exports fell dramatically amid continued falling prices on world commodity markets

and tensions with Russia

Imports declined even sharper, partially due to lower volumes of gas imports

External official financing and decline of FX cash outside banks were the main drivers for the

net inflows in financial account

The overall balance of payments posted a surplus of USD 0.8 billion in 2015 (in contrast to

USD 13.3 billion deficit in 2014)

0,0

-10

-8

-6

-4

-2

0

2

I.1

3

II.1

3

III.

13

IV.1

3

I.1

4

II.1

4

III.

14

IV.1

4

I.1

5

II.1

5

III.

15

IV.1

5

Source: NBU

Current Account Balance, USD bn

Secondary income

Primary income

Services (net)

Merchandise trade (net)

Current account balance

-0,7

-6

-4

-2

0

2

4

6

8

I.1

3

II.1

3

III.

13

IV.1

3

I.1

4

II.1

4

III.

14

IV.1

4

I.1

5

II.1

5

III.

15

IV.1

5

Source: NBU

Private sector

Public sector

Financial account

Financial Account: Net External Assets, USD bn

NATIONAL

BANK OF

UKRAINE

140

160

180

200

220

240

260

280

300

IV.2

012

I.20

13

II.2

013

III.2

01

3IV

.20

13

I.20

14

II.2

014

III.2

01

4IV

.20

14

I.20

15

II.2

015

III.2

01

5IV

.20

15

I.20

16

II.2

016

III.2

01

6IV

.20

16

I.20

17

II.2

017

III.2

01

7IV

.20

17

Grains Export Price, USD per t

previous forecast

current forecast

Source: own estimates

…but is to be hit by the sharply deteriorating terms of trade

2015 2016 2017

-19.5 (-14.2) -4.7 (5.5) 0.0

6 Data in the tables represents average price changes, % y-o-y

170

220

270

320

370

420

470

IV.2

012

I.20

13

II.2

013

III.2

01

3IV

.20

13

I.20

14

II.2

014

III.2

01

4IV

.20

14

I.20

15

II.2

015

III.2

01

5IV

.20

15

I.20

16

II.2

016

III.2

01

6IV

.20

16

I.20

17

II.2

017

III.2

01

7IV

.20

17

Imported Gas Price, USD per 1000 m3

previous forecastcurrent forecast

Source: own estimates

280

330

380

430

480

530

580

IV.2

012

I.20

13

II.2

013

III.2

01

3IV

.20

13

I.20

14

II.2

014

III.2

01

4IV

.20

14

I.20

15

II.2

015

III.2

01

5IV

.20

15

I.20

16

II.2

016

III.2

01

6IV

.20

16

I.20

17

II.2

017

III.2

01

7IV

.20

17

Ferrous Metals Export Price, USD per t

previous forecast

current forecast

Source: own estimates

30

40

50

60

70

80

90

100

110

120

IV.2

012

II.2

013

IV.2

013

II.2

014

IV.2

014

II.2

015

IV.2

015

II.2

016

IV.2

016

II.2

017

IV.2

017

Crude Oil Brent Price, USD per barrel

previous forecast

current forecast

Source: own estimates

2015 2016 2017

-28.8 (-24.6) -22.5 (4,3) 0.0

2015 2016 2017

-47.0 (-45.7) -41.9 (-3,7) 0.0

2015 2016 2017

-6.5 (-3.8) -30.7 (3.7) -4.3

NATIONAL

BANK OF

UKRAINE

The slide in EM currencies erodes the competiveness of the

Ukrainian economy

7

-4,7

-11,2

-11,5

-12,3

-21,7

-25,4

-26,2

-27,5

-33,9

-48,8

-52,9

-69,5

-86,6

-99,5

-1,3

-3,4

1,2 -0,8

-3,0

-1,5

-3,6

-2,7

-2,6

-1,6

-7,4

-13,9

-7,0

-2,9

-100 -90 -80 -70 -60 -50 -40 -30 -20 -10 0

CNY

PLN

HUF

RON

RUB

TRY

MDL

GEL

ZAR

BRL

ARS

BYR

KZT

AZN

January 2016

2015

Source: Thomson Reuters Datastream

Emerging Market Currencies versus US Dollar (%

change, eop)

0,5

0,6

0,7

0,8

0,9

1,0

1,1

1,2

1,3

12

/99

12

/00

12

/01

12

/02

12

/03

12

/04

12

/05

12

/06

12

/07

12

/08

12

/09

12

/10

12

/11

12

/12

12

/13

12

/14

12

/15

Hryvnia REER Index (Based on Interbank Exchange Rate), Dec-1999=1

Source: IFS, NBU staff estimates (preliminary data)

NATIONAL

BANK OF

UKRAINE

8

The external position in 2016 is further damaged by the retaliation

measures by Russia and abolition of special import surcharge

Food exports to Russia almost stopped since January 1, 2016

Russia repealed the Free Trade Agreement with Ukraine since January 1, 2016. That resulted in

increase in imports duties to 5%-20% from 0% (average weighted – 7.7%). Also, Russia will be

able to implement additional quotas, bans and others non-tariff limitations

Losses of exports to third countries due to a transit ban through Russia’s territory estimated to

USD 0.46 bn. (calculations includes possible exports’ reorientation through the other routes)

-0,6

-0,5

-0,5 -0,1

-0,6 -0,1

-0,2

-2,5

-2,0

-3

-2,5

-2

-1,5

-1

-0,5

0

20

15

Ru

ssia

Tra

nsit

Import

surc

hag

e

EU

Volu

me

s

Prices

20

16

20

17

Actual forecast, USD bn

-0,3

-0,8

-0,3

-0,1

-0,5 +1.5

-0,8

-1,2

-3

-2,5

-2

-1,5

-1

-0,5

020

15

Ru

ssia

Import

surc

hage

EU

Oth

ers

Volu

me

s

Prices

20

16

Previous forecast, USD bn

NATIONAL

BANK OF

UKRAINE

9 9

NBU keeps tight monetary stance aiming at bringing inflation down

to 12% target by end-2016

Easing of the monetary stance, started in August last year, has halted recently amid the delay in IMF

program, elevated political risk and deteriorating terms of trade

To re-anchor public expectation from the exchange rate to price stability the NBU put a strong focus on

reaching 12% inflation target in 2016

At the same time, to manage pass-through effect from the exchange rate to prices, the National Bank

is trying to smooth exchange rate fluctuations by conducting FX interventions on both sides

Tight capital controls, introduced in 2014-2015, remain largely in place, as the prerequisites for the

removal have not been met yet

Inflation objectives

0

5

10

15

20

25

30

35

01

/14

02

/14

03

/14

04

/14

05

/14

06

/14

07

/14

08

/14

09

/14

10

/14

11

/14

12

/14

01

/15

02

/15

03

/15

04

/15

05

/15

06

/15

07

/15

08

/15

09

/15

10

/15

11

/15

12

/15

01

/16

02

/16

Overnight interbank IR

Discount rate

Overnight credit rate

Overnight deposit rate

IR on loans for up to 3 m.

18.0%

Source: CredInfo; NBU

24.0%

Overnight Interbank IR and NBU Policy Rate, % pa

(as of 19.02.2016)

22.0% 21.3%

NATIONAL

BANK OF

UKRAINE

Policy stance is conditional on the political and macroeconomic

developments

Scenario Results NBU actions

Base scenario GDP +1.1% +3%

CPI 12% 8%

Administrative

measures ↓

Key rate ↓

Pessimistic

- Escalation in the East

- Commodity prices ↓

- Impact of “Russian factor” ↑

- Political instability ↑

GDP ↓

UAH/USD ↑

CPI↑

Administrative

measures =

Key rate = ↑

Optimistic

- Commodity prices ↑

- Privatization ↑

- Structural reforms

GDP ↑

UAH/USD ↓

CPI↓

Administrative

measures ↓↓

Key rate↓↓

10

NATIONAL

BANK OF

UKRAINE

Disinflation (inflation target for 2016 – 12%)/Maintaining FX market stability

Successful implementation of the IMF program

Replenishment of international reserves

Gradual elimination of administrative measures

CURRENT TARGETS TO ACHIEVE:

Stage 1. Monetary targeting (framework of IMF

program):

accumulation of international reserves

targets on NDA, base money and NIR

flexible exchange rate

disinflation

Stage 2. IT lite:

price stability (1-digit target - 5%) as ultimate goal of

the NBU monetary policy

accumulation of international reserves

interest rate as a key instrument

Stage 3. Full-fledged IT:

price stability (CPI target 5%) as ultimate goal of the

NBU monetary policy

floating exchange rate

Future evolution of MP regime and goals

Establishment of NBU Board`s regular meetings on

Monetary Policy issues. Decision making process is:

• Clear and transparent

• Forward-looking

• Analytically supported

More transparent and market-friendly MP

instruments framework

Raising the role of key policy rate

Liquidity providing / absorbing auctions

Simplification of RR framework

Improved communication framework: Development of comprehensive

communication strategy

Revamp of NBU analytical product line,

including the publication of Inflation Report

Improvements that already done

NBU policy actions: Gradual transition to inflation targeting regime

11

NATIONAL

BANK OF

UKRAINE

Revamping the banking system Priorities in other sectors

NBU policy actions: revamping the banking system, liberalizing

capital account and transforming the central bank

12

Ensuring adequate capitalization of the banking

system:

conducting diagnostic studies and

stress-testing

sticking to the recapitalization schedule

Solving the related party lending problem

Addressing NPLs

Strengthening banking supervision:

improving early warning signal system and

implementing consolidated supervision

developing and implementing

macroprudential supervision tools

ensuring transparent banks’ ownership

structure

making thorough analysis of banks business

models

Foreign exchange liberalization:

cancelling the outdated Foreign Exchange

Regulation Decree and reducing the number of

regulatory acts in this field

liberalizing export of services

developing the long-term strategy of liberalizing

capital account

The development of cashless payments

(“Cashless economy” project)

An overhaul of Ukrainian securities market (jointly

with the National Securities and Stock Market

Commission) and setting up the efficient system

of integrated prudential risk based supervision

(“Risk based supervision”)

The continuation of internal transformations

aimed at implementing the NBU’s vision,

mission and values, and, also, enhancing the

efficiency of internal processes, and

implementing ‘the process management’

Implementation of electronic document circulation