At the regular meeting of the Board of the National Bank of Ukraine has made decision to leave discount rate at the level of 18.0% per annum, as previously reported.
But the news has a more profound meaning and leads to questions that deserve detailed analysis.
According to the Agency, tight monetary conditions remain an important prerequisite for the further gradual deceleration of inflation to the target of 5% in 2020. Trend change in the deceleration of inflation in the first place contributed to the tightening of monetary policy of the National Bank, which was reflected in a six-session raising the NBU discount rate to the current 18.0% per annum, which influenced the increase in market interest rates in local currency and, accordingly, increased incentives for savings.
Trends leave no doubt that it is high time the National Bank to recall his thesis that in the baseline scenario, the tightening of monetary policy will gradually decrease the weakening of inflationary pressures.
The evaluation of background of inflationary trends
The actual rate of inflation in February almost to the trajectory forecast by the National Bank. We will remind, at the end of 2018 was recorded the lowest level of inflation for the past five years. In 2018, consumer inflation slowed to 9.8% (from 13.7% in 2017).
According to the analysis of inflation, we can state the preservation of the trend the slowdown in consumer inflation in February. According to official data of the NBU, in February 2019, CPI in annual terms slowed to 8.8% from 9.2% in January. According to data published by the State statistics service of Ukraine, a monthly measure of prices rose only 0.5%, and YTD 1.5%.
It is important to note that consumer inflation in Ukraine shows the trend in the decline. Basic index of consumer prices, i.e. inflation, is devoid of shocks of administrative regulation, in February has decreased from 8.7% to 7.7% per annum. Amid falling inflation, the National Bank has revised the inflation forecast for the second and third quarter of 2019 in the direction of reduction. According to the January forecast inflation will drop to 6.3 percent In 2019, and return to the target range of 5% +/- 1 percentage point in the beginning of next year.
But it is worth remembering that the tight monetary policy of the National Bank contributed to the inflation slowdown, in particular, it has become one of the reasons for the strengthening of the hryvnia. In turn, the strengthening of the exchange rate affected prices of imported goods and commodities with a significant import component. In addition, the sequence of the NBU in monetary policy aimed at reducing inflation, together with the situation on the currency market contributed to a gradual improvement in inflation expectations, which led to the increase in rates in real terms, which led to the increase in attractiveness of Bank deposits. The set of relevant factors has a positive effect on the reduction of inflation.
Investment climate as a prerequisite of economic recovery
In 2018, the proportion of Bank loans as source of capital investment in total is 6.7%. Lending last year rose just 3.8%. The ratio of Bank loans to enterprises to GDP is at about 30%, which is significantly different from most of the countries are similar in scale economy. Therefore, a high base rate is not conducive to increased lending to the real sector of the economy.
Impact assessment economic recovery
The economy of Ukraine shows the presence of braking effects. According to statistics from the state statistics service, in January of this year there was a fall in industrial production by 3.3%. If you compare with last year’s figures, it is worth noting that in January of 2018 was recorded industrial production growth of 4.3%. In the processing industry recorded a decline of 5.5% compared to last year. In the mining industry also recorded a drop of 1.6%.
Given the experience of many countries that faced the problem of industrial the fall, it is worth noting that the expansion of the credit expansion of domestic banks is important.
Interesting is to study the experience of China, and of the steps aimed at stimulating the development of domestic production and business. Against the background of economic trends, in particular, industrial fall rate 10-year government bonds China fell to the lowest in the past two years level. This is a sign of expectations of market participants, further measures of monetary authorities to ease monetary policy to combat slower economic growth.
The monetary authority of the PRC is well aware of the situation of the economy, implicitly lowers the cost of interbank borrowing, not lowering the official interest rates: the last step in this aspect was a record for a single day infusion of liquidity into the market.
We will remind, the people’s Bank of China has provided financial system 560 billion yuan ($ 83 billion) in net terms, which was the largest operation in the open market. Although this step was aimed primarily at eliminating the seasonal factor of lack of funding, it also demonstrates a shift of emphasis, the priorities of the people’s Bank of China to expand credit expansion by providing banks with cheaper funding to the company had the ability to borrow at lower interest rates. Overall, by the end of 2020, the PRC government plans to inject into the economy about 9-10 trillion yuan, or 1.4 trillion dollars.
The strategy works due to the substitution of more expensive sources of Bank funding such as medium term lending, cheaper short-term liquidity or release of additional reserves for a wider range of banks.
Recently, the Central Bank of China has implemented a number of steps in this direction, and the strategy proved effective. The cost of interbank borrowings operations 7-day REPO rate was below a 7-day reverse repos people’s Bank of China for much of January, rising only this week, amid the withdrawal of funds by companies for payment of tax liabilities.
The people’s Bank of China is increasingly using liquidity management instead of reducing basic interest rates to reduce the cost of interbank funding and bond yield of banks and ensure higher profitability, so they can offer customers less money loans.
In this context, we note that the rates on government securities and Deposit certificates of the NBU is directly proportional to depend on the discount rate. High level of interest rates on securities of banks focuses on investments in profitable and risk-free securities rather than lend to the real market.
Global reduction factor
Global factors that led to uncertainty, and slowing growth in China and Europe, forecasts of a recession, U.S. trade negotiations, the U.S. and China for five weeks and their effects — broadcast conflicting signals about the prospects.
The Federal reserve gave a clear signal, at least temporarily ends the increase in the key rate and will be flexible in reducing their investments in bonds is a sharp turnaround from previous statements when the regulator was determined to tight monetary policy. The suspension of rate hike by the fed ceases to provoke the outflow of capital from developing countries, which led to the reaction of increasing domestic rates. This increases the cost of financial resources in the countries concerned, which could then lead to a drop in investment. While the growth rate of developing economies is quite high, so this factor was not critical, and as you can see, brewing trends for the risk reduction. It is difficult to predict which of these channels to create the greatest risks for the global economy and for Ukraine, however, according to the forecasts of the fed, the key rate will increase in the future, so these trends will continue.
Against the background of decisions of the Federal reserve, the European Central Bank has suspended the process of reducing its balance sheet. And as noted above, is pursuing a policy of quantitative easing, the people’s Bank of China.
Thus, the global trends are opposed to the current actions of the leading Central Banks and the NBU, which keeps monetary policy relatively tight.
The national Bank of Ukraine notes that planned for the coming months, the increase in social benefits and monetization of subsidies for payment for housing and utility services can put pressure on prices. Although the effects of these individual factors are minor, collectively their impact can be substantial if impact on inflation expectations in the face of increasing uncertainty in the year of double elections.
Finally, we note, leaving interest rates unchanged, the Board of the National Bank allows the possibility to reduce it in the short term. The timing of the transition to the cycle of rate cuts will depend on how sustainable is the weakening of inflationary risks and improving inflation expectations. Further dynamics of the discount rate will be based on the updated macroeconomic forecast of the National Bank, which is scheduled to publish in April.