Inflation in Ukraine: Why the IMF, the National Bank, and the average citizens "feel" it differently

Inflation in Ukraine: Why the IMF, the National Bank, and the average citizens "feel" it differently

And how regulators should behave to ensure that the Ukrainian economy survives the war.

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Inflation in Ukraine: Why the IMF, the National Bank, and the average citizens "feel" it differently
Photo: NBU Press Service

On April 27, the National Bank is set to release its quarterly inflation forecast review. Preliminary indications are that there will be an improvement in expectations, suggesting a decrease in Ukrainians' purchasing power amidst ongoing but not as rapid price increases as before.

Mind investigates how reliable the official figures are and what can and should be done now to support the Ukrainian economy.

What is happening with prices, according to the National Bank of Ukraine (NBU)? Despite difficult times for the Ukrainian economy and the country as a whole, Ukrainian businesses have improved their inflation expectations, according to the NBU's survey of business leaders in Q1 2023.

According to the NBU, expected annual inflation in January-March stood at 20.7%, compared to 23.3% in the previous quarter. "46.8% of the surveyed enterprises believe that inflation in the next 12 months will not exceed 20.0%. At the same time, the share of those who expect inflation above 30.0% has significantly decreased – to 16.2%," the NBU said.

The regulator says that in March 2023, consumer inflation in the annual measure (y/y) continued to slow, falling to 21.3% from 24.9% in February. Prices rose by 1.5% in the monthly measure. In March, core inflation fell to 19.8% y/y from 22.7% y/y in February.

So why does the average consumer see the opposite – prices for basic goods and products rising? It is true that these optimistic official figures do not reflect the real picture that Ukrainians see on store shelves.
The current calculation system is imperfect but well-established.

Sergiy Kolodiy, the chief macroeconomic analyst at Raiffeisen Bank, explained to Mind that the National Bank of Ukraine uses data from the State Statistics Service of Ukraine in its calculations. The SSSU estimates inflation using the consumer price index (CPI), which is based on the internationally recognized methodology for its calculation.

"In the absence of a better approach, we rely on the CPI in our analysis. Indeed, in March, the annual CPI sharply decreased from 24.9% to 21.3%, but this was mainly due to the base effect (4.5% m/m in March 2022). Monthly inflation in March was 1.5%, which, on the one hand, is better than expected, but, on the other hand, is worse than the average for March (0.8% m/m) in years when annual inflation did not exceed 20%," Sergiy Kolodiy says.

It is likely that the data from Ukrstat does not fully reflect reality, as it takes into account the consumption structure from two years ago, acknowledges analyst Oleksandr Parashchiy. "Obviously, the consumption structure in Ukraine has changed dramatically with the start of full-scale war. For example, consumption of durable goods has significantly decreased. But this is the methodology," he says.

Yet, why does official statistics say that inflation is slowing down while everything is getting more expensive? "Slowing down inflation does not in any way mean a decrease in prices; they simply do not grow as quickly as before," explains Oleksiy Blinov, Head of Analytics at Sense Bank.

For example, according to data from Ukrstat, vegetables (+17.3%) and clothing and footwear (+12.5%) were the most expensive in the monthly measure during March. According to Kolodiy, seasonal price increases for products (including vegetables and fruits) and clothing were lower than expected due to not only the expansion of supply but also restrictions on demand, which can be seen in the weak year-on-year dynamics of prices for clothing and footwear (+3.6% y/y), healthcare (+14.5%) and recreation (+14.8%).

"Such price jumps very often cause distrust in official data because they are too noticeable over a short period of time. At the same time, inflation is mostly used in the annual measure in practice, because in this format, the indicator is not so strongly influenced by seasonal fluctuations. Thus, for example, the same clothing and footwear from March 2022 to March 2023 only became 3.6% more expensive," says Ivan Svitek, CEO of Yunex Bank.

Overall, most goods from the "inflationary" basket moderately increased in price in March. Although some items, such as fuel and sunflower oil, slightly decreased in price.

Analyst Oleksandr Parashchiy notes that the main mechanisms for curbing inflation today are the fixed official exchange rate of the dollar and restrictions on reviewing utility tariffs.

Do the forecasts of the NBU and the IMF coincide? According to the International Monetary Fund’s forecasts, inflation in Ukraine in 2023 will be 20%. According to the January forecast of the National Bank, it will slow down this year and be below 19%. "Consumer inflation began to decline earlier and faster than the National Bank expected in January. This will be taken into account during the next quarterly forecast review," Mind was told at the NBU.

How sensible are such long-term forecasts in the context of war? The state and business need forecasting for building further plans. State forecasts are a certain consensus that everyone refers to and orients themselves to, but adjusts to reality.

"Like any other forecast, this one is purely probabilistic and based on a bunch of hypotheses. But the country is in a state of open war, therefore  deep uncertainty," Ivan Svitek believes. "It is impossible to predict inflation without understanding when the war will end, what will be the behaviour of consumers, what almost 300 billion hryvnias of additional liquidity in banks accumulated over the last year will react to, how the hryvnia will react to the easing of currency restrictions, how great the interest of foreign investors in post-war Ukraine will be. And this is only a question for an optimistic scenario." He recommends treating such long-term forecasts with extreme caution in a state of maximum uncertainty.

But in general, experts agree that based on the inflation statistics of the first half of last year, it can be confidently said that inflation will continue to slow down over the next two to three months.

Do any global factors contribute to the slowing of inflation? Yes. In recent months, there has been a global decrease in the prices of resources, including fuel and food products. The UN Food and Agriculture Organisation recorded the lowest food price index since autumn 2021 in March.

What do the State Statistics Service and the NBU not take into account in their assessments? Certainly, some components of the consumer basket require objective adjustment. For example, a significant part of the urban population subscribes to various online services. But the State Statistics Service's methodology does not include, say, a subscription to YouTube or some Ukrainian OTT service.

"For the most part, any disputes about the adequacy of the formula are meaningless. For example, should the cost of a Big Mac be included in the price index? The answer for an urban resident who frequently buys burgers will be affirmative. For a rural resident, the answer is no. Many such questions can be asked, and then twice as many answers can be obtained. The general global practice regarding this issue includes periodic  once every few years  research on typical consumer behaviour, based on which the basket is adjusted," says Ivan Svitek.

The National Bank specifies that Ukraine adheres to the IMF's Special Data Dissemination Standard (SDDS), to which it joined in 2003, and "constantly improves the quality of official state statistical information to comply with international standards and methodology."

What measures need to be taken now to support the economy? The Ukrainian economy exists in conditions of high uncertainty and dependence on external financing due to the ongoing war. "Everything will depend on the ability of the government and the NBU to manage the above-mentioned indicators. If the government can manage the budget without a large deficit or if sources of financing the budget deficit can be found without significant money printing, and if the NBU, in turn, can control the exchange rate and prevent the increase in the money supply, we can avoid inflation growth and stay within the 20% forecast," says Igor Levchenko, Head of the Personal Banking Service Department  at UKRSIBBANK BNP Paribas Group.

As Mind reported, the regulator continues to strive for a systematic reduction in inflation and support for exchange and macro-financial stability in conditions of high uncertainty.

"These components are a necessary precondition for economic recovery. In particular, stable functioning of the banking system and uninterrupted payments, along with fixing the exchange rate, reduced uncertainty for the population and businesses, laying the foundation for a revival of economic activity after the first shock of full-scale war. And keeping the accounting rate at 25% in combination with additional measures taken by the NBU to increase the attractiveness of hryvnia assets (including changing mandatory reserves and updating operational design) encourages banks to compete more actively for depositors, which ultimately leads to banks activating marketing strategies and raising deposit rates," the NBU says.

They add that such a policy influences the increase in the term of funds of the population in the banking system, which minimises the risks for exchange rate stability and further sustainable inflation reduction.

However, analysts predict otherwise. "The main consequence of the inflation slowdown in the coming months will be a decrease in interest rates in hryvnia – from bank deposits and government bonds to the accounting rate," says Oleksiy Blinov.

Igor Levchenko believes that the main measures that need to be taken now to prevent an economic crisis are funding the budget deficit "not by printing money, but through reducing unnecessary expenses to reduce the budget deficit, regulating energy prices, "tying" a large amount of liquidity in banks to current customer accounts, and regulating the currency market."

According to the Ministry of Finance, in 2023, Ukraine's GDP is projected to be UAH 6.3 trillion, state budget revenues – UAH 1,329.3 billion, expenditures – UAH 2,640.2 billion, and the projected deficit – up to 20.6% of GDP, or UAH 1.3 trillion.

Priority expenses include national security and defence, amounting to UAH 1,141.1 billion, or 18.2% of GDP, social protection and security – UAH 447.6 billion, education – UAH 156 billion, and healthcare – UAH 176.1 billion.

"Our economy has proven to be more resilient and flexible than anyone expected. The government should work on increasing orders for domestic enterprises, not hinder business, and most importantly – ensure stable external financing. It is also necessary to actively work on obtaining compensation from the aggressor country, so that Ukraine has a financial resource for the post-war period," advises Oleksandr Parashchiy.

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