Inflation makes things go up and down
Inflation has become the main issue in 2021, and does not bode well for Ukraine’s growth prospects: industrial output fell in Q1, despite soaring export prices. However, galloping prices reduced pressure on fiscal accounts, adding extra inflationary revenues. What’s more, soaring resource prices, coupled with continuing limitations on travel abroad, strengthened Ukraine’s external trade outlook. All in all, the country is caught in a strange set-up, with a nearly stagnating economy—a low statistical base being the main “driver” of growth— ballooning prices for all commodities and services; inexcusably easy access to external markets—for the same reason that inflation is booming— and no idea when and how this crazy rally might end up for Ukraine. Nevertheless, for the next few years, until the day the Fed hits the brakes, Ukraine’s economy will remain afloat, and even see some modest growth.
In our base-case scenario, we leave our previous GDP growth forecast unchanged at +4% y/y for 2021, and +3.8% y/y for 2022. Q1 was poor, with falling agro-production and contracting industrial output. But external accounts looked better due to still-subdued external travel, which should offset sluggish activities throughout the year. Stronger grain crops, a low baseline, and resilient private consumption should keep economic performance in the black. With scarce investments and the absence of reforms, the economy is highly unlikely to pick up pace in 2022.
We did have to change our estimates regarding inflation and deflators. Food prices are performing much more strongly than we could imagine. Given sustained dovish talk among leading central bankers, we expect the inflation trajectory to be substantially higher than initially projected. We revised our CPI estimate upward to +8.4% ytd or +8.6% y/y in 2021 from +6.7% ytd or +7.3% y/y. We also had to upgrade our GDP deflator to +15.8% y/y from 8.4% y/y considering double-digit producer prices growth.
Fiscal accounts no doubt will benefit from the “inflation tax.” Ukraine already saw good budget proceeds at the start of the year, and these are expected to strengthen on the back of a ballooning nominal GDP through the year. We expect spending plans to be revised upwards accordingly, and the actual deficit should remain close to 4% of GDP. Global quantitative easing removes from the agenda any serious risks for deficit financing—as long as the music keeps playing—and even a continued delay over an IMF program is not really deterring investors from buying Ukrainian securities.
External trade prospects improved amid soaring export prices, and dampened spending on imported services such as travel. Against this backdrop, we revised our CAD forecast to a $1.2 billion deficit, or 0.7% of GDP for 2021, down from the $2.3 billion deficit or 1.4% of GDP estimated previously.
The national currency is under slight appreciation pressure, given the good external accounts. However, we believe the NBU will prevent the hryvnia from strengthening excessively, since the majority of tax proceeds depend on imports, and thus on the exchange rate. We expect the hryvnia to hover close to UAH 28/dollar.
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