16 Jan 2023 14:51

Fixed hryvnia exchange rate is main factor containing inflation in Ukraine - NBU executive

MOSCOW. Jan 16 (Interfax) - While a pegged exchange rate of the hryvnia has been and is the main factor of keeping inflation under control in Ukraine, other measures have also contributed to this, including the decision to increase the refinancing rate to 25%, Vladimir Lepushinsky, director of the National Bank of Ukraine (NBU) Monetary Policy and Economic Analysis Department, said in an interview with Ukrainian media.

"Inflation, which turned out to be lower than the anticipated 30% by the end of the year, has been kept under control owing to a package of measures. This is not only the refinancing rate. First, this includes the fixing of the exchange rate. If the NBU had not fixed the exchange rate, inflation would have been higher," Lepushinsky said.

To maintain a fixed exchange rate, Ukraine needs to retain its international reserves and ensure the hryvnia's attractiveness, he said.

"Depositors should be confident that a deposit interest rate would protect their finances from inflation at least in part. Therefore, in the context of the forex market's stability and the fixed exchange rate, the 25% refinancing rate has been helpful. Certainly, a discussion on whether something could have been done differently is always relevant, but for now, the result is on the scoreboard," Lepushinsky said.

Another efficient tool to maintain inflation under control is restricting the volume of deficit monetization, as the National Bank has observed a direct correlation between monetization and pressure on the forex market, he said.

At the current stage, a fixed exchange rate still has more advantages than disadvantages, Lepushinsky said. "Firstly, a fixed rate is an anchor for stabilizing expectations. It's hard to find an alternative to it now, because, even though inflation remains under control, it is still high enough, and we haven't yet seen it follow a downward trajectory," he said.

Secondly, the forex market is too weak to find a point of equilibrium at the moment, as demand for foreign exchange is strong, resulting, among other things, from the significant budget deficit, "which is an objective thing in these conditions," he said.

"For the time being, we don't see any substantial misbalance related precisely to the exchange rate pegging," Lepushinsky said.

Ukraine might reinstate a floating exchange rate depending not on some calendar date but provided certain preconditions, Lepushinsky said. "This will happen when the forex market has more opportunities to balance itself and find a point of equilibrium, when there's an alternative anchor to stabilize expectations. Inflation played this role before the crisis," he said.

It is hard to anticipate the moment when Ukraine might switch from a pegged to a floating exchange rate, "especially because this is likely to happen gradually," Lepushinsky said.

In deciding on a refinancing rate to be set, it makes sense to take into account expectations and anticipated inflation, Lepushinsky said. "Despite all of the challenges, expectations are lower than the refinancing rate now. As for a forecast, we'll see inflation to somewhat accelerate within the next few months, but it'll begin gradually going down starting the second quarter to a level lower than the refinancing rate," he said.

The NBU has not given up its inflation target of 5%, he said.

As reported earlier, the NBU increased the refinancing rate to 25% from 10% on June 3, 2022 to make the hryvnia more appealing, relieve the pressure on Ukraine's international reserves, and control inflation, which reached 26.6% by the end of the year.

The NBU expected that the banks would also increase their deposit rates and that the Finance Ministry would increase yield on domestic government bonds, while lending rates would not grow that much. The Finance Ministry has increased yield on domestic government bonds maturing in five to 24 months to 14%-19.5% since October, and it has reached 20% or higher on the secondary market.

The interest rates on hryvnia-denominated deposits for households averaged 10.6% in December, which is 4.9 percentage points higher than they were in May, when they had reached an all-time low.

The interest rates on hryvnia-denominated loans to households increased over the past year by only 1.4 percentage points to 35.1%, and those to the corporate sector by 11 percentage points to 20.1%.