Dragon Capital improves 2023 year-end outlook on Ukraine inflation and UAH exchange rate

MOSCOW. June 5 (Interfax) - Dragon Capital investment company, one of the leaders on the Ukrainian market, has adjusted its forecast for the Ukrainian hryvnia against the U.S. dollar at the end of this year to UAH 39/$1 from UAH 43/$1.

"A favorable macroeconomic background and an improvement in the situation on the foreign exchange market create opportunities for a return to limited exchange rate flexibility this year," Ukrainian media reported, citing a company statement.

Dragon Capital notes that it has updated its exchange rate forecast, despite the fact that the hot phase of the situation in Ukraine is likely to last beyond Q3 2023, which company analysts had previously expected.

Based on updated estimates, the National Bank of Ukraine's reserves at the end of 2023 will remain at $37 billion, as the increase in the volume of foreign currency sales by the National Bank as a result of the easing of forex restrictions and increased demand for the currency in the first months of the transition to a more flexible exchange rate will be offset by international assistance.

Meanwhile, Dragon Capital indicates that in a still extremely unstable environment, the transition to a flexible exchange rate will take place very gradually and after the implementation of a number of additional prerequisites, and once the National Bank develops a currency liberalization strategy and coordinates it with the IMF by the end of June.

"Given the improvement in the exchange rate outlook and the faster-than-expected slowdown in consumer inflation in recent months, we also cut our inflation forecast by the end of 2023 by 3.5 percentage points to 12.5% YoY. We expect that favorable inflation dynamics will allow the NBU to reduce the discount rate to 20% by the end of the year," the investment company also noted.

Dragon Capital adds that it maintains its 2023 GDP growth forecast for Ukraine at 3% after improving from minus 0.5% in April.

"We estimate that the rate of GDP decline in the first quarter of 2023 decreased to -13% YoY from -31.4% in Q4 2022, primarily due to a low base of comparison in March last year, but also thanks to the gradual resumption of economic activity since the beginning of the year against the background of the absence of electricity shortages, favorable external conditions in the steel and ore markets, improving consumer sentiment, as well as inflation and exchange rate expectations," the press release states.

The company noted that the forecast is based on the assumption that the grain deal, which allows for the export of agricultural products across the Black Sea, will continue after July 18.

At the same time, Dragon Capital claims that the potential shutdown of the grain corridor is no longer a critical risk for the foreign exchange market and the economy of Ukraine as a whole: since the start of the grain agreement in July 2022, Ukrainian exporters have exported 43 million tonnes of grain, which significantly unloaded elevators after a record harvest in 2021.

"With an expected grain harvest this year of 55 million tonnes, we estimate the average monthly export potential of grain at about 3.5 million tonnes compared to 4.4 million tonnes per month of actual exports since the start of the grain deal. At the same time, the capacity of alternative export routes has significantly expanded to 3.2 million tonnes of grain per month compared to 1-1.5 million tonnes in the first months [of the military operation in Ukraine]," the press release says.

As previously reported, the National Bank of Ukraine fixed the official exchange rate of the hryvnia against the dollar at the level of UAH 36.57/$1 since the end of July last year. In April, Ukraine's international reserves increased by $4.07 billion to $35.94 billion, and by the end of May, thanks to external support, they are expected to increase to $37 billion.

Inflation in Ukraine in annual terms in April fell to 17.9% from 21.3% in March.

The National Bank has maintained the discount rate at 25% per annum since June 2022.