Macroeconomic Forecast 2019: Deviations from UEO’s forecast and those of IFIs

Ukraine’s State Statistics Service has published final values for key macro-indicators of 2019.

Real GDP growth in Q4 decreased to 1.5% against 4.6% and 4.1% in Q2 and Q3. Annual growth was 3.2%, according to the service. The total increase in prices in the economy, against the backdrop of industrial deflation, in Q4 slowed to 4.7%, against 9.9% in the Q2. Against the background of the strengthening of the hryvnia and the export parity of many commodity items, domestic producers had to lower prices and remain in the same currency corridor to maintain competitiveness. In 2019, the GDP deflator (the price index of all produced and exported goods and services) slowed to only 8.1%.

Ukraine’s nominal GDP reached the level of UAH 3.9 trillion (+ 11.6%), which is equivalent to $150 billion (+14.9% compared to 2018).

Last year’s preliminary estimates for Q4 and the basic forecast for 2018, which Ukraine Economic Outlook traditionally announces each year on December 10, showed the largest deviations from actual data during the five years of UEO’s existence.

2019 was the most turbulent in the last five years. A large number of political and non-political factors affected the accuracy of the forecast, including partial introduction of “martial law” after the Kerch crisis and two stages of presidential elections that completely transformed the country’s “political landscape.” But the key variable was the policy of strengthening the hryvnia and “linking” excessive banking system liquidity to certificates of deposit, instead of the classic “banking.”

In 2019, a surplus of $7-8 billion was observed on Ukraine’s foreign exchange market. However, with insufficient reserves in accordance with the IMF composite norm (25%) and an extremely high level of openness of the economy (50%+), balancing between an increase in the rate of currency redemption into reserves (corresponding emission of the hryvnia, even with a slight exit from the targeted inflation corridor) and the strengthening of the hryvnia became an important component of macro stability.

The decline in consumer inflation in December to 4.1% year-on-year, which was achieved thanks to the strengthening of the hryvnia, cannot be considered the foundation for sustainable economic development against the background of a recession in the real sector – primarily agriculture and industry.

As a result, the increase in the dollar equivalent of GDP turned out to be even higher than our forecasted range (+14.9% actual, against the forecast of 12.6%, or $150 billion against $147 billion). It was formed due to revaluation, not redemption of currency in reserves and concomitant price increases. At the same time, the IMF estimate in October 2018 was much more pessimistic and amounted to only 5.2% of the increase to $126.4 billion against the actual $150 billion.

Industrial deflation, which began in September and amounted to 14.4% for exports and 5.8% for domestic supplies by the end of the year, could not help but reduce the GDP deflator (the general price index in the economy) below our forecast of 14 4% (8.1% actual). Therefore, the inflation forecast of the National Bank and other institutional operators (from 8% to 9%) was much more accurate. A key methodological discrepancy of our approach was based on how the National Bank would respond to currency inflows: would it allow the hryvnia to revalue or, within the framework of a short-term deviation from the targeted inflation corridor, or would it redeem the currency surplus in reserves.

To outline the effect of the influx of non-residents ($4.2 billion) into hryvnia-denominated government bonds, one can compare the National Bank’s core inflation forecast by types with actual values. It was assumed that by the end of the year, industrial prices (producer price index) would increase by 8.7% (December 2019 to December 2020) and consumer prices by 6.3%. In fact, industrial deflation and a decline in consumer inflation to 4.1% were observed.

As for the real sector, the production index in agriculture and industry has been on a downtrend since June. The main reasons are the decline in world prices for raw materials (primarily for metals) and the strengthening of the hryvnia. High values of the total growth of real GDP in Q2 and Q3 (4.6%-4.1%) were supported by an increase in consumer imports and domestic trade.

Our basic forecast for real GDP growth for 2019 was 3.9%. The actual value is 3.2%, due to revaluation and a drop in industrial exports in Q3 and Q4. Forecasts of the National Bank and the IMF in the Q4 2018 were much more pessimistic, only 2.5% and 2.7%, respectively. The most optimistic forecast for dynamics of real GDP were set by the Kyiv office of the World Bank, which predicted +4% in 2019.

Similarly, forecasts of the relative balance of payments balance turned out to be significantly distorted in 2019, mainly due to the inflow of $4.2 billion by non-residents in government bonds. Our basic forecast in December 2018 provided for a net inflow of $1.8 billion. The National Bank assessed the situation more pessimistically and expected an outflow of $1.6 billion, which should have been covered by the IMF tranche. In fact, the inflow of foreign currency in 2019 amounted to $6 billion.

Rate forecast. The weighted average dollar exchange rate in 2019 amounted to UAH 26.5/USD. By the end of the year, the hryvnia strengthened to the level of UAH 22.5 UAH/USD. The average annual rate that the Economy Ministry set in the budget was UAH 29.4/USD. In fact, a combination of external and unstable factors of currency inflow (non-residents, elections, and a decrease in the cost of energy imports) strengthened the hryvnia against all forecasts of market operators. Recall that our basic forecast for the average annual rate in December 2018 was UAH 29/USD and UAH 29.8/USD by the end of December.

Already in March, Ukraine Economic Outlook’s Chief Economist Mykhailo Kukhar made significant adjustments to the forecast, estimating the “limit” of summer-autumn revaluation at UAH 25.5 UAH/USD.

Note Bene. At the UEO’s Annual Economic Lecture on December 10, 2019, we presented the crisis macro-forecast scenario of Ukraine for 2020. However, the depth of the global economic slowdown and spread of the COVID-19 virus will likely compel us to reconsider the forecast when the necessary amount of initial information appears.

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