Ukraine Watch: Monthly update – economy in war (November 2024)

The absence of additional positive factors and new risks in October helped to stabilize business sentiment, which mostly fit our expectations. Even though the business confidence index continued its slow upward movement (increasing marginally by 1.4% mom to 49.4 points, which is close to the neutral level), this happened fully on a rather strong (by 6% mom) and unexpected improvement in business sentiment in services to a five-month high of 47.2 points. Despite such a firm upturn, business sentiment remains the most pessimistic in the services sector.

We noted earlier that the negative impact of additional mobilization measures (which visibly lowered the demand in cafés and restaurants) and power outages (which severely limited the working hours of businesses in the services sector) as the main factors contributing to the rather high level of pessimism in the service sector. We believe that the improved prospects for electricity supply in October and a growing number of online orders were the core factors behind the relatively positive dynamic of the services sector in October. However, the influence of these factors did not spill over to the other three main sectors, which simultaneously posted a slight deterioration in business sentiment while remaining fairly close to the neutral mark.

Business Activity Expectations Index (BAEI) and its components (in points)

Source: NBU, RBI/Raiffeisen Research

Acceleration of monthly inflation to 1.8% in October (from 1.5% a month before) was substantially worse than all forecasts with a consensus of just 1.2% mom. Contrary to our estimates, the acceleration in yoy inflation (by 108bp to a 15-month maximum of 9.7%) has not slowed down last month but was almost at the same speed as in September.

We think the preservation of the supply deficit in raw food products, the mounting pressure from private demand (on higher inflationary expectations) and higher producer costs (due to rising energy and labor prices) were the main drivers behind the rapid inflation acceleration. Even though the increase in food prices in Ukraine (by 3.3% mom) was not a purely domestic phenomenon but also reflected in global dynamics (where the FAO Food price index increased by 2% mom and by 5.5% yoy in October), we still understand that scarce supply of some food products domestically adds some additional fuel to inflation in Ukraine currently.

We noticed several product groups that contributed to accelerating inflation in October, including vegetables (by 18.2% mom), eggs (18.1%), butter (6.9%), fruits (4.0%), milk (3.3%) and sunflower oil (3.3%). Definitely, in some products, this occurred on seasonal factors as well, while the influence of their low supply due to poor harvest was among the most influential on the overall price level. This caused a fairly high monthly growth rate in food prices. In contrast, other CPI components showed less pronounced price dynamics, which is reflected in core inflation slowing down its growth to 1.3% mom in October vs 1.7% in September.

Because October inflation has already exceeded our year-end forecast of 9.2% and reached the recently updated year-end forecast of the NBU, we understand that the near-term outlook of a preservation of monthly inflation growth would require definitely a revision of forecasts for this year. If considering the influence of inflation drivers for the coming two to three months (together with their seasonal impact), we see prospects for a further acceleration to 10.7% by the end of 2024, which forced us to revise our forecast for this year accordingly. At the same time, we still maintain our inflation forecast for 2025 at 8%, thus expecting a better situation with raw food products supply next year due to improved harvest and higher comparison base effect correspondingly.

Inflation and key policy rate

Source: Ukrstat, NBU, RBI/Raiffeisen Research

The number of MPC members who voted for a rate hike was still far from influencing NBU decision

The accelerated rise in inflation in recent months was the core topic of discussion at the latest Monetary Policy Committee meeting on 31 October. MPC members focused on the reasons for increased price pressure and its impact on expectations. Despite some predictability in the acceleration of inflation and understanding of its main reasons (primarily concentrated on the supply side), the rate of acceleration in price growth raises the necessity to search for an optimal combination of monetary policy tools. NBU officials still consider the current spike in prices as a temporary one, driven primarily by a poor harvest and the simultaneous one-sided impact of electricity tariffs, wage increases and excise hikes on business costs. This concept fully reiterates our views on the inflationary dynamic over the first half of next year.

The majority of MPC members believe that halting the monetary policy easing and maintaining the stability of the USD/UAH exchange rate is an influential measure to oppose current price pressure. Therefore, it was rather logical to see that nine members of the monetary committee supported preserving the key rate at 13% in October, thus considering it sufficient to control inflation expectations and bring inflation back to the 5% target. Even though the number of NBU officials voting for a hike in key rate to 14% by the end of this year has increased to two, we believe this is still rather far from having an influence on the decision of the NBU monetary committee. We do not exclude that this number may be increased after a substantial acceleration of inflation in October and its approach year-end forecasts, while we still doubt it will have an impact on NBU's decision regarding the policy rate.

Even though the greater part of NBU monetary committee members expect the policy rate to remain at 13% in the coming months, they do not rule out the possibility of a hike in case inflationary pressures mount. However, in our view, this should be the only in case no instruments would be no more effective, because a hike in policy rate is highly undesirable in terms of its impact on the prospects of economic recovery, which are currently under pressure from various risk factors tied to the war. Moreover, we fully share the view of NBU officials that the transition effect of previous decisions on the key policy rate has not been fully passed through on the domestic rates. Hence, we keep our forecast so far on an unchanged policy rate at 13% until the middle of next year.

The central fiscal performance in October was not very different from what we saw last month. Tax revenues, according to our estimate, came in at around UAH 128 bn and remained unchanged. At the same time, fiscal expenditures, which grew by 3% mom, may also be treated as rather stable if considering the usually high volatility of this component over the previous months even this year.

Unlike relatively stable tax revenues and fiscal expenditures, non-tax revenues demonstrated a strong decline after their traditional high growth in September. However, this is also not surprising to us if considering the seasonal patterns in the budget process. Therefore, this was a major reason for a significant widening in the central budget deficit to a maximum level of about USD 190 bn this year, according to our estimates. The total state budget deficit for the first ten months of 2024 was about UAH 1 trillion, and the cumulative deficit for the twelve months increased to 19% of GDP, which is slightly higher than our forecast for the whole of 2024 of 18%. However, we expect that Ukraine will receive a fairly large amount of grants from the US and EU in the last two months of the year, which will have a positive impact on the dynamics of this indicator, thus bringing it closer to our forecast.

Central budget revenues and deficit by months (in UAH bn)

Source: NBU, RBI/Raiffeisen Research

There was a mostly growing trend in the USD/UAH over October, with the exchange rate inching up by 0.5% mom to its 1.5-month maximum of 41.48 closer to the end of the last month. However, this dynamic has not changed the market situation substantially, because the USD/UAH has remained below its current benchmark of 41.50, which stayed unbeaten since mid-July. In any case, we fully understand the trend on the market, because the gap between foreign currency demand and supply widened greatly in October, which forced NBU to enlarge the net volume of its interventions to support the market to this year’s maximum of USD 3.4 bn, thus expanding total volume of interventions over 2024 to USD 26.8 bn. On the one hand, this is slightly higher than the same period a year ago (USD 22.6 bn). However, it could be fully justified if considering increasing foreign currency demand since May, i.e. when NBU softened some core FX market limitations.

A visible hike in foreign currency demand from importers (by 11% mom in October) occurred mostly on seasonal factors, like higher energy resources imports (due to colder weather) and greater imports of energy equipment (due to increasing chances of additional energy terror from the country-aggressor). We also noticed rather an abnormal devaluation mood in the cash segment of the FX market in October due to seasonal patterns and growing uncertainty tied with security risks after the US presidential elections. This increased net purchase of foreign currency by households to the largest volume over the last twelve years on the back of rapidly expanding demand and relatively unchanged supply. We also noticed a visibly smaller increase in foreign currency sales by exporters (vs FC demand volumes) over October, due to some seasonal pause in agriculture exports coupled with the postponement of active agriculture exports by farmers in order to catch a higher price globally. Therefore, all aforementioned factors widened FX market imbalances in the last months, thus forcing the NBU to spend more foreign currency through interventions.

Net weekly NBU interventions in 2023-2024 (in USD bn)

Source: NBU, RBI/Raiffeisen Research

We should see a definite improvement in the FX market situation in November amidst smaller gaps between foreign currency demand and supply. First, we expect a revival of exports in the season of more active exports of oil seeds and vegetable oils. The volume of these exports would be even higher due to peaking local maximums by global prices for these products. Also, the stabilization of other global agriculture prices would encourage farmers to export their stocks more actively. On the other hand, volumes of foreign currency demand are expected to be smaller on a calmer market mood and understanding that the NBU would not allow excessive hryvnia devaluation in the coming several months. Even though this should not change the fluctuations of the USD/UAH in the range of 41.20-41.50 during the month, we definitely believe calmer market imbalances would lower the necessity for the NBU to intervene, thus allowing to save foreign currency reserves.

The rather negative dynamic in NBU FX reserves in the second consecutive month was not surprising considering changing the rhythmicity of the core volumes of international aid from monthly in 2023 to quarterly this year. Additionally, net NBU sales of foreign currency to support the stability of the FX market in October reached this year's maximum of USD 3.4 bn, which also looks justified to us considering the seasonal pause in agriculture exports and a seasonal increase in devaluation fears. On the other hand, net foreign currency flows turned back into a positive area in October (after a negative figure a month before) due to higher inflows of eternal aid (which includes the next tranche from the IMF and a package from Canada). In any case, smaller NBU FX reserves weakened their imports' coverage to 4.7 months of future import flows in October from almost five months in September. However, the NBU's ability to maintain control over the FX market remains intact.

FX Reserves (in USD bn)

Source: NBU, RBI/Raiffeisen Research

The expected inflow of foreign aid in October would at least smooth the negative dynamic in NBU reserves over November as support from the EU should arrive. However, if Ukraine also receives a financial aid package from the US (as it is highly expected until the newly elected US president obtains his position), there could be a positive dynamic in FX reserves this month. We also expect a slightly smaller volume of NBU FX interventions in November due to an improvement in FX market sentiment caused by a seasonal rebound in agriculture exports (additionally boosted by rather attractive global prices).