New Macroeconomic Forecast: 4.6% GDP Growth In Next Year Is Realistic

Raising the minimum wage and setting the inflation rate which exceeds the goals of the National Bank remain the problem

depositphotos / Wadym

The Cabinet of Ministers forecasts 4.6% GDP growth next year with inflation of 7.3% and also a slowdown in GDP growth by 4.3% in 2022. The size of the minimum wage next year is projected at UAH 6,250. In the new podcast of the program “What about the economy?” on Public Radio, Sergiy Nikolaychuk, head of the ICU’s macroeconomic research department, and Maria Repko, deputy director of the Center for Economic Strategy, discussed whether such indicators are achievable, what they are based on, how macro forecasting works and why the state needs it at all. Andriy Fedotov, Communications Director of the Center for Economic Strategy, spoke.

Listen to the full conversation here

Sergiy, the first question. Is the new forecast, in your opinion, one that can be relied on and can we expect such figures next year? And in general, why does the state need macroeconomic forecasting?

Sergiy Nikolaychuk: So many questions, let’s start with the first, about the realism of this forecast. This forecast differs significantly from the forecasts of other organizations engaged in macroeconomic forecasting, and from the forecast of the National Bank and private organizations. Its key difference is that in this forecast the Cabinet of Ministers has already laid down rather sharp increases in the minimum wage to UAH 6,000 from January 1 next year and to UAH 6,500 from July 1. This is a significant factor in the macroeconomic forecast. First of all, it is reflected in the fact that the Cabinet’s forecast has much higher wage growth, and this, in turn, has consequences for the inflation forecast: currently the Cabinet has 7.3% for next year, while now the consensus forecasts are close to 5%, to the goals of the National Bank. The latter, by the way, raised its inflation forecast to 5.5% next year a week before the Cabinet’s forecast.

And why such a big difference? How can this be explained?

Sergiy Nikolaychuk:  The decision to raise the minimum wage was quite unexpected, it was announced by the President and the Cabinet a month and a half ago, but there was no other confirmation as to why. Other organizations have not yet taken this fact into account in their forecasts – even the National Bank, who published its forecast for the week before the Cabinet. An average increase of 30% in the minimum wage next year is quite significant. This increase is higher than the expected growth of nominal GDP and other nominal parameters. And that changes the landscape for next year’s macro-forecasters.

What does this macro-forecast mean in general? How is it used further by the state? What depends on it?

Sergiy Nikolaichuk: If we are talking about the state, the macroeconomic forecast is the basis for budget development. In our country, the Cabinet of Ministers is to prepare and submit the first draft of the state budget to the Verkhovna Rada by September. Accordingly, this budget should be based on a macroeconomic forecast, as the calculation of the same budget revenues is based on a macroeconomic forecast.

Maria, what are your impressions of this macro forecast and what are your main thoughts?

Maria Repko: First of all, we understand that this year will be post-crisis. The forecast is based on the assumption that there will be no second wave of strict quarantine and that the economy will begin to recover. We can already see that retail trade has recovered almost to pre-crisis levels, especially in the food industry. We see that people have started to move much more compared to the most crisis-ridden April and May. Banking operations have resumed. Due to quarantine, 2020 will be a year of low base, when no investments were made, no new employees were hired, new projects were frozen and we waited for what would happen next. If we do not see a new wave of the virus and if a new strict quarantine is not introduced in Ukraine or anywhere else in the world, there will be a significant delayed demand for both consumer goods and investment goods, and in principle the economy will recover. All those projects that were postponed in 2020 can be launched in 2021. In addition, a significant factor will be that Europe and the United States have made a large money issue, and these funds will also go to markets, including emerging markets. And the production of European and American countries can transfer from China, including to our region. That is, if there is no virus, this year will really be a year of recovery for Ukraine.

So can we expect more than 4% growth next year?

Maria Repko: In principle, yes. I believe that 4% growth is a figure to which we have no questions, it is a realistic figure. Figures for forecasts of export and import growth are realistic, too. Imports will grow due to high deferred demand, and exports have not suffered so much even in 2020. But I absolutely agree with Sergiy that the biggest question to this forecast is the minimum wage. The fact is that the Cabinet has not yet decided to increase it. The vote to increase the minimum wage to 5,000 UAH by 2020 from September is yet to happen. And the level of salary in 2021 is not yet defined by law. That is why the growth of the minimum wage is laid down in the government’s forecast, and isn’t in the forecasts of other macroeconomists, including the net of the National Bank. The fact is that such an increase in the minimum wage will, firstly, increase inflation, and secondly, increase consumer demand, because people will have more money to buy goods, including imported ones. But it will greatly reduce the companies motivation to invest, and this is not included in government forecasts. The fact is that taxes increase due to the minimum wage. Due to the increase in the minimum wage, companies will be forced to pay higher SDRs, and small and medium-sized businesses will also receive increased taxes. In themselves, increased wages are also the costs of enterprises. That is, those funds that could have been used for investment, for deferred investments that were not made in 2020, these funds will be used for consumption, in fact. On wages, on consumption, on eating. And we may not see the amount of investment we would like. This is the problem with this forecast.

This forecast provides for significantly higher inflation growth than the previous inflation targeting. In recent months, there has been a very active debate on whether the policy of the National Bank will change. According to this forecast and your personal observations, what kind of cooperation between the Government and the National Bank do you expect? How will the National Bank react to the rapid rise in inflation, to the indicators that are now set in the macro-forecast?

Sergiy Nikolaichuk: Thank you for the question. It is really very interesting and worries everyone now, because if we look at the previous experience of the Government’s macroeconomic forecasts, the Government has traditionally set higher inflation over the past few years, and the National Bank, who had to fight inflation, could not agree with it, fighting higher inflation expectations by raising its interest rate, pursuing a fairly tight monetary policy. As a result, our nominal economic indicators were lower than the Government’s targets and the Government had budget problems. What we have now is a continuation of this story. Again, the government is setting inflation that exceeds the National Bank’s targets. In theory, if the National Bank continued the policy it has pursued over the past few years, the next meeting could be expected to raise the National Bank’s interest rate in response to such a forecast and the expectation of an increase in the minimum wage. Then the National Bank would have every opportunity to keep the inflation up to 5%. But the question arises as to whether the new leadership of the National Bank will continue such a rather aggressive policy, whether the National Bank will agree with this forecast of the Government and will take more time to bring inflation to the target level. According to the forecast, in the next 2 years inflation will be above the target horizon and will fall to 5% only in 2023. Frankly, I do not have an answer to this question now. I don’t think anyone has. But I think that in one, two, three subsequent meetings of the National Bank, we will be able to see how aggressive its reaction function has remained.

Maria Repko: I would like to mention here that these are only expectations, in fact, they are formed not so much by the National Bank, but by deputies who talk about the hryvnia at 29 per USD, hryvnia at 30 per USD. This is a self-fulfilling prophecy. I already know a company of importers who are already reviewing the prices of their products in Ukraine in accordance with the new exchange rate expectations. It is not something economically justified, it is simply a consequence of such verbal interventions. It seems to me that inflation can also be driven by such exchange rate expectations and changes in import prices. It seems to me that this is important, and it needs to be mentioned and talked about much more carefully than the authorities are doing now.

Sergiy, when the Cabinet of Ministers published its macro-forecast, they also considered a decrease in GDP at different hryvnia exchange rates. For example, in their press release, they said that at the rate of 27 hryvnias per dollar in 2021 GDP will decrease by 0.5 percentage points, and at the rate of 27 hryvnias per dollar by 0.2 percentage points. Is it possible to translate the hryvnia exchange rate so directly into losses for the economy, and to what extent is this presentation of information correct in your opinion?

Sergiy Nikolaichuk: Thank you for the question. Economists very often make different scenarios, make certain assumptions, and, accordingly, assess the consequences for other macroeconomic parameters. Therefore, I think that the assessment made in the Ministry of Economy has a right to life. But as for the reaction of the economy to changes in the exchange rate, it is very important what leads to this change in the exchange rate. For example, if we talk about a change in the exchange rate, which is caused by productivity growth in the economy, it will be one scenario with one effect on GDP. Conventionally speaking, if wheat yields increase in 2021 and we have higher GDP and a stronger exchange rate because of this, this is one scenario. Another scenario is the one Maria, for example, talked about. If the change in the exchange rate is caused by certain statements of the authorities and changes in the portfolio preferences of various economic agents, when they simply begin to transfer part of their savings, their portfolios from national currency to foreign currency, then the impact may be completely different. In this case, on the one hand, the competitiveness of Ukrainian companies increases compared to foreigners, on the other hand, due to the growth of such uncertainty, the cost of servicing Ukrainian debts, both sovereign and corporate, increases.

From the point of view of an ordinary Ukrainian, what do you need to prepare for? Before the salary increase? To rising prices? Before the devaluation of the hryvnia? What will be the economic situation in the fall or early next year?

Maria Repko: If we start from the government’s macro-forecast, we need to prepare for that, and for that, and for that. If salaries are increased, prices will rise. If they talk about the hryvnia at 29, then everyone will focus on the fact that the hryvnia will be at 29, and, accordingly, to set such expectations. The market has such a property that such strong expectations affect the market rate itself. But there are no macroeconomic reasons to worry too much if we assume that the coronavirus will not catch up with us again. First, the economy has survived this crisis and quarantine quite well, the recovery is already underway, it is already visible on such advanced indicators. It’s electricity consumption, it’s shopping malls and so on. Secondly, there is an increase in the price of our main export product. This is iron ore. Prices are rising, prices are high. And the banking system after the cleansing of 2014-2015, after a lot of banks collapsed, the remaining ones remained stronger. They have fewer problem portfolios, fewer risks on the balance sheet, and they have survived this crisis very well. Therefore, there should be no significant volatility, provided there is no new quarantine. We expect a recovery. And people will get new jobs and higher wages, and the economy will breathe more freely. But if macroeconomic policy is not optimal, then there are risks. The biggest risk is that they will pursue policies that will cause a new crisis. You can look at Turkey as Erdogan treats the monetary policy that is happening now with the exchange rate of the lira, their national currency, and interest rates. If, for example, we have high inflation, it is beneficial for the Government, because it will simply collect more taxes from the people. If prices increase, there will be higher VAT and so on. And his costs will remain the same as they were. But neither for people nor for companies will high inflation bring such benefits. It devalues savings, it reduces real income and purchasing power. Therefore, there is a danger from the actual policy of the government, and now it is not very predictable for me personally, I do not know what to expect.

Let me remind you that the program “What about the economy” is published jointly with VoxUkraine, and in May this year Sergiy wrote a good article for VoxUkraine about global trends of low inflation and changes in the structure of the economy due to the pandemic. How do you think the Cabinet’s expectations regarding high inflation and global low inflation trends correlate? To what extent is it possible to overestimate inflation expectations? And how does the global crisis provide some guidance on what to do in terms of the global situation?  

Sergiy Nikolaychuk: Indeed, I wrote an article on a very popular topic at that time, and now it remains quite relevant. This is the current crisis, as far as it is deflationary, as far as it is inflationary. The issue is that a sharp decline in demand leads to a low-inflation environment, but given the large-scale measures to support the economy primarily in developed countries by fiscal authorities, by central banks, many experts have begun to worry that this may lead to high inflation. But the key conclusion of my article in May was that deflationary trends are likely to prevail in the next year or two, and inflation will remain low in the world. In the world, inflation, especially in developed countries, remains very high, despite all these incentives. In addition, inflation has declined significantly in developing countries. This crisis is very different in this respect from previous episodes, when central banks in developing countries, instead of providing incentives to the economy, had to fight the devolutionary trend and rising inflation. We now see a very similar picture in Ukraine. Inflation today remains very low. It rose to 2.4% in June, and in May it was 1.9% — the lowest level since 2013. As for what will happen next, in Ukraine we can go our own way this time, as we often do before. And such an increase in social standards, which is now set by the Government, suggests that inflation may accelerate, and Ukraine may once again become one of the world leaders in inflation. Why did I expect that the world inflation will not be high in the next year or two? Because despite significant incentives from central banks, they still support low inflation. If their incentives accelerate inflation, central banks will return those incentives quickly enough. Will the National Bank do that? Will he be able to quickly deploy his policy and move from a cycle of lowering the interest rate to raising it as inflation and devaluation risks begin to rise? For me, this is still an open question.

Maria, how will the 4% economic growth forecasts affect the growth of each individual business? Given the large drop, especially in some sectors most affected by the crisis, how much resources do they have to grow by an average of 4%? Will this growth be uneven? Which sectors will not be able to recover despite such an overall positive trend?

Maria Repko: This is the average temperature in the hospital, because even now we see that the recovery in retail, in the consumer sector is very fast, utilities did not fall at all, as well as telecom services, and air transport is still at the bottom. But I would like to add to the question of global trends. Few people in Ukraine are talking about it now, but in my opinion, it is very important. In Europe, the issue will be somewhere around 750 billion euros. This is about 7 times more than the annual Ukrainian GDP. This is a huge amount of money. In addition, there will be a reorientation of the movement of production from China. Large companies will move, manufacturers will move businesses that are built into their value chains. Ukraine now really needs to be with the global world, because if Ukraine remains isolated, localized and away from these processes, this wave of capital flows will pass. And in Ukraine the capital will have nowhere to go. This will be the biggest problem. If Ukraine opens up to the world, if it attracts foreign investment, if it participates in tenders in Europe, as our tram manufacturer recently won a tender to supply trams to a European country, if Ukraine takes advantage of these opportunities, then it may even be that growth will be larger than expected. If it does not take advantage, localization, protection of the domestic producer, protection against unproductive outflow of capital due to currency restrictions will be done as in all the years of independence, then Ukraine will not be able to jump into this world train. It isolates us even more and throws us back.

Sergiy, maybe you have a comment on the openness of the Ukrainian economy, the growth of investments next year? What do you think it will be like?

Sergiy Nikolaychuk: I rather agree with Maria here. Now for Ukraine, as well as for many developing countries, there are many opportunities due to the fact that there will be a certain localization of production, and I am inclined to think that this localization will be within certain continents. That is a closed cycle on the European continent, on the American continent. Of course, this creates many opportunities for Ukraine, given the low cost of labor. But in order to realize these opportunities, it is necessary, firstly, not to make macroeconomic and structural mistakes and, secondly, to solve the problems that everyone has been talking about for a long time: improving the judiciary, protecting property, and so on. These problems have not gone anywhere, and they can unfortunately hinder the inflow of investment into the Ukrainian economy, for which a large window of opportunity is now opening up.  

Maria, what are the main, in your opinion, priority actions to take so that Ukraine does not miss this train, and has time to receive investment and attention in terms of macroeconomic assistance?

Maria Repko: The fact is that there are almost no such low hanging fruits. Iit is important to work systematically, persistently, step by step, day by day on two key things. The first key point is macroeconomic stability. You do not have to jump from a 10% rise to a 15% drop. It is better for the economy to grow by 3%, 4%, 5% per year, but for it to be stable, so that there are no bubbles, which will then burst and crash half of the banking system. No need to chase after something impossible. We just need to work hard from day to day, to keep the stable budget deficit at a low level. Yes, it is better that it was a surplus, that we pay off debts, maintain adequate monetary policy and keep the risk of the banking system within: not to give banks too much to lend to risky borrowers. The second is productivity growth. In Ukraine. It is possible only by attracting capital investment, because the Ukrainian economy has very little capital and investment. Hence the poor performance. This is addressed through the business climate, through the climate in the legal system, and also through issues that can only be addressed at the central-local level, such as building permits and the like. You have to work hard from day to day, it’s just hard work and I don’t see any magic wand that can help us here. 

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