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New discount rate of National Bank will not contribute to economic growth

Author : Bohdan Danylyshyn

Positive trends in the foreign exchange market, good forecasts for the 2019 harvest and favorable pricing environment for global commodity markets in Ukraine allowed the bank to lower the discount rate at a rapid pace, easing monetary policy
11:03, 10 September 2019

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On September 5, the National Bank lowered the discount rate by 0,5 percentage points – from 17% to 16.5%. From my personal point of view, this is a continuation of the half measures policy, which the bank board has been adhering to for a long time.

Such a policy will not contribute to the achievement of those ambitious goals that the Prime Minister of Ukraine noted - the country's economic growth by 40% over 5 years.

The National Bank affects the real interest rate by controlling the nominal rate. The level of the real interest rate (that is, reduced by the level of inflation) affects production and consumption.

Its high level leads to the fact that enterprises are in no hurry to implement investment projects, and households seek to delay consumption. This will adversely affect the dynamics of production.

Restraining monetary policy does not create the conditions for economic growth.

Compare the ratio of the Central Bank discount rate and inflation. The rate of the Central Bank of Turkey is 19,75% with inflation of 15%, the rate of the Central Bank of Argentina - 74% with inflation of 55%.

In Ukraine, the discount rate is 16,5% with inflation of 9% (July in annual terms). Thus, in Turkey, the Central Bank rate exceeds inflation by 1,3 times, in Argentina - by 1,35 times, and in Russia - by 1,8 times.

As Bernanke, Gilchrist and Natalucci in 2007 showed in their work, in a small open economy, (namely, Ukraine’s economy belongs to this class), imperfections in the functioning of the credit channel associated with high interest rates negatively affect production volumes.

In an economy with a more developed financial system, if a bank loan is difficult to access, then enterprises will seek a replacement for it, resorting to other sources of financing.

However, the stock market, which is practically non-functioning in Ukraine, difficulties in attracting financing from institutional investors and the recession in the balance sheets of Ukrainian companies narrow the potential sources of capital.

The only way out would be to intensify bank lending.

Related: Russian Gazprom ready to provide Ukraine with 25% discount on gas


But prohibitively high rates on loans for a direct borrower, the level of which is influenced by the NBU discount rate, hinder lending growth.

So it turns out that in the structure of capital investments, the share of bank (and other) loans is only 7,7% according to the results of the first half of 2019. One of the most important reasons is excessively high interest rates on loans.

In such a situation, one should not hope to accelerate economic growth. And statistics warn about this - industrial production for January-July of this year compared to the same period last year grew by only 0,4%.

We hope that agricultural exports will once again be able to "pull out" the dynamics of GDP. Maybe. But as the trade and economic confrontation between the largest economies of the world escalates, protectionist measures will extend not only to the industrial, but also to the agricultural sector.

The excessively restrained pace of decline in interest rates with rather moderate inflation (3% in January-July) may be explained by the desire of the NBU board to reduce inflation to the planned level.

But we need to look for ways to go between the Scylla of increasing economic growth, and Charybdis - to return to accelerating inflation, which we also seek to avoid.

The NBU cannot be a locomotive of economic growth; the Cabinet of Ministers plays the main role in this matter. But, if the government will by all means implement the policy of ensuring economic growth, then the actions of the National Bank should correspond to this.

As you can see, Ukraine in 2019 brilliantly overcame a period of political risks, a president was elected, a new parliament with a stable majority, and a government was formed.

The country is on the verge of a new cooperation program with the International Monetary Fund, which will provide a high level of external support and accelerate reforms.

In my personal opinion, positive trends in the foreign exchange market, good forecasts for the 2019 harvest and favorable pricing environment for global commodity markets in Ukraine allowed the NBU to lower the discount rate at a rapid pace, easing monetary policy.

On the one hand, lowering interest rates on the credit market is an important factor for achieving the future growth rates declared by the Ukrainian government.

On the other hand, it remains important for the NBU to maintain price stability and achieve the inflation target of 5% +/- 1%. Now the search for a balance between price stability and economic growth continues.

Related: Deflation in August 2019 amounted to 0.3%, - Ukraine's Statistics Service

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