Ukraine's economy to grow only 3.3% in 2025 if security risks heighten - NBU

MOSCOW. May 6 (Interfax) - The National Bank of Ukraine (NBU), which earlier set certain terms of "significant improvement of the security situation" in its baseline macroeconomic forecast for Ukraine, has abandoned such an approach, but instead published in its April inflation report an alternative scenario, the main difference of which is a slower economic growth in 2025 with a larger budget deficit, weakening of the hryvnia and reduction of international reserves.

"The alternative forecast scenario is based on the assumption of higher security risks and correspondingly slower return of the economy to normal operating conditions on the forecast horizon. Under this scenario, Ukraine's economy will recover more slowly in 2025 compared to the baseline scenario. However, the trajectory of inflation will not differ considerably," the inflation report quoted by the Ukrainian media said.

In the reinstated alternative scenario in this year's April inflation report, GDP growth in 2025, in particular, will accelerate to only 3.3% from 3% this year, while the baseline scenario includes a 5.3% economic growth next year.

At the same time, the baseline scenario for 2026 assumes a slowdown in growth to 4.5%, while the alternative scenario implies an acceleration to 5.6%.

The economic recovery in the alternative scenario would be more fragile, even with larger budget deficits, the National Bank said. "Increased disproportions on the labor market against the backdrop of worse than in the baseline scenario situation around migration will restrain consumer and business activity, increase pressure on business spending on labor costs. The recovery of industrial production from damage and losses in this scenario will be slower, as well as the recovery of sowing areas," the NBU said.

It added that energy shortage will also have an adverse impact on economic activity, which, however, is assumed unchanged compared to the baseline scenario, that is, at about 5% in 2024-2025.

"Ensuring macro-financial stability will require slightly higher volumes of international assistance and at the same time significantly higher expenditures of the NBU reserves in order to maintain a controlled situation on the foreign exchange market and moderate inflation," the National Bank said.

In accordance with the document, the main factor to support the economy will be the maintenance of fiscal policy, which is softer than in the baseline scenario. The budget deficit (excluding revenue grants) will amount to 18% of GDP in 2025 (13.5% of GDP in the baseline scenario) and 12% of GDP in 2026 (7.5% of GDP in the baseline scenario). The government will maintain significant spending for infrastructure rehabilitation, population support, and defense and security. Their impact on the budget deficit will be partially offset by additional measures to mobilize budget revenues at the level of 3.5% of GDP, the National Bank added.

According to its forecasts, large budget deficits in 2025-2026 will be funded both by additional domestic borrowing and external ones. In particular, the alternative scenario envisions international aid of $28.7 billion in 2025 and $18.5 billion in 2026 against $25.1 billion and $12.6 billion in the baseline scenario, respectively. "As a result, this will make it possible not to resort to monetary financing of the budget," the NBU said.

According to the alternative scenario, budget deficits will lead to the rise in government debt and government-guaranteed debt, which will approach 100% of GDP at the end of the forecast period.

The NBU added that the inflation trajectory will be similar to the baseline scenario, but it will require more substantial spending of international reserves: consumer inflation will temporarily accelerate to 8.6% at the end of 2024 with a subsequent decline to 5.5% at the end of 2025 against 8.2% and 6% in the baseline scenario, respectively.

"In addition to the exhaustion of temporary supply factors, inflation, primarily its core component, will be additionally pressured by the weakening of the real effective exchange rate of the hryvnia amid a slow recovery of the economy's competitiveness," the National Bank said.

It added that slower normalization of economic processes would hamper the resumption of exports, the inflow of foreign investment and debt capital in the private sector and generate greater demand for cash currency. Slower resumption of exports of both food products and metals, and more prolonged negative migration trends will restrain the reduction of imports under the article "travel".

To cover a larger structural deficit on the forex market, the NBU will spend large amounts of international reserves. Therefore, despite the external financial assistance, reserves will remain almost unchanged in 2024 and fall to $33 billion in 2025-2026, while in the baseline scenario they will amount to $39.3 billion at the end of 2026.

"At the same time, such volumes of reserves will allow further gradual easing of currency restrictions," the NBU said.

As reported, Ukraine's GDP, according to the State Statistics Committee, rose 5.3% in 2023 after a 28.8% decline in 2022.