Exchange rates, prices, taxes, and populism: what to anticipate for the economy in 2025.

At the end of 2023, the United States fully entered the election mode. Any decisions made in Congress afterward became a political dividing line, splitting American lawmakers into two opposing camps. This included decisions regarding support for Ukraine.

The delay in the allocation of American aid hinted that 2024 would be challenging for our country. Despite this, by the end of 2024, the government not only made overtly populist decisions to distribute money to everyone but also expressed confidence in international funding for 2025 and even partially for 2026.

Political instability and war also affected the Ukrainian economy. The year began with record low inflation rates in recent years, but it ended with a rapid increase in prices, outpacing the National Bank's ability to update its forecasts. The currency exchange rate also fluctuated, experiencing its first year under the so-called "managed flexibility" regime.

How did the Ukrainian economy withstand 2024, and what will prices and the dollar exchange rate be in 2025?

Exchange Rates and Prices

For the dollar, 2024 marked the first full year of the "managed flexibility" regime. This regime was introduced by the National Bank on October 2, 2023, after maintaining the official exchange rate fixed first at 29.25 UAH, then at 36.56 UAH for a year and a half.

From January to March, the dollar exchange rate fluctuated between 37.5-38.5 UAH, but by spring, the national currency began to devalue relatively quickly, crossing the 40 UAH per dollar mark at the end of May. This exchange rate factor influenced the price levels, which began to rise sharply during the summer.

0

Moreover, the acceleration of inflation was influenced by worse harvests and power outages during the July heat. Businesses that operated on generators during blackouts incorporated the cost of consumed fuel into the prices of their products and services.

The negative inflation trend ultimately affected the National Bank, which since July has tried to keep the dollar exchange rate in Ukraine within a narrow corridor of 41-41.5 UAH per dollar. Only at the end of the year did the NBU decide to slightly weaken the hryvnia, which finished 2024 at around 42 UAH per dollar.

Despite a relative calm in the currency market, prices continue to rise. Inflation has accelerated to the point where the NBU can no longer keep its forecasts updated. For instance, in October, the regulator projected inflation for 2024 at 9.7%, but by November, it had actually reached 11.2%. The upward price trend continued into December and is likely to persist at the beginning of 2025.

"The most crucial factor for inflation dynamics will be the harvest volume in 2025. Considering historical data, it should be better than the volume in 2024. This will help increase the supply of food products and adjust their prices downwards or at least prevent further growth.

We expect a significant decrease in the inflation rate starting mid-2025, which could bring it down to 8% by the end of the year," said Alexander Pecheritsyn, director of analytical research at Raiffeisen Bank.

The latest IMF forecast suggests that prices in Ukraine will rise by 7.5% next year (under a scenario that anticipates the end of the war by the end of 2025) or by 11% (in the case of a longer period of active hostilities).

It is likely that the current inflation spike will prevent the NBU from further devaluing the hryvnia against the dollar. At least, this will hold true at the beginning of the year.

"Right now, we do not see the NBU's desire to significantly weaken the hryvnia in the near future. However, after inflation slows down in the second half of 2024, the NBU may be more open to a moderate devaluation of the hryvnia. In any case, according to the baseline scenario, we can confidently exclude the possibility that the rate of hryvnia devaluation will exceed 10% next year," said Vitaliy Vavryshchuk, head of macroeconomic research at ICU Group.

Interest Rates and GDP

In the first half of 2024, while inflation rates were slowing, the National Bank's discount rate gradually decreased, and with it, the rates for bank loans and deposits also fell.

However, by summer, the NBU decided to pause its easing cycle, and by the end of the year, it completely reversed its policy by 180 degrees. On December 12, the regulator increased the discount rate by 0.5 percentage points to 13.5%. Moreover, they announced plans to continue this in the future.

1

2

By raising the discount rate, central banks aim to reduce the money supply and the velocity of money circulation, which leads to a slowdown in inflation. However, this also results in reduced consumption of goods and lower production volumes. At least, that is what economic theory suggests.

Whether a tighter monetary policy will impact GDP growth is still hard to determine, as even within the NBU, there is uncertainty about how much and for how long interest rates will be raised. Current forecasts from NBU board members regarding the discount rate at the end of 2025 vary significantly: from 11% to 14% per annum.

What is certain is that many other factors will influence economic growth: from energy shortages to labor shortages, from the situation at the front to the successes and failures of the government in combating the shadow economy.

"It is clear that due to the war, economic growth rates will be limited, and external factors, particularly aid from international partners, will play a significant role in recovery. However, there are also risks associated with energy resource shortages, potential power supply disruptions, and labor shortages. All of this could complicate economic development," said Inna Provotar, head of management accounting and business analysis at OTP Bank.

The IMF predicts that the Ukrainian economy could grow by 2.5-3.5% in 2025. In the case of a negative scenario, GDP could instead decline by 2.5%.