The National Bank of Ukraine (NBU), previously incorporating into the baseline macroeconomic forecast certain timelines for "significant improvement in security," has abandoned such an approach. However, instead, it published an alternative scenario in its April Inflation Report, the main difference of which is a slower economic growth in 2025 with a larger budget deficit, depreciation of the hryvnia, and reduction in international reserves.

"The alternative forecast scenario is based on the assumption of higher security risks and, consequently, a slower return of the economy to normal operating conditions over the forecast horizon. According to this scenario, Ukraine's economy in 2025 will recover more slowly compared to the baseline scenario. However, the inflation trajectory will differ insignificantly," the National Bank said in the report.

As reported, in the first inflation reports after the Russian invasion pause in July and October 2022, the NBU, in addition to the baseline, provided an alternative scenario with a longer duration of the war. However, it subsequently abandoned it, although the IMF continued to use such a scenario.

In the restored alternative scenario in the April Inflation Report of this year, GDP growth in 2025 will accelerate only to 3.3% from 3% this year, whereas the baseline scenario suggests economic growth next year at 5.3%.

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

According to the National Bank, the recovery of the economy in the alternative scenario will be more fragile, even in conditions of more significant budget deficits. "The strengthening of labor market imbalances against the backdrop of worse migration conditions than in the baseline scenario will restrain consumer and business activity, increase pressure on business expenses for labor remuneration. The recovery of industrial production from damage and losses under this scenario will be slower, as well as the recovery of sown areas," the NBU said.

The negative impact on economic activity will also come from the energy deficit, which, however, will remain unchanged compared to the baseline scenario – around 5% in 2024-2025.

"Ensuring macrofinancial resilience will require significantly higher volumes of international assistance and significantly higher reserves spending by the NBU to maintain a controlled situation in the foreign exchange market and moderate inflation," the National Bank said.

According to the document, the main factor supporting the economy will be the continuation of a more lenient fiscal policy than in the baseline scenario. The budget deficit, excluding grants in revenues, will amount to 18% of GDP in 2025 (compared to 13.5% of GDP in the baseline) and 12% of GDP in 2026 (compared to 7.5% of GDP in the baseline). The government will maintain significant expenditures for infrastructure restoration, support for the population, as well as for defense and security needs. 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, added the National Bank.

According to its forecasts, large budget deficits in 2025-2026 will be financed by both additional domestic and external borrowings. In particular, the alternative scenario provides for international assistance at $28.7 billion in 2025 and $18.5 billion in 2026, compared to $25.1 billion and $12.6 billion, respectively, in the baseline scenario. "As a result, this will allow avoiding resorting to monetary financing of the budget," the NBU said.

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

The National Bank added that the inflation trajectory will be similar to the baseline scenario, but this will require more significant spending of international reserves: consumer inflation will temporarily accelerate at the end of 2024 to 8.6%, with subsequent decrease to 5.5% by the end of 2025, compared to 8.2% and 6.0%, respectively, in the baseline scenario.

"In addition to the exhaustion of temporary supply factors, the weakening of the real effective exchange rate (REER) of the hryvnia amid slow recovery of the economy's competitiveness will also put pressure on inflation, primarily its core component," the National Bank said. It added that the slower normalization of economic processes will hinder the resumption of exports, inflow of foreign investment and debt capital into the private sector, and generate greater demand for foreign currency. The recovery of exports of both food products and metals will also be slower, and prolonged negative migration trends will restrain the reduction in imports under the "travel" item.

To cover a larger structural deficit in the FX market, the NBU will spend significant volumes of international reserves. Therefore, despite more external financial assistance, reserves will remain almost unchanged in 2024 and will decrease during 2025-2026 to $33 billion, whereas in the baseline scenario, by the end of 2026, they will amount to $39.3 billion.

"At the same time, such volumes of reserves will allow gradually easing foreign exchange restrictions further," the NBU said.

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