Ukraine’s economy shows signs of improvement, but considerable challenges remain. Limited exchange rate flexibility, a large budget deficit, and sizable quasi-fiscal losses in the energy sector have given rise to a large external current account deficit and a steady loss of foreign exchange reserves. The tight monetary policy and administrative measures in support of the exchange rate will likely continue to constrain investment and depress growth. And Ukraine’s significant external financing needs remain a key vulnerability.
The mission and the authorities consider that a set of comprehensive and credible reforms is needed to address vulnerabilities and revive growth. The mission recommends that the reform agenda include: (i) increased exchange rate flexibility combined with policies to strengthen the financial sector; (ii) ambitious fiscal consolidation; (iii) increases in domestic energy tariffs, and (iv) comprehensive structural reforms to improve the business climate and support growth.
A more flexible exchange rate would boost Ukraine’s export performance and economic growth, especially in the face of volatile export prices and partner country demand. It would also allow more room for independent monetary policy to keep inflation on target. In the medium term, inflation targeting is the appropriate monetary framework for Ukraine, and preparations for its introduction should be accelerated.