Editor's Note: The following was published by the U.S.-Ukraine Business Council in Washington, D.C. on Nov 19. It was prepared by the SigmaBleyzer private equity investment management firm and The Bleyzer Foundation. The complete October 2012 analytical report, including several color charts and graphs, can be found in the attachment to this e-mail in a PDF format and at the following link: http://www.sigmableyzer.com/macroeconomic-updates/current-reports/.
SUMMARY:
(1) According to preliminary estimates, real gross domestic product contracted by 1.3 percent year-on-year in the third quarter of 2012.
(2) Industrial production fell by 4.7 percent year-on-year in August
and 7 year-on-year in September amid further slowdown in external demand and weakening
domestic factors.
(3) Slower budget revenue growth and faster growth in
expenditures resulted in sharp state budget deficit widening in
January-September.
(4) Due to parliamentary elections, the government not
only delayed fiscal consolidation measures but also increased the official
budget deficit target to 2.1 percent of GDP from the previous 1.7 percent of GDP.
(5) Without fiscal adjustment measures, total public
sector deficit (including Naftogaz and Pension Fund) may reach 5 percent of GDP in
2012.
(6) On a positive note, the 2013 draft budget law will
likely be revised in compliance with IMF requirements as the 2013 budget was
at the core of talks with the technical IMF mission that visited
Ukraine at the end of
October.
(7) Ukraine reported zero annual inflation in
September. Year-end price growth will likely not exceed 4% yoy, but some
acceleration is expected next
year.
(8) Despite further growth in agricultural exports,
Ukraine’s external balances continued to worsen in August-September with nine
month current account gap amounting to $9.2 billion.
(9) Deteriorating foreign trade balance, high external
financing needs and strong population demand for foreign currency kept
generating hryvnia depreciation
pressures.
(10) The National Bank of Ukraine used a mix of monetary and
administrative measures to maintain the hryvnia peg to the dollar, but may
allow greater hryvnia flexibility after the parliamentary elections.
EXECUTIVE SUMMARY
The
slowdown in the Ukrainian economy intensified in August-September, affected by
further weakening of the external environment and softening domestic demand.
Ukraine’s industrial output fell by 4.7 percent year-on-year in August and 7 percent year-on-year in
September.
Slipping global demand for steel and iron ore weighed on the
steel and mining industries. In addition, production of machinery equipment
and transport vehicles suffered from increased trade tensions with Russia, the
largest consumer of Ukraine’s machinery products. In particular, output production in the machine-building
industry fell by almost 17 percent year-on-year on average over August-September as the
Ukrainian government failed to negotiate an exemption from the utilization fee
introduced by Russia on imported cars.
Domestic demand has also
been cooling. A steep decline in the construction sector (by about 9 percent year-on-year over
January-September 2012) signaled the subdued investment activity. Due to
strained public finances, an ongoing credit squeeze and restricted access to
foreign financing, the current level of investment spending cannot fill the
gap left after the completion of large infrastructure projects related to the
Euro 2012 football championship.
Moreover, a deceleration in retail sales growth to 16 percent year-on-year over January-September indicates that private consumption has started to ease.
While a deceleration in real wage growth to 11.7 percent year-on-year in September contributed
to softening demand, consumer spending was likely affected by growing
political and economic uncertainties. Due to weaker external and internal
growth factors, the Ukrainian economy is forecast to increase by about 1 percent year-on-year
in 2012.
Worsening real sector performance adversely affected
budget revenues, which rose by a nominal 8.7 percent year-on-year over the first nine months
of 2012.
At the same time, expenditures kept gaining momentum on higher social
spending ahead of parliamentary elections, causing sharp state budget deficit
widening. Although slower economic growth and lower inflation, as well
as the practice of collecting tax payments in advance, leaves little room for
revenue improvement, the government delayed the fiscal adjustment measures
until after the parliamentary elections.
On the contrary, during the second half of September and
October, the state budget law was amended several times, increasing the state
budget deficit target by almost 24 percent to 2.1 percent of GDP. Given these developments,
we have revised our full-year public sector deficit (including Naftogaz and
the Pension Fund) to 5 percent of GDP in 2012, but believe the necessary adjustments
will be made for next year’s budget.
The arrival of the technical IMF mission to Ukraine at the
end of October to discuss the 2013 budget and the Ukrainian government’s
reform measures increases the chances that the IMF program may be resumed at
the end of this year/the beginning of 2013.
Ukraine’s inflation
remains at a decade-low level.
In September, consumer prices stayed flat
compared to a year ago thanks to continuing reduction in the cost of
foodstuffs and beverages, downward adjustment in public transportation tariffs
and virtually unchanged utility tariffs. As a result, annual inflation may
stay below 4 percent year-on-year at the end of 2012.
Despite eased inflationary pressures,
monetary policy remains tight. The National Bank of Ukraine continues to use a mix of its
policy measures (banking sector liquidity regulation, foreign exchange interventions, and
administrative restrictions) to suppress the hryvnia foreign exchange
fluctuations. A relative stability of the exchange rate, however, was achieved
at the cost of subdued bank lending activity. Indeed, the stock of bank loans
rose by only 1.2 percent from January to September this year.
A
good agricultural harvest, large grain stockpiles ahead of a new marketing
year and elevated world grain prices supported Ukraine’s exports of
agricultural products, which expanded by about 50 percent year-on-year on average over
August-September this year.
This improvement, however, could not compensate
for weaker exports of other key commodity groups (metallurgy, machinery,
minerals). As a result, exports slowed to 1.1 percent year-on-year in August and fell be about
3 percent year-on-year in September.
While imports also eased, Ukraine’s current account stood
high at about $1.4 billion in August and September. The nine-month gap
amounted to $9.2 billion and is forecast to reach 6.5 percent of GDP this year.
Growing external imbalances, high external debt financing
needs amid turbulent international financial markets and strong population
demand for foreign currency generate depreciation pressures. Moderate Hryvnia
depreciation may be allowed after parliamentary elections to prevent depletion
of gross international reserves beyond three months of imports and improve
competitiveness.
ECONOMIC
GROWTH
As the global slowdown
intensified and domestic demand softened, the Ukrainian economy contracted by
1.3 percent year-on-year in the third quarter of 2012, for the first time since 2009, according to early State
Statistics Committee of Ukraine estimates.
Sharp declines in economic
activities were reported for August and September this year. Weak external
demand and trade tensions with Russia hampered exports and export-related
sectors.
In addition, tight credit conditions, deterioration in
consumer and producer confidence amid rising economic and political
uncertainties, and lower public investment spending following the finalization
of major infrastructure projects and a more difficult fiscal situation weighed
on domestic demand and investments in particular.
Weakening investment
activity led to a marked decline in the construction sector, where real value
of works fell by 9.1% yoy over the first nine months of the year.
Moreover, real wage growth, the driver of private
consumption in the first half of 2012, continued to lose momentum over these two months.
While consumer inflation remains at a decade low, the deceleration mainly
reflects weak performance of real sector activities. Real wage growth
moderated to 11.7 percent year-on-year in September, pointing to softening consumer
demand.
Due to the combination of weaker foreign and domestic
demand, industrial production output fell by 4.7 percent year-on-year in August and 7 percent year-on-year in
September.
Machine-building was particularly hit following Russia’s
introduction of a recycling fee on imported transport vehicles.
As Russia is the principal market for Ukraine’s exports of
transport vehicles and the Ukrainian government failed to negotiate an
exemption from the fee, the output decline in the industry deepened to 13.7 percent
year-on-year and about 20 percent year-on-year in August and September respectively.
Affected by slipping global demand, world commodity prices
continued to decrease, weighing on Ukraine’s production of steel and chemical
products.
Output production in metallurgy was 9.4 percent year-on-year lower in September,
while the growth in the chemical industry slowed to 0.8 percent year-on-year that month
compared to 10.3 percent year-on-year growth a month before.
A steep decline in the construction sector and weak steel
industry performance exerted a toll on Ukraine’s production of construction
materials and extraction of non-energy minerals, whose output declined by
about 8 percent year-on-year and 2 percent year-on-year respectively in September. A continuing downturn in
domestic oil refining (where the output drop amounted to about 50 percent year-on-year in
August-September) and an almost 5 percent year-on-year decline in food processing in September
contributed to the industrial sector’s downturn.
By the end of
October, the country had collected 41.2 million tons of cereal and legumes;
the total grain harvest is estimated at 46 million tons, according to the
Ministry of Agrarian Policy and Food. Although this year’s crop will be higher
than the five-year average, it will be 19 percent lower compared to a record high
56.7 million tons reaped last year.
Given the very high base effect in crop production, the
sector’s total output production reported a decline of 4.6 percent year-on-year for
January-September. At the same time, as the harvest campaign neared completion
in Ukraine, the decline in agriculture lost speed in
September.
Despite a lower harvest, Ukraine’s grain stockpiles
stood high before the new marketing season due to a record high 2011 crop and
export restrictions. Taking advantage of elevated world grain prices and
anticipating the possibility that Ukrainian authorities may restrict grain
exports, traders notably increased grain sales abroad. This supported
Ukraine’s cargo transportation sector but could not compensate for the decline
in cargo turnover related to a weaker industrial sector and non-agro exports.
As a result, although cargo turnover reported a slight
improvement in September, it was 7 percent lower than in January-September last year.
Due to weaker external and internal growth factors, the Ukrainian economy is
forecast to increase by about 1 percent year-on-year in 2012.
FISCAL
POLICY
Worsening real
sector performance and lower than projected inflation resulted in a sharp
deceleration in budget revenue growth over August-September.
In nominal terms,
collections to the state budget were only 8.7 percent year-on-year higher over
January-September.
Moreover, excluding the impact of higher NBU profit
transfers to the budget, revenue growth amounted to a modest 5.6 percent year-on-year for the
period.
The main reason for the deceleration was poor corporate profit tax receipts.
Being the second largest source of budget revenues (about
17 percent of total), they rose by a nominal 1.8 percent year-on-year over the first nine months of
the year.
While economic slowdown in the third quarter had a significant
impact, the revenue growth from this tax was also affected by a tax rate
reduction by 2 percentage points since the beginning of this year, as well as
the widespread practice of advance collections of tax payments. At the same
time, the slowdown in VAT and excise proceeds may be an additional signal of
weakening domestic demand.
At the same time, expenditures kept
gaining momentum on higher social spending ahead of parliamentary elections.
In particular, budget spending on social security and safety, excluding
expenditures to cover the Pension Fund deficit, accelerated to a nominal 33 percent year-on-year over January-September.
Total expenditures grew at a more moderate pace of
15.2 percent year-on-year for the period.
However, this growth was achieved thanks to lower public
investments and under-execution of ‘non-social’ programs. As revenue growth
weakened and expenditures sped up, Ukraine’s state budget deficit widened to Hr 24.4 billion (about $3 billion) for January-September. The deficit was
almost three times higher than in the respective period last year and
represented about 90 percent of the annual target for 2012.
Due to lower than planned economic growth and
inflation for 2012, the full-year budget revenue target is likely to be
under-fulfilled. Given little room for raising additional revenues without a
spending adjustment, the deficit will be driven higher than projected.
Due to
parliamentary elections, however, the revision of the budget policy was
delayed. On the contrary, during the second half of September and October, the
state budget law was several times amended.
As a result, budget revenue and expenditure plans for 2012
were raised by 0.9% and 2.3% respectively, while the deficit target was
increased by about 24 percent to Hr 31.1 billion ($3.9 billion or 2.1 percent of GDP.
These amendments as well as the accumulated financing to
cover short-term fiscal need raise uncertainty that the necessary fiscal
adjustment will be made after the elections. As a result, we have worsened our
full-year public sector deficit (including Naftogaz and pension fund) forecast
to about 5 percent of GDP.
A pause in the reduction of public sector
deficit in 2012 will likely mean a more painful fiscal adjustment next year,
particularly taking into account the government intention to resume
cooperation with the IMF.
In particular, the Ministry of Economy has already
revised its macroeconomic forecast downwards for 2013, which means the revenue
target will also be lowered for next year.
Real GDP is now forecast at 3.5 percent year-on-year for 2013 compared to
the previous 4.5 percent year-on-year.
Despite the pick-up in economic activity in 2013, the
revenue growth alone may be insufficient to restore Ukraine’s fiscal position
and sustain its public debt as fiscal needs will also increase. In particular,
Ukrainian authorities (government and NBU) have to repay about $6 billion to
the IMF alone next year compared to about $3 billion this year.
To secure financial assistance from the IMF, the government
will have to show progress in fiscal consolidation. For this, measures to
address Naftogaz and pension fund imbalances should be presented, but are
still lacking. On a positive note, a technical mission of the IMF arrived in
Kyiv at the end of October to discuss further cooperation with next year’s
budget parameters being at the core of negotiations. This increases the
chances the program may be unfrozen at the end of 2012/ beginning of
2013.
MONETARY POLICY
Ukraine continues to enjoy low inflation. In September,
consumer prices stayed flat compared to a year ago. Continuing reduction in
the cost of foodstuffs and beverages, downward adjustment in public
transportation tariffs and virtually unchanged utility tariffs compensated for
resumed growth in domestic fuel prices and a seasonal increase in the cost of
education services.
To a notable extent, however, almost decade
low consumer price growth was achieved thanks to the Ukrainian authorities’
administrative control over price developments on socially important goods and
services (bread, cereals, sugar, utility costs and transportation tariffs,
etc.). Contained ahead of parliamentary elections, price growth may accelerate
through the end of the year and next year as the government may allow at least
partial tariff adjustments after the elections.
In particular, the government may now be more prepared to
raise heavily subsidized natural gas and heating tariffs to the population.
Low energy tariffs for the population amid high costs of energy imports exert
a severe drag on public finances (both state and Naftogaz budgets). Hence,
their adjustment remains one of the principal requirements of the IMF to
resume its cooperation with Ukraine.
Additional
inflationary pressures may be the result of a weaker agricultural harvest this
year and likely Hryvnia depreciation pass-through to import prices. However,
given the first nine month price growth, annual inflation may not exceed 4 percent at
the end of 2012 but is likely to speed up to about 7-8 percent year-on-year next
year.
Ukraine’s deteriorating foreign trade balance, high
external debt financing needs and strong population demand for foreign
currency amid increased political and economic uncertainties pressured the
Hryvnia exchange rate during September-October.
To suppress hryvnia foreign exchange fluctuations, the
National Bank of Ukraine continued to use a complex mix of foreign currency
interventions on the interbank market, banking sector liquidity regulations
and administrative restrictions to curb population demand for foreign
exchange. These measures allowed the NBU to keep the hryvnia at about 8.1 per
USD through the end of October but caused a depletion of gross international
reserves and a credit crunch.
Thus, gross international reserves fell by 2.5 percent month-on-month to $29.2
billion as of the end of September and continued to decline in October. Given
Ukraine’s challenging external balance outlook for the rest of the year, high
depreciation expectations and the reserves approaching the safety threshold of
three months of imports, greater exchange rate flexibility may be expected
after the parliamentary elections.
Moving from a hard currency peg to greater exchange rate
flexibility is also a repeated IMF recommendation for the Ukrainian government
to cushion against adverse shocks. At the same time, with the resumption of
IMF financing, depreciation is expected to be moderate.
The
sterilizing effect of the NBU interventions on the interbank foreign exchange market
(amounting to $1.5 billion on September) on monetary aggregates and a tight
liquidity stance continued to drag on commercial banks’ lending activity and
thus economic growth. Indeed, bank credit stock was only 1.3% yoy higher as of
the end of September 2012.
Moreover, excluding loans issued to state-run enterprises,
credit growth stood at only 0.7 percent year-on-year.
To revive credit growth, and thus
economic activity, the central bank may be prepared to ease banking sector
liquidity after the parliamentary elections. However, given current economic
uncertainties and Hryvnia depreciation expectations, improved liquidity may
cause higher hryvnia exchange rate fluctuations.
INTERNATIONAL TRADE AND
CAPITAL
As anticipated,
following some improvement in July, Ukraine’s external balance worsened in
August-September.
Thus, Russia’s new import restrictions to protect its
domestic machinery industry after accession to the WTO have severely hit
Ukraine’s exports of transport vehicles.
Overseas shipments of this commodity group decelerated to
12 percent year-on-year in August and dropped by 3 percent year-on-year in September.
Weak external demand and
declining world steel and fertilizer prices hamper metallurgical and chemical
exports, which fell by 11.6 percent year-on-year and 13.3 percent year-on-year over August-September
respectively.
On a positive note, thanks to a good agricultural
harvest, large grain stockpiles ahead of a new marketing year and elevated
world grain prices, Ukraine’s exports of agricultural products expanded by
almost 50 percent year-on-year on the period. But they could not compensate for weaker exports
of other key commodity groups. As a result, total exports of goods slowed to
1.1 percent year-on-year in August and fell by 3 percent year-on-year in September.
Imports also
decelerated in August and declined by 3.6 percent year-on-year in September. Weaker imports
are mainly attributed to economic activity slowdown over these two months,
although lower volumes of energy imports also contributed.
At the same time, as the total volume of imports exceeded
exports, Ukraine’s current account deficit remained high at about $1.4 billion
in both August and September. These brought nine month cumulative gap to $9.3
billion, almost 60% higher than in the corresponding period last year. Given
current trends, the deficit is likely to reach 6.5% of GDP in
2012.
In August, as in the previous months, sovereign debt
borrowings and short-term capital inflows fully covered the current account
deficit. Already in September, the surplus in the financial and capital
account shrank to only $0.2 billion amid trade credit repayments and higher
population demand for foreign currency.
In particular, net purchases of foreign currency by the
population amounted to $1.8 billion in September, which was almost 50% higher
than monthly purchases over the previous three months. The deterioration
of external balances and foreign exchange market tensions signal the need for
rebalancing of the Ukrainian economy, which could be partially achieved
through exchange rate adjustment.
At the same time, without a broader program of economic
measures to restore and promote the competitiveness of Ukrainian goods, these
measures would bring only temporary improvements. Hence, Ukrainian authorities
should seize the opportunity of a calm political season of about two years to
implement economic reforms.
