From a macroeconomic perspective, Ukraine’s news will be decidedly mixed in 2018 — just as in 2017.
2017 could be described as the year when growth struggled to take off because of disappointment on the reform front. 2018 is likely to see even less reform progress due to President Petro Poroshenko’s increasing focus on re-election in 2019, or perhaps sooner.
There will be a temptation to sacrifice some hard-won achievements on fiscal consolidation with fiscal pump-priming so as to bolster poll numbers while likely storing up problems for the future.
Let’s review and look ahead:
Real GDP growth
After dropping 17 percent in 2014–2015 due to conflict, revolution, Russia’s intervention and annexation, the real gross domestic product grew 1.6 percent in 2016. The expectation was that GDP growth accelerate thereafter.
Unfortunately, the economy has struggled to gain much traction. At present, Ukraine lacks a consistent reform message to sell to investors who largely remain on the sidelines because of lack of meaningful reform on the key anti-corruption agenda.
For 2018, it is hard to see much changing, given what seems to be a fundamental unwillingness from the Poroshenko administration to meet demands of international financial institutions, non-profit organizations, civil society and international businesses to do what it takes to create a clean business environment and tackle corruption.
I can see growth momentum picking up steam to perhaps 2.5–3 percent in 2018, but only on the back of fiscal pump priming which, arguably, is not sustainable. This will all be a short-term tactical election play, without much strategic thinking for the economic long term.
Inflation
Despite the stellar best efforts of the National Bank of Ukraine in tightening policy, inflation has remained sticky and elevated, holding in double digits, and reaching 13.6 percent in November with the central bank revising its end year inflation forecast now to 12.2 percent from 9.2 percent previously.
Higher food price inflation due to the poorer harvest, an unfavorable base period effect, higher oil and energy prices, poor quality growth, skilled labor shortages — all reflects strong vulnerability.
The fact that 1.2 million Ukrainians now work in Poland, and maybe five million elsewhere in Europe is a reflection of the lack of economic prospects at home. It also represents a huge loss to the domestic economy notwithstanding the benefits from remittance inflows.
Fiscal policy
Fiscal policy has been one of the bright spots in recent macroeconomic performance, helped by the reforms instigated since 2015.
Compared to a deficit target of more than Hr 80 billion for 2017, as of November the consolidated budget was running a surplus of under Hr 34 billion, albeit somewhat massaged by NBU profits and one-off receipts from the reclamation of ousted former President Viktor Yanukovych’s assets. Likely heavy end-year spending will have pushed the budget into deficit for the full year in 2017, and this was also evident from the massive drop in the cash balance on the single Treasury account, from Hr 54.1 billion at the end of November, to just Hr 5.1 billion as of early January 2018.
I expect fiscal deterioration in 2018 in the run-up to elections as the Poroshenko administration tries to ensure re-election — likely a deficit of 3–4 percent of GDP. In terms of funding this, I assume an early re-entry to international capital markets, or more domestic issuance, and likely a deterioration in debt ratios if International Monetary Fund lending is not restarted.
IMF struggle
There will be lots of warm words about reengagement with the IMF, even if there will be little practical progress in getting the program back on track. The positions of the two sides on the anti-corruption agenda remain just too far apart. Overall, the strategy will be similar to that of 2011–2013 under ex-President Viktor Yanukovych of using international capital markets to fill any shortfall left by the lack of official financing. All this depends on international capital markets remaining liquid and forgiving of backtracking on reform. So far that appears to be the case, given the liquid state of global markets, but that can easily change.
Balance of payments
The hryvnia proved stronger than expected for much of the past year, reflective of IMF early-year disbursements, then Eurobond issuance and reverse currency substitution. During January-November of last year, the current account deficit flat-lined around $3 billion on an annualized basis. But disappointingly, net foreign direct investment dropped from $3.2 billion to just $2.1 billion for the year. The fact that FDI failed to take off is reflective still of the difficult business environment (corruption) and still challenging political and geopolitical setting.
Foreign investors still need to question why they should invest in Ukraine and not Poland, where they can still access cheap Ukrainian guest labor.
For 2018, I would expect deterioration in the current account position as Poroshenko looks to stimulate domestic demand, which boosts import demand. Higher oil and energy prices globally will also put upside pressure on imports. Meanwhile, and despite the relatively competitive hryvnia, I do not see enough to suggest a takeoff in exports.
All this could put some downward pressure on the hryvnia, albeit likely countered by some NBU intervention as the authorities look to use the hryvnia as an anchor for stability and confidence. NBU reserves will be under downward pressure, depending on market access and IMF/official financing. But the overall strategy will be to try to hold the line until elections and maintain a semblance of macroeconomic stability in terms of the currency, while most of the big ticking time bombs in the banking sector (Russian-owned banks, PrivatBank) have been diffused for the time being, and then provide a fiscal kicker through hikes in pension and public sector wages, plus road building and capital investment. In addition, the 2018 budget again introduced plenty of tax preferences for connected businesses. The combined hope will be for a feel-good factor just before elections.
Disappointing
It all looks very disappointing, as elites put their personal political careers ahead of the country.
Indeed, with Russia’s ruler Vladimir Putin focused on his own re-election in March and the FIFA World Cup in June, Russia seems set to be on the back foot over Ukraine at least for the first half of 2018.
This would have provided a window of opportunity for Ukraine to push ahead with the still challenging reform agenda, to get the economy in a position where it is more durable and able to withstand future pressure from Moscow. It seems almost inevitable that Putin has not finished with Ukraine yet.
Backtracking on reform this year and focusing on fiscal pump priming will just store up the problems for after the elections, when the risks will likely emerge again from imbalances potentially threatening macroeconomic stability. If this comes at the time of another push by Moscow against Ukraine, politicians and policy makers might come to regret the opportunities lost in 2018.
Timothy Ash is a London-based senior emerging markets sovereign strategist for Bluebay Asset Management Company.
