As a starting point, a plus is that the economy is growing, with second quarter real gross domestic product growth revised up to 3.8 percent year-over-year, from 3.1 percent in the first quarter, and from full year growth of around 2.5 percent for 2017. With some pre-election pump priming expected, the International Monetary Fund and World Bank forecasts for full year growth of around 3.5 percent in 2018 don’t look that unrealistic.
Disappointing
The real GDP growth of around 3.5 percent is fair but hardly stellar, and given the low Ukrainian base and cheap hryvnia, and compared with some of its peers in emerging Europe it is perhaps a little disappointing.
Ukraine therein comes in the middle of the pack. Explanations might lie with the drag of Russia’s continued war in eastern Ukraine, but also slow progress still in reining in corruption, which makes for a challenging, albeit improving business environment, with foreign and domestic investment continuing to lag. Perhaps we can also add in the loss of growth potential from the continued still large out-migration of young, skilled Ukrainians — predominantly to Europe (over 1 million in Poland) and ask why so many still chose to migrate, and perhaps therein the link is back to corruption, and slow progress in changing how business is done in Ukraine.
Delayed IMF
Growth is also being held back by the now long delay in getting the IMF program back on track. This has stalled the inflow of much needed IMF and other official credits — perhaps to the tune of $6–7 billion (4–5 percent of GDP). Capital inflows have been limited, and arguably ensuring greater depreciation pressure on the hryvnia, and higher National Bank of Ukraine and market policy rates as a result. This has ultimately fed back into limiting real GDP growth and raising the price of credit to the economy.
But the long delay in getting IMF and official financing back on track also creates a missed opportunity for being able to sell Ukraine as a reform success story to investors. Instead, Ukraine appears in the headlines for the wrong reasons — delays with the IMF.
Inflation has surprised on the upside. After hitting single digits in 2016, the consumer price index pushed back into the mid-teens in 2017. But a commendably orthodox and tight monetary stance from the central bank has at least brought some light on the inflation front with the consumer price index dropping to just 8.9 percent in August.
Future trends in inflation will likely be determined again by whether the government can secure the resumption of IMF lending. Seasonality and a tendency for foreign exchange demand to pick up through elections, plus emerging market foreign exchange weakness, might see more weakening pressure over the near term — which could be stemmed by a confidence boost from the release of IMF and related credits.
Fiscal performance has shown some improvement over the course of the year. Indeed, at one point the deficit had seemed set to exceed the IMF’s target of 2.5 percent of GDP by as much as 1 percent of GDP. But perhaps due to improved GDP growth, revenues have bucked up, while the Finance Ministry seems to have reined in budget spending.
Delays in privatization, reduced National Bank of Ukraine profit transfers, and also limited market access, again because of stalled IMF lending, have strained the ministry’s cash balance and forced a more prudent fiscal stance than would otherwise perhaps have been maintained. But the Finance Ministry’s treasury cash balance is not much above Hr 20 billion at present, and that just does not seem enough to enable coverage of the weight of debt service now looming — without the security of cheap IMF funding and then also the cheaper market access that that would facilitate.
One silver lining from the large numbers of Ukrainians now working overseas is that remittances have continued to increase. So much so that the NBU has revised estimates for remittance flows up by several billion dollars per year for the period since 2015 and to over $9 billion in 2017, and likely something similar, or higher, for 2018.
The stock of public sector debt has flatlined around $75 billion for the past year, and with real foreign exchange appreciation, the ratio of public sector debt to GDP has fallen much more rapidly than had been assumed by the IMF and others, to around 63 percent, from a peak of over 90 percent in 2015. The ratio of gross external debt to GDP has also fallen below 100 percent for the first time in years. Improvements in both ratios suggest reduced vulnerability in the context of a challenging environment around emerging markets as global financing conditions tighten.
But vulnerability remains and the answer is to bolster foreign exchange reserves by kickstarting IMF lending, which would then help gain market access — specifically now the long-delayed Eurobond market access.
It is probably fairly clear that while there have been meaningful improvements in the macroeconomic performance of the Ukrainian economy over the past year, performance could be much better, and vulnerabilities remain.
And therein now so much rests on Ukraine managing to get IMF lending back on track.
Indeed, it seems key to ensuring Ukraine can securely finance itself through elections, and hence that the hryvnia and inflation remain well-anchored.
Indeed, some of the huge reform achievements made since 2014 could so easily now unwind if the right decisions are not now taken.
And those that argue that Ukraine has alternatives to IMF financing are simply not being realistic. With stresses around Argentina, Brazil, India, Russia, South Africa, et al. — they are being outright cavalier in approach.
There are some real positive signs of macroeconomic improvement, let’s hope these are not put at risk now by populist choices in the run-up to elections.
Timothy Ash is a London-based senior emerging markets sovereign strategist for Bluebay Asset Management
Company.
