Ukraine will enter 2022 with a solid safety cushion thanks to sound fiscal and monetary policies, strong external commodity markets, and a resilient banking sector.
However, sluggish economic growth and high inflation will be a grain of salt. Russia’s aggression toward Ukraine will be the key non-economic factor to closely monitor next year and beyond. Repetitive maneuvers of Russia’s troops along Ukraine’s borders will continue to disturb business and damage investor sentiment toward Ukraine.
Completion of the first review of the IMF-Ukraine Stand-by Programme came after a significant delay of more than one year, but, still, it was a significant milestone. Ukraine reconfirmed its commitment to reforms, which was received as a much-awaited positive signal to the international community. However, risks are still high that some commitments, like removing the cap on gas prices for households, may be difficult to deliver. Smooth rollover of external debt and the state deficit financing in 2022 critically depend on Ukraine being able to stay firmly on track with the IMF cooperation programme.
Unimpressive economic growth will remain the key concern in 2022 as several new headwinds emerge. Those include high energy prices and decelerating growth of Ukraine’s key trading partners. All in all, we expect GDP will increase 3.2% in 2022, below its potential growth rate. Weaker private consumption due to decelerating real salaries will be the key force behind slower economic growth. Meanwhile, investment demand is likely to recover strongly as companies restart their maintenance CAPEX programmes and government continues to increase investment in infrastructure. Ukraine is still lacking powerful growth drivers that could be a game changer for GDP growth in the coming quarters. Faster structural reforms are needed to provide an impetus to long-term economic growth.
Vaccination has gained pace recently and about 35% of the adult population are now inoculated with at least one dose, up from 12% at the end of summer.
While lockdowns and quarantine-related restrictions still pose risk to the service sector, they are becoming less painful and are largely treated as the new normal by local businesses. New restrictions are not harsh: all shopping malls and hospitality-industry businesses remain open to vaccinated customers.
Inflation has emerged as a major concern for Ukraine since the spring, and the NBU’s response has been consistent so far. The key policy rate was hiked from 6.0% at the beginning of 2021, to 9.0% as of the end of the year. With significant price pressure coming from multiple sources, CPI is unlikely to slip back to the NBU’s target band of 5% ± 1pp in 2022. This implies that any reversal of the tight monetary policy is very unlikely at least until 2022.
Ukraine’s current account deficit is set to widen in 2022 to about 2.3% of GDP on the back of lower steel and iron ore prices combined with elevated energy prices. This will not present a significant challenge. However, the government and the private sector may still face temporary difficulties in raising debt abroad due to turbulent capital markets and Russia’s continued pressure on Ukraine. Our base-case scenario at this point assumes Ukraine will be able to cover its financing needs thanks to concessional loans from IFIs. FDI, net of reinvestments, is likely to remain minimal.
Given balanced external accounts and continued cooperation with the IMF, we expect the FX market will remain largely balanced throughout 2022. However, the hryvnia may see psychological pressure if Russia continues to build up its military presence near Ukraine’s border. As of the beginning of December, NBU reserves totaled US$30.5bn, above 90% of the IMF composite adequacy criteria, and we expect they will decline only marginally in 2022. This provides sufficient comfort that the NBU has ammunition to counteract FX-market shocks should they occur. NBU maintained its presence in the market and alleviated temporary imbalances when they were material. Yet, the exchange rate continued to be driven broadly by fundamentals.
The government has consistently outperformed its fiscal-deficit targets in recent years and has kept its expenditure appetite in check. The government’s intent to keep the fiscal gap at 3.5% of GDP in 2022 and below 3% into 2023 looks totally feasible. We believe Ukraine will continue to grow its fiscal space and significant negative surprises are unlikely in the fiscal area. The debt-to-GDP ratio will slip below 50% by the end of 2021, which is a significant comforting factor for domestic and foreign investors. Despite rapid deleveraging, Ukraine is still facing challenges as far as public debt is concerned. Those are a high share of FX in total public debt stock and still high cost of debt.
The outlook for 2022 is a mixed bag for investors in Ukrainian debt. Global capital market jitters and slowing economic growth across EMs imply investors will require a higher premium. Yet, Ukraine’s solvency profile is likely to further improve thanks to continued fiscal consolidation. Also, an upgrade of Ukraine’s sovereign debt by rating agencies after a two-year pause is a real possibility in 2022. High interest rates on local securities on the back of the NBU’s tight monetary policy imply attractive yields for investors into local government bonds. The outlook is, however, much less encouraging for the VRI holders. They are unlikely to benefit from economic growth and general EM debt sentiment in 2022.
RESEARCH TEAM
Vitaliy Vavryshchuk, Alexander Martynenko, Taras Kotovych, Mykhaylo Demkiv, Dmytro Diachenko, CFA
Complete report available from ICU
ICU Macro Review, 21 Dec. 2021
