| UKRAINE - MACROECONOMICSITUATION - AUGUST 2009 |
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August 18, 2009
FOR IMMEDIATE RELEASE: UKRAINE - MACROECONOMICSITUATION - AUGUST 2009 SUMMARY ----- However, despite improved global economic prospects, we expect Ukraine’s economic recovery to be quite slow and weak. Moreover, we have worsened the near-term outlook for Ukraine. The forecast revision reflects i) the severity of the economic downturn in 1Q 2009, ii) weak economic activity in 2Q 2009, and iii) strained financial market conditions. However, Ukraine’s demand for imports declined even more sharply – more than 35% yoy, softening the decline in real GDP. Increased unemployment (from 7.5% in 4Q 2008 to 7.5% in 1Q 2009, ILO methodology) and a large decline in real household income (by almost 13% yoy in 1Q 2009) have weighed on consumption. Consumer spending was down 11.6% yoy, but less than we anticipated and at a smaller rate than the drop in real income. Spending was apparently supported by savings made in previous years. Moreover, entering 2009 with very high inventories (UAH 15.5 billion, or $1.9 billion), despite the run-off in the fourth quarter of 2008, enterprises continued to aggressively destock inventories in 1Q 2009. Considerable inventories at the beginning of 2009 may be another explanation for the sharp decline in industrial output as well as imports observed in the first half of 2009. Preliminary external trade statistics for May-June was remarkably weak. Although imports fell even sharper in 2Q 2009, to a large extent this was achieved on the back of lower volume of imported energy resources. The latter was not only the result of depressed economic activity, but also delays in the import of natural gas to be pumped into gas storage to secure continuous gas transit during the next heating season. Imports of fossil fuels are likely to receive strong impetus in the second half of the year. Investment activity is likely to remain depressed amid poor credit availability and firms’ deteriorating financial conditions. Some improvement, supported by inventory rebuild, may be expected in the second half of the year. Although the NBU has already performed diagnostic stress-tests for most banks and requested that the banks raise their capitalization (either by the shareholders’ or the state), the capital projection may be insufficient to deal with the ongoing problems in the banking sector as the test was based on a 9% GDP contraction in 2009. At the same time, even if the second wave of the crisis is avoided, the process of cleaning up commercial banks’ balance sheets (which is likely to be protracted) and the virtually closed debt markets will undermine the banks’ ability and willingness to resume credit, thus dragging on real growth. All these considerations made us reduce our GDP growth forecast for Ukraine from the previous -8% to almost -14% in 2009. In particular, the government kept reporting above-planned budget revenues in May-June. Thus, according to the government, referencing the State Treasury, proceeds to the state budget were over-fulfilled by 4.6% in January-May and by 4.1% in January-June. Moreover, total state budget revenues were down less than 1% in nominal terms in the first five months of 2008 compared to the respective period last year. The Ukrainian authorities used successful execution of budget revenue targets as an argument to explain their reluctance to carry out fiscal adjustment. At the same time, a deeper fiscal data reading revealed significant fiscal deterioration, raising worries about the likely size of fiscal deficit as well as the sources of its financing. Moreover, collections to the budget notably deteriorated in May-June. In the previous months, the government relied heavily on one-off proceeds and early payments of tax bills and other charges. However, being inherently unsustainable, these sources of funds may have started to dry up. Import duties declined almost 60% yoy in line with a sharp drop in import values over the respective period. VAT revenues, which account for almost 60% of total tax proceeds, have fallen by 7.5% yoy over the period. On the upside, state budget revenues were supported by non-tax collections and excise proceeds, which went up by about 40% yoy each in nominal terms. [2] At the same time, the situation with budget revenues looks even more worrisome considering increased VAT refund arrears, resumed mutual offset deals between the budget and enterprises (mainly state-owned) as well as advance tax payments. As a result of falling revenues amid growing expenditures, Ukraine’s consolidated budget gap widened to UAH 3.2 billion ($0.4 billion) in January-May 2009. A consolidated budget deficit this high has not been seen in ten years. Moreover, we believe the major deterioration in fiscal accounts will occur in the second half of the year. Despite an expected improvement in economic activity in 2H 2009, particularly in the last quarter of the year, budget revenues may remain depressed due to early payment of taxes in the first half of the year. On the other hand, expenditures are likely to increase due to their seasonal nature (typically expenditures rise markedly in the last couple of months of the year) and delivery of fiscal stimulus (to the agricultural sector, construction, mining, etc.). Plus, there may be growing pressure to increase budget spending in the run-up to presidential elections scheduled for January 17th 2010. At the same time, planned expenditures in the amount of UAH 81.1 billion were fully executed. As a result, the pension fund deficit amounted to almost UAH 10 billion ($1.3 billion) in 1H 2009, or about ¾ of the targeted amount for the full year. The fund’s higher than expected deficit was covered by the cash balances accumulated in the previous year and loans from the state budget. Although the situation with the pension fund is likely to improve in the second half of the year (in mid-April, the government approved a number of corrective measures - capping maximum pensions, increasing deductions to the pension fund for entrepreneurs who chose a simplified taxation system), the end-year deficit may be wider than foreseen in the budget. [3] Although the government approved a number of measures to improve the company’s financial situation – boosting the company’s capital by UAH 18.6 billion ($2.4 billion), approving a 20% price increase for households in September and for heating companies in October, as well as developing a schedule of quarterly price increases since the beginning of 2010 – Naftogaz’s net financing needs were still estimated at about 2.5% of GDP in 2009. With closed external financial markets, Ukrainian authorities have been working to secure external financing from a number of international financing institutions (the World Bank, EBRD, etc.). Moreover, it was agreed with the IMF that half of the second and all of the third tranches would go to finance government and quasi-government external obligations. Recently, a consortium of international financial institutions announced it is considering an offer of a $1.7 billion loan for Naftogaz’s financing needs. The loan will be conditional on a number of reform efforts in the energy sector of Ukraine. Furthermore, in June the government expressed its firm intention to resume the stalled privatization process and offered for sale a number of potentially interesting enterprises (Odessa port plant, several oblenergos). Amid depressed economic activity and with all of these funds successfully obtained, the impact of such a high fiscal deficit on inflation may be rather limited in 2009. However, with a slow recovery in 2010, a high social security net burden and 2010-11 being election years, Ukraine risks running high budget deficits beyond 2009. Hence, restoring/maintaining fiscal prudence will be on the agenda for Ukraine in the medium term. Thus, due to a more than twofold increase in excises on tobacco and tobacco products, prices on these commodities grew by 9.5% mom in June and were 40% higher than in June last year. The scheduled tariff adjustment on railway transportation and further increase in fuel prices explain a 3% mom price increase in the transportation sector. Utility services were 4.1% mom more expensive in June, mainly on account of tariff adjustment in Kyiv, the capital of Ukraine. However, the suspension of the utility tariffs increase in July caused a 3.3% mom downward adjustment in the utility services price index that month. Moreover, food prices seasonally went down by 0.2% mom in July. However, as the favorable statistical base effect vanished, annual consumer inflation picked up to 15.5% in July. As a result, we maintained our forecast of end-year inflation at 15% in 2009. Observing good disinflation progress and stabilization of the exchange rate market during May-June, the NBU reduced its discount rate by 100 basis points to 11%, effective mid-June. This decision concurred with the improved liquidity in the banking system as well as increased demand for foreign currency, causing higher volatility of the Hryvnia-Dollar exchange rate since the end of June. While the reduction of the NBU discount rate may have a limited effect, better liquidity in the Ukrainian banking system was attributed to a drop in deposit withdrawal, the sale of government securities from the banks’ portfolios and NBU support with its refinancing resources (the NBU provided UAH 8.9 billion of refinancing support in June alone). All of this came on the back of virtually stalled credit activity. Excess liquidity may have been directed to the foreign exchange market, causing higher volatility since the end of June. Recent NBU decision to tighten reserve requirements [4] for commercial banks may be linked to such practices. Uncertainty regarding the disbursement of the third tranche under the IMF program, the accumulation of foreign currency to service/repay external debts as well as expectations that depreciation pressures will intensify in the fall of this year spurred the demand for foreign currency. Combined with limited supply of foreign exchange due to depressed foreign trade, these factors led to a 5% depreciation in the average Hryvnia exchange rate to UAH 8.0 per USD on the interbank forex market in July. Due to large debt services maturing in the second half of the year, the likely worsening of the foreign trade balance, growing political instability ahead of the presidential election and concerns over banking sector stability, the exchange rate is likely to remain volatile through the rest of the year, depreciating to UAH 8.5-9.0 per USD. Moreover, a number of international financial institutions (the EBRD, the WB, etc.) have allocated about $2 billion to support Ukraine’s commercial banks by acquiring minority stakes. On the other hand, the likely Hryvnia depreciation in 2H of 2009, high debt service repayments and deteriorating quality of commercial banks assets [5] increase the likelihood of further stresses in the banking sector. Although export performance deteriorated in 2Q 2009, imports fell even more sharply. In particular, exports dropped at an annual rate of 51% in the second quarter, exceeding the 39% yoy decline in 1Q 2009. Import of goods fell by 58% yoy in 2Q 2009, with imports of machinery and transport vehicles showing particularly strong declines. The deterioration of goods imports this year was influenced by sharp Hryvnia depreciation in the fall of 2008, import restrictions, low world commodity prices and falling domestic demand. At the same time, the trend may start to reverse in the coming months, affected by resumed growth in energy products and larger volumes of natural gas imports (necessary to pump into Ukraine’s underground storages to secure smooth gas delivery during the peak consumption in winter). Moreover, demand for imports may also start to recover in 2H 2009, reflecting the need to replenish inventories (due to sharp destocking in 1H 2009). Although the rate of export decline is likely to decelerate in 2H 2009 as the global economy shows signs of improvement, the current account gap is likely to widen in 2H 2009. Although external debt financing needs are estimated to intensify in 2H 2009, with growing evidence of successful private debt restructuring/refinancing amid available financing from IFIs, the gap may exert relatively moderate pressure on the exchange rate. SigmaBleyzer/The Bleyzer Foundation also publishes monthly Macroeconomic Situation reports for Bulgaria, Romania and Kazakhstan. The present and past reports, including those for Ukraine can be found athttp://www.sigmableyzer.com/en/page/532. SigmaBleyzer is a member of the U.S.-Ukraine Business Council (USUBC), Washington, D.C., http://www.usubc.org.
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Analytical Report: by Olga Pogarska, Edilberto L. Segura
