Welcome to the U.S.-Ukraine Business Council

Monthly Analytical Report: By Olga Pogarska, Edilberto L. Segura
SigmaBleyzer Emerging Markets Private Equity Investment Group,
The Bleyzer Foundation, Kyiv, Ukraine, Monday, June 23, 2008

[The Ukraine Macroeconomic Situation, June 2008, analytical
report is found below. Click here to download the pdf]


(1) Ukraine continued to enjoy robust economic growth as real GDP
growth accelerated to 6.4% yoy over January-May. The growth was
underpinned by continuing expansion in domestic trade, transportation
and industry.

(2) Realization of generous social promises made during early 2007
parliamentary elections caused further substantial fiscal loosening in 2008.
State budget expenditures grew by almost 54% yoy in nominal terms
over January-April 2008. However, thanks to vigorous growth of tax
revenues and under-execution of expenditures, the consolidated budget
was in surplus of 2% of period GDP.

(3) In May, consumer price inflation reached 31% yoy. While supply-side
shocks contributed to current inflation developments, the major blame
should be put on loose fiscal and monetary policies over the last few years.

(4) Continuing its efforts to combat inflation and credit growth, the NBU
has raised its discount rate by 200 basis points to 12% at the end of April.

(5) Anchoring nominal exchange rate stability amid large foreign capital
inflows were among the primary reasons for rapid growth of the money
supply. Since mid-April, the NBU has allowed the inter-bank exchange rate
to fluctuate beyond the officially set exchange rate band. On May 22nd, it
appreciated the national currency by 4% to UAH/$4.85.

(5) Favored by high world commodity prices, Ukraine's merchandise exports
grew by a strong 31% yoy in January-April. At the same time, imports surged
by an impressive 50.3% yoy over the period, resulting in rapid deterioration
of foreign trade and current account deficits.

(6) In mid-May, Ukraine became the 152nd member of the World Trade


In 2008, the Ukrainian economy continued to grow at a robust pace. Ukraine's
GDP growth accelerated to 6.7% yoy in April and further to 7.2% yoy in May,
bringing cumulative growth to 6.4% yoy. Economic growth was primarily led
by an increase in value added in wholesale and retail trade, which grew by
15.8% yoy over the first five months of the year.

Strong expansion in the sector is closely linked to buoyant consumption,
supported by households' rising disposable income and the continuing credit
boom. Indeed, real disposable income of households grew by almost 18% yoy
over January-April 2008 (compared to 10.5% yoy in the respective period last

Growing population income, strong industry performance and external trade
activity supported an 8% yoy rise in value added in transportation over
January-May 2008.

At the same time, the growth in the sector was slightly weaker compared to
the 8.7% yoy increase in the first three months of the year, which may be
attributed to growing transportation costs, prolongation of grain export
quotas and declines in crude oil transit and supply to Ukraine. [1]

Favored by high international prices and strong domestic demand for iron
ore, domestic extraction of ore and coal grew by 6.4% yoy and 2.5% yoy
respectively, which outweighed a decline in extraction of crude oil and gas.
As a result, Ukraine's mining industry reported a 4.8% yoy increase in value
added over the first five months of the year.

Manufacturing was the second largest contributor to GDP growth over
January-May 2008 as value added in this sector advanced by 9.5% yoy, up
from 9% yoy reported for the first three months of the year. Strong industrial
performance was led by four major industries: machine-building, food
processing, chemicals and metallurgy.

High domestic demand underpinned a healthy 7.5% yoy output increase in
food processing. However, industry growth kept decelerating as a poor 2007
harvest continued to spill over into this year. High world steel prices supported
Ukraine's metallurgical production.

However, higher energy and transportation costs as well as growing prices on
raw materials (such as iron ore and coke [2]) resulted in a moderate 3.1%
yoy output expansion in January-May 2008. Production of chemicals grew by
7.4% yoy, underpinned by robust external demand.

At the same time, chemical industry performance slightly worsened as output
growth decelerated from 11.2% yoy in January-February, which may be
attributed to adjustment to increased natural gas prices as well as weaker
external demand on select fertilizers (e.g., ammonia, on which international
prices have been declining during March-May of this year). Machine-building
production went up by about 31% yoy over January-May, underpinned by
strong both domestic and external demand.

On the downside, the coke and oil-refining industry reported a 13.5% yoy
decline in output production, mainly due to lower volumes of processed oil.
As the shortage of domestic coke was compensated for by imports, domestic
production of coke continued to increase.

In contrast, oil-refining production dropped by 23.5% yoy in January-May,
affected by lower domestic oil extraction as well as crude oil imports. At
the same time, oil-refining industry performance slightly improved compared
to the first four months of the year (a decline of 28.5% yoy).

The improvement may be attributed to resumed fuel processing at an oil
refinery that had been closed for repair and reconstruction. Construction
continues to demonstrate weak performance as value added in the sector
declined by 3.8% yoy over the first five months of the year.

As about 1/3 of all construction works are carried out in Kyiv, a
deceleration in the volume of construction works in the city to about 3.6%
yoy in January-May (down from almost 19% yoy in the respective period
of 2007). The deceleration may be related to early Kyiv council elections.

In addition, declining construction works may be attributed to rallying
prices on construction materials, which may have depressed individual
construction, as well as lower government financing of public infrastructure

Value added growth in agriculture remained at 0.4% yoy in January-May.
Favorable weather conditions formed a rather optimistic forecast of the
grain harvest this year.

The Ministry of Agriculture expects about 40 million tons or grain will be
gathered this year, which will be a substantial increase compared to 29.3
million in 2007. Hence, agriculture is expected to recommence its position
as one of the main contributors to economic growth.

Despite good prospects in agriculture, economic growth is likely to moderate
to about 5.5% yoy for the whole year. The projection assumed that though
domestic demand will remain the main driver of economic growth, its rate of
growth will weaken due to high inflation and forecasted slower credit

The latter will be the result of tighter monetary policy and the spillover
of financial turmoil on international markets through lower private sector
external borrowings (particularly commercial banks). Weaker credit growth
will also affect investments. In addition, the rapidly deteriorating foreign
trade balance, as imports continue to notably outpace exports, will exact a
toll on economic growth expansion.


During the last three years, Ukrainian authorities maintained prudent fiscal
policy with consolidated budget deficits of less than 1.5% of GDP on

However, budget expenditures grew by about 30% yoy per year in real terms
since 2004, giving strong impetus to disposable income growth as the budget
shifted toward distributing a larger fraction of budget revenues to
consumption rather than investment spending.

Thus, notwithstanding modest budget deficits, growing budget spending
notably contributed to the build up of inflationary pressures. Execution of
generous social promises made during early 2007 parliamentary elections
caused further substantial fiscal loosening in 2008, though rallying
inflation as well as the widening current account deficit (the typical signs
of an economy overheating) called for fiscal tightening.

Thus, state budget expenditures grew by almost 54% yoy in nominal terms
over the first four months of the year with current transfers to the population
rising 85% compared to the respective period last year, while capital
expenditures were 24% yoy lower.

In addition to increased minimum and living wages, which entailed a
multiplicative increase in public sector wages and pensions, an
impressive increase in state budget consumer spending was attributed to
compensation payments for depreciated Soviet-era savings.

According to the Ministry of Finance, in the first four months of the year
alone the government paid about UAH 4.8 billion (about $1 billion), which
represents almost 8% of total state budget expenditures over January-April
and almost 80% of the planned amount for this purpose in the 2008 state
budget law. [3]

Despite large increases, state budget expenditures were still below target
(the general fund of the state budget was under-executed by 6.5%). Together
with strong growth of budget revenues, the state budget reported a 0.4% of
period GDP surplus at the end of April. Thanks to large positive local
budget balances, the consolidated budget surplus constituted 2% of GDP.

As in previous years, favorable fiscal performance was achieved thanks to
robust growth of budget revenues. Over the first four months of 2008,
consolidated budget revenues grew by a nominal 43.5% yoy underpinned
by a almost 50% yoy increase in tax proceeds.

Receipts from VAT, which account for about 45% of total tax revenues, grew
by 59% yoy in nominal terms, reflecting booming consumption and buoyant
foreign trade growth, as well as government efforts to streamline customs

Fast growth of real household disposable income led to 43% yoy higher
personal income tax collections over the period, while strong corporate
profits generated a 49% yoy increase in enterprise profit tax revenues. Due
to rapid import growth, collections from import duties rose by 74% yoy.
Despite current favorable performance, the fiscal outlook for the rest of
the year remains uncertain.

According to the 2008 State Budget Law, the deficit is targeted at UAH 18.8
billion or about 2.1% of forecasted GDP. As the state budget was developed
on a 9.6% end-of-period inflation forecast, state budget revenues as well as
nominal GDP are likely to be higher, suggesting that the actual fiscal deficit
may be notably lower.

At the same time, state officials repeatedly called for amending the budget,
in particular revising social expenditures to adjust for higher inflation.
Moreover, about half of the fiscal deficit is planned to be financed through
privatization receipts.

Though the government approved an extensive list of enterprises to be
privatized in 2008, including telecommunication monopoly "Ukrtelecom",
chemical plant "Odessa pre-port plant", several energy supply oblener goes,
etc., the privatization process was virtually stalled due to the absence of
a privatization program and dissent among key government officials regarding
management of the State Property Fund of Ukraine.

Thus, privatization receipts amounted to just UAH 0.2 billion, or 2.7% of
the targeted amount. In view of the sluggish privatization proceeds, in April
the government announced its plans to begin issuance of Eurobonds in the
first half of 2008.

Previously, the government declared that the issue would be postponed until
the second half of the year to contain inflationary pressures that might
originate from the conversion of these bonds into national currency. At the
same time, the government did not provide additional information.


In April, the consumer price index grew by 3.1% month-over-month (mom).
Though the price growth slightly slowed compared to the 3.8% mom increase in
March, April was the second month in a row with monthly inflation exceeding
3%. But in May consumer price growth notably decelerated reporting a 1.3%
mom increase. May's monthly inflation was the lowest for the last nine

However, in annual terms consumer prices continued to grow at a fast pace
reaching 31% in May. As in the previous months, inflation was primarily
driven by foods. In addition to paces of price increase (48.5% yoy in May),
foods are also the weightiest component in consumer basket, accounting for
more than 50%.

To a significant extent, supply-side factors (such as the poor 2007 harvest,
growing global food prices and higher energy prices) may be blamed for
current inflation developments.

However, a decrease in the grain harvest was reported in many European
countries, Australia and North America. Moreover, a decline in agriculture
was much more severe in Bulgaria and Romania, where value added dropped
by 30% yoy and 17% yoy in 2007 respectively.

However, the price growth in these countries was much more moderate, while
Ukraine demonstrated the highest inflation in the region and even in the
world. his indicates that demand factors were the major contributors to
building inflationary pressures over the last several years.

In addition to loose fiscal policy, the monetary policy framework of
anchoring nominal exchange rate stability amid large foreign capital inflows
into the country resulted in rapid growth of money supply. To defend the
peg, the National Bank of Ukraine had to purchase large amounts of foreign
exchange, thus injecting large sums of Hryvnias into the economy.

The NBU sale of foreign currency in January and moderate purchases in
February-March were reflected in monetary base deceleration to 41.5% yoy
in March 2008, down from 46% yoy in 2007.

However, in April net NBU purchases of foreign currency amounted to almost
$620 million, which immediately translated into a 6.3% mom increase in the
monetary base. As a result, annual monetary base growth accelerated to 45.6%
in April. Reinforced by strong growth in deposits, the money supply kept
growing at a fast pace of 52.2% yoy in April.

Since the end of 2007, the NBU has been making efforts to contain rapid
money supply and credit growth. It tightened reserve requirements, performed
sizable sterilization operations and raised the NBU discount rate by 200
basis points to 10% since the beginning of 2008. Moreover, at the end of
April, the NBU raised its discount rate by another 200 basis points to 12%.

However, rising interest rates while keeping the exchange rate pegged will
likely encourage higher inflows of foreign capital (especially on the back o
widening international interest rate differentials due to the accommodative
monetary policy of the major world central banks).

Defending the peg, they will be accumulated in the forex reserves of the NBU
and, consequently, will increase money supply.

Realizing this, the NBU allowed the exchange rate to go beyond the lower
bound of the rate band set in the Main Guidelines of Monetary Policy for
2008- UAH/$4.95. By mid-May, exchange rate appreciated to UAH/$4.8
on the inter-bank market, while the official rate was kept unchanged.

However, on May 22nd, the NBU revalued the official hryvnia exchange rate
with respect to the US dollar by 4% to UAH/$4.85 to bring it in line with
the market-determined rate.

Foreign capital inflow remained quite significant. As a result, the NBU
still had to intervene in the market to defend the hryvnia from a sharp
appreciation. The NBU forex interventions amounted to $950 million in May.

The impact of sizable NBU foreign currency interventions on monetary base
growth was compensated for by accumulation of funds of government
accounts with the NBU.

Unlike in April when the government cash balances declined by UAH 3.2
billion ($635 million, UAH/$5.05), in May they grew by UAH 5.7 billion
($1.18 billion, UAH/$4.85).  As a result, monetary base grew by a moderate
0.6% mom in May. In annual terms, monetary base growth decelerated to

Valuation adjustments as well as rising inflation and exchange rate
uncertainty explain a 0.8% mom decline in the stock of deposits in May.

Slower monetary base and deposits growth translated into modest reduction
of money supply. Indeed, money supply (M3) declined by 0.1% mom that
month. In annual terms, money supply growth decelerated to 49%.

Tighter monetary policy caused liquidity constraints in the Ukrainian
banking system. The interbank credit rate, which serves as the closest
indicator of banks' liquidity stance, reached 27% per annum in mid-May.
Liquidity shortages have translated into slower credit growth.

Commercial bank loans to the economy grew by almost 69.5% yoy in May,
down from about 75% yoy in April and 78% yoy in January 2008.


According to the State Statistics Committee, Ukraine's exports of goods grew
by a vigorous 31% yoy in the first four months of 2008. Favored by high
world steel and chemical prices, export of metallurgical and chemical
products rose by 33.5% yoy and 19% yoy respectively.

Robust growth in CIS countries (particularly Russia), the main destination
of Ukraine's machine-building exports, drove a 44.4% yoy increase in
machinery and transport exports. A slight deceleration in exports of this
group from the impressive 53% yoy increase in 2007 may be attributed to a
high statistical base effect as well as weaker growth in select Asian CIS
countries (e.g., Kazakhstan).

High world food prices stimulated export of food products, edible oil, mill
products, milk and dairy products (including eggs). Their export values grew
by 32.2% yoy, 38.5% yoy, 2.6 and 2.2 times respectively. Following
prolongation of the grain export quotas [4], export of cereals declined by 6.5%
yoy in January-April 2008.

Despite favorable export performance, much faster growth in imports resulted
in rapid deterioration of the foreign trade deficit. According to the SSC,
merchandise CIF imports grew by 50.3% yoy in the first four months of 2008.
As a result, the FOB/CIF merchandise trade deficit widened to $7.4 billion,
which was 2.5 times higher than in the respective period last year.

High domestic demand for foods, edible oil and crop products inspires
vigorous imports of these commodities. Respectively, import values were
37.1% yoy, 2.4 times, and almost 93.5% yoy higher in January-April 2008.
Imports of mineral products, the weightiest component in total merchandise
imports, rose by 42.2% yoy over the period.

Within this commodity group, imports of coal and gasoline grew the most-
122% yoy and 120.5% yoy respectively. As already mentioned, domestic
shortages of coal, particularly coking coal, were the primary reason for
strong import growth of coal this year.

Falling domestic production of fuels as well as higher gasoline prices
explained brisk imports of gasoline products. Surprisingly, the value of
natural gas imports showed a moderate 14.6% yoy increase over January-
April 2008, while its price grew by 38% since the beginning of the year.
Consequently, volumes of natural gas imports may have declined by about
17% yoy.

Lower volumes of natural gas imports may be attributed to the revision of
gas delivery schemes and payment delay for imported gas in previous periods.
During negotiations, daily natural gas supplies to Ukraine were cut by about
35% for several days. On the positive side, the share of investment goods
imports kept growing as well.

Thus, imports of machinery and electric equipment grew by about 32% yoy,
while imports of transport equipment surged by almost 90% yoy.

Imports of transport equipment were primarily driven by car imports, but it
is hard to differentiate between consumption and investment goods due to
lack of information. At the same time, more than 5 times higher imports of
railway transport equipment support the above argument.

The widening foreign trade deficit was the main cause of Ukraine's
deteriorating external balances. According to preliminary NBU estimates, the
current account gap widened to $3.5 billion in the first quarter of 2008,
representing almost 9.5% of period GDP. The deficit, however, was almost
fully covered by the surplus on the financial account, with FDI covering
most of the current account gap.

However, the pace of CA deficit widening with growing reliance on external
debt financing raises concerns over the sustainability of its financing in
the future. Reflecting rising internal (accelerating inflation) and external
(widening current account gap) vulnerabilities, Fitch revised the outlook of
Ukraine's sovereign rating from 'positive' to 'stable', though confirming
its ratings.


On May 16th, Ukraine became the 152nd member of the World Trade
Organization (WTO). The negotiations for Ukraine's accession to the WTO
had lasted for almost 15 years.

During that period, Ukraine introduced a number of structural and economic
reforms, underwent transition from planned to market economy, signed 52
bilateral agreements with WTO members, and adopted more than 50
legislation acts required for WTO membership.

The most significant progress was achieved in the areas of intellectual
property and minority shareholder rights protection, liberalization of
foreign trade barriers, foreign banks and insurance sector regulations,
improving banking legislation and preventing money laundering practices.

WTO membership will provide the country with a sustainable and predictable
trade environment and will give strong growth impetus for multilateral trade
and investments. Moreover, it may facilitate Ukraine's European integration,
as entry to the Organization was the main prerequisite for signing a free trade
agreement with the EU.
[1] According to the Ministry of Transportation and Communication, cargo
railway transportation tariffs were raised by 12% since the beginning of
February and 17% since the beginning of April. In November 2007, the
government replaced the ban on grain exports with a quota during January
1-March 31 2008.

Since the beginning of April, the export quota on maize was abolished while
the quotas on other cereals were extended until the end of April. On April
24, the quotas were prolonged until July 1st by enlarging their size to
1,200 thousand tons for wheat (up from the previous 200 thousand tons)
and 900 thousand tons for barley (up from 400 thousand tons).

However, uncertainty with grain export quotas during April resulted in a
2.9% reduction in grain rail transportation over January-April. Though in
May export of grain resumed, causing a 6.7% yoy increase in grain railway
transportation over January-May, its growth still was a significant
deceleration compared to a 28.8% yoy increase over the first two months
of the year.

The dispute between shareholders of closed joint-stock company
"Ukrtatnafta", a company controlling one of the largest oil-refineries -
Kremenchug, caused a decline in crude oil supply to Ukraine and transit.

Thus, crude oil imports from Russia (accounting for almost 3/4 of the total
crude oil supply in Ukraine during January-May 2007) declined by almost a
half over January-May 2008 compared to the respective period last year.

[2] High world iron ore prices stimulated exports of Ukraine's iron ore.
While domestic extraction also increased, exports grew much faster.
According to State Statistics Committee of Ukraine, the value of ore exports
grew by about 50% yoy over the first three months of 2008. Moreover, about
40% of this growth was achieved thanks to higher export volumes.

Domestic shortages amid strong external demand for coking coal (and thus
more expensive imports) kept exacting a toll on Ukraine's metallurgical
production through rising coke prices. Since the beginning of the year, coke
producer prices grew by almost 9% and were about 64% yoy higher in May

[3] The 2008 State Budget Law envisages UAH 6 billion ($1.2 billion) for
compensation for depreciated Soviet-era savings paid in cash and UAH 2
billion ($0.4 billion) to be paid as an offset deal for utilities. Moreover,
the government planned to allocate an additional UAH 12 billion ($2.4
billion) from extra privatization revenues for these purposes.

Considering that the government did not approve procedures for offsetting
utility payments, with sluggish privatization process and rallying inflation,
we assume compensation payments will be limited to UAH 6 billion this year.

[4] See footnote 1 for details.
NOTE: To read the entire SigmaBleyzer/The Bleyzer Foundation
Ukraine Macroeconomic Situation update report for June 2008 in a
PDF format, including color charts and graphics click on the attachment
to this e-mail or go to the following link, and click on Ukraine June 2008,
http://www.sigmableyzer.com/publications/monthly_reports. A Ukraine
Macroeconomic Situation report was not issued for May 2008.
NOTE: 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 at http://www.sigmableyzer.com/en/page/532.