Ukraine Country Report Jul18 - July , 2018

July 3, 2018

Ukraine’s economy pick up a little in first quarter of this year, growing by 3.1% y/y, but while the situation is improved, partly thanks to strong metal exports, the economic growth is not gathering the momentum that one would expect following such a deep collapse in 2017 when GDP contracted by 15%.

The nation's real GDP accelerated from a 2.2% y/y growth in October-December 2017. Private consumption, which grew 5.6% y/y in January-March, remained the major driver of GDP growth, while investment rose 5.8% y/y.

In a very encouraging sign of improvement the size of Ukraine’s shadow economy has fallen to an estimated 31% of GDP as the situation stabilises and companies begin to recover from the pummelling they took in 2015. This suggests people are increasingly moving from moonlighting to make ends meet that is typical in a crisis into regular jobs.

Consumption is being driven by a recovery in real income, but at circa $300 per month wages in Ukraine remain the lowest in Europe. That has lead to a mass migration where Ukrainians are going to countries like Poland to find work and where they are paid up to four times more than at home.

As a result remittances have been rising each year but about half and this year Ukrainians working abroad are expected to send some $10bn home – more than the country earns from grain or metal exports. While this cash is a useful shot in the arm for the FX starved country – the central bank’s entire hard currency reserves are little over $18bn – the migration of the most economically active citizens will be a drag on long-term growth.

However, wage increase are partly being driven by local companies increasing salaries to compete with Polish wages and as most migrant workers tend to come home again after about three months at this point it is still possible to reverse this trend fairly easily if the government can improve the business climate at home and ensure enough economic growth.

That is not happening yet as a negative impact of net exports on GDP growth diminished amid a reported decline in real imports by 5.4% y/y in January-March (vs. a 20.2% y/y growth in October-December). Ukraine is still not making much that other countries want to buy. This is made worse by the effective embargo imposed by Russia on many key goods and the very limited export quotes granted by the EU under it Deep and Comprehensive Free Trade Area (DCFTA) – Ukraine’s duty free quotas to the EU market are usually used up in the first few months of the year.

On the production side, growth in the first quarter was led by the trade (5.8% y/y) and manufacturing (2.7% y/y) sectors, while agriculture (-0.5% y/y) served as the restraining factor.

At the time of writing it looks like the agricultural sector will take a blow this year as drought had affected much of the southern part of the country. It is still not clear how big a problem this will be but some estimate that the harvest could be down by as much as 50% this year over last year. Grain is a export commodity for the country and one of its major sources of hard currency earnings.

On the political front relations with Russia remain dire and the whole Minsk II accord peace process is frozen. However, Kyiv has also run foul of its main donors as the Poroshenko administration has failed to deliver on the key anti-corruption court (ACC). While an ACC law has been passed it included a clause that allows appeals to heard in regular (corrupt) courts, which effectively guts the entire initiative of its value.

The IMF has dug its heels in and it appears that the $17.5bn stand by programme, of which Ukraine has received half and most of that in 2014, is now effectively frozen.

The IMF is also insisting Ukraine follow through on promises to hike domestic gas tariffs and also cut public spending. The IMF insists that the public deficit be capped at 2.5% of GDP but the current budget assumes a 4%, with heavy spending in the social sphere given that next year is an election year.

President Petro Poroshenko himself has fallen between the cracks of failing to please either the voters or the donors and his personal popularity has tumbled to single digits, as has that of his eponymous party. Popularist Yulia Tymoshenko is now the front-runner in both parliamentary and presidential elections next year, but as a popularist with a track record of lying to the IMF she is less popular with Ukraine’s western backers. In the meantime a whopping 82% of the population say the country is “going in the wrong direction” according to recent polls.

If the IMF is not placated and a new deal put in place in 2019 then Ukraine could run into serious trouble. It has some $3bn of debt redemptions to make this year, rising to $7bn next year, as the debt relief deal cut by former Finance Minister Natalie Jaresko is about to expire. With out international support Ukraine could be facing a fresh round of devaluation and default as soon as next year.

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