Ukraine Country Report Mar18 - March, 2018

March 5, 2018

Last year the Ukrainian economy expanded by 2.2%, in spite of the trade suspension with the non-controlled area in the East, which dampened growth by ca. 0.9%.

Except for inflation, which exceeded the National Bank’s target, macroeconomic indicators performed rather well. Especially the fact that fiscal consolidation is bearing its first fruits and led to a decrease in the public debt-to-GDP ratio for the first time since several years is to be highlighted: This indicator decreased from more than 81% of GDP to 73%.

These trends will most probably continue this year; real GDP growth will accelerate to 3.2%. The current account and budget deficits remain moderate and government debt will decrease further.

Putting the IMF programme back on track should be the main target of policy makers in the short term: During 2018/19 Ukraine is facing debt servicing obligations amounting to more than USD 10 bn for sovereign and quasi-sovereign liabilities – which is an enormous challenge, taking into consideration that two elections will be held in 2019.

According to first estimations by the National Statistical Office, real GDP increased by 2.2% in the last year, which implies a slight deceleration compared to 2016. In this context the trade suspension vis-à-vis the non-controlled area in Eastern Ukraine since March 2017 has been a negative factor, which had an especially adverse impact on industry. According to current estimates by the National Bank the trade suspension dampened GDP growth by 0.9%, which is slightly lower than expected (originally 1.3%).

Still, 2.2% is well below potential considering that the economy should be bouncing back from a very deep crisis indeed.

Inflation was one of the few less favourable surprises of economic developments in the last year. The annual average in 2017 was 14.5% and thus exceeded the level of the previous year. The fact that the National Bank missed its inflation target (8% +/- 2 percentage points towards the end of the year) is rather worrying; inflation amounted to 13.7% in December. This was partly caused by the supply side (e.g. higher prices of certain agricultural products), but also by the demand side. In particular, wages increased strongly – partly due to economic recovery, but also as a consequence of the doubling of the minimum wage in January 2017.

The external situation was rather stable, in spite of the mentioned trade suspension with the non-controlled area. External trade has noticeably picked up, whereas imports of goods increased a bit stronger (21.1%) than that of exports (18.8%). The current account deficit amounted to acceptable 3.5% of GDP in 2017 and thus decreased slightly compared to the previous year. In this context increased remittances by migrant workers (e.g. from Poland) played an important role. The flexible exchange rate was relatively stable and fluctuated between UAH/USD 25.6 and 27.5 vs the US dollar.

Especially from a fiscal perspective the last year was a successful one; the budget deficit amounted to 1.4% of GDP and was thus significantly below the target and also below last year’s deficit. Despite additional funds for the recapitalisation of state-owned banks (PrivatBank, Oschadbank) the public debt-to-GDP ratio fell from 81.2% of GDP (2016) to 73.4% (2017). This implied a break in the trend, which reflects the progress made in the fiscal consolidation process.

On the supply side, industry and agriculture should provide the necessary contributions. On the demand side, investment and private consumption will give the corresponding growth impulses, whereas net exports will be negative. Investment closely correlates with the economic recovery, while consumption reflects the strong income dynamics, which are to be seen also in the context of the upcoming elections in 2019. After the minimum wage and pensions have been increased in 2017, another increase of the minimum wage is planned, however at a lower scale than in 2017 (when it was doubled).

Exports and imports will further expand during this year, however, probably at slightly lower pace. The current account deficit is likely to shrink again in 2018; it is expected to reach 3% of GDP. A moderate improvement of the external position, which includes also the exchange rate development, would enable the National Bank to continue the gradual liberalisation of administrative exchange restrictions.

The budget for 2018, which has been adopted in December 2017, foresees a deficit target of 2.5% of GDP, which does not exceed the provisions of the IMF programme. In case no further debt relevant transactions will be made (e.g. bank recapitalisation, Naftogaz), government debt should fall below 70% in relation to GDP this year.

The process of gradual economic recovery is continuing and will slightly accelerate this year. Even though losses of the years of crisis in 2014/15 have by far not been compensated, the general trajectory is positive, whereas high inflation remains a worrying factor.

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