Ukraine’s economy fell back into recession in the second quarter of this year as the fallout from the pandemic and soaring inflation that caused the National Bank of Ukraine (NBU) to dramatically hike interest rates start to weigh on growth.

GDP shrank by a seasonally adjusted 0.8% q/q in the second quarter after falling 1.2% q/q in the previous three months, preliminary data released by Ukrstat showed on August 16.

However on an annualised basis GDP growth was positive advancing by 5.4%, up from -2.2% y/y growth in the first quarter, although the second quarter growth was less than the 7.3% y/y increase analysts were expecting.

Ukraine’s economy has been recovering from last year’s crisis with industrial production bouncing back strongly in April, up 13% y/y. However, the growth is going off the boil now with industrial production also falling back to a mere 1.1% y/y in June as the low base effects fade away.

The fly in the ointment has been inflation which has come roaring back this year and broke above 10% for the first time in years in July to reach 10.2%, after the National Bank of Ukraine (NBU) had effectively crushed inflation in the summer of 2020 as it briefly dropped below 2%.

In response the NBU was forced to put through a series of large and growth-killing rate hikes -- March (50bp), April (100bp), flat in June and July (100bp) -- in an attempt to bring price rises back under control.

During the same quarter, basic sector output growth, which is a rough proxy for GDP growth, was mainly attributable to improvements in retail trade, industrial output and construction, all thanks to a low base.

Basic sector output growth peaked at 18.3% y/y in April, mainly due to the low base effect, before slowing to 4.1% in May and 1.7% in June. The slowdown was evident in most of the largest sectors, including industrial production, retail trade and agriculture.

“In 1H21, GDP growth reached 1.7% y/y. We expect the economy to continue to see modest growth this year and the annual number to come in at around 1.5%,” Sova Capital said in a note.

On the question of funding the government, Ukraine received a much needed $2.7bn gift from the International Monetary Fund (IMF) as part of its $650bn Special Drawing Rights (SDR) give away. Ukraine still faces a debt redemption spike of $11bn in September, but the SDR money takes off some of the pressure.

The talks with the IMF to restart the stalled $5bn Stand By Agreement (SBA) programme are reportedly going well but are not complete. A second tranche of $700mn is up for grabs that may be distributed in the fourth quarter. That leaves the final $2.2bn tranche, but at the end of August the finance minister said that the IMF deal may be extended by six months to allow Ukraine access to that money too. The current deal was due to expire in December and the last tranche would be lost if it does.

Although relations with the US have cooled – Zelenskiy planned trip to meet US president Joe Biden at the White House was delayed again to September – there are also talks about a possible US guarantee for future Eurobond issues. This scheme has already been used at least once and allows Ukraine to issue debt on the international capital markets very cheaply. A US-backed bond issue could also help Ukraine get through the debt redemption spike in September and so is likely to go ahead as despite rising local bond issues and tax receipts, Ukraine will still struggle to cover the payments without raiding its hard currency reserves. Ukraine had $29bn of reserves in August, or about 4.4 months of import cover, which is enough to ensure the stability of the hryvnia but not enough to meet its debt obligations.

On the political front Ukrainian president Volodymyr Zelenskiy campaign against the oligarchs continues as does his attempts to pressure Ukraine’s western partners into more firmly committing to supporting Ukraine in its fight with Russia.

A noticeable crackdown on corruption has begun with more state officials being investigated and arrested for running various scams. State-owned enterprises like the national railway company have been targeted.

At the same time Zelenskiy has been consolidating his hold on power with several changes at the top. The all powerful interior minister Arsen Avakov quit in August for unspecified reasons and was widely considered the second most powerful man in the country after Zelenskiy himself. In what many see as a related development the authorities also cracked down on the far right Azov movement that has been running various scams and extortion rackets with impunity and were seen as under the control of Avakov.

Zelenskiy has already taken control of the General Prosecutor’s office by appointing Iryna Venediktova in March 2020 as part of the last big government reshuffle, who is considered a Zelenskiy-loyalist.

There have been reports that Zelenskiy plans another major government reshuffle in the autumn as the process of consolidating power in his own hands continues.

This year Zelenskiy has launched a campaign to get Ukraine’s EU partners to commit to the country’s eventual membership in both the EU and Nato. “We can sit in the waiting room forever,” he told a French newspaper shortly before meeting French President Emmanuel Macron. However, Ukraine is very unlikely to be admitted to either body any time in the foreseeable future – largely because of Russia’s objections, which sees those membership deals as red line issues.

However, to make sure Ukraine stays high on the international agenda Zelenskiy organised the first Crimea Platform summit and a grand parade to celebrate Ukraine’s 30 years of independence. A total of 46 countries, including all the Nato members, attended both back-to-back events at the level of foreign minister or above and made strong statements of solidarity. While the Crimea Platform is unlikely to change anything, it was a major PR coup and very embarrassing for the Kremlin which issues an angry statement rebuking Ukraine for its “blatantly anti-Russia” provocation and reasserted Russia’s sovereignty over the Crimea.

However, in pragmatic terms Ukraine took a major blow after Germany signed off on the new Nord Stream 2 gas pipeline that is all but complete. Zelenskiy met with German Chancellor Angela Merkel in Kyiv two days after she met with Russian President Vladimir Putin in Moscow and is clearly trying to thrash out some compromise deal. However, she is not in a position to promise Zelenskiy anything, who is clearly becoming very frustrated with the weak support Ukraine is getting from its western partners. Merkel is offering a compromise and says Germany is prepared to fund heavy investment into renewable energy, but Kyiv is focused on the $2bn transit fees it will almost certainly lose after the current transit deal with Gazprom expires in 2024 than money the country may earn in the future if it invests in solar and wind now.