Another Tough Year Ahead

UKRAINE - Report 02 Feb 2016 by Vladimir Dubrovskiy and Dmytro Boyarchuk

January was a relatively silent month, especially after an intense December, with tax changes and the budget 2016 on agenda.The public was primarily preoccupied with resurgent FX volatility, while politicians have been actively discussing the possibility of early parliamentary elections.

In January, the hryvnia dropped by nearly 8%, down to 26 hryvnia per $1 (28 hryvnia per $1 on the black market) amid nerve-wracking talks about another round of falling resources prices. Later it appeared that large public disbursements in December, with UAH 14 billion allocated to advance pensions’ payments, and UAH 9 billion wired to the deposit guarantee fund, were the key reasons for FX volatility. So far hryvnia remains in the range 25-26.

We hear much talk about “inevitable” parliamentary elections.The situation is indeed very shaky, and Ukrainians are irritated with mainly painful reforms that have so far lacked a clear positive impact on incomes. However, early elections might be beneficial only for new political movements (like the one Mikheil Saakashvili is creating), while those factions in power, as well as Western partners, don’t see any sense in starting new elections right now. The quality of the Parliament will hardly improve, while even the slow reform process we’re seeing now might be seriously damaged at this stage (when reforms seem to be only pain, without visible benefit).

Industrial output fell 13.4% y/y in 2015.Occupation of the Eastern Donbas was the main reason for such a dramatic drop last year.Numbers have been improving through yearend (in December, industry fell only 2.1% y/y vs. -20.5% in H1 2015); however, this was primarily due to the effect of the low statistical base. At the same time, we don’t see signs of real recovery of industries, amid sluggish resource prices. For 2016, we estimate a 2.1% y/y industrial output increase, mainly due to the low statistical base effect.

CPI came in at 43.3% ytd (48.7% y/y) mainly due to the hryvnia decline, and energy rate adjustments. Foodstuff prices (41.5% ytd) and utility tariffs (103% ytd) were the core of inflation last year.For 2016, we do not expect currency shocks, which means that inflation will be easing gradually. We estimate CPI growing 8.2% ytd (+16.1% y/y) in 2016.

Last year’s budget ended with a 1.6% of GDP deficit (4.6% of GDP deficit in 2014), far below the 4.2% limit agreed upon with the IMF. What’s more, the wide deficit, which includes quasi-fiscal spending, also dropped significantly down to 5.4% of GDP in 2015, vs. 13.2% of GDP a year ago. Devaluation-driven inflation (CPI increased 48.7% y/y in 2015) and temporary collections (like UAH 68.1 billion “profits” of the Central Bank) were the main reasons for the positive outcome. Yet fiscal prospects for 2016 are quite opaque.Inflation will ease, while temporary collections will not be passed along to 2016. What’s more, large-scale tax changes outline considerable uncertainty for this year. Nevertheless, we believe the Cabinet will stick to the 3.7% of GDP deficit target committed to at the behest of the IMF, no matter what.

External accounts improved in 2015, with the CAD narrowing to nearly $1 billion (1% of GDP) vs. $4.6 billion (3.5% of GDP) a year ago.The hryvnia decline was the key reason for the result.Prospects for 2016 also look gloomy, amid sliding resource prices.For 2016, we expect the CAD to widen to $3.8 billion (4.5% of GDP). Gross international reserves are expected to increase to $23 billion (5.8 months of imports) on the back of Western support.

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