Economy Stabilizes, But Recovery is Far Away

UKRAINE - Forecast 01 Oct 2015 by Vladimir Dubrovskiy and Dmytro Boyarchuk

We continue to observe positive developments in the economy. GDP shrinkage slowed down from -17.2% y/y in Q1 to -14.6% y/y in Q2.Industrial output’s ongoing decline shrank “just” -5.8% y/y in August, from -20.5% y/y in H1. As the hryvnia strengthened, disinflation was also noticeable. The risks that could potentially contribute to a default have waned, particularly after a debt restructuring deal was reached.

Still, economic recovery has yet to be found on the agenda of the day, thanks to falling global resource prices, and the regional situation that has surfaced due to Russia’s economic problems.Against this backdrop, we expect the performance of the Ukrainian economy to remain sluggish, at least till mid-2016.So we have lowered our 2015 GDP forecast to -11.0% y/y (from -8.7% y/y, previously), and to +0.8% y/y (from +2% y/y previously) for 2016.

External accounts also saw some positive developments in H1, and CAD narrowed tomodest $133 million as of August.Still the positive tendency was not sustainable over the course of H2.A stronger hryvnia, increased levels of energy imports and exports’ own lethargic performance all threaten to raise the trade deficit in autumn. Thus, for 2015 we project the CAD will reach about $1.8 billion (2% of GDP), rising to $3.8 billion (4.4% of GDP) in 2016.

Capital flows will be positive, thanks to the debt restructuring deal, and the overall positive light in which Ukraine is being seen by the IMF, due to progress with reforms. Thus we expect the capital accounts to be in surplus over the forecast period: $4.3 billion in 2015, and $7.2 billion in 2016.That will raise gross international reserves to $16.9 billion (4.2 months of imports) in 2015, and to$22.7 billion (5.5 months of imports) in 2016.

Though positive capital flows are expected through 2015-2016, we sense further gradual hryvnia weakening on the heels of CAD widening. By the end of 2015, we believe that the hryvnia will approach an exchange rate of 25 per $1, weakening to 27 in 2016.

Due to booming inflation, the national budget is expected to be on the safe side. State collections are expected to increase more than 30% in 2015, which is more than enough to implement official revenue targets for the year.So we don’t see any problems to prevent the Finance Ministry from meeting its 4.2% of GDP deficit target in 2015. But we do see several fiscal risks in 2016, as much current revenue coming in (like the proceeds from the 3-G licensing, temporary import duties as well as some part of the Central Bank’s own inflationary “profits”) won’t be available in 2016. Nevertheless, we expect the government to stick to the 3.7% of GDP deficit target it committed to with the IMF.

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