Stagnation Ahead
Rather confusing signals for the Ukrainian economy emanated from the first months of this year. On the one hand, resource prices strengthened, meaning that deeper economic decline is unlikely. On the other, a corruption scandal involving President Petro Poroshenko’s cronies has effectively blocked Western support, and has created yet another domestic political crisis. Amid economic stagnation, the data appears to indicate a relatively satisfactory macroeconomic situation for the rest of 2016.
In fact, the political crisis triggered by a recent corruption scandal is one of Ukraine’s most pressing issues right now. We assume that, despite a possibly slow process to deal with the issue, it will eventually be resolved. Yet we understand perfectly well that the technocratic government society and Western donors are demanding is an arguable idea in itself, and certainly a threat to local elites, who will put up stiff resistance, to keep their rent-making schemes going for as long as possible. Only incredible pressure from the public and a halting of Western aid support can force local elites to accept giving up at least some of their rent-seeking schemes, if only for the sake of survival.
We are basing our projections on the assumption that the current political crisis will be resolved without any serious consequences, whether political or economic. If this proves to be accurate, Ukraine’s macroeconomic figures stand to be quite good.
Take, for example, GDP, projected to increase 1.4% y/y in 2016. The main “source” of growth, however, is its low statistical comparative base, after a 9.9% GDP plunge in 2015. In fact, the “growth” observed actually indicates further stagnation for Ukraine, since private consumption and external demand are both expected to fare poorly. There is also no investment to be seen on the horizon so far, amid the regularly complicated business environment and political situation.
Ukraine’s fiscal prospects are somewhat murky, after a recent reshuffling of the large-scale tax rules. For February, budget revenues were strong (+22.6% y/y) but this was again primarily due to a low comparative baseline, with inflation surging in February 2015 after a sharp decline in the hryvnia. To put it differently, the real surprises associated with budgetary revenues still lie ahead. Nevertheless, the relatively modest target for central budget revenues (+11.5% y/y) provides a good opportunity for preserving the central budget deficit at a mark below 3.7% of GDP in 2016.
External accounts began to worsen over Q1 2016, amid falling resource prices, though this tendency already saw some reversals in February on the back of stronger prices for metal. A 10%+ decline in the value of the hryvnia in the same month also eased pressure on the CAD. We are therefore keeping our CAD forecast unchanged at $3.8 billion, or 4.4% of GDP. Still, we have concerns over the prospects for financial inflows during this political crisis.
The hryvnia was volatile at the beginning of the year, thanks to growing concerns regarding a major corruption scandal and sliding resource prices. The national currency at one point exceeded 27 hryvnia per $1 in February, though by March the situation stabilized and the hryvnia started hovering near 26, without a sign of any potential threat – in spite of the ongoing political crisis and a related pause in the IMF funding. Though the general turmoil has calmed, we do not think that the story of the currency’s depreciation is over for 2016, given the CAD’s widening prospects. Thus, we expect the currency to weaken even further, to 28 by yearend.
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