Timid Signs of Recovery

UKRAINE - Report 06 May 2016 by Dmytro Boyarchuk and Vladimir Dubrovskiy

New statistical data and the formation of a new government in Kyiv offered a small dose of optimism. True, new Prime Minister Volodymyr Groysman is part of the old system, and we have our reservations about calling him a “reformer.” Yet, the Cabinet’s initial moves are moves in the right direction, though the reasons for the careerist Groysman’s initiatives are open to speculation. A few came as no surprise. One, his raising of gas prices, was rather pragmatic – it was a gesture to the IMF, and an attempt to advance cooperation with Western donors, since Kyiv depends on the IMF’s support to secure their financial support. There have been a few surprises, though. First, there was the transparent appointment of two new key managers to Ukrzalinytsya, the state railway company, and Ukrposhta, the state postal service, two large and very lucrative state companies. The other unexpected move was a push to finally deregulate the highly corrupt pharmaceutical market, limiting a system that ably produced a significant number of bribes each year. We are not entirely certain what to make of all of Groysman’s actions, though. Whether they are part of a kick-off strategy to build a positive image and credibility, or he is serious about pushing forward with reforms, remains to be seen.
The economy’s performance is also sending interesting signals. On the one hand, we see industrial performance (+4.8% y/y in March) and retail trade (+13.4% y/y) improving; on the other, the situation is volatile: strong growth in one month could easily dissipate in the next. And there is no reason to be optimistic about any pattern of steady growth of resource prices, which has fed into these recent positive figures.
We think cautiously about the recent strengthening of the hryvnia, to 25.2 per dollar from 26.2 at the start March. Recovering resource prices and some restored confidence after the installation of the new Cabinet are the primary catalysts. But we expect the CAD to widen on the back of the quickening climb of non-energy imports, which promise to put renewed pressure on hryvnia in H2. We still expect the hryvnia to fall to 28 by yearend.
Budget collections in March fell to +9.6% y/y, from +16.2% y/y in February, and +32.7% y/y in January. Slowing inflation, coupled with lower temporary revenue collections, specifically the absence of further revenues from the proceeds from the sale of the 3-G license and the abolished temporary additional import duties, are behind the slowdown. We expect this trend to continue, as inflation eases. Still, the Finance Ministry has some money to compensate for the slowdown (UAH 38.0 billion of the Central Bank’s profits should be wired to the FM in 2016) and there’s a good chance the authorities will keep to the 3.7% of GDP deficit cap they promised the IMF.
The CAD keeps widening, despite stronger resource prices, to $942 million in Q1 (vs. $429 million a year ago). This was partly due to a $473 million coupon payment made on Eurobonds in March that pushed the balance for income into the red. However, the worsening trade balance for goods and services ($1.1 billion deficit in Q1 vs. $556 million in Q1 2015) remains the key source of CAD expansion. Given that non-energy imports have gained momentum (+15.3% y/y in March vs. +8.9% y/y in February) with a stabilized currency and emerging signs of a recovery, we expect the CAD to grow to $3.8 billion (4.5% of GDP) in 2016.

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