Emerging

Favourable conjonction

EcoEmerging // 1st quarter 2019  
19  
economic-research.bnpparibas.com  
Ukraine  
Favourable conjonction  
Ukrainian growth accelerated rapidly in the first nine months of 2019, driven notably by the agricultural sector and household  
consumption, the latter being largely stimulated by borrowing. The appreciation of the hryvnia (UAH) triggered a sharp drop in  
inflation, which facilitated greater monetary policy easing. In the short term, monetary policy support should offset the impact of the  
global economic slowdown, which has already eroded industrial activity. At the same time, the announcement of a new IMF  
agreement is bound to reassure foreign investors. The central bank will have to deal with a classic dilemma: it needs to ease  
monetary policy to curb portfolio investment inflows, but doing so risks triggering a credit boom.  
Since his inauguration in May 2019, President Volodymyr Zelensky  
1- Forecasts  
has consolidated his position on the domestic political scene by  
winning a majority in the house of deputies while distancing himself  
from the oligarch Igor Kolomoisky, one of his main backers during  
the presidential campaign. Internationally, he proved he could be  
firm with his Russian counterpart on the Donbas and Crimea  
questions during the quadripartite summit, with France and  
Germany serving as mediators, while remaining open to dialogue.  
He has also benefited from the ongoing improvement in the  
economic situation. Lastly, healthy public accounts and his  
commitment to structural reform (draft law to lift the moratorium on  
the sale of farm land) convinced the IMF to grant the country  
another credit line.  
2
018 2019e 2020e 2021e  
Real GDP growth (%)  
3.3  
10.9  
2.1  
3.5  
3.2  
3.8  
Inflation (CPI, year average, %)  
Gen. Gov. balance / GDP (%)  
Gen. Gov. debt / GDP (%)  
7.9  
5.0  
5.2  
-
-2.2  
-2.1  
-2.0  
61.9  
-3.3  
50.0  
-2.8  
48.0  
-3.2  
47.0  
-3.8  
Current account balance / GDP (%)  
External debt / GDP (%)  
87.7  
20,8  
80.1  
25,3  
76.1  
27,0  
75.0  
29,0  
Forex reserves (USD bn)  
Forex reserves, in months of imports  
Exchange rate USDUAH (year end)  
3.5  
4.0  
3.8  
3.8  
30.0  
26.6  
27.0  
28.0  
e: BNP Paribas Group Economic Research estimates and forecasts  
Private demand fuels growth  
2
- Stable growth since 2016  
In the first nine months of 2019, Ukrainian GDP rose 3.8%  
compared to the same period in 2018 (+4% in Q3, the most recently  
available quarter). On the supply side, all sectors contributed to  
growth, notably agricultural production  which accounts for about  
▪▪▪ Agricultural output (3 mma, yoy)  Industrial production (3 mma, yoy)  
Real GDP (yoy)  
2
1
1
0
5
0
5
0
5
10% of GDP, roughly the same as industrial output  with bumper  
grain harvests, thanks not only to favourable weather conditions but  
also to the improvement in sector productivity.  
As to demand, growth has been fairly well balanced so far, buoyed  
by private demand: household consumption, investment and exports  
have all grown at roughly the same robust pace (10%, 13% and 9%,  
respectively). Over the same period, public spending declined by  
-
-
-
-
10  
15  
20  
5
%.  
Household consumption benefits from persistently strong real wage  
growth (9.7%, after 12.6% in 2018), falling unemployment (7.8% of  
the active population) despite an increase in the participation rate,  
and a sharp upturn in consumer credit (+19% in real terms).  
Investment, in contrast, was largely funded through cash flow as  
lending to companies eased after rebounding in 2018. The  
acceleration in GDP growth can also be attributed to vigorous  
exports, notably of farm produce.  
-25  
2012 2013 2014 2015 2016 2017 2018 2019  
Source: Ukrstat, BNP Paribas  
 Liquidity swells  
As the country’s external liquidity continues to rise, official foreign  
exchange reserves reached USD 25.3 bn at the end of December,  
the equivalent of nearly 4 months of imports of goods and services.  
The current account deficit narrowed to USD 3.4 bn in Jan.-  
Nov. 2019, down from USD 4.2 bn over the same period in 2018,  
while net FDI flows amounted to USD 2.5 bn. The basic balance has  
thus improved, but continues to show a deficit. The consolidation of  
foreign reserves is mainly due to non-resident portfolio investment,  
which doubled to USD 5 bn in Jan-Nov 2019 compared to the year-  
earlier period, but also to Gazprom’s USD 2.9 bn pay-out to  
This momentum probably ran out of steam in Q4, as reflected by the  
slowdown in industrial output (chart 2). Yet monetary policy easing  
and the announcement of IMF financial support should trigger a  
sharper easing of domestic and external financing conditions, which  
should facilitate an upturn in investment lending. Although 2020 is  
likely to be a slow year compared to 2019, the country’s  
macroeconomic fundamentals are improving (inflation, external  
accounts, public finances).  
EcoEmerging // 1st quarter 2019  
20  
economic-research.bnpparibas.com  
Naftogaz as part of the renegotiation of its natural gas supply  
contract.  
3- Consumer credit boom  
Consumer credit in LC  
▪▪ Consumer credit in LC in real terms (CPI deflated)  
Consumer credit in FC  
200  
180  
160  
140  
120  
At year-end 2019, the normalisation of relations between Naftogaz  
and Gazprom had a positive impact on the balance of payments in  
the short term. In late December, the two companies signed an  
agreement under which Gazprom pledged to deliver a cumulative  
total of USD 7 bn in natural gas through the end of 2024. In  
exchange, Naftogaz agreed to write off Gazprom’s arrears, with the  
exception of a USD 2.9 bn pay-out in late December. This pay-out  
will largely offset the decline in Naftogaz’s transit revenues in 2020.  
2012=100  
1
00  
8
6
4
0
0
0
Considering that the hryvnia’s appreciation was due more to  
speculation than to a fundamental improvement in the balance of  
payments, the central bank made major net currency purchases  
20  
0
(
USD 7.9 bn), which facilitated the payment of external debt  
servicing charges for the government and the central bank.  
2012 2013 2014 2015 2016 2017 2018 2019  
Source: NBU, BNP Paribas  
Looking beyond these positive short-term trends, the improvement  
in external liquidity makes the country more vulnerable to foreign  
investors who hold now 14.5% of total domestic debt compared with  
only 1% at end-2018. The announcement of the IMF’s USD 5.5 bn  
Extended Fund Facility surely reassured investors. But foreign  
reserves are still relatively low compared to the annual external debt  
servicing charge (USD 15 bn excluding trade debt and intra-group  
debt in 2020). Fragile external accounts require fiscal austerity,  
which the authorities have maintained so far.  
Monetary policy dilemma  
The hryvnia’s appreciation against the dollar since early 2019 has  
fuelled disinflation: consumer price increases fell back to 4.1% yoy  
in December, from 9.8% at the end of 2018. The central bank was  
able to lower its key policy rate to 13.5%, from 18% at year-end  
2
018, and this trend has accelerated since October (the key policy  
Public finance targets met  
rate was cut by a cumulative total of 300 bp). Until mid-2019,  
monetary policy was very conservative with a key rate of more than  
10% in real terms. This policy was justified by the political  
uncertainty that reigned ahead of legislative elections.  
In Jan-Oct 2019, the central government deficit was capped at 2%  
of GDP, below the target of 2.3%, the primary surplus narrowed  
slightly to 1.1% from 1.5% in 2018, and interest payments shrank  
from 3.3% to 3.1%.  
Now that this uncertainty has been lifted, the central bank has more  
manoeuvring room, but it will soon be faced with a classic dilemma  
for the emerging countries: with further monetary easing, the  
economy risks overheating, notably via a credit boom, but  
maintaining a very positive domestic interest rate spread risks  
attracting portfolio investment, which could lead to an overvalued  
currency.  
For the year 2020, parliament adopted a budget with a projected  
deficit of UAH 94 bn (USD 3.5 bn), or 2.1% of GDP. For the  
government, the big risk is not in underestimating spending but in  
overestimating revenues, due to the appreciation in the exchange  
rate: 30% of revenues are denominated in USD, compared to only  
5
% for spending (all other factors being the same, a stronger  
currency increases the deficit). Yet the budget was based on a  
conservative assumption of a USDUAH exchange rate of 27,  
compared to 24 currently. This is another argument for curbing the  
hryvnia’s appreciation. Yet the risks of budget overruns are very  
small, and the IMF will be keeping a close watch.  
Even the central bank believes that consumer credit is catching up  
too quickly. Fortunately, lending has become highly de-dollarized in  
recent years. Moreover, as of 2021, the central bank intends to  
require banks to apply a higher weighting to consumer loans when  
calculating the weighted average assets used in capital adequacy  
ratios.  
Currency appreciation triggered a share decline in the central  
government’s debt ratio, from 62% of GDP at year-end 2018  
(
including guaranteed debt) to 50% in November 2019 (nearly 60%  
of which is denominated in foreign currency).  
The financing plan is very cautious. The government intends to  
issue USD 5 bn in international bonds solely to cover the payment  
of its external debt. Given the expected pay-outs by the IFIs and the  
EU, the need for international bond issues should be limited to  
USD 2 bn.  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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