Let’s start by stating the obvious for those of us living in or visiting Ukraine: the country has been one of the worst hit victims of the recent financial crisis. The reasons for why the impact has been so pronounced in Ukraine have been analyzed in depth during the last months and can be – broadly speaking – simplified to three main causes.
Firstly, there were significant pre-crisis excesses fuelled by the availability of cheap money and resulting in disproportionate foreign-currency leverage of both the corporate and individual balance sheets. This was not unique to Ukraine and occurred in most of the Central and Eastern European countries, but the damage in Ukraine was more severe than elsewhere.
Secondly, an over-reliance on commodity exports backfired massively when global demand dried up. Ukraine suddenly looked structurally vulnerable. Further, a lack of economic structural reforms came back to haunt the country.
And, finally, the overall policy response to the crisis was unconsolidated and an extremely fragmented political system was unhelpful.
The fallout, which came last fall with the global financial crisis, was painful.
Ukraine’s real gross domestic product dropped by 8 percent in the last quarter of 2008, while growth declined to 2.1 percent for the full year. In the first quarter of 2009, the situation deteriorated further. GDP contracted by a whopping 20.3 percent year-on-year on the back of a further slide in exports and a collapse of consumer demand. The economic contraction began to slow only in the second quarter of this year when global recovery began.
Since then, there have been some encouraging signs.
To pick a couple: the metallurgical sector, the backbone of the Ukrainian economy, posted a positive month-on-month growth since May (growing by 15.3 percent in July versus June, for example), the relative increase in real wages resulted in modest growth in the retail trade and agricultural output has been growing by 3.8 percent year to date.
Moreover, consumers carefully dipped their feet back in the water thanks to a decline in prices on goods, such as cars, and an unwillingness to return money to the banks.
The billion-dollar questions now seems obvious: Is this recent quarter-on-quarter growth enough to assume that Ukraine’s economy has reached its bottom and that the recovery is sustainable?
Some of the trends are clearly long term in nature. The devalued hryvnia helped balance imports and exports and reduced the trade deficit. The rebound in commodity prices is holding firm and we do not expect the government to notably reduce its spending this year. Overall, the 2009 GDP decline is expected to improve to minus 9.8 percent and growth will be back on the cards in 2010.
However, risks remain.
Local credit issuance is still negligible and the population still does not return their savings en masse to the banks. A restoration of trust in the banks is a psychological but key component for a swift recovery. How fast this happens will largely determine the level of growth in 2010.
Furthermore, foreign currency denominated debt redemptions this year will continue to put pressure on the currency. While unlikely, the risk of a disorderly devaluation of the hryvnia is possible.
The stability of the currency still depends on interventions by the National Bank of Ukraine. However, the central bank is limited in its ability to support the hryvnia due to quantitative requirements imposed by the International Monetary Fund, Ukraine’s main lender. The NBU can spend only about $875 million a month to the end of the year versus $1 billion in the first half of the year.
Based on the above, we expect that the hryvnia will fluctuate in a band between Hr 9.0-9.5/$1 closer to the end of the year, resulting in an average exchange rate of Hr 8.7/$1 for 2009. However, we do not rule out a possibility that the authorities, for opportunistic reasons, may strengthen the rate of the hryvnia at year’s end to Hr 8.3/$1, as was done in 2008.
Finally, with the upcoming elections, a level of political uncertainty and instability is added to the mix and, if it gets out of control, it could become toxic.
In this light, further cooperation with the IMF is crucial. The $10.6 billion in IMF funds from a $16.4 billion aid package received this year are and have been hugely important for Ukraine, both from an economic and a psychological point of view. IMF funds as well as the conditionality have been a strong stabilizing force and have allowed the country to go through the crisis without falling off the cliff.
In view of the difficult political landscape and the current lack of political consolidation, the IMF has shown a deep understanding and appreciation for the situation on the ground, without getting dragged into the local infighting. They have been successful in looking at the broader picture and have implemented their approach accordingly.
It is also clear that neither Europe, nor Russia, nor the U.S. has an interest in a Ukrainian meltdown and – therefore – has been supportive of the IMF’s role. Especially, now, that the Ukrainian economy is showing signs of recovery.
In view of the upcoming elections, it is to be expected that on all major issues the “noise” from politicians will increase and the statements will become louder. While this might create a perception of gloom and doom, Ukraine has shown a remarkable level of resilience and tends to outperform when it is least expected.
Peter Vanhecke is the CEO of Renaissance Capital Ukraine, part of Moscow-headquartered Renaissance Capital, a full-service investment bank group that focuses on emerging markets. He can be reached at [email protected]
