Ukraine - Economic Report - March 2011

Here is the latest report from SigmaBleyzer Emerging Markets Private Equity Investment Group & The Bleyzer Foundation

SUMMARY POINTS

• Industrial production growth accelerated to 10.5% yoy in February 2011.
• Despite a later spring sowing campaign and smaller area sown under winter crops, Ukraine’s grain harvest is forecast to be slightly better than last year.
• The State budget reported a UAH 4.1 billion surplus over January-February 2011 amid spectacular growth in tax revenues and moderate spending.
• Weaker reform implementation led to a delay in March’s IMF tranche release. However, the impact of the current delay is likely to be neutral.
• Annual consumer price growth accelerated to 7.7% in March 2011.
• The government decided on state-intervened bank resolution plans.
• The current account balance switched to a large deficit in February 2011, but the financial account was in surplus mainly thanks to a successful sovereign Eurobonds placement in February 2011.
• Ukraine has intensified trade negotiations with its main trading partners – Russia and the EU – raising confusion over its current foreign policy.
  

EXECUTIVE SUMMARY

In February 2011, the Ukrainian economy maintained a good pace of growth. Most of the sectors improved their performance compared to the previous month thanks to high world prices on steel, robust growth in Ukraine’s main trade partner countries and strengthening domestic demand.

Industrial production growth accelerated to 10.5% yoy in February as stronger increases in metallurgy, machine-building and production of utilities compensated for some deceleration in the chemical industry and stagnation in food processing.

Retail trade turnover, typically used to gauge private consumption patterns, picked up by a solid 12.7% yoy. Due to colder weather during February-March 2011, Ukraine started the spring sowing campaign later than projected.

While the delay may negatively affect yields, better conditions than last year for winter crops allowed the government to project a slightly higher grain harvest at about 41-42 million tons in 2011. Despite better-than-forecast growth momentum in the first two months of 2011, we maintain our real GDP growth forecast at 4% yoy in 2011.

Robust real sector growth, higher tax rates, the improving financial stance of Ukrainian corporate enterprises and banks as well as abolishment of the 11-month reporting period for corporate profit tax (EPT) helped raise budget revenues by an impressive 44.5% yoy for the first two months of the year.

Larger VAT refunds in March and a vanishing EPT base effect were likely the main reasons of more moderate but still impressive growth in budget revenues over the first quarter. As government spending grew quite moderately over January-February, the state budget was in a large surplus over the period.

Budget performance could weaken in the coming periods. Revenue growth may continue decelerating due to enforcement of EPT rate reduction and small business privileges on April 1st and government plans to reduce excises in order to soften inflation pressures. Expenditures, on the other hand, may increase amid postponement of reform measures and initiatives to relax budget spending.

Weaker reform implementation led to a delay in disbursement of the IMF tranche. The delay is likely to have a neutral impact on the Ukrainian economy as there is a good degree of confidence that co-operation with the IMF will continue. Favorable budget performance over the first quarter of 2011 may be a strong argument for the IMF to tolerate more gradual reform implementation.

During February-March 2011, Ukraine intensified trade negotiations with its main trading partners – Russia and the EU. Ukraine began the final stage in talks on the creation of a free trade area with the EU, which has already existed for four years. Simultaneously, Ukraine was urged to deepen cooperation with members of the Customs Union (Russia, Belarus and Kazakhstan).

The lack of details over the likely design of an agreement with the Customs Union raised confusion over Ukraine’s foreign policy among both Western officials and Ukrainian citizens. So far, Ukraine has stood firm in its willingness to increase engagement with the European Union with the utmost goal of becoming a member of the EU. The road, however, has turned out to be much longer than expected.

In contrast, close trade relations with Russia and high dependence on natural gas imports hold near-term benefits for Ukraine as participation in the Customs Union is likely to bring a notable reduction in the price of imported natural gas, abolishment of Russia’s export duties on crude oil and gasoline products and improved opportunities for Ukraine’s heavy machinery industry. This may be a strong argument for Ukraine, as its trade and current account balances started to worsen in 2011, following notable improvements in 2009-2010.

At the same time, membership in the Customs Union will automatically complicate Ukraine’s relations with the WTO and its members as tariffs in the Union are higher than those agreed with WTO members.

Furthermore, the benefits from joining the Union may turn out to be short-lived as by receiving cheaper energy resources, the country will have less incentive to modernize its outdated and energy-consuming technologies. So far, the Ukrainian authorities have assured that Ukraine’s FTA agreement with the EU remains a priority for the country.