MBS Blog

Retirement no joy for most because of paltry pensions

Yuliya Popova, Kyiv Post Staff Writer

An average monthlypension of $100 might be enough tosurvive on, but certainly not enough to live well on.

Here is the weekend update from MBS staff…and an article from www.businessneweurope.eu

While we agree with much of Ben here, we note the wide disparity not only between Ukrainian Government projections-which are optimistic to say the least-but also among the various firms tracking the Ukrainian economy.

We find it ironic that Ukraine’s economy is considered more diverse than many other economics, yet the emphasis is still on steel prices. The consensus would be that it is the lynchpin of the Ukrainian economy.

The one thing we believe will happen are more privatizations. We also don’t think the Ukrainian Government projection of a 7.30 hryvnia to the U.S. dollar as the average rate for 2009 is realistic. We believe the hryvnia will depreciate further in 2009. That could however, accelerate reforms. However, Ukraine will have to endure economic pain during that transition period. 

UKRAINE 2009: tough times ahead

Ben Aris in Berlin  December 20, 2008                Ukraine will have a harder time of it in 2009 than any other country in the region. It enters the year in recession and the prospects for growth in the second half of the year depend heavily on what happens to the global economy.  In general, the economy remains more resistant to external shocks, as it is relatively well diversified by Eastern European standards and the large consumer base helps. However, public finances are in mess and monetary policy is weak. The banking system was also teetering on the brink of collapse in late 2008 when the National Bank of Ukraine had to resort to administrative measures to prevent bank runs and a total meltdown.  The crisis was feeding through into the retail sector by the end of 2008 as retail turnover fell by 1.1% in November after growing by 16% the month before, bringing a consumer boom that has been running for years to an end.  An emergency $16.5bn loan from the International Monetary Fund (IMF), of which $4.5bn was already disbursed before the end of 2008, saved Ukraine’s bacon during the worst of the instability.  Still, the outlook for the second half of 2009 is rosier and Ukraine has made a lot of progress in recent years. “By many measures, Ukraine is currently much more immune to cyclical shocks: foreign exchange reserves have increased substantially, foreign capital increased its share on the local financial market (which is now well capitalized and profitable), the fiscal system has a strong budget code (with defined roles and responsibilities in the budget process) and the [World Trade Organisation] has liberalized external trade,” Maryan Zablotskyy, macroeconomist at Erste Bank Ukraine, points out.  Ukraine’s economic policy is weak both fiscal and monetary wise. On the one hand, the state budget has had a good balancing influence on fiscal policy - since 2000, the average budget deficit has stood at just 0.75% of GDP. However, budget planning was only conducted for one year, which meant that the government has tended to increase spending in nominal terms during times when steel prices and growth were increasing and this tends to amplify the economic cycle and the impact of steel price volatility on the economy. Consequently, the sudden plummeting of steel prices in the current crisis caught the government off guard.  ECONOMIC FORECAST  Ukraine will see the sharpest slowdown of all the countries in Eastern Europe in 2009. The cabinet released its macroeconomic forecast for 2009, projecting real GDP growth of just 0.4% on year. These numbers are based on the Economy Ministry’s optimistic scenario and assume an improvement in foreign demand and effectiveness of the government’s anti-crisis measures. Earlier, the ministry announced an estimated 5% GDP decline based on the pessimistic scenario, which the ministry has not released.  Dragon has a bit more pessimistic scenario, with GDP declining by either 0.7% in case of a fast global recovery, or by 4%, in a more pessimistic case. Fitch forecasts a contraction in Ukraine’s real GDP in 2009 by 3.5%. Erste analysts project a recession of 2.5% of GDP in 2009, with economic growth returning only in the second half of 2009.  “Despite clearly having very strong international support, it will take some time to sort out the imbalances. Still, as the political sphere is now united by a foreign anchor (International Monetary Fund loan), we believe that there is a good chance that Ukraine might finally start implementing the reforms that it did not do for 10 years,” says UBS.  If it does, the medium term looks good: “GDP growth will return to its potential growth of 5-6% in 2010, while inflation is likely to come down to a single-digit figure,” conclude Erste analysts.  Ukraine had the highest rate of inflation in Europe in 2008, but the crisis was a blessing in that it at least helped slow to 22.3% in November the galloping price rises. “We consider the government’s one-digit inflation forecast much less realistic as the hryvnia’s sharp depreciation will put significant pressure on domestic prices. We currently expect inflation in Ukraine to rise by 14.2% on year (base case) or 16.9% on year (pessimistic case) in 2009,” says Dragon  inflation forecasts  Government 9.5%  Dragon 14.2% (base) - 16.9% (pessimistic)  Fitch 17.5%  Foyil Securities 14.5%  DEVALUATION  Ukraine is vulnerable to external shocks to its currency as nearly 50% of total lending in Ukraine is in foreign currency. After spending more than $7.5bn – 20% of its reserves – to support the hryvnia in October and November, the NBU lowered both its official rate repeatedly, and its interbank intervention rate to finally unify them both at the IMF’s behest.  The hryvnia lost nearly 60% of its value from its high in May 2008 of UAH4.5/USD as a result of the crisis. By the end of December the currency had probably oversold and was trading at UAH8.2/USD, at which point the government said it would stabilize.  The optimal level of the UAH/USD will depend on steel prices and Erste analysts project the optimum level to be around UAH7 per dollar, which suggests the currency has overshot at UAH8/USD. However, ultimately the value of the currency will depend on where steel prices settle.  In order to remove some of this unpredictability from the public finances, one of the strings the IMF has attached to its loan is the government must set up a UAH40bn stabilisation fund that can be used to issue stabilisation loans and bail out banks. The fund will be maintained in the future partly from privatisation receipts and the whole privatisation programme has been put back on the agenda for 2009.  The average exchange rate in 2009 will be UAH7.30/USD, according to the government. However, the currency will be affected by Ukraine’s unpaid gas debts to Russia and the price it has to pay for gas imports.  However, the really big change is the current crisis has effectively smashed the foreign currency trading band inside which the NBU has kept the hryvnia more or less constant at about UAH5/USD for most of the last five years.  CURRENT ACCOUNT DEFICIT  The government is hoping to reduce the current account deficit in 2009 as a result of the devaluation. “I hope that a fall in fuel prices, a very moderate rise in gas prices and the exchange rate will bring a zero or a deficit of the current account at 1-2% [of GDP],” Deputy Governor of the National Bank of Ukraine Oleksandr Savchenko said in December.  Fitch estimates the current account deficit will rise to $4.5bn, while the total foreign debt that needs to be paid in 2009 is $45.6bn, equivalent to 157% of Ukraine’s international hard currency reserves. Andrew Colquhoun, the director of sovereigns group at Fitch Ratings, said that clearly Ukraine will not be able to meet these payments unless it can raise some external financing.  With steel exports falling and the compensatory inflow of foreign direct investment (FDI) also slowing, balancing the current account has become a major challenge going forward. FDI in Ukraine in 2008 is projected at $8bn-9bn and in 2009 at over $5bn, said the NBU’s Oleksandr Savchenko.  BANKS  Ukraine’s fast growing bank sector came close to collapse and the rescue measures are likely to have far reaching consequences on the whole sector.  “The government received the right to borrow money in foreign currency on the local market and use government bonds to buy troubled banks [as part of its new crisis powers]. These, alongside the increase in the state fund guarantee for deposits from UAH50,000 to UAH150,000 (covering 99% of individual accounts) and the increase in refinancing activities by the NBU are meant to secure overall banking system stability, which is likely to go through a period of large-scale evolutionary changes,” say analysts at Erste. “The IMF and Ukraine have effectively agreed on driving further consolidation in the banking sector. Even with minimum capital requirements twice those in Europe, Ukraine has some 170 banks, a number that could fall by as much as 30% in 2009 and 2010.”  An attempt to rescue the troubled Prominvestbank seems to have failed and is likely to be nationalised. The whole sector should enter a period of consolidation running into 2009.  EQUITY  After equity prices rose 136% in 2007, the Ukrainian equity market lost nearly 80% in 2008, wiping out all the gains for the last several years in the process. By the start of 2009, Ukraine was one of the cheapest markets in the world in terms of P/E ratios. Only Russia is cheaper.  “Ukraine’s premiums over Russia are justified in our view, as the Ukrainian economy is to a large extent hedged against decreasing commodity prices,” explain analysts at Galt & Taggart. “The country is a large net importer of hydrocarbons, which impact directly on production costs for energy-intensive Ukrainian industries. We believe any potential natural gas price hike in 2009 is more likely to be symbolic. Despite Gazprom’s fear-mongering rhetoric, reference prices are falling and Ukraine holds the transit and storage keys to the bulk of Russian gas exports to Europe. In addition, a bottom-up inspection offers a number of national champions like Enakievo Steel and Ukrsotsbank, among others, which have some of the lowest valuations in their Eastern European peer groups.”  But comparisons to Russia are of limited value due to the vast difference in the size of the markets. Daily trading volumes on the Russian markets are in the billions of dollars whereas in Ukraine the volumes have crashed from between $30m-60m down to about $1m a day as of the end of 2008. Such tiny liquidity makes prices extremely susceptible to shocks.  “Given the liquidity and volatility issues are likely to plague the Ukrainian market until the world finds answers to the financial upheaval, we recommend investors look at shares traded abroad, namely London and Warsaw. Liquidity on those markets remains better than on the local market due to stricter disclosure requirements, better market infrastructure and the presence of ‘quality’ long-term investors. For all intents and purposes, the Ukrainian agricultural sector is represented only on foreign bourses and we see the sector as a solid performer in uncertain times,” says G&T.

Technorati Tags: MBS Ltd., fiscal policy, commodity prices, Galt & Taggart, natural gas prices, Gazprom, Romania, Hungary, Poland, equity, P/E ratios, Prominvestbank, Oleksandr Savchenko, bank sector, Andrew Colquhoun, Fitch Ratings, foreign direct investment, FDI, current account deficit, foreign debt, Russia, NBU, inflation, domestic prices, slowdown, recession, economic growth, monetary policy, budget planning, Maryan Zablotskyy, economic cycle, GDP, steel prices, external trade, World Trade Organization, Erste Bank Ukraine, foreign exchange reserves, International Monetary Fund, IMF, instability, East Europe, National Bank of Ukraine, Anton Olff, retail sector, reforms, hryvnia, U.S. dollar, depreciation, privatiziations, www.businessneweurope.eu, Ukraine, economy,

Although this article from the Russian News & Information Agency at www.en.rian.ru states that money will make its way to Switzerland and Cyprus. OOPS!! They don’t actually say that…but wherever it winds up, it will not be in Russia.

We believe that capital outflows will be higher than $90 billion if the crisis continues. On the other hand, much of this capital will eventually return to the Russia when the crisis passes as investors see beyond the current mess to burgeoning opportunities in this emerging market.

MOSCOW, December 18 (RIA Novosti) - Capital outflow from Russia is expected to continue, and hit $90-91 billion next year, a deputy economics minister said on Thursday.

Andrei Klepach said Russia’s international reserves are expected to decline $110-140 billion amid the ongoing global financial crisis, but remain above $300 billion.

Russia’s Central Bank announced on Thursday that its international reserves, which hold foreign exchange and gold, stood at $435.4 billion as of December 12, down $1.6 billion against $437 billion on December 5.

International reserves declined $28.9 billion in November, $71.5 billion in October, $25.6 billion in September and $14.3 billion in August. The reserves had been increasing in the months prior to August.

Inflation in Russia in 2009 could drop to 10-12% from the economics ministry’s revised 2008 forecast of 13.4%, Klepach said.

Russia is expected to keep its foreign trade balance favorable at $18 billion, with $303 billion in exports and $283 billion in imports, Klepach said.

In its macroeconomic forecast for next year, the ministry also said that crude exports from Russia were expected to decline 3.8%, year-on-year, in 2009 to 235 million metric tons (1.7 billion barrels).

Natural gas exports from Russia are expected to grow from 203 billion cubic meters in 2008 to 208 billion cubic meters in 2009, the ministry said.

Russia’s oil production is expected to decline 1.6%, year-on-year, in 2009 to 480 million metric tons (3.5 billion barrels) while natural gas output is likely to increase 0.7% to 670 billion cubic meters, the economics ministry said.

Technorati Tags: Russia, Andrei Klepach, natural gas, oil production, natural gas, inflation, foreign trade balance, international reserves, global financial crisis, Russian Central Bank, foreign exchange, gold, Moscow, RIA Novosti, Russian News & Information Agency, www.en.rian.ru, Anton Olff, Switzerland, Cyprus, capital outflows, emerging markket,

If only I had the crystal ball the World Bank seems to have for telling us the obvious. Once again, the Financial Times (www.ft.com) delivers the timely news to those of us watching and waiting to decide where to put our hard earned kopecks.

Looks like commodities will not be the ticket to riches that I had supposed….if I follow the World Bank.  Of course, this won’t be good news for our Russian friends, but I wouldn’t sell the Bentley just yet. I have a feeling that some of Wall Street gurus like Jim Rogers…who lives in Asia now…may be right about this being a dip before commodities resume their rise to the sky. Just think of all those governments and central banks…including mine in the United States…that will need to inflate to pay for all that stimulus, debt, bailouts and universal health care. 

The bottom line is that commodities-like equities and real estate- experienced a boom due to real demand as well as unreal interest rates, cheap money, and lots of speculation. The flip side is that hard assets will make a comeback-though maybe not to the stratosphere-but will post solid gains in the inflationary environment that we could see within the next several years.

Global demand for oil to plummet

By Javier Blas in London and Krishna Guha in Washington

Published: December 9 2008 20:09 | Last updated: December 9 2008 20:09

Global oil demand will collapse next year and commodities will not return to the highs they reached this summer in the foreseeable future, two authoritative reports said on Tuesday as they forecast a long and painful worldwide recession.

The stark conclusions came as the World Bank’s chief economist predicted that the world faced “the worst recession since the Great Depression”.

The US energy department said global oil demand will fall this year and next, marking the first two consecutive years’ decline in 30 years.

“The increasing likelihood of a prolonged global economic downturn continues to dominate market perceptions, putting downward pressure on oil prices,” it said, forecasting that demand would drop 50,000 barrels a day this year and a hefty 450,000 b/d in 2009. US oil demand will drop next year to the lowest level in 11 years.

Meanwhile, the World Bank’s Global Economic Prospects report said the commodities boom of the past five years – which drove up prices 130 per cent – had “come to an end”.

The World Bank’s analysis of the commodities boom contrasts with the prevalent view among natural resources companies – and most Wall Street analysts – that the ongoing price drop is a correction within an upward trend.

Although it ruled out a return to the torrid high prices of this summer, it said commodities prices would not fall back to the depressed levels of the 1990s.

Oil would return to about $75 a barrel within the next three years, it said, while food would trade 60 per cent higher than in 2003, but about half below this year’s record.

“Over the longer run, the price of extracted commodities should fall,” the bank said, adding that because of slower population and income growth, world demand for raw materials will ease.

Andrew Burns, the leading author of the report, dismissed the idea – widely supported among the industry and international bodies such as the International Energy Agency – that the credit crunch could result in higher prices when the economy recovers as companies cancel supply expansion projects.

The bank forecast that world trade – an engine of growth for many developing countries – would contract for the first time since 1982.

Justin Lin, the World Bank’s chief economist, said the current downturn was likely to see simultaneous recessions in most of the industrialised world, and that these recessions were likely to last longer than in the early 1980s, and the decline in growth would be more universal than in past episodes in recent decades.

Technorati Tags: World Bank, Anton Olff, Justin Lin, Andrew Burns, International Energy Agency, credit crunch, recession, the Great Depression, U.S. Energy Department, cheap money, interest rates, speculation, inflation, hard assets, Financial Times, central banks, global demand, Javier Blas, Krishna Guha, London, Washington, , debt, stimulus, bailouts, universal health care, www.ft.com, commodities, Bentley, Russia, Jim Rogers, Wall Street,

Although the situation is rather fluid regarding the Ukrainian economy, this report  featured on www.unian.net  by the private equity firm SigmaBleyzer (www.sigmableyzer.com) gives a good idea of where it is headed. 

The real question is whether the political climate will stabilize sufficiently to allow for macroeconomic conditions to improve. Coordinated actions in Kyiv will prevent further deterioration of an already fragile transition economy reliant on the export sector for growth.

 Stay tuned….

Ukraine macroeconomic situation report, November 2008

SUMMARY:

• Ukraine`s real economy has continued to perform well with a real rate of GDP growth of 6.9% yoy in January-September 2008. However, Ukraine`s near term outlook has worsened substantially, although medium-term prospects remain good.

• Over the first nine months of 2008, the consolidated budget was in surplus of UAH 11.8 billion ($2.3 billion) or 1.6% of period GDP, backed by above-target revenues and tight control over expenditures. With weak prospects of fully covering the planned financing gap and the likely shortfall in revenues through the rest of the year, the government started to revise their expenditure plans. As a result, the fiscal deficit is likely to be significantly below target.

• Following two months of inflation relief, consumer prices returned to growth, advancing by 1.1% month-over-month in September. Though inflation continued to decelerate in annual terms, government plans to adjust a number of service tariffs will notably hinder this process in the coming months.

• With rapidly widening trade and current account deficits, large external debt financing needs and high banking system exposure to credit and foreign currency risks, Ukraine was and remains extremely vulnerable to adverse external shocks. On the back of heightened global financial instability since September, falling world steel prices and a weakening global economy, these risks started to materialize during September-October.

• Reflecting growing stress to the Ukrainian economy, major international rating agencies downgraded Ukraine`s sovereign rating.

• Despite the recent turbulences, the prompt government and monetary authorities` response as well as gained support from international financial institutions increases the chances that Ukraine may be able to weather the storm with relatively moderate pain.

ECONOMIC GROWTH

Buoyed by outstanding performance in agriculture, real GDP growth picked up to an impressive 10.4% yoy in August, bringing cumulative growth to 7.1% yoy. At the same time, the Ukrainian economy is likely to lose steam through the rest of this year and also 2009, courtesy of both external and domestic factors.

Resilient so far, Ukraine`s heavily export-oriented and external-financing-dependent economy looks increasingly vulnerable to the recent financial crisis. Weakening external demand has already manifested through plunging world commodity prices, while foreign investors` flight-to-quality and risk aversion may dry up foreign capital inflows to emerging markets.

On the domestic front, lingering inflationary pressures and political instability, weaknesses in the domestic banking system, a rapidly widening trade deficit

and large private sector indebtedness subdue Ukraine`s economic outlook in the near future.

Already in September, real GDP growth slowed to 5.5% yoy on the back of weaker industry, domestic trade and construction. Cumulatively, however, economic growth decelerated only marginally to 6.9% yoy, supported by strong value added growth in agricultural and the transportation and communication sectors.

Thanks to a 15-year record grain harvest, agriculture expanded by 15.7% yoy over the first nine months of the year. At the same time, due to unfavorable weather conditions in September, the harvest of corn, sugar beets and some other crops and vegetables turned out to be less successful than previously expected. This explains value added growth deceleration in January-September compared to an explosive 24.4% yoy increase in January-August.

Transportation and communication kept expanding at a robust 10.4% yoy over January-September, virtually the same rate as in 1H 2008, according to the revised State Statistics Committee data.

On the other hand, construction plunged by 10.3% yoy over the first nine months of the year, affected by tight access to credit. The industrial sector also continued to decelerate and grew by only 5% yoy due to weaknesses in the global demand for iron, steel and chemical products. In particular, following several months of deceleration, metallurgical production has been contracting in annual terms since August, in line with the sharp decline in world steel prices.

In September, output in industry fell by 17% yoy, driving cumulative growth below zero. October is likely to see another major decline in industry as a number of metallurgical producers announced production and employment cuts.

The depression in the metallurgical sector will exact a significant toll on the whole Ukrainian economy as the sector accounts for more than 45% of total export revenues and about 25% of total industrial production. In addition, poor metallurgical performance will also affect a number of other industries and sectors, including the extractive industry, machine-building, construction, and transportation.

Expectations that the new harvest will improve food processing performance did not materialize. Industrial production grew by a modest 2.2% yoy over the first nine months of the year, decelerating from about 10% yoy at the beginning of the year. Weak external demand was among the main reasons of worsening chemical industry performance.

Over the nine months, output growth in export-oriented chemical production slimmed down to 2.9% yoy compared to 9% yoy growth at the beginning of the year.

After all, warning signs of economic weakness were already evident in the second quarter of 2008. In particular, investments advanced by only 6.3% yoy as tighter monetary policy limited access to banks` credit. Private consumption growth decelerated to 13.3% yoy, down from almost 18% yoy in the previous quarter. A domestic trade slowdown to 9.4% yoy in January-September from 13% yoy in 1H 2008 foretells further weakening of domestic consumption in 3Q 2008.

Moreover, while exports rebounded at a strong 9% yoy (up from less than 1% yoy in 1Q 2008), imports continued to outpace exports, expanding by a record high 25.6% yoy in 2Q 2008. Ukraine`s deteriorating current account balance puts pressure on economic growth and increases the country`s dependence on external capital flows.

On the back of easing steel prices, tight external and domestic credit markets amid large external financing needs, a cooling world economy and recent turbulence on the domestic financial market (which is likely to cause a further credit squeeze and aggravate domestic banking sector weaknesses), Ukraine`s near-term outlook has worsened substantially. Economic growth is forecasted to decelerate to 6.3% yoy in 2008 and enter a downturn in 2009.

At the same time, the country maintains a good medium-term outlook, supported by a large domestic market, great agricultural potential, a cheap and skilled labor force, good prospects for signing a free trade agreement with the EU and greater chances of reform acceleration (in part thanks to recently applying to the IMF financing).

FISCAL POLICY

Ukraine`s public finances remained in a good shape as the country ran a consolidated budget surplus of UAH 11.8 billion ($2.3 billion) through the end of September, which is equivalent to 1.6% of period GDP. Public spending rose by a nominal 41% yoy over the first nine months of the year, underpinned by higher spending on public wages and social transfers.

In particular, remuneration to public sector employees grew by a nominal 38.1% yoy, while current transfers to the population advanced by 48% yoy. Despite strong growth, fiscal expenditures were still below target mainly due to under-execution of capital spending. The government refrained from tightening social expenditures in view of the turbulent political environment and looming presidential elections (scheduled for early 2010).

At the same time, though expenditures notably increased, they were still below the targeted amount. According to the State Treasury, expenditures from the general fund of the state budget were under-executed by about 3%. Together with above-planned revenues, this secured a budget surplus for the period.

During January-September, consolidated budget revenues grew by 43.7% yoy in nominal terms over the first nine months of the year backed by a 53% yoy increase in tax receipts. As in the previous periods, value added tax proceeds, advancing by almost 70% yoy in nominal terms, were the main contributor to tax revenue growth over the period.  Defined usually as the tax on consumption, impressive growth in VAT receipts this year is explained by high inflation,  robust imports, and improved tax administration.

In parallel, however, the authorities started to accumulate VAT refund arrears, as it became clear in the middle of the year that the targeted amount for VAT refunds, envisaged in the 2008 budget law, was significantly underestimated. In January-September, VAT reimbursement was 43% above the planned amount. According to expert estimates, VAT refund arrears amounted to UAH 11 billion (about $2 billion) at the end of September, up from about UAH 8 billion in the middle of the year.

However, the situation is unlikely to improve until the end of the year, as a reduction in arrears will require a budget revision, the likelihood of which looks quite low. At the same time, the accumulation of further arrears may lose speed substantially through the rest of the year given notable export weakening.

Execution of other taxes, particularly corporate and personal income taxes, has been good in January-September, as proceeds from these taxes picked up by a nominal 57% yoy and 38% yoy respectively.

Despite current favorable budget performance, successful budget exercise through the rest of the year looks quite worrisome. First, due to further projected worsening of economic performance through the rest of the year and government initiatives to introduce tax benefits for a number of industries affected by a sharp deterioration in the external environment, budget revenues risk being substantially under-executed.

However, above-target revenues and strict control over expenditures allowed the government to accumulate significant cash balances on its Treasury account (about UAH 16 billion at the end of September).

Second, the financing gap, targeted at about UAH 19 billion, or 1.8% of expected 2008 GDP, looks insurmountable. The budget deficit was planned to be financed by new government borrowings (both external and internal) and privatization proceeds.

Despite the greater reliance on domestic debt financing this year, Ukraine`s fiscal authorities still planned to raise UAH 8.1 billion ($1.6 billion) in foreign borrowing, including about $1 billion by placing Eurobonds, for which a road-show was conducted in June.

However, on the back of tight external credit markets and investors` flight to safety, the government decided to shelve the bond issuance. At the same time, reliance on domestic debt issuance also was not very successful. Given frankly unattractive yields amid high domestic inflation, the authorities raised only UAH 1.4 billion into state coffers in January-September, or less than 20% of the targeted amount for this year.

And finally, government plans to receive UAH 8.8 billion ($1.5 billion) in the form of privatization receipts this year will not materialize. At the end of September, the accumulated privatization proceeds amounted to less than 4.5% of the annual target.

With the deteriorating prospects for an already slowing economy and the lack of targeted fiscal deficit financing, the government started to revise their expenditure plans. In particular, the President and the Cabinet of Ministers issued a number of Decrees, envisaging expenditure cuts on public administration.

Moreover, the government is likely to continue to tightly control expenditures through the rest of the year. This would mean moderate expenditure loosening in the last couple of months. However, the year-end fiscal deficit may turn out to be significantly lower than previously expected.

Presented in September, the draft Budget Law for 2009 is likely to be recalled or significantly amended, as it was developed prior to financial stresses on both the external and domestic markets and deteriorated prospects for the next year. Moreover, the targeted deficit of UAH 17.4 billion ($3 billion), or 1.4% of GDP, is not in accordance with the government`s commitment to the IMF to maintain a balanced budget in 2009.

A prudent fiscal stance is considered the most effective measure to cool aggregate demand, tackle inflation and narrow the foreign trade deficit. Given the turbulent political environment, it looks like the 2009 budget law will be approved next year.

MONETARY POLICY

Monetary policy tightening, appreciation of the national currency in May, and a record harvest caused prices to fall during July-August. As a result, annual inflation continued to decelerate, reaching 26% yoy in August, down from its peak of 31.1% yoy in May. However, two-month deflation was a temporary relief as in September, monthly inflation advanced by 1.1%.

However, inflation kept slowing in annual terms to 24.6% due to a high statistical base. A rise in monthly inflation reflects a 3.8% mom increase in utility tariffs (starting September, natural gas prices for the population were increased by 13–14%), 21.2% mom growth in the cost of education services and 1.2% mom more expensive services in restaurants and hotels and higher excises on tobacco.

Some relief was brought by declining gasoline prices (down by 6% mom in September) consistent with falling world crude oil prices.While inflation is expected to decelerate further through the end of the year, its pace will be much slower.

First, easing inflation provided the government authorities with some room to adjust a number of regulated prices and tariffs. A 20% rise in communication tariffs since the beginning of October, another 35% increase in natural gas tariffs for households since the beginning of December, and multi-fold increases in utility tariffs for legal entities and transportation tariffs in Kyiv, the capital and the largest city of Ukraine, were already announced.

Second, the recent sharp depreciation of the national currency may spill-over into domestic inflation as it will make imported goods more expensive. Although the substitution effect will be present, it may be quite limited for a number of inelastic goods such as medicines, energy, etc. Annual inflation is expected to slow moderately to about 22% yoy in 2008.

Unfavorable sentiments formed amid recent intensification of global financial turmoil and Ukraine`s deteriorating fundamentals prompted foreign investors to more actively withdraw capital from the country. A combination of falling world steel prices and weakening external demand, a large current account deficit and sizable payments due on private sector external liabilities, weaknesses in the banking system (high exposure to credit and foreign exchange risks) as well a new wave of political instability since September tilted the balance towards sharp Hryvnia depreciation.

The NBU refrained from active support of the exchange rate, allowing it to depreciate, which was consistent with May`s decision to switch towards a managed float regime. The NBU, however, wanted a smooth exchange rate adjustment to its market clearing level by selling limited amounts of foreign currency on the interbank foreign exchange market.

This strategy resulted in a loss of $4.5 billion in the NBU`s foreign exchange reserve during September-October and in a depreciation of the Hryvnia by about 27% of its value against the US dollar over the period (to UAH/USD 5.95 on average on the interbank market at the end of October).

Devaluation may also intensify stress on the banking sector due to existing currency mismatches of banks` assets and liabilities. Although the level of indebtedness of the Ukrainian private sector is far below that of developed countries, more than half of all loans issued by commercial banks are denominated in foreign currencies.

This means that local borrowers are particularly exposed to currency risks. On top of that, the sixth largest Ukrainian bank suffered a bank-run by depositors in September. Although the National Bank of Ukraine responded quickly by providing UAH 5 billion (about $1 billion) of emergency refinancing and later took control of this bank, this occurrence undermined confidence in the banking system.

To minimize counterparty risks in the banking sector, commercial banks cut or closed their bilateral credit limits, restraining commercial bank access to domestic finances. In addition, the population rushed to withdraw funds from their deposit accounts. The NBU`s active support of a number of commercial banks with liquidity through its refinancing operations calmed these fears. In October, it provided UAH 29.3 billion (about $5 billion).

To avoid bank-runs, the NBU has imposed a six-month freeze on the early withdrawal of savings deposits from commercial banks. Simultaneously, an increase in the deposit guarantee was suggested to UAH 150,000 (about $25,800), tripling from the previous level. The NBU has also imposed tight limitations on the capacity of the commercial banks to expand their credit portfolio.

Although the NBU softened this restriction a few days later, trying to avert a local credit crunch, the ban on foreign currency loans to borrowers without foreign currency income was left intact. The NBU strengthened its monitoring capacity of external private sector debt. In particular, it required commercial banks to report data on their and their clients` external liabilities maturing each quarter over the next 12 months.

Government officials have also considered the establishment of a stabilization fund, which would work with a government-owned Asset Recovery Company to buy and resolve some of the distressed assets of the banks.

Ukrainian authorities applied for IMF financing support and on October 26th, an agreement was reached on a two-year $16.5 billion stand-by IMF loan. Given the above measures and support from the international financial institutions, Ukraine may still weather the storm with relatively moderate pain.

INTERNATIONAL TRADE AND CAPITAL

Ukraine`s foreign trade data, released by the State Statistics Committee for January-August, still demonstrate a rather favorable picture. Exports kept increasing fast, advancing by an impressive 48.5% yoy over the first eight months of the year. An outstanding harvest triggered a surge in grain exports, which expanded by 120% yoy over the period.

High world iron ore, coal and energy prices over the period underpinned an almost 70% yoy increase in mineral products exports, whose share grew to 10.4% of total merchandise exports, up from 9% in the respective period last year.

Weakening of world steel prices, which was observed since July, had a minor impact on Ukraine`s exports of metallurgical products in August. Export of the weightiest group of commodities surged by 60.6% yoy, bringing cumulative growth to 54.5% yoy.

Robust economic growth in Ukraine`s main trading partner countries supported a 40.5% yoy increase in exports of machinery and transport equipment. At the same time, export growth started to decelerate in August as exports in value terms were by about $1 billion lower compared to the previous month.

Although a decline in world iron ore, steel and energy prices, tighter domestic credit conditions and slower growth in real households` income contributed to a deceleration in imports in August, rates of growth remained at an impressive 63% yoy that month (down from almost 70% yoy in July) and 58.3% yoy to date.

As imports continued to notably outpace exports, the FOB/CIF merchandise trade deficit widened to $12.5 billion over the first nine months of this year. A deteriorating foreign trade balance is the main cause of the widening current account gap. According to preliminary estimates of the NBU, the CA gap widened to $7.5 billion in January-August, representing 6% of period GDP.

Over the period under review, this amount was fully covered by foreign direct investments, estimated at $8.1 billion over the period. However, the current account gap is expected to reach $12–13 billion, or about 7% of GDP, in 2008.

In addition to this, Ukraine will need to serve significant foreign short term debt. As of June 2008, out of total external debt outstanding of $100 billion, about $28.2 billion was due up to one year. At the same time, the NBU registers external debt by original maturity.

This means that if the short-term portion of the long term debt is included, the total amount of external debt refinancing may be as high as $40–45 billion. Although a portion of this sum is either due by subsidiaries to parent companies or represents more stable trade credits, the net external financing requirements still remain at a substantial $25–30 billion.

While this amount looks manageable, amid a turbulent global environment marked by risk aversion and worsening macroeconomic fundamentals, raising it may be very difficult, which points to rising stress on Ukraine`s balance of payments.

Although official data is not available yet, very high risk premiums on Ukraine`s securities, a decline in portfolio investments, partly as a result of which the country`s stock exchange (PFTS) index has declined by more than 80% year-to-date, and finally sharp currency depreciation during September-October show that the above risks have started to materialize.

On a positive note, declining world crude oil prices increase chances that the natural gas price increase on imported gas in 2009 may be significantly lower than in was previously anticipated. Coupled with the implementation of a government program developed in close cooperation with the IMF to restore financial and macroeconomic stability, current account pressures will ease substantially. The current account gap is now forecasted to decline to about 3% of GDP in 2009.

OTHER DEVELOPMENTS AFFECTING INVESTMENT CLIMATE

Following rapid deterioration of macroeconomic fundamentals, currency pressures and increased worries over banking sector health, international rating agencies downgraded Ukraine`s sovereign ratings as well as individual ratings of a number of private companies and commercial banks.

For the same reasons, the Ukrainian authorities applied for IMF financial support at the beginning of October. On October 26th, a tentative agreement was reached on a two-year $16.5 billion stand-by agreement. The final decision was conditioned on the parliament`s approval of a number of legislative initiatives, including approval of a bank recapitalization program and a firm commitment to prudent fiscal policy coupled with tighter monetary policy.

Despite a turbulent political environment, the government authorities promptly developed the “stabilization” package, which was approved by the parliament at the end of October. For the Parliament vote to be legitimate, the President has suspended the dissolution order of the Rada. Moreover, early parliamentary elections called by the President at the end of September are likely to be delayed until spring of next year.

Although the approval of the IMF financial support package is not a panacea, it sends positive signals about the possibility that Ukraine may weather the storm with relatively moderate pain.

The IMF support also opens other alternative external sources of financial assistance to Ukraine. In particular, the World Bank has already announced it is revising its program of cooperation with Ukraine to provide rapid assistance in hot areas, such as restructuring and recapitalization of the banking sector, improving support to the poor, deepening of structural reforms to restore Ukraine rapidly to sustainable economic growth, etc.

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Monthly Analytical Report: By Olga Pogarska, Edilberto L. Segura

SigmaBleyzer Emerging Markets Private Equity Investment Group,

The Bleyzer Foundation, Kyiv, Ukraine, Tuesday, December 2, 2008

Technorati Tags: Ukrainian economy, IMF, PFTS, international trade, iron ore, steel, energy prices, personal income taxes, free trade, Olga Pogarksa, Edilberto L. Segura, fiscal policy, reform, current account deficit, foreign exchange risks, hryvnia, balanced budget, natural gas prices, hotels, restaurants, oil prices, tobacco, National Bank of Ukraine, NBU, utility tariffs, transportation tariffs, EU, monetary policy, Anton Olff, current account balance, domestic credit markets, credit squeeze, export, chemical production, private consumption, domestic consumption, extractive industry, machine-building, construction, transportation, metallurgical producers, industrial production, State Statistics Committee, flight to quality, GDP, banking, inflation, export, www.unian.net, www.sigmableyzer.com, Kyiv,

While the perception in “the street” and in boardrooms is for more economic pain, there are some bright spots. Moreover, there is a consensus that Ukraine will continue to grow as well as transition to a brighter future.  The well respected ERSTE Banking Group (www.erstegroup.com) chimes in:

“The steel industry will continue to invest heavily in production efficiency programmes. The local steel industry has great potential for cutting production costs, as Ukraine has one of the world’s biggest layers of iron ore and large layers of coal. The recent introduction of steel price futures on the London Metals Exchange (and plans to introduce them on the New York Mercantile Exchange) will bring new hedging possibilities for steel producers. The banking system will also strengthen after a period of consolidation and an increase in the share of foreign capital. In the future, Ukraine will remain influenced by cyclical downtrends in steel demand, but will be much more resilient to them, than it is now (compared to just several years ago). “GDP growth will return to its potential growth of 5-6% in 2010, while inflation is likely to come down to a single-digit figure,” conclude Erste analysts”

The key for investors, will be reassessment of risk relative to other markets. It is my view,  Ukraine offers attractive returns over the longer term given the momentum of structural reforms that the current economic situtation may in fact, accelerate. The real question is whether Ukraine will be transparent enough for investors to accurately measure this to their advantage. 

Anton Olff

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