Wednesday, 21 October

The coming year will not be easy for the Ukrainian economy. GDP growth will slow down, despite the good expectations of the business. The reasons are rather a moderate consumer demand, due to the slow growth of incomes of the population and the situation in the world markets is not too favorable for our exporters.

At the same time, in 2019, the state should return a significant part of foreign debt, to maintain the declared level of the state budget deficit, to hold presidential and parliamentary elections, to attract additional funding in both external and domestic markets, while competing with neighboring states not only for the funds of investors, but also for qualified labor. To cope with all these tasks is possible only under the condition of balanced state policy and coordinated cooperation of the Government, Parliament, business and banking sector.

Macroeconomic risks

In 2018, investment and consumer demand contributed to accelerating economic growth, according to averaged forecasts, by the end of the year it will reach 3.5%. According to the macroeconomic forecast of the NBU, next year the economy will grow more slowly. At the end of 2019, the growth rate of nominal GDP will be 2.5%, and core inflation will decline from 10% in 2018 to 6.3% at the end of 2019. That is, the current goal of the NBU in terms of inflation, Ukraine will be able to achieve only next year, and the achievement of the medium-term goal of 5% is postponed to the end of 2020.

This is primarily due to the accelerated growth of administratively regulated prices and the cost of fuel, unaccounted for in the central bank’s forecasts. In addition, production costs in the real sector grew at a faster pace, including company wage costs and energy purchases. The growth of wages of Ukrainians (by 26% compared to the previous year) and social benefits stimulated a revival of consumer demand, which also influenced inflation. According to the NBU, it extended a tight monetary policy to curb inflation and left the discount rate at 18% (it increased from 12.5 to 18% over the year), which significantly limits the availability of funds for the real sector.

In 2018, the main drivers of GDP growth were agriculture and industries focused on meeting domestic demand (trade, services, transport). The business expectations of Ukrainian producers are rather optimistic, but the strict monetary policy of the central bank limits their access to monetary resources, necessary to increase production. This is one of the main factors, contributing to the slowdown in the growth of our economy.

Another important factor is the increased labor migration in Ukraine. In addition to Poland, which has been actively attracting Ukrainians to its labor market for several years in a row, the Czech Republic and Germany announced such intentions, promising to simplify procedures for the employment of foreigners. The next outflow of labor will deepen the imbalance between supply and demand on the labor market, on the one hand, accelerating wage growth in certain sectors, on the other, creating local deficiencies of skilled workers.

Additional factors will be the general “cooling” of the world economy and some deterioration in the price situation on the commodity markets.

Despite significant changes in the structure of our exports, ferrous metals and ore are still one of the priority export products of Ukraine. And the protectionist measures of the US and the EU have significantly narrowed the number of free markets for the supply of these products that accordingly increased the competition for them. Therefore, next year the downward trend in the cost of ferrous metals and iron ore will continue. In addition, the slowdown in economic growth in China, one of the world’s steel producers and China’s “trade wars” with the United States, is expected to lead to an excess of steel in world markets. Accordingly, the agricultural industry will remain the main driver of economic growth next year. Our manufacturers will continue to increase their presence on both new and already traditional markets for us (EU, Middle East, China, and India). According to preliminary calculations, even under adverse conditions in world markets, the fate of the physical volumes of agricultural products in our exports next year will increase to 45%.

This will provide the country with the minimum necessary amount of currency in the domestic market. Of course, given the high devaluation expectations that exist today, it’s too early to say that the hryvnia is gaining momentum. But even the expected devaluation will be fairly smooth and restrained ‒ to the level of 30 UAH/USD at the end of 2019.

Of course, there are a number of factors that could make this forecast worse, but most of the baseline scenarios suggest that Ukraine will be able to cope with the main challenge next year ‒ excessive debt load.

Debt trap

An unequivocal positive is the resumption of cooperation between Ukraine and the IMF in the framework of the next Stand-by program. On the eve of Catholic Christmas, Ukraine will receive the first tranche of aid, amounting to about 1,500,000,000 dollars of the total amount of 3,9 billion dollars. Getting loans from the IMF and other official lenders will not only allow us to increase our international reserves but also to finance part of our loans, attracting new loans. Of course, such a debt service strategy of the state can hardly be called balanced and far-sighted, but in this case, the Government is deprived of other reasonable alternatives, because otherwise, the country will be in default.

According to the data of the Ministry of Finance and the National Bank of Ukraine, the next year, payments of Ukraine on the external debt will amount to about $ 5 billion, of which the actual debt repayment is 3,5 billion, and the rest are its servicing. It is clear that with existing international reserves in the amount of $ 16,7 billion to fulfill such obligations it will be very difficult because the currency is necessary for the NBU not only to repay loans, but also to regulate demand and supply in the domestic market, and to ensure the smooth operation of importers. Consequently, the Government will once again enter foreign borrowing markets, and, most likely, already in the first quarter of 2019, with a proposal of $ 1‒1,5 billion. And these loans will not be cheap. Taking into account the current value, the decline in investor interest in emerging markets and our internal political risks, associated with the elections, the cost of government loans will be at least 10.5% per annum. In conditions of such a high price, it would be reasonable to pay off these debts ahead of schedule, but for this, the Ministry of Finance will go to foreign markets several times during the year. It is quite difficult, because the “window of opportunity” does not open so often, and the risks associated with the Russian aggression against Ukraine are unpredictable and significantly affect investor interest in our securities.

“Internal” deficits

The key to our cooperation with international donors is to contain low budget deficits, which will require the Government to continue the tight monetary policy. Of course, certain state expenditures will increase next year, above all “social” ‒ wages and pensions financing. If according to the plan, the Road Fund will start working, at the expense of which funds the restoration of the road infrastructure should begin, then capital expenditures will also increase. However, the rest of the financing is planned to be very restrained.

Despite the outflow of labor, the unemployment rate will remain fairly high due to slow economic growth. The growth of wages will also be moderate since the financial resources of enterprises are exhausted and they simply cannot withstand the real competition for labor with neighboring countries. Accordingly, the growth of wages, according to the forecasts of the central bank, next year will be about 16% in nominal terms and 7% in real (taking into account inflation), and wage growth in the state sector will be even slower. People will be poorer then. The resulting deferred demand for goods and services will stimulate the further development of retail lending ‒ by about 30% for the year.

This year, the growth in retail loans and auto loans reached 49%, and since this segment had previously developed very sluggishly, in the total loan portfolio of Ukrainian banks, even at such rates, retail loans make up only 17%. Therefore, the potential for increasing the volume of consumer loans without risks for the banking system still remains significant. Although the NBU, for example, looks at this trend without enthusiasm, it is unlikely that it will somehow begin to limit consumer lending before 2020. The Central Bank understands that now consumer demand is not the only factor, stimulating economic growth, and it is worthwhile to do everything to keep it at the existing level. And for this, people need funds that, with slow growth in their own income, can only be obtained in the form of loans.

In general, the banking sector is still stable, all banks have adequately withstood recent stress testing, with the exception of some. The main problem of banks, as in previous years, remains the problem of loans to legal entities that are not serviced, as long as their level in the total portfolio is 57%, and for individual state banks, it exceeds 80%. This is one of the main reasons why, unlike consumer lending, corporate lending does not develop at all. Banks do not want to issue new loans to businesses, which, as a result, lack funds not only for development but also for current activities. Unfortunately, despite all the promises of the Government to solve the problem of “toxic” loans, at least for state banks, this is unlikely to happen next year, and even if it does, it will not give instant results. Therefore, the real sector can only hope for external investors, who so far, unfortunately, have not shown interest in cooperation with our companies.

In fact, the presence of non-resident investors is felt only on the market for the sale of our domestic government bonds, earning on exchange rate differences, investors substantially support the state budget of Ukraine. Interest in domestic government securities is noticeable among individuals, and it is not surprising, since, with a valid discount rate, their yield is extremely attractive. Despite the obvious speculativeness of these investments, the state budget will only benefit from this, because it receives additional funding. If the demand for domestic bonds will grow at the same pace, then in the next, the Ministry of Finance will be able to raise quite substantial amounts to the budget through domestic government bonds.

However, this only partially compensates for the burden on the next year’s state budget. Provided that the privatization plans fail once again, the amounts required for the payment of subsidies are still very conditional, and the Pension Fund may once again face the problem of paying pensions, it will be extremely difficult for the Government to execute the budget. And the Parliament is likely to add work to it, making informed decisions on the eve of the elections, which require additional funding. But, probably, the main task for the Government and the NBU will be to maintain demand, which now guarantees Ukraine, albeit a slow, but predictable economic growth. From a shaky balance between population incomes and inflation, it will depend on whether the real sector will work, whether taxes will be paid on time, and ultimately whether Ukraine will leave 2019 without significant disadvantages.

By Valentyna Yushchenko

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