Ukraine 2016: Closer to Stabilization, Far Away From Growth

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The economic situation in Ukraine in 2015 and 2016 will depend on progress in externally supported reform program and on stabilization in the Eastern Ukraine. Currently, we assume that there will be no escalation of military conflict but instability will continue until the end of 2016. Fiscal consolidation, decline in real wages and unemployment will cause reduction of real private consumption. Weak hryvnia, despite dragging down consumption and investments, helps to increase fiscal revenues and narrow the current account deficit. Overall, net real exports will positively contribute to real GDP growth due to lower purchasing power and imports substitution.

GDP

Escalation of military conflict in the East of Ukraine in February, collapse of trade with Russia and weak external demand resulted in larger than previously expected drop in exports. Besides, low level of international reserves and instability of financial system led to capital outflows and elevated demand for imports. On top, the decision of the National Bank of Ukraine (NBU) to liberalise foreign exchange market was timed very badly, i.e. at low point of market confidence. Hryvnia sharply depreciated in February and economic activity fell more than expected in the first quarter of 2015. Therefore, real GDP is expected to decline by 8.2% in 2015.

However, Ukraine successfully completed negotiations with the IMF, fulfilled preconditions and received first tranche of the Extended Fund Facility with the IMF (EFF). This resulted in higher international reserves of the NBU, unlocked access to funding from other donors and it is expected to help the Government to finance FX liabilities. To receive the new Program the Government predictably had to increase tariffs and revise the State Budget Law, but tariff increase was much higher than expected. The situation in banking sector remains difficult, but most of the largest banks continue operations with the help of the NBU if needed. Thus we forecast real GDP growth at 1.6% for 2016.

Consumption

Real private consumption in 2015 is expected to decline by 9.7% in 2015 due to the drop in real disposable income by 12.9%. Real wage income will sharply decline this year. In particular, unemployment will remain at over 10% of economically active population (15-70 years old) as it was in second half of 2014. This will reflect job losses in most sectors, efforts to increase efficiency of public sector and a large number of displaced persons from Donbas and Crimea. Increase in nominal wages primarily due to indexation will be much lower than projected inflation partially due to cuts in premiums and bonuses. Income from social assistance will also decline in real terms due to frozen social assistance payments and limited indexation for inflation. Net lending is likely to be negative, while purchases of cash foreign currency will be limited due to limited spare cash for saving in any form.

Real private final consumption in 2016 is forecasted to decline further by 0.4% as real disposable income will fall by another 2.1%. In particular, wage increases are not likely to keep up with still high inflation. Households are likely to increase somewhat bank deposits in 2016, while bank lending will be restricted as well as purchases of cash foreign currency.

Investment

Investment in 2015 will be determined by severe financing constraints i.e. few if any bank loans and drop in free cash flows after paying for labour and inputs. Besides, hryvnia depreciation and inflation would result in a much larger drop of investment, but several factors support investment. These include international project loans, continued demand for residential housing, increased defence spending, and very high wear of equipment forcing companies to spend on essential repairs. It is expected that real gross fixed capital accumulation will decline by 10.5%.

Real gross fixed capital accumulation in 2016 is forecasted to grow by 4.4%. We expect that inflow of the international financial support and lower intensity of the unrest in the East of the country will have small but positive effect on investments. It is unlikely that the Government will start large investment project, but some crucial reconstruction of controlled part of the Donbas is still possible. It is expected that the level of investments will be lower or close to replacement level that have negative economic effect in the longer run. As a result, strong economic recovery will be postponed.

Trade

Real exports of goods and services is forecasted to continue its drop by another 10.5% in 2015. Drop in exports to some degree reflects impact of military conflict in the East and tensions with Russia on external trade that occurred in the last four months of 2014. However continued instability in the East, mounting financial difficulties, low external demand for key export commodities, collapsing trade with Russia were also felt in the first quarter of 2015 and will likely weigh down exports in next months. Increased competitiveness of Ukrainian goods due to hryvnia depreciation as well as autonomous trade preferences from the EU will help Ukraine’s exporters to adjust to new conditions but will have limited immediate impact on exports.

Real imports of goods and services is projected to decrease by 13.7%. This will reflect continued depreciation of hryvnia (from weighted average level of UAH 11.87 per USD in 2014 to estimated 22.96 in 2015), imports surcharge of 5-10% as well as low domestic demand.

We expect that Ukraine’s foreign trade will increase slightly in 2016 due to some improvement in export capacity and increase in investment demand. Real exports of goods and services are projected to increase by 3.4% in 2016 in response to stronger external demand. Adjustment of exporters to new logistical routes and substitution of broken trade ties with Russia (partially due to expected increase in tariff barriers by Russia) will positively contribute of exports.

Real imports of goods and services in 2016 is projected to increase by 1.3% in response to lower tariffs for EU goods and delayed consumer demand for imported goods. Consumer income is also projected to increase in dollar terms. However, households’ purchasing power will remain weak. Accordingly, we expect some increase in imports of consumer goods.

An article by Oleksandra Betliy, Vitaliy Kravchuk, Mykola Ryzhenkov, Oleksa Stepaniuk, Artur Kovalchuk

This is an extract from the Macroeconomic Forecast Ukraine (MEFU). The MEFU includes the IER’s forecast of the GDP and its components, disposable income and unemployment rate, fiscal indicators, balance of payments, inflation, exchange rate for current and next years. There are 12 issues per year. Quarterly issues (published in January, April, July and October) present new and revised estimates, while monthly issues focus more on recent trends and define the direction of possible forecast revision in the quarterly issue. The product is distributed among subscribers.

The Institute for Economic Research and Policy Consulting - Kiev
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