The announcement on May 20, 2019 of the dissolution of
the parliament, made during the inaugural speech of the President Volodymyr
Zelensky, followed by thye subsequent announcement of Prime Minister Volodymyr
Groysman’s resignation, forces us to revise our previous forecast for Ukraine’s
Our previous forecast was STABLE with a possible
slowdown in growth rates to NEGATIVE and CRISIS for the short-term
macroeconomic stability (until the end of 2019).
Listed below the are the factors which can
significantly influence (and, after May 20, are already influencing) servicing
(prospects for refinancing payments) foreign debt, the state of gold reserves,
inflow of export earnings into the country, business activity, stability of the
banking system and population’s deposits in banks, budget and tax revenues, as
well as the risks of hryvnia devaluation until the end of the year:
1. Risk factors in servicing (and refinancing)
external payments and reducing gold and foreign exchange reserves
Ukraine entered the year 2019 with a record schedule
of liabilities for external payments in the amount of $6.3 billion (and $9
billion of foreign currency debt, if we take into account government payments
on foreign currency bonds). According to our preliminary forecast, the balance
of external payments and borrowings in the current year should have been minus
$2.7 billion dollars, which, with an increase in foreign exchange earnings,
investments and transfers of labor migrants, should have reduced the country’s
balance to $0-$1.5 billion dollars. That should not have affected the exchange
rate stability with a net inflow of currency.
However, the government’s resignation on May 20 makes
it impossible to receive a tranche of $1.3 billion in May-June and $1.3 billion
in the fall of this year.
Receipt of IMF funds is closely related (“bound by
condition” under loan agreements) to receiving EUR 500 million of
macro-financial assistance from the European Union and $1 billion in two
tranches from the World Bank.
2. The risk factor of the “gas blockade” of Ukraine by
Russia scenarios for countering this blockade
At the end of 2019, the Agreement on Gas Transit
between Ukraine and Russia expires. There are signs Russia is preparing to
totally abandon gas transit through the territory of Ukraine. To this end, in
2018-19 Gazprom artificially increased gas pumping volumes to Europe, but
solely with the goal of filling the Haubgarten and other European gas storage
facilities with its own gas and reducing the level of pumping through the
Ukrainian State Customs Committee to zero from 2020. This is not a new risk.
All European agencies have written about it since the beginning of the year.
The only way to prevent the “complete shutdown of gas from the Russian
Federation” is to inject the required amount of gas into Ukraine’s gas storage
facilities. With a minimum of 22 billion cubic meters against 8 billion cubic
meters available, we are talking about the need to pump 16 billion cubic meters
of gas for the summer season (May-September). At current market prices, this
amounts to $3.2 billion of additional foreign currency expenditures by the
state during the summer period. (NAK Naftogaz’s credit line of $500 million for
gas pumping for the winter period will obviously not be enough to preempt this
This generates not only the risk of deficiencies in
the state’s currency and/or exchange rate risk in the summer, but also creates
a higher-order social and political risks, because if gas in the storage
facilities does not suffice to operate the system in full “reverse” conditions
next winter, there emerges the risk of “freezing” million-plus cities
in Ukraine, not to mention leaving large industrial enterprises without gas.
This will have consequences for Ukaine’s economic growth in 2020.
3. The risk factor of “panic” in the market of
non-resident holders of Ukrainian government bonds
About $25,1 billion is the equivalent of the domestic
market for loans in government bonds and domestic currency. About $1.7 billion
is comprised of investments of non-residents (“portfolio investors” in
Ukrainian government securities). The “signal” of instability (not to mention
the “resignation”) of government could produce a snowball effect and force bond
holders to “close their positions ahead of schedule.” This may have an
additional impact on the balance of supply/demand in the foreign exchange
market for an additional $1.7 billion in May-June-July. This scenario, of
course, was not included in regulator’s plans.
4. Loss of gold reserves and stability of the hryvnia
exchange rate through 2020
Ukraine entered the year 2019 of heightened
macroeconomic risks, political turbulence, and threats related to the need to
refinance payments on external debt with a full understanding of the sources
and stocks of foreign currency inflows into the country. According to the
January forecast of Ukraine Economic Outlook, despite record payments in the
current year, the economic development forecast should have brought the country
$1-$1.7 billion prevailing in foreign currency earnings over its expenditures
from reserves according to the “moderately pessimistic” scenario.
Risks have arisen in just one day (May 20, 2019), to
our great regret, completely negating our previous forecast. They are manifold:
a shortfall of $2.6 billion from the IMF, $1 billion from the World Bank, EUR
500 million from the EU, a deficit of $3.2 billion dollars for gas injection,
risk of “exit” of portfolio investors by $1.7 billion dollars by the
end of the year from their hryvnia-based government bonds and, during
May-June-July-August, the subsequent creation of “additional
overhang” over exchange rate stability, or the risk of hryvnia collapse
due to imbalance of demand/supply foreign currency at $5-$7 billion a year.
This is either the sum of the loss of reserves of the National Bank until the
end of the year or the loss of exchange rate stability, which was not under
threat a week ago.
5. Risk of budget revenue losses
Despite the fact that the budgets of the previous two
years (2017-2018), due to the lack of macroeconomic forecasting
(underestimation of inflation), were reduced to a balance of UAH 60-100 billion
(actual performance against the “plan”), the current 2019 budget was made in
the first quarter mainly due to the transfer of NBU profits to UAH 47 billion
and advance payment of a number of taxes, so that the budget was able to
fulfill 93% of the plan for the first quarter.
If negative trends materialize (described in points
one through four), already in June-July the problem of timely payment of wages
to state employees will arise. This will be one more significant symptom of the
“unfriendly” transfer of power in the country.
6. Without the “May 20 factor”
Ukraine was the east European state, where the growth
of “dollar GDP” exceeded 46% during the last three years. Over the period
average monthly wages increased from $170 to $400 dollars.
Ukraine had become a predictable leading country of
industrial outsourcing for the countries of Western Europe (given the
availability of the Free Trade Zone with the EU and milder, in comparison with
Europe, taxation conditions and wage conditions). The country turned into a
“new China” for the European Union. Since 2015, more than 600 new enterprises
focusing on exports to to the EU were opened in the country.
According to statistics, from the first quarter of
2019, exports to the EU for the first time in the history of Ukraine exceeded
exports to Russia.
The country’s balance of payments, despite record
external debt payments, remained at a positive level, which showed Ukraine
could maintain macroeconomic stability and “zero” exchange rate risks for the
7. Additional risks and their “compensators”
Ukraine Economic Outlook does not consider all the
above risks to be “unconditional” and “obvious”
Although the described risk factors above have every
reason to materialize, we still, nevertheless, allow for a scenario in which
Ukraine retains macroeconomic stability in 2019.
Firstly, the National Bank of Ukraine reserves amount
to $20.5 billion. Despite the real risks of breaking the cooperation program
with the IMF, even if this takes place, the NBU reserves by the end of 2019
will be only $13–$15 billion, instead of $20 billion, which will certainly be a
negative signal for investors, but will not be the basis for a so-called cross
At the same time, the President Volodymyr Zelensky’s
“new administration” and “signals” from the “Trump administration” regarding
undesirable personalities surrounding the new Ukrainian President is a matter
of serious concern, especially if we consider the formality of providing
external loans to Ukraine at 1.6% under the guarantees of the U.S. State
Treasury (against commercial rates in the loan market for Ukraine at 8%-9% per
annum). The decision of Ukraine’s “new presidential administration” to ignore
signals sent directly from Washington is not only absurd, but also unfriendly
with respect to its main strategic partner, not taking into account other
non-economic aspects of the relationship.
For the sake of the completeness of this macroeconomic
analysis, we are obliged to point out “compensators” which could “work” against
all the above trends:
– Ukraine maintains a positive inflow of currency,
based on the previous (in the last three years) increase in export rates.
– Ukraine continues to increase the amount of currency
transferred by labor migrants from abroad (from $12 to $14 billion this year,
according to the forecast), which acts as additional insurance of exchange rate
stability in the country despite the trade balance indicators (“negative”
forecast for $5 billion.)
– in connection with the announcement of “early
elections,” Ukraine will receive an additional “influx” of foreign currency
from offshore companies for expenses related to the upcoming “early” elections
in the amount of $1.5-$2.5 billion dollars in the next two months, which “will
support” hryvnia exchange rate at the current level, minimizing exchange rate
risks of devaluation until the end of July.
8. Summary and scenario course forecast until the end
The political events of May 20 (dissolution of the
parliament and the resignation of the government) are destabilizing factors for
the country’s macroeconomic situation. They threaten the receipt of tranches of
IMF loans and other sources of external financing (World Bank, euro loans) in
the summer of 2019. However, in view of the inertial trend of positive economic
growth existing in the country (export growth, transfers from labor migrants,
money for elections), the hryvnia exchange rate in June-July may maintain a
tendency not only towards stability, but also towards strengthening.
However, we see more than significant risks to this
trend by August-September, when the government will not be able to receive the
planned EUR 2 billion loan on the market and will have to repay non-residents’
funds invested in domestic government bonds.
Together with the seasonal demand of foreign currency
importers, this could lead to a “breakdown” of the exchange rate trend in
August-September. And Ukraine will have only two choices: either a sharp
devaluation of the hryvnia or depletion of NBU reserves, which will last until
the end of 2019.
In June-July, we predict (taking into account all
factors) the preservation of the hryvnia exchange rate in the corridor of UAH
25.5-27/$1. Starting in August-September, the hryvnia rate may weaken to UAH
28.5-30.0 UAH/$1. Much will depend on the preservation of the NBU’s
independence from political influence of the country’s leadership. If the
independence of the central bank is preserved, this will give great chances for
the resumption of the program of cooperation with the IMF at the end of autumn
of this year and protect the country from negative externalities described in
the section of exchange rate risks.
The decision of newly elected presidential administration to interfere in the activities of the country’s central bank after the “May 20” blitzkrieg to overthrow the government and parliament, in order to take the regulator’s activities under the political control of the winning business group, could trigger financial destabilization, leading to a sharp increase in the dollar rate and the beginning of a large-scale outflow of household deposits from the country’s banks under the 2014 scenario