Political instability weighs on economic recovery


HIGH RISK for entreprise

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

GDP USD112bn (World ranking 60, World Bank 2017)
Population 44.8mn (World ranking 31, World Bank 2017)
Form of state Republic
Head of state Volodymyr ZELENSKY (President)
Next elections 2024, presidential and legislative
  • Fertile black soil
  • Willingness of International Financial Institutions and bilateral donors to support Ukraine financially
  • Severe conflicts with separatists in east Ukraine ...
  • ... and with Russia (which supports the separatists)
  • History of political instability and government inefficiency; weak constitutional framework
  • High economic dependence on Russia (major trading partner, in particular natural gas supplier)
  • Poor economic policy track record
  • Exchange rate vulnerability
  • Modest foreign exchange reserves, implying significant transfer and convertibility risk
  • High public debt, of which about 60% in foreign exchange
  • Very high external debt
  • A generally weak business environment

Protracted economic and political crises

Ukraine has been in an economic crisis since 2011 and was in recession from mid-2012 to 2015. In 2014-2015, the violent conflict between government forces and separatists in east Ukraine, and the related serious dispute with Russia (which annexed Crimea in March 2014 and supports the separatists), drastically aggravated the situation, leading to two years of deep recession (-6.6% in 2014 and -9.8% in 2015). Ukraine’s  economy returned to modest growth in 2016-2018 (+2.7% on average) but has remained fragile overall and dependent on international financial support.

After the second ceasefire agreement in February 2015, the fight­ing in the east moderated some­what, though it has flared up again several times, most recently in late 2018, when Russia captured three Ukrainian naval ships east of Crimea in the shared territorial waters of the Black Sea. The renewed tensions highlighted once again that the conflict is far from over and may re-escalate at any time; an accidental war cannot be fully ruled out.

In May 2019, Volodymyr Zelensky succeeded Petro Poroshenko as President, after winning the second round of the presidential election by a landslide in April, gaining 73% of the vote. Poroshenko’s failures during his term included a poor track record on IMF-mandated reforms, little progress in the fight against corruption and almost no advancement with regard to the Russian-backed insurgency in the east of Ukraine. To tackle the latter two issues were key campaign promises of Zelensky, but we do not expect rapid, significant progress on these in the next two years or so, even though Zelensky has called for early elections on 21 July 2019 in order to create a base in parliament for himself. In the near term, an economic challenge is already waiting: Russia announced a ban on oil and coal exports to Ukraine from June. As Russia accounts for 35% and 65% of Ukraine’s total oil and coal imports, respectively, we expect supply shortages and, as a result, rising inflation in H2 2019.

The IMF program agreed in March 2015 was cancelled in December 2018. It had been more off track than on track, reflecting a very slow structural reform process. An important issue had been the introduction of an anti-corruption law. In late 2018, the government finally adopted such a law,.but implementation, including formally establishing the respective court, will take time. As a consequence, the fourth review of the IMF funding program (running from March 2015 to March 2019), which was scheduled for May 2017, had been pending until end-2018 (and so had the funding).

Instead the IMF approved a new 14-month Stand-By Arrangement (SBA) for Ukraine, with funding amounting to about USD3.9bn, at the end of 2018. USD1.4bn was immediately disbursed. The next tranche has been postponed until after the early elections in July. However, the total funding of the new program is much smaller than that of the previous program (USD17.5bn). Overall, the slow reform progress does not bode well for Ukraine’s medium-term economic outlook.

Growth slows while economic policy remains bumpy

Recovery loses momentum

Real GDP growth decelerated to a five-quarter low of +2.5% y/y in Q1 2019 (from +3.5% in Q4 and +3.3% in full-year 2018). As in 2018, growth was not balanced in Q1, mainly driven by surging consumer spending (+10.9% y/y) and fixed investment (+17.4%), with the latter boosted by a construction boom. However, inventories subtracted a hefty -5.9pp from Q1 growth. Government spending contracted by -8.3% y/y. External trade activity recovered somewhat and net trade subtracted -0.4pp from Q1 growth. On the production side, construction output soared by +26.8% y/y in Q1 while services and agriculture posted reasonable increases. Industrial production was the weak spot, declining by -1.5% y/y.

Euler Hermes expects annual economic growth to stabilize at around +2.5% in 2019-2020, with private domestic demand to remain the key growth driver. Still, the annual level of GDP in 2020 will then be around -4% below the level in 2012 and -10% below the level in 2008 (i.e. before the global financial crisis, which had also hit Ukraine hard). Moreover, downside risks to our forecast prevail, including the renewed intensification of political instability and disruptions to international funding programs.

Currency and inflationary risks have declined but not disappeared

After the National Bank of Ukraine (NBU, the central bank) abandoned the peg of the UAH to the USD (at 1:8) in February 2014, the currency experienced a sharp downward correction and heavy volatility. At the end of 2016, it had lost around -70% in value. Since then, the UAH has more or less stabilized in line with the economy, recording reasonably small losses in 2017-2018 and a +6% gain in H1 2019. The gap between the official exchange rate and the middle rate on the foreign exchange (FX) cash market has almost waned, reflecting that downward pressures on the currency have declined. Euler Hermes expects the exchange rate to remain relatively stable overall until mid-2020, albeit with bouts of volatility likely in response to significant political events and/or surprising economic data.

As the UAH has steadied, by and large, headline inflation has decelerated from a peak of 60.9% y/y in April 2015, and an annual average of 48.7% in full-year 2015, to 10.9% in 2018 and a recent low of 8.6% y/y in March 2019. However, thereafter inflation picked up again to 9.6% y/y in May 2019 and we expect it to remain close to 10% for the remainder of this year due to the Russian ban on oil and coal exports to Ukraine (see above). In 2020, inflation is forecast to fall to an average 7.5%.

After a period of monetary tightening until September 2018, the NBU cut its key monetary policy interest rate by 50bp to 17.5% in April 2019. Once inflation moves back on a trajectory to the NBU’s target range of 6% ±2pp, monetary easing is likely to be continued in order to support the recovery.

Public finances remain a key concern

Public finances rapidly deteriorated in the wake of the 2014 crises, with the fiscal deficit surging to a peak of -10.1% of GDP in 2014 and public debt rising to 81% of GDP in 2016 (up from 37% in 2011). Since May 2014, financial support from the IMF, the EU and other bilateral and multilateral partners, as well as a debt restructuring of USD15bn or so with 13 private creditors, helped to stabilize public finances.

Against this background, the fiscal deficit narrowed and has been below -3% of GDP since 2015 and should remain so until 2020. But public debt is still very large at about 64% of GDP, posing refinancing concerns and a risk to the recovery in the medium term.

External liquidity risk remains high

A balance-of-payments crisis evolved in 2014 as the current account deficit (-3.9% of GDP) was accompanied by a large capital account deficit (-7% of GDP) due to capital flight. As a result, FX reserves dwindled to a low of USD4.7bn in February 2015, despite international financial support. Since 2016, the capital account has been back to annual surpluses of +5% or more of GDP, mitigating the balance-of-payments problems to some extent. However, the current account deficit rose again to -3.7% of GDP in 2018 and only half of it was covered by net FDI inflows, i.e. the remainder had to be financed through more risky short-term debt. We forecast the external deficit to remain elevated at around -4% of GDP in 2019-2020.

Meanwhile, FX reserves have recovered to around USD19bn in early 2019. Yet, this is just adequate in terms of import cover (3 months). In other terms, however, reserves cover only 40% of all (public and private) external debt payments falling due in the next 12 months, much below a satisfactory level of 100%. As a consequence, non-payment risk will remain very high, not only in the private sector but also in the public sector, especially if external financial support continues to be frequently interrupted. Total external debt will remain hefty at over 100% of GDP in 2019-2020. 

Trade structure by destination/origin

(% of total)

Exports Rank Imports
Russia 13%
20% Russia
Turkey 7%
10% Germany
China 7%
10% China
Egypt 5%
6% Belarus
Poland 5%
6% Poland

Trade structure by product

(% of total)

Exports Rank Imports
Agricultural products; foodstuff 38%
32% Mineral products (incl. oil, gas)
Metals & metal producs 25%
16% Machinery
Machinery 10%
13% Chemicals & pharmaceuticals
Mineral products (incl. oil, gas) 8%
9% Agricultural products; foodstuff
Chemicals & pharmaceuticals 6%
7% Plastics & rubber

  • Low

  • Medium

  • Sensitive

  • High

  • Payments

  • Court proceedings

  • Insolvency proceedings