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.