UKRAINE MACROECONOMIC SITUATION, September 2014

Key points:

• The gradual progress of Ukraine’s military forces in regaining control over rebel-occupied territories was interrupted at the end of August, following an ‘undeclared’ invasion of Russian troops in Ukraine.
• Amid growing damages and losses, Ukraine has agreed to participate in trilateral peace talks with Russia and the EU, which ended with a ceasefire deal reached on September 5th.
• On September 16th, Ukrainian and European parliaments both ratified the EU-Ukraine association agreement. However, due to pressure from Russia, implementation of the free trade agreement was delayed until 2016.
• Ongoing hostilities in the east, Hryvnia depreciation, fiscal austerity and worsening trade relations with Russia hit the Ukrainian economy. In 2Q 2014, real GDP decreased by 4.6% yoy, bringing the cumulative decline to 3% yoy.
• High-frequency real sector indicators for July-August point to a deepening recession in 3Q 2014. In particular, the decline of industrial output production worsened from 4.7% yoy in 1H 2014 to 12% yoy in July and 21.4% yoy in August.
• Unlike other sectors, agriculture remains the bright spot of the Ukrainian economy. The sector demonstrated solid 6.3% yoy growth over the first eight months of 2014, and the country is estimated to collect a high grain harvest this year de- spite an unfavorable environment.
• Due to a deeper economic downturn and the intensified armed insurgency in eastern oblasts, which exerted an additional toll on budget revenues and required higher expenditures on military operations, Ukraine’s fiscal accounts remained under significant strain despite a number of fiscal austerity measures. Worsening public finances demanded additional fiscal con- solidation efforts. The total deficit is still forecast to widen notably to about 10% of GDP, mainly on account of larger Naftogaz imbalances.
• As anticipated, consumer inflation kept accelerating and reached 14.2% yoy in August 2014 amid the ongoing pass- through of sharp Hryvnia depreciation, an increase in excise taxes and utility tariff adjustments. End-of-year inflation is projected to reach about 20% yoy in 2014.
• Hryvnia devaluation, economic recession and political instability further weakened the fragile Ukrainian banking sector. The sector lost almost a fourth of its deposit stock over the first eight months of the year and faces asset quality problems. However, thanks to NBU measures and IFI financial assistance, the situation in the sector remains manageable, although temporary NBU administration was introduced in a number of troubled banks.
• Ukraine’s current account balance notably improved from April to August 2014, mainly on account of a steeper decline in imports. Although exports suffered from Russia’s trade restrictions, they benefitted from early EU trade supportive meas- ures, Hryvnia depreciation and a high agricultural harvest.
• In turn, the capital account remained under significant strain. Despite a sizable financial aid package, access to foreign capital markets remains limited due to high country risks (geopolitical and economic), adversely affecting Ukraine’s abil- ity to successfully issue sovereign debt as well as to roll over private debt.
• Capital account pressures triggered further Hryvnia depreciation in late August and September. Thanks to NBU capital controls and foreign exchange administrative restrictions, the NBU stabilized the Hryvnia at around UAH 13 per US Dol- lar. From January to September, the Hryvnia lost almost 63% of its value. With the IMF program on track, the exchange rate is forecast to remain at around UAH 13.5 per USD throughout the rest of 2014 and in 2015.

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