Oleksiy Blinov of Astrum Investment Management -

After falling by an estimated 13.5% in 2009, Ukraine's economy has started its cautious climb back up.

For example, despite a 30-40% decrease in November 2009 from the peak in May 2008, the monthly output of the Ukrainian steel industry's key products was still 60% above its low, hit in November 2008. As the steel industry is the backbone of the Ukrainian economy and since demand for steel is a proxy for general external demand, the state of the industry is usually a leading indicator for Ukraine's economic development.

We expect Ukraine's real GDP to grow by 5% in 2010. Higher external demand should have a spillover effect for the domestic market. All key demand-side components of GDP should provide positive contributions to economic growth in 2010. After falling below the 20% of GDP level in 2009, investment should regain its role in the economy, growing 8% in real terms in 2010. At the same time, consumption growth should lag behind, constrained by inflationary pressure on disposable incomes, which should be flat in real terms, and by retail lending, which should remain anaemic. We expect that total consumption will increase by just 2.5% in real terms in 2010.

Thus, economic growth in 2010 should be different in nature compared with that in 2005-08, when household demand was a key driver. Actually, the path of recovery in 2010 should resemble the 2000 scenario, when export-oriented industries led the economy out of the 1998-99 crisis.

Inflation still high

The year 2010 should be marked by increased inflationary pressures in the economy as annual growth in the consumer price index (CPI) hits 20% in December, with growing residential tariffs for gas and electricity being a major factor. However, we expect that wage inflation will not mount significantly in 2010. Businesses should still be concerned about cost-savings, while the high unemployment rate should prevent labour from becoming significantly more expensive. At the same time, the government should have limited opportunities to lead the process by inflating the minimum wage in 2010, as the budget should be constrained by a deficit amounting to 6% of GDP. Also, now the elections are over there's no need to please voters with vote-seducing spending. Moreover, increased inflationary pressure from growing utility prices should bring wages down in real terms. We expect that nominal wages will grow 14.4% on average in 2010, while real wages will decrease by 0.9%. This should mean flat real disposable household incomes in 2010.

We expect that the current account will post a deficit of $0.5bln in 2010. The weighted average imported natural gas price growth from $210 per 1,000 cubic meters in 2009 to $325 in 2010 should prevent the current account from pulling out of the red, which would otherwise be the case. At the same time, in 2010 the financial account should reduce its deficit to just $0.5bln due to continued cooperation with the International Monetary Fund (IMF), the revival of external loans, and increased foreign direct investment. These balance-of-payment factors should provide support for the hryvnia, preventing it from going either upwards or downwards.

After the adjustment of the current account and the massive external debt redemption periods that followed, and supported by less liquidity in the national currency, the exchange rate in autumn 2009 found its new "balanced" UAH/USD rate in the range of 8.0-9.0 to the dollar. In the second quarter, the rate should stabilize at the 8.5 level, which should persist until the end of the year. We expect that the National Bank of Ukraine will continue its "managed float" currency policy.

Beyond 2010

We believe that Ukraine's economy is poised for another period of rapid growth in the five-year forecast period. After seeing 5% growth in 2010, Ukraine's real GDP should increase by 5%, on average, over the period 2011-14. Growth should be supported by a cyclical upturn globally, with significant spillover effects for the domestic market already evident in 2011.

We see 2014 as the next turning point for the Ukrainian economy, when capacity utilization rates in most industries should be too high to support further growth at the 5-6% rates. We expect a significant slowdown in economic growth to 3% in 2014. That year, external imbalances in the form of a significant current account deficit, which should reach 6.7% of GDP in 2013, will require adjustment. As a result, the hryvnia should start devaluing again.

However, strong economic fundamentals throughout 2010-13 should mean that Ukraine will provide significant investment opportunities during that period, both for portfolio and strategic investors. The expected exchange rate stability and the hryvnia's appreciation from UAH/USD 8.5 at the end of 2010 to UAH/USD 8.0 at the end of 2011 should make a supportive case for investing in hryvnia-denominated assets.

Oleksiy Blinov is economist at Astrum Investment Management