Foyil Securities -

The February 5 announcement by the General Council of the World Trade Organization (WTO) that opened the way for Ukraine to join this important global trading group offers, in the main, long-term prospects for deeper economic development of Ukraine with little short-term negative impact.

Since it has taken 14 years for Ukraine to enter the WTO, the manifold effects of accession have been well considered and, indeed, factored into the projections of overall economic and specific industry development. Therefore, we are confident that Ukraine will enjoy a relatively painless accommodation of the lowering of trade barriers, which is the main purpose of the WTO, allowing the nation of 46m people to increase both the import and export of goods and services.

The expected increased competition should lead to restructuring of the Ukrainian economy in the form of greater industrial specialization, but it should also lead to higher levels of efficiency and better quality products. In short, WTO accession should benefit Ukrainian consumers, some industries and the country's prospects for entering the EU. In this article, Foyil reviews the projected impact of Ukraine's WTO accession on the macroeconomic scene and several key industries.

Parliament should ratify WTO agreement by April this year

Ukraine has nearly finished its 14-year campaign to enter the WTO following the WTO's decision on February 5 to give the green light to Ukrainian membership. Thus, Ukraine should become a full-fledged member of the WTO within 30 days of Ukraine's parliament ratifying the accession terms and conditions. Even though parliament is currently in disarray and sitting irregularly, owing to a conflict between the ruling coalition and the main opposition party, we expect the MPs to mobilize in order to ratify the WTO accession terms and conditions, since all major parties represented in parliament had WTO membership as a key plank in their election manifestos. Moreover, taking into account the balance of business group lobbies in parliament, we believe that the proponents of WTO membership (steel and chemical lobbies) by far exceed the opponents of accession (automakers and agricultural lobbies). Therefore, we expect that the new trade rules will become effective no later than at the end of April 2008.

Key implications of the accession are mostly positive

Lowered trade barriers will have an immediate negative impact on the merchandise trade deficit, dragging it deeper in red in 2008, up to 8.4% of GDP.

However, we believe that WTO accession will have a positive long-run (2009-2012) effect on the Ukrainian economy, as the gradual recovery of Ukrainian exports will lead to the merchandise trade balance deficit reducing to 5% of GDP by 2012.

In addition, more competition from developed manufacturers will force domestic producers to increase the efficiency of production and quality of products. But this will take time (3-5 years) and will lead to deeper specialization of the Ukrainian economy.

However, the global economic slowdown that is widely expected in 2008 and the higher imported natural gas price for Ukraine (up 38% in 2008 after the recent deal with Russia's Gazprom) should have a bigger impact on Ukrainian economic growth than the accession to the WTO will have in the short term.

The global slowdown and higher gas prices should lead to a deceleration in industrial output (which we estimate will grow 10.2% in 2007, falling to 9.2% growth in 2008) and GDP growth (which we see coming in at 7.3% in 2007, slowing to 6.5% in 2008).

Finally, we expect accession to the WTO to open the way for deeper integration with the EU through the free trade agreement, which is part of the New Enhanced Agreement between Ukraine and the EU. This new agreement between Ukraine the EU is expected to be ratified sometime in 2009.

Balance of Payments should recover after early dip

Over the past three years the Ukrainian merchandise trade balance deficit has been persistently growing and reached $10.4bn in 2007. The main factors that pushed the merchandise trade balance into the red were currency revaluation and a significant reduction of the import tariffs in 2005, which brought Ukrainian foreign trade conditions very close to the standards accepted by WTO members.

Therefore, accession to the WTO itself should not be critical for the trade balance trend in 2008. Rather, the main drivers of the widening merchandise trade balance deficit to $13.3bn in 2008 should be rising energy resource prices, the global steel and chemical market downturn, increasing domestic demand (spurred by the need for modernization and rising disposable household incomes). Despite the growing merchandise trade balance deficit, we expect that the foreign currency reserves of the National Bank of Ukraine will rise on the back of an expected large inflow of foreign direct investment (FDI) and attracted financial resources by Ukrainian companies from abroad. Thus, we expect that those trends in foreign trade we saw in 2005-2007 to continue in 2008, while in 2009-2012 we expect that the merchandise trade balance will gradually recovery and FDI inflow will stabilize at the average annual level of $9.0bn.

We also expect to see changes in the export-import structure geographically and product-wise. We expect that during 2008-2012 Ukraine will raise its foreign trade turnover with Europe, Asia and North America, while its foreign trade turnover with CIS countries and Africa will fall due to the membership of Ukraine in the WTO and the creation of a free trade area with the EU (in 2009). In the product structure of Ukrainian foreign trade, we expect an increase of machinery, metals, chemicals, and food products due to the strong international demand for these product categories.

Industrial output should grow in the "dirty" sectors

We believe that WTO accession will serve as a cushion for Ukrainian industrial production growth on the back of the global economic slowdown in 2008. Enlarging the geography of sales of the steel and chemical industries will allow them to maintain strong growth of output (estimated at 7.9% and 7.2% on year in 2008, respectively), which has been their hallmark over the past five years.

However, we expect WTO accession to have an overall negative impact on the food processing industry, given that domestic consumers should switch to higher- quality and cheaper imported products on the back of increasing disposable incomes, despite the essentially good quality of Ukrainian-made food products.

The machinery sector, which made the highest contribution (41.2%) to the gross industrial production growth of 10.2% in 2007, will be mildly affected by WTO membership, since the main markets for Ukrainian machinery are in Ukraine and Russia, where Ukrainian machinery should retain strong positions due to its high price/quality ratio. Therefore, we believe that machinery-builders will continue to drive up industrial production growth in 2008, closing 2008 with 25.4% annual growth.

GDP to be cushioned against global slowdown

As with industrial production development, we expect that WTO membership will only soften the slowdown of Ukrainian GDP growth from 7.3% in 2007 to 6.5% in 2008, which will be caused mainly by the global economic slowdown. We believe that the key support for GDP growth in terms of WTO accession will come from the wholesale and retail trade sector (+19.0% in 2008), which should benefit from the liberalized foreign trade. In our view, the acceleration of trade sector development should compensate for the deceleration in the extractive (2.9% up in 2008) and processing (10.5% up in 2008) industries. Nevertheless, we expect that WTO accession will stimulate the economic growth of Ukraine in the long run (2009-2012) as WTO membership was the last condition for starting negotiations between the EU and Ukraine on creating a free trade area within the framework of the New Enhanced Cooperation Agreement.

In our view, the removal of trade barriers will facilitate modernization of the Ukrainian economy, leading to rising investments in fixed capital formation by 22% on year in 2008, financed to the large extent by the FDI. Therefore, WTO accession should bring more indirect benefits to the Ukrainian economy, such as increasing investment and FDI inflow, deeper integration with the EU, and healthier diversification of foreign trade with a corresponding reduced dependence on CIS markets. Thus, against the background of a slowing world economy, we expect WTO accession to cushion Ukrainian economic growth in 2008 and become a catalyst for long-run economic development.

Impact on sectors:

Automotives - short-term and long-term strong negative

Banking - short-term negative, long-term mixed

Chemicals - short-term and long-term strong positive

Coke and coal - short-term, long-term mild positive

Machinery - short-term, long-term mild negative

Pharmaceuticals - short-term mixed, but overall negative

Pipes - short-term and long-term positive

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