The pace of economic recovery so far this year has not been particularly breathtaking as temporary negative factors, especially the suspension of trade in Eastern Ukraine, have prevented a full-fledged recovery after a hard crisis.
Mid-term prospects look reasonably bright as the economy continues to show fundamental strength. Key macro indicators, including inflation and the BoP, are consistent with a slow but sustainable recovery.
The next IMF review in October is the key event over the coming month. While not critical in the nearterm, securing the next loan tranche is important for the smooth servicing of the large sovereign debt redemptions coming in 2019. However, the government’s intention to water down gas price reforms and tinker with the pension reform suggest Ukraine will not receive another IMF tranche this year.
GDP growth remains sluggish and volatile. As expected, industry has been the most vulnerable sector, with y/y growth swinging from negative to positive YTD.
On a positive note, domestic-oriented sectors of the economy are showing persuasive signs that domestic demand is recovering rapidly and becoming the key driver of growth. In 7M17, retail trade grew 7.5% y/y, cargo transportation turnover increased 8.7%, and construction surged 24.2%.
After a mixed 2017 hit by the effect of the trade blockade and a weaker trend in agriculture (we expect a slight output decline for full 2017), economic growth is well-placed to accelerate to 3.5-4.0% in 2018.
Consumer price growth has been accelerating since May and CPI increased 15.9% y/y as at end-July. Accelerating food prices have thus far been the key factor – poor weather had a material negative impact on the fruit and vegetable harvest. The wave of utility tariff revisions continues and the key inflation-related risk on the horizon is the need to revise gas tariffs for households in October (a requirement of the IMF program). The government remains reluctant to pull the trigger and is determined to negotiate a delay with the IMF.
Overall, risks continue to build of end-2017 inflation exceeding forecastst of 10.1% and the NBU’s target of 8% +/-2pp. Even though the key inflation drivers are temporary in nature, demand-side factors are gaining weight on a double-digit expansion of nominal household incomes.
There are diminishing prospects for the NBU to further cut its key policy rate (the last 50bp decrease to 12.5% took place in late May); any movement in the key rate is unlikely over the next three months.
The C/A deficit expanded moderately over the past month and the 12-month trailing tally stood at $4.6bn, or 4.4% of 2017E GDP as of July.
Commodity imports are growing robustly and outpacing export growth, supported by both consumer and investment consumption. Imports of energy materials, including gas, have been substantial YTD and should thus decrease over the rest of the year. The C/A deficit approaching c. 4% of GDP for FY 2017.
FDI, debt inflows, and the use of accumulated cash by households remain sufficient to fully cover the C/A shortfall.
The FX market remains fairly balanced – the NBU’s sporadic interventions are inconsequential and haven’t altered the trend. Based on the stronger-than forecast UAH performance YTD, we revise our average and end-2017 FX rate projection to UAH26.5/$and UAH27.0/$, respectively (from UAH28.0/$and UAH28.5/$).
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