Depending on who's talking, Ukraine's battered economy is now over the hump, turning the corner, or being set up by the country's enemies for the next spiral down.

Signs of a groaning recovery are certainly there. GDP figures for the third quarter show a 7% year-on-year (y/y) contraction, much improved from the catastrophic 14.7% GDP slump in the second quarter as fighting in East Ukraine ravaged industrial output, and as much as 17.2% in the first.

A 5% y/y fall in industrial production in October reported by Ukrstat is bad, but still improves on September's 5.1% drop, as does the January-October decline of 15.4% y/y, compared with 16.4% y/y for the first nine months. However, as Sberbank CIB analysts note, "only one more region in Ukraine out of 25 posted positive growth in October, which points to the low quality of [the] statistics overall".

Upgrading Ukraine's foreign currency IDR to 'CCC', Fitch on November 18 forecast GDP growth of 1% next year, and 2-3% in 2017. This is the first positive re-rating by a major agency since Ukraine's current turmoil began in early 2014, and reflects the reduction in the (albeit now rekindling) hostilities in the Donbas region, and success of the finance ministry in Kyiv in restructuring Ukraine's debts.   

"The country has emerged from default on commercial external debt, issuing new bonds on November 12 to holders of $15bn in defaulted Eurobonds," Fitch said in a statement. "Public debt sustainability has improved. Reduced refinancing needs and a pipeline of official financing give the public and external finances some breathing room and lower the risk of a sovereign debt crisis over the short to medium term."

On November 19. Moody's also upgraded the sovereign rating of Ukraine's government to 'Caa3' from 'Ca', citing settlement of the restructuring of the $15bn in privately-held debt and progress in political and economic reform under the auspices of the International Monetary Fund-led programme. This supported a rebalancing of the economy and a meaningful reduction in public and external financial deficits, Moody's said.

Meanwhile, capital inflows to Ukraine increased 34.1% to $2.55bn in January-September, against a 40.7% decrease in outflow in the year-earlier period to $526mn, compared with $888mn a year ago. However, foreign direct investment slid 3.3% y/y ($1.8bn) owing to an exchange rate adjustment.

Despite the uptick, growth may only rebound by 1-2% in 2016, believes investment bank Dragon Capital, while the National Bank of Ukraine (NBU) forecasts 2.4% growth at 12% inflation, and the government hopes to see at least a 2% rise in GDP.

The Russia factor 

But even with Western support and a $17.5bn credit from the IMF, significant economic recovery in Ukraine still largely depends on what Russia wants as it pursues its regional and international agenda.

After Moscow's purported olive branch offer on November 15 to restructure its $3bn Ukrainian Eurobond, it called the EU-Ukraine free trade pact due to come into effect on January 1 "absolutely unacceptable". Russia will respond with a simultaneous embargo on Ukrainian food imports to protect its economy, Economic Development Minister Alexei Ulyukayev said.

This could cost Ukraine up to $600mn a year, according to Ukrainian Prime Minister Arseny Yatsenyuk, although this is viewed as exaggerated given the severe tail-off in bilateral trade in the last 20 months. However, "Exporters face a permanent loss of Russian demand – [Russia's] share of Ukraine's exports has shrunk to just 12% in 2015 to date from 24% in 2013," Fitch notes.

Meanwhile, many people  regard Moscow as keeping the conflict in East Ukraine on the back burner – along with an array of other means – ready to bring to the boil again as needed. "Russia has not given up on Ukraine, but its tactics of undermining its sovereignty and drive to Europe are evolving and very dynamic," wrote analyst Tim Ash of Nomura International. "Sometimes the pressure is exerted via the military channel, sometimes trade, or debt, or diplomatic, cyberwar, or via domestic politics – but the pressure is pretty much relentless."

Warns Ukrainian President Petro Poroshenko: "We have to be ready for economic consequences, as Russia resorts not only to the occupation of sovereign and independent Ukraine, but also to the trade war against us."

Threat from within

Meanwhile, commentators warn that the failure of the Ukrainian authorities to root out corruption coupled with obstruction of reforms in parliament is as dangerous for the economy as military conflict.

"Those in the trenches facing off against the Ukrainian armed forces in the east are problematic, but it is those that are entrenched in the corrupt networks at all levels in and behind the Verkhovna Rada [parliament] who are a far more destructive force," an Odesa-based British blogger writing as Nikolai Holmov commented. "One has to suspect the latter is far more of a threat to sustained economic growth in 2016."

Nonetheless, recent days has seen a marked rally in Ukrainian Eurobonds as a reflection of optimism over signs of compromise from Russia with the West (evidenced by Moscow's offer on its $3bn bond), including cooperation prospects in Syria, with the assumption being that this will moderate tensions over Ukraine.

Future agency rating trends will depend on maintaining peace in East Ukraine, plus the success of Poroshenko's administration in rolling the reform agenda forward, thereby ensuring that the IMF's credit programme for Ukraine remains on track, wrote Tim Ash of Nomura International. "Perhaps most difficult therein now are efforts to counter graft, improve the business environment and hence spur investment," he added.

Ukraine's financial authorities country have rightly feted their successful, IMF-required restructuring of some $15bn in external sovereign debt to save 20%. "We restructured our external sovereign debt by immediate write off of $3bn of our debt burden," the finance ministry announced on November 12, eight months after the process began.

Finance Minister Natalie Jaresko added: "Today, we close one important chapter in Ukraine's economic history and open another. Few thought we would get to this point when we launched this process eight months ago. The successful conclusion of our debt restructuring process, completed while avoiding default, leaves Ukraine's economy in a much stronger position and is an important prerequisite for our return to growth."

Brass tacks

By sectors, the decline in Ukraine's industrial production seems to have bottomed out. Strengthened statistics on chemical production (0% y/y in October vs. -15% y/y in September) as well as an October slowdown in the decline of machinery production (-9.3% y/y vs. -9.6% y/y) and utilities (-4.9% y/y vs. -5.4% y/y) combined to brighten the picture.

At the same time, mining slowed to +1.9% y/y (compared with +3.2% y/y in September) and metals switched in red to -4.9% y/y (+3.0% y/y). Output in the separatist-held Donetsk and Luhansk regions continued to recover at +8.7% y/y and +23.0% y/y, respectively.

The Concorde Capital brokerage in Kyiv gave a cautious welcome to the improved figures.
"With October's performance slightly better than we expected, we improve our industrial output forecast to -13.8% yoy for 2015 from our previous estimate of -14.6% yoy," analyst Alexander Paraschiy wrote in a research note.

Of the improved nine-month capital inflow of $2.55bn, $743mn was investment in telecommunications from the Netherlands, $483mn was in the banking sector from Russia, plus another $172mn from Austria. "The reported inflow was due to two main sources, with bank recapitalization being one of them. The other source, telecommunications, also looks like a one-time capital injection," Paraschiy said. "Apart from that, we do not see any institutional investors eager to spend their money amid debt restructuring, sluggish reforms and the military conflict. We anticipate stronger investments by the middle of 2016."

Still, Ukraine's investment prospects took a high-profile boost on November 18, when it was announced that billionaire philanthropist George Soros has set up a Ukraine-dedicated private investment fund, Ukrainian Redevelopment Fund (URF), to become a seed investor in a direct investment fund, the New Ukraine Fund.

But investment and a robust fillip for the economy will only come if Ukraine can finally stand down from its war footing. In a strong indication that the Ukrainian government does not count on this, the 2016 budget will focus on national security and defence. "National security and defense undoubtedly constitute the basis of the budget," Prime Minister Arseniy Yatsenyuk said in an interview with Focus magazine on November 19. "As was stated, we'll allocate UAH100bn [$4.2bn] for these purposes. This is because the war is far from its completion, judging by the latest reports."