The International Monetary Fund (IMF) approval of the new Stand by agreement (SBA) program in December significantly raises Ukraine's ability to repay the $9bn FX debt coming due in 2019. However, even with the $1.2bn external financing available in total from the EU and the guarantees provided by the World Bank, the government will have to refinance 100% of domestically issued FX bonds, and come to the capital markets for $1-2bn Eurobond issuance.
The government will have to repay $8.3bn of domestic FX and local-currency bonds in 2019, including $5.4bn in 1H19.
In the case markets are unfavourable, the government will have to ask the IMF to redirect one of the SBA tranches to the state budget. April and May are critical for the government's efforts to secure financing of external debt payments, as they peak at $1.6bn in September.
Fiscal policy: More restrained on risks of underperforming budget revenues. The IMF praised Ukraine's 2019 state budget as sound, as its revenue assumptions are conservative, current spending is contained and deficit is targeted at 2.3% of GDP. However, budget revenues still face high risk of underperformance, which may nudge the government to spend even more cautiously this year. Eventually, such restrained fiscal policy will negatively affect domestic demand and quell inflation, although at the cost of slowing economic growth.
Monetary policy: Remains tight with cautious rate decrease. NBU will maintain tight monetary policy focused on bringing inflation down to the target of 5+1%. Both ICU's and NBU's forecasts predict that the YE2019 inflation will be north of this range. However, the risk of inflation rising significantly above the target remain and will determine the conservative behaviour of the NBU throughout the year. Regulator might commence the cycle of rates decrease as early as January 2019 by cutting the key rate by 50bps as the current rhetoric suggests but will abstain from dramatic moves. We expect the key rate to reach 16% by the end of 2019 (-200bps from current). UAH deposit rates will gradually decline in 1Q19 by 100bps and will follow the path of the NBU's monetary policy. As for corporate lending, average rates on UAH loans may decrease by 400bps to 17% by the end of 2019.
Banking sector: Profit recovery will be slow but steady. In 2018, the sector returned to profitability due to moderate provisioning expenses and strong interest margins. However, scarcity of creditworthy corporate borrowers still constrains Ukrainian banks. High interest rates boosted by the NBU's key rate hikes is another key obstacle to corporate-lending growth. At the same time, consumer lending should expand by a further 30% y/y in 2019, driven by households' high demand for credit and banks' seeing it as an opportunity.
GDP and inflation: Weighed by tighter policies and cooling world markets. We maintain our forecast of Ukraine's 2018 real GDP growth at 3.5%, boosted by rising household incomes and business investments. In 2019, we expect GDP growth to slow to 2.3%. The key headwinds will be more cautious spending by the government, tight monetary policy of the NBU, a slowing global economy, and weaker commodity markets. These factors will also depress inflation, which should slow to 8.5% by YE2019. We see further growing incomes and high inflation expectations during the election period as the key risks, which should drive inflation above the NBU's target range as of YE19.
UAH: Soft deprecation to continue; elections bring more uncertainty. A slowdown in trade-deficit growth, further growth in remittances from labour migrants and a decline in dividends' repatriation will be supportive for the current account and the hryvnia in 2019. The current-account deficit should shrink to 3.3% of GDP in 2019 from 3.8% in 2018. Tight UAH liquidity caused by restrictive policies, as well as robust supply of hard currency from agri exporters should keep the hryvnia near the UAH28/$level in 1Q19. We expect the national currency to go through its seasonal strengthening in 2?3Q19, and then resume its soft depreciation to UAH29.5/$by year-end. At the same time, devaluation expectations and the election-year factor introduce substantial uncertainty and downside risk to our FX forecast.
This report was prepared by ICU group, Ukraine's leading investment bank, and emailed to clients. Authors: Alexander Martynenko, Taras Kotovych, Mykhaylo Demkiv, Dmytro Dyachenko