Despite the significant headwinds Ukraine has faced in 2023, economic activity is surprising to the upside. Real GDP will be up more than 5% in 2023, inflation has plummeted to single digits, NBU reserves hit historical highs, and budget-deficit financing has been relatively smooth.
Thanks to these positive developments, the economy is on a much firmer footing. Domestic demand strengthened and business sentiment improved.
The financial sector continues to operate seamlessly. Nonetheless, we expect 2024 to present a new set of challenges, not the least of which is uncertainty about the size and sustainability of foreign financial aid.
At this point, the risk of a significant cut in foreign sourced financial aid is low, says Ukrainian investment bank ICU, and sees Ukraine securing at least what is needed to keep the country’s external accounts fully balanced through 2024. This means the NBU will remain in a position to keep the FX market firmly under control and may even take decisive FX liberalisation steps. Also, all preconditions are now in place for managed and gradual hryvnia depreciation. We see the end-2024 exchange rate at UAH41/$.
The economy is likely to remain on track to grow if no new, major safety risks materialise, although we expect it will slow vs. 2023.
Inflation will stay in the range of 6-7% in 2024 at least until summer before picking up somewhat by the end of the year. NBU’s monetary policy easing cycle is almost done, but symbolic cuts are possible in 2H24 if inflation and FX market risks remain balanced.
While Ukraine is set to receive enough foreign funding to cover gaps in external accounts, the aid package may fall short of the budget needs. Raising over $40bn in external funding that the government needs is not guaranteed, and the risk of money printing by the NBU will be present in 2024. One of the things to keep an eye on next year is the restructuring of Ukraine’s Eurobonds. Its terms will heavily depend on the government’s assessment of the length of the war and sustainability of foreign financial aid.
Economic recovery driven by household demand
Economic recovery in 2023 to November has been impressive. We expect GDP to be up 5.8% year on year in 2023, thus reaching 75% of pre-war real output.
The pick-up in economic activity has been mainly driven by a rapid recovery in household demand since the decline in real income in the private sector has been offset with high and robust income of military personnel. The recovery was also helped by a dramatic improvement in internal logistics and better sentiment of businesses and consumers.
Agriculture is a large contributor to GDP growth this year thanks to very favourable weather conditions. The harvest of grains and oilseeds has far exceeded beginning-of-the-year expectations and grew about 15% y/y.
The broad consensus now is that economic recovery will continue in 2024, but growth will slow vs. 2023. We share this view and expect a GDP increase of 5.0% next year (vs. our earlier forecast of 6.4%). The balance of upside and downside risks for the next year remains very fragile, but we believe the upsides are very likely to prevail.
Private household demand will continue to be the engine of economic recovery. So far, real incomes have been supported by an upsurge in the salaries of military personnel, but the situation will change next year. The budget incorporates a 16% y/y reduction in salary payments to the defence sector in 2024, implying an even deeper decline in real terms.
However, this decline is likely to be fully compensated with an increase in salaries in the private sector.
The real average salary was little changed in 1H23 vs. 1H22, but it increased substantially in 2H23 due to a rapid slowdown in inflation. In 2024, businesses will be forced to raise salaries due to a tight labour market and high competition for employees. A gradual reduction in unemployment will also increase total disposable income. A supporting factor is a scheduled 19% increase in minimum salary over the second quarter. Against the background of low inflation, these factors combined will be a powerful catalyst for an increase in real incomes of households.
Other demand components, specifically export and investments, will remain weak. Export is severely constrained by the blockade of the Black Sea routes. Although shipments are now possible even without a russia-approved grain corridor, they remain non-systematic.
The blockade of cargo trucks carrying goods to and from Ukraine through Poland has become a new major concern. The problem, if it persists, may have huge negative implications for the Ukrainian economy. Yet, at this point, we assume that a reasonable long-term solution will be found once the transition of power in Poland is complete. Investments, both public and private, are unlikely to pick up substantially any time soon while the safety situation remains shaky. Companies only approve maintenance capex to keep their production current.
Business sentiment, as approximated by the NBU business activity index, remains largely neutral following a significant improvement in the second quarter. While the overall mood is volatile, companies in the industrial sector and trade expect a further increase in output and turnover.
Also inspiring are results of the survey of the European Business Association. Nearly 77% of respondents, among which are Ukraine’s largest businesses, said they operate without any restrictions in 4Q. This is a sharp increase from 68-69% in 2Q and 3Q.
ICU is one of Ukraine’s leading investment banks. Download the complete report here.