Ukraine Country Report Jun17 - June, 2017

July 7, 2017

Ukraine’s economy seems to be finally on the mend putting in 2.5% GDP growth in the first quarter. It is not the bounce that might be expected that usually follows a crash as deep as that the Ukrainian eocnomy suffered in the last two years, but the lack of any reforms over the last two decades still weighs on the country, which has everything still to do.

Still despite the government's reluctance to bite the reform bullet, as most of the reforms to be made will be painful for the long suffering population, progress is being made, albeit not fast enough for the country’s international donors.

This month’s good news is Ukraine's shadow economy decreased to 34% of GDP in 2016 from 40% in 2015, according to a report published by the Economic Development and Trade Ministry. The decline was attributed to the maintenance of relative macroeconomic stability in the country, renewal of economic growth, improvement of the business climate due to deregulation, and legalisation of the labour market due to a lower social security tax.  

At the same time the European Business Association reports that the country’s investment attractiveness is at a six-year high, albeit from a very low base. But Ukraine is only slowly climbing out of its hole and the biggest foreign investor into the country remains Russia, with which the country is de facto at war, which says it all. There is some real FDI into the manufacturing sector in the west of the country, but it remains minimal.

The fighting in Donbas continues to weigh on the economy, which used to account for a quarter of GDP. The economic blockade imposed by the government on Donbas earlier this year has shaved at least a percentage point off the growth potential -- probably more.

Ukraine’s State Statistics Service marginally revised its flash 1Q17 real GDP growth estimate up by 0.1pp to +2.5% y/y (vs. +4.8% y/y in 4Q16), keeping the seasonally adjusted reading at -0.3% q/q (vs. +1.9% in 4Q16).  

In April, the National Bank of Ukraine (NBU) confirmed its revised 2017 GDP forecast from 2.8% to 1.9% growth year-on-year due to expectations that a trade blockade in eastern Ukraine.

On the reform front, Kyiv has made enough progress to persuade the IMF to release another $1bn tranche earlier this year, but this is still a fraction of the aid that has been promised. The chances of the next payment being made in the  autumn faded in at the start of July after the government postponed votes on the crucial land reform that would have created a market for land. The issue is now unlikely to be addressed until after the presidential elections in 2019.

Land  is one of three key reforms demanded by the IMF and the next IMF tranches are tied to progress on the issue that could unlock significant foreign investment.

More progress has been made on another key issue: pension reform. The first reading on the draft pension reform bill was due in the Rada before parliament broke up for the summer and the second and final reading is likely in the autumn session. However, the MPs have watered the politically explosive bill down somewhat and argued that they don’t need to seek IMF approval for the changes. However, the IMF is unlikely to object, happy to see any sort of progress at all.

The final reform on the docket is that to the judiciary and a reform of the supreme court. Again this one is being watched closely as it strikes to the heart of the anti-corruption drive. An associated reform is the establishment of an anti-corruption court that could work with the National Anti-corruption bureau of Ukraine (NABU), but as corruption remains a key level of control for the Poroshenko government not much progress is expected here.

Having said that there has been a string of high profile indictments and arrests of lower level functionaries in June. This is almost certainly partly for show -- the General Prosecutor applied to lift the immunity of several MPs while Poroshenko was on a trip to the US -- but the government is slowly moving in the right direction.  

The major event in the fight against against graft was the opening of a criminal case against the former owners of PrivatBank, which was nationalised in December, after they missed a deadline to restructure the related party loans worth around $5bn by the July 1 deadline. This is could be the opening salvo in a major oligarch conflict as one of the PrivatBank owners is Ihor Kolomoisky, the most powerful oligarch in the country and a sworn enemy of Poroshenko. The investigation is welcome, but in Ukraine the chances of that leading to charges and an actual arrest, let alone jail time for a big business figure, remain vanishingly small at the moment, even if the object of the authorities attention is a political enemy.

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