Ukraine Business Forecast Report Q4 2008

Slower Growth And Elevated Inflation To Persist

Our core scenario that economic growth will slow significantly this year results from a combination of domestic and external factors. On the domestic front, we believe that following seven years of boom growth, the economy is in need of consolidation. Indeed, the excesses built up over the previous years, with gross external debt climbing from a multi-year low of 45.0% of GDP in 2005 to reach 59.9% in 2007, as well as a current account balance which swung into deficit in 2006 (1.5% of GDP) widening to 4.2% in 2007, will need to be worked off. We also believe that the solid rates of growth seen during 2000-2007 will not be sustained over our five-year forecast period as the quality of Ukraine's infrastructure and business environment will provide a limit to economic growth. Indeed, Ukraine's business environment score, part of BMI's composite risk ratings, receives a lowly 45.8, below regional peers Romania (52.1), Poland (57.6) and Hungary (60.5), and reflecting the relatively poor state of the national infrastructure. Substantial investment in roads, power generation and modernising production is needed for industrial expansion to keep apace with the 10.2% average annual growth experienced during 2000-2007.

The likelihood of Ukraine securing membership to the EU looks doubtful within the next decade. EU foreign ministers met on July 22 to discuss Ukraine's future role in the EU, ahead of a planned summit in September. Though there are tentative indications that Ukraine will be able to sign an association agreement (potentially in 2009), officials have also hinted that this will not necessarily confirm that EU membership will be extended to Ukraine. Whereas similar association agreements with ex-communist countries such as Poland and the Czech Republic were followed by eventual membership to the Union, we believe that Ukraine is unlikely to take the same path.

Spiralling inflation showed further signs of cooling in July as consumer price growth slowed to 26.8% y-o-y from an almost eight-year peak of 31.1% y-o-y in May. Moreover, the month-on-month rate contracted for the first time since April 2006. While we believe that inflationary pressures will continue to ease through H208, partly as a result of the recovery in crop yields across Europe helping to rein in food price inflation, we caution that upside pressures remain. Aside from elevated soft commodity and energy prices, we believe that there are underlying dynamics operating in the economy which will continue to buoy price growth. As such, we are unlikely to see a period of sharp disinflation, but rather expect headline inflation to remain above trend for the rest of 2008 and through H109.

Ukrainian car manufacturer Bogdan Corporation has announced the opening of a new car plant in the town of Cherkassy, with a production capacity of 120,000 vehicles annually. Speaking at the plant's inauguration ceremony, Bogdan's President Oleg Sinarchuk disclosed that the plant was built over a period of two years, with a total investment of US$300mn. The new facility will be used for the production of two models from Lada and three models of Hyundai, Sinarchuk said. As a part of a broader strategy to increase efficiency in production, the company is also currently constructing a 'Techno Park' which would provide logistics support to the new plant in Cherkassy. The site, spread over an area of 18ha, will cover all aspects of production from processing and packaging of cargo to the distribution and delivery of the finished product, project head of the logistic centre, Dmytro Boiko said.