Ukraine Business Forecast Report Q1
2013

Ukraine Business Forecast Report Q1 2013

Core Views:

In line with our view for a sharp slowdown in growth, Ukraine contracted in by 1.3% in Q311. We expect real GDP to contract by just -0.1% and expand by 1.0% in 2012 and 2013 respectively.

We maintain our expectations for growing external account imbalances to drive a devaluation of the hryvnia.

We see political risks as likely to grow over the next 12 months.

The imprisonment of former prime minister Yulia Tymoshenko has severely soured relations with the EU, while bilateral relations with Russia remain tense over the issue of Ukraine's gas imports.

Major Forecast Changes Recent economic indicator readings suggest a more aggressive economic slowdown earlier than we anticipated. We have long-held a negative outlook for Ukrainian economic activity, on our negative outlook for global metallurgical markets, a hryvnia devaluation and a weaker external demand. As a result, we have downgraded our real GDP growth forecasts to -0.1% and 1.0% in 2012 and 2013 respectively, from previous forecasts of 2.0% and 0.9%.

We retain our negative outlook on Ukraine's fiscal deficit, which we now expect to arrive at 4.9% of GDP in 2012 and 4.6% of GDP in 2013. Expensive debt servicing costs, expansionary social spending policies coupled with over-optimistic official growth forecasts underpin our cautious stance towards Ukraine's fiscal outlook.

Key Risks To Outlook A sharper than expected devaluation could trigger major shockwaves through the domestic economy, particularly within the financial sector, which has barely recovered from the 2008 devaluation. Existing capital buffers may prove insufficient to deal with a devaluation of 20% magnitude or greater.

The main upside risks to our forecast arrive from China's US$158bn infrastructure programme, announced at the start of September.

While Chinese markets are barely linked to Ukraine's steel sector, the announcement could help to boost slumping steel prices in increasingly globalised markets, in turn providing some support to Ukraine's exports.

• Executive Summary
  • Core Views:
  • Major Forecast Changes:
  • Key Risks To Outlook:
• Chapter 1: Political Outlook
  • SWOT Analysis
  • BMI Political Risk Ratings
  • Domestic Politics
  • Difficult Decisions Lie Ahead Post-Election
  • The ruling Party of Regions has held onto its majority following the parliamentary elections on October 28, providing President Viktor
  • Yanukovych with a pro-presidential majority. With the Party of Regions' majority now secured and the next election three years away,
  • the government will turn its long-overdue focus to economic policy and reform. Energy policy and currency stability will present majornear
  • term obstacles to economic growth and the government will have to undertake difficult decisions to avoid a full-blown crisis
    • TABLE: POLITICAL OVERVIEW
  • Long-Term Politics
  • At A Political Crossroads
  • Ukraine's long-term political trajectory is far from certain, with the coming years likely to prove crucial to the country's convergence
  • prospects through 2020. Weak institutions remain the greatest challenge to long-term stability, though we also highlight systemic
  • tensions in bilateral relations with Russia and growing demographic issues as additional threats likely to confront future governments
  • The worst case scenario for Ukraine would entail a continuation of the status quo
• Chapter 2: Economic Outlook
  • SWOT Analysis
  • BMI Economic Risk Ratings
  • Monetary Policy
  • No Quick Fix To Exchange Rate Pressures
  • The 8.4% collapse in Ukraine's international reserves reinforces our long-held view that the country's deteriorating balance of payments
  • dynamics will drive a devaluation of the hryvnia. While the government has since moved aggressively to slow the pace of erosion,
  • authorising the National Bank of Ukraine to force exporters and certain individuals to sell foreign currencies, we believe that the
  • fundamental drivers behind the deteriorating balance of payments will remain in place, and as such, a devaluation will remain almost
  • inevitable
    • TABLE: MONETARY POLICY
  • Economic Activity
  • Sliding Into Recession In H212
  • Recent economic indicator readings suggest a more aggressive economic slowdown earlier than we anticipated. We have long held
  • a negative outlook for Ukrainian economic activity, on our negative outlook for global metallurgical markets, a hryvnia devaluation and
  • a weaker external demand. As a result, we have downgraded our real GDP growth forecasts to -0.1% and 1.0% in 2012 and
  • respectively, from a previous forecast of 2.0% and 0.9%
    • TABLE: ECONOMIC ACTIVITY
  • Fiscal Policy
  • Negative Stance On Fiscal Outlook
  • We retain our negative outlook on Ukraine's fiscal deficit, which we expect to arrive at 4.9% of GDP in 2012 and 4.6% of GDP in 2013
  • Expensive debt servicing costs and expansionary social spending policies coupled with over-optimistic official growth forecasts underpin
  • our cautious stance towards Ukraine's fiscal outlook
    • TABLE: FISCAL POLICY
  • Balance Of Payment
  • External Accounts Will Remain Under Pressure
  • We anticipate Ukraine's external position will remain under pressure in 2013, although our expectations for a devaluation of the
  • hryvnia due to pressures on the current account should help to drive a slight narrowing of the deficit. Exports will remain depressed,
  • due to weak external demand, while financing of the deficit will remain unpredictable, likely resulting in further erosion of international
  • reserves
    • TABLE: CURRENT ACCOUNT
  • Banking
  • Assessing Devaluation Shocks On Domestic Banks
  • We retain our negative assessment of Ukraine's banking sector, based on our expectations for hryvnia devaluation and slowing
  • economic growth. High levels of FX exposure in the banking system will require significant increases in loan-loss provisioning in the
  • event of devaluation, and current capital buffers remain at risky levels, particularly given that expected profitability will be hard to come
  • by in the coming quarters
    • TABLE: EXCHANGE RATE
    • TABLE: ACCOUNTING NET FX POSITION
    • TABLE: DYNAMICS OF REGULATORY CAPITAL RATIOS UNDER DEVALUATION SCENARIOS
    • TABLE: FX LOANS & FX LOANS-TO-TOTAL LOANS RATIO
• Chapter 3: 10-Year Forecast
  • The Ukrainian Economy To 2021
  • Colossal Structural Reform Needed To See Through The Decade
  • Having failed thus far to break free from its dependence on cheap energy and a low-value-added export base, Ukraine has arguably
  • squandered the economic windfall experienced over the last 10 years. While there is still enormous unrealised potential in terms of
  • political reform and economic catch-up, without institutional and economic reform, Ukraine's current economic growth model will prove
  • unsustainable over the coming decade
    • TABLE: LONG-TERM MACROECONOMIC FORECASTS
• Chapter 4: Business Environment
  • SWOT Analysis
  • BMI Business Environment Risk Ratings
  • Business Environment
  • Institutions
    • TABLE: BMI BUSINESS AND OPERATION RISK RATINGS
    • TABLE: BMI LEGAL FRAMEWORK RATING
  • Infrastructure
    • TABLE: LABOUR FORCE QUALITY
    • TABLE: EMERGING EUROPE - ANNUAL FDI INFLOWS
    • TABLE: TRADE AND INVESTMENT RATINGS
  • Market Orientation
  • Operational Risk
• Chapter 5: Key Sectors
  • Oil & Gas
    • TABLE: OIL & GAS - HISTORICAL DATA AND FORECASTS, 2009-2016
  • Infrastructure
    • TABLE: CONSTRUCTION AND INFRASTRUCTURE INDUSTRY DATA, 2008 -2016
  • Other Key Sectors
    • TABLE: AUTOS SECTOR KEY INDICATORS
    • TABLE: FOOD AND DRINK SECTOR KEY INDICATORS
    • TABLE: DEFENCE AND SECURITY SECTOR KEY INDICATORS
    • TABLE: PHARMA SECTOR KEY INDICATORS
    • TABLE: TELECOMS SECTOR KEY INDICATORS
    • TABLE: FREIGHT KEY INDICATORS
• Chapter 6: BMI Global Assumptions
  • Global Outlook
  • Downward Revisions, But Core Views Remain Unchanged
    • TABLE: GLOBAL ASSUMPTIONS
    • TABLE: DEVELOPED STATES REAL GDP GROWTH FORECAST
    • TABLE: REAL GDP GROWTH CONSENSUS FORECASTS
    • TABLE: EMERGING MARKETS REAL GDP GROWTH FORECAST.