Ukraine Business Forecast Report Q1 2009

Immediate Crisis Averted, But Risks Remain

In BMI's latest Ukraine Business Forecast Report, we assess the country's medium term political and economic outlook heading into 2009. In light of the turmoil currently engulfing the domestic economy, highlighted by the near collapse of the domestic banking sector, and the need for a US$16.4bn emergency loan from the IMF, we believe 2009 will test the limits of Ukraine's underlying stability. While we believe the IMF's emergency funding will help avert an immediate banking sector and balance of payments crisis, we nevertheless caution that numerous challenges lie ahead. In particular, we highlight the impact that the ongoing regional economic slowdown will pose for Ukraine's economic growth dynamics, particularly as this had already led to a marked reduction in the demand for steel, the production and export of which has hitherto been a key driver of robust economic growth. Moreover, as Ukraine's economy heads into a recession, we believe that the next parliamentary elections will result in a change in government. We believe it is likely that a new proRussian coalition government, led by former Prime Minister Viktor Yanukovych, could come to power, which could weigh on foreign investment in the shorttomedium term.

Heightened political and economic risk variables continue to weigh on Ukraine's underlying stability. Ukraine was pushed to the brink of an economic and financial market crisis in October 2008, when the country's parliament nearly failed to pass emergency measures required as part of an US$16.4bn loan from the IMF. Ongoing disagreements between leading politicians regarding election financing nearly scuttled the deal, with only President Viktor Yuschenko's lastminute decision to remove the election earmark saving the package's approval. Although the IMF's emergency loan has helped avert an immediate financial market crisis, we remain concerned that the lack of a functioning government, in addition to the uncertain state of December's 2008 parliamentary elections, will continue to impair the government's ability to respond to the more fundamental mediumterm economic challenges facing the country.

Due to ongoing problems afflicting the Ukrainian economy, we have made a substantial downward revision to our 2009 real GDP growth forecast, which we now expect to contract by 3.4%, down from our previous forecast which saw economic growth of 2.2%. The challenges presented to macroeconomic stability are many, including a fragile domestic banking sector, a substantially weaker hryvnia, a drastic deterioration in both external demand and credit markets, a widening current account deficit, in addition to ongoing elevated international risk aversion. The fact that the plethora of these economic asymmetries continue to unfold against a backdrop of continued domestic political uncertainty only elevate our concerns further.

According to several recently released annual surveys, Ukraine's underlying business environment and attractiveness as a destination for foreign investment continues to deteriorate. According to the World Bank's Doing Business 2009 report Ukraine dropped to 145th position, one place lower than last year. Although the World Bank noted several positive changes, including the establishment of a new private credit bureau, it also noted that reforms were taking place at an insufficient pace compared to its regional peers. Moreover, in Transparency International's 2008 Corruption Perceptions Index, Ukraine dropped to 134th worldwide, down significantly from its previous rankings of 118th and 99th in 2007 and 2006, respectively. As Ukraine's external environment continues to deteriorate we believe it will become increasingly difficult for Kiev to continue attracting foreign investment inflow.