The latest developments in the eastern parts of Ukraine lend further weight to the idea that the country is becoming destabilised to the point where it represents significant downside risk to previous economic forecasts, says Andreas Schwabe, analyst at Raifeissen Research.
Economic impact on Ukraine
UAH already in free fall against the backdrop of heightened political instability – The FX rate almost reached the level of USD/UAH 13 after depreciating by about 10% last week; the loss in value amounted to around 35% loss since the beginning of the year.
The National Bank is not supporting the UAH anymore, i.e. it is not intervening on the FX market, apparently expecting that the forthcoming financial assistance would reverse exchange rate dynamics, bringing it closer to fundamentally justified levels around 10.50-11.50. However, in our opinion, given the escalation of political turmoil, the National Bank might be forced to step in – either with FX interventions or tightening administrative restrictions. Though, lack of interventions allowed the NBU to minimize the loss of FX reserves in March – they decreased only by USD 400 mn in March (to USD 15.1 bn).
There are some factors which could help to strengthen the UAH in the near future, in particular the receipt of the first tranche of the IMF loan (possibly at the end of April), followed by the support from World Bank, EU and US (the total support package might reach $5-6bn in Q2 2014), the decline in imports of energy and seasonal export growth in the 2nd quarter. However, the difficult political situation remains a very high risk for the currency and the indecisive stance of the National Bank raises questions. Therefore, we might not have seen the weakest point of the UAH development this year (in looking at a sample of large scale depreciation in EM over recent years, devaluations ranged from 20% to over 70%, on average at around 40%).
At current FX levels, the risk of a destabilization of the economy and the banking system, in particular, grows significantly. Recent developments also put our FX forecast for the end of 2014 of USD/UAH of 10.50-11.50 in danger.
Despite rather large amounts of funds announced, international financial support has been rather slow to trickle in (given technical requirements and procedures of IFIs). The IMF and Ukraine already reached a working level agreement for a support package of UAD 14-18 bn over two years (around USD 27 bn including other multilateral and bilateral funds), but there has been no disbursement of funds yet. EU help is tied to the IMF money as well. The IMF said that a first trance (expected to amount to USD 3-5) will be disbursed in late April or early May the latest.
Given political unpredictability economic uncertainty in Ukraine looms high, with risks to the downside:
– Disputes around natural gas prices and delivery have heightened in recent days
– posing the risk of gas delivery disruptions. Russia removed previous discounts from the gas price, resulting in a staggering figure of USD 480 per 1000m3 – 30% more than the price for European clients. Ukraine rejects this (politically motivated) price and the dispute seems far from over.
– Besides likely higher energy import costs, the austerity measures attached to the IMF programme will negatively affect domestic demand
– Potential forthcoming restrictions on trade with Russia caused by the strained political relations with the neighbour are another source of uncertainty and potential negative factor for manufacturing exports.
As a baseline scenario we expect the economy to contract by around 3-7% this year and inflation to increase to levels around 10-14% (from a level around 0 in 2013), while we expect recession to end in 2015 (partially supported by the recent exchange rate adjustment). There are significant risks that the recession in 2014 will be deeper and more protracted than currently projected.
In a more negative scenario a cumulative GDP drop by 10-15% over the next two years cannot be ruled out. This would be in particular the case if the political turmoil in heavy-industry oriented Eastern Ukraine would affect the conduct of business, production and/or trade on a larger scale in the region.