With the world’s economy grinding almost to a standstill due to the ongoing pandemic, we speak to Makar Paseniuk, Founding Partner at ICU to find out his take on where Ukraine’s economy is headed and his view on the impending IMF deal.
Ukrainian authorities have introduced quarantine measures that are among the most stringent ones compared to other countries globally to fight the Covid-19 pandemic. While these measures are necessary to prevent and contain the spread of the coronavirus, they will undoubtedly have a devastating effect on the Ukrainian economy.
Given the uncertainty of how long the lockdown will last and when the government might lift the restrictions to open the economy, there is still room for more tightening, and further negative impact on economic activity; but the overall view seems to be that the government is unlikely to extend the same tough lockdown measures beyond May.
According to Mr Paseniuk, the government is likely to adopt a more flexible approach to avoid an even harder economic collapse and to avoid grievances from the general public who might protest being under lockdown for prolonged periods especially if they have lost jobs as a consequence. He believes the resulting economic recession in Ukraine will be U-shaped with a slow recovery in 2H20. This is because a possible gradual lifting of quarantine barriers will also be accompanied by very cautious consumer behaviour and low business confidence. As a result, he says that Ukraine’s real GDP may drop by 6–8% which is the optimistic forecast. The forecast is subject to high risks skewed to the downside.
Consumption was the key driver of GDP growth in 2016–19, and it will likely take the heaviest toll on the economy according to analysts from ICU. Early statistical data and business polls indicate that domestic sales and production might have fallen 20–40% in the initial weeks of the lockdown with a high risk of an acceleration in the coming weeks as businesses shut down, people lose jobs and live off their savings, and consumer confidence plummets. Once the government eases the lockdown measures, the recovery will still be slow. Analysts from ICU anticipate the decline in household consumption to be as high as 30–40% in 2Q20, while full-year 2020 consumption may decline 10-15%.
The economy will also be affected by the lack of investments spurred by the steep fall in investor confidence and state budget constraints. Last year’s figures are slightly skewed by large investments into the alternative energy sector which will have an additional negative effect this year. Mr Paseniuk estimates fixed-asset investments to drop 25–30% in 2020, with high downside risks. He adds that inflation may accelerate to 6-8% by the end of 2020, while the average growth in CPI for 2020 may amount to 5-6% versus 7.9% in 2019. Mr Paseniuk comments that inflation will be driven by high food prices boosted by limited supply during the lockdown (due to closed farmers’ markets and open-air bazaars and limited logistics) as well as a likely worse harvest.
A weaker hryvnia and rising social payments to the unemployed and low-income citizens will further add to higher inflation but Mr Paseniuk believes that it will be slightly countered by lower oil and gas prices and depressed consumption rates. ICU analysts expect that the decline in imports caused by falling consumption and lower world prices for oil and natural gas will far outpace losses in Ukraine’s export revenues. Mr Paseniuk expects the trade deficit could shrink 80–90% to around 1% of GDP. He also believes exporters of agriculture products and IT services will be most resilient to a global recession, the transportation sector will benefit from the pump-or-pay clause and fixed price agreement with Gazprom while the steel and machinery sectors will be the most vulnerable.
The hryvnia remains highly vulnerable especially in light of the emerging markets staying out of investors’ favour because of the pandemic crisis, but Mr Paseniuk believes a signed IMF deal may prompt a rally. He cites the availability of FX funds from IFOs and continuing demand from exporters may cause the hryvnia to strengthen to around 26–27/USD in 2Q20. As consumer demand and oil prices will be recovering in 2H20, the hryvnia may depreciate to 28–29/USD with current account deficit expanding by the end of 2020, he adds.
The IMF deal is seen as critical for financing sovereign debt by analysts and experts alike as Ukraine is unlikely able to cope with the fallout from the pandemic and lockdown without support from external financing. Mr Paseniuk reinforces that point by saying that the IMF arrangement will be the only opportunity for Ukraine to obtain funds from international financing institutions, as financial markets will likely remain shut for the country for at least the next few months.
The $5.5bn new Extended Fund Facility (EFF) arrangement agreed between Ukraine and the IMF on the staff level in December may be extended to $8bn. That amount will likely include a $4–5bn stimulus package to mitigate economic losses from the pandemic and lockdown. This is equivalent to 3% of 2019 GDP, and comparable with the 2–3% GDP fiscal stimulus announced by the leading national governments in the EU as of end-March. Kristalina Georgieva, the Managing Director of the IMF stated that Ukraine made good progress on the program discussions. However, the agreement will only be finalized if Ukraine adopts the legislation to improve the bank resolution framework.
According to different sources familiar with the negotiations, $4-5bn of the IMF facility may come directly to the state budget this year. After the IMF deal is signed, the government may receive an additional $2bn financing from the EU, EBRD, and the World Bank within a few weeks.
The Ukrainian parliament has already approved the revised state budget for 2020, which now includes an 8% deficit relative to GDP, a significant expansion compared with the previous 2.2% figure. That has been a necessary step to cope with the pandemic crisis and support the economy, likely sanctioned by the IMF. Mаkar Paseniuk sees the risks of budget-revenue underperformance will be high due to falling taxable volumes of imports, sales, and income. He adds that this may further exacerbate the economic contraction.
Taking a cue from other central banks around the world, the National Bank of Ukraine (NBU) will continue to soften its monetary policy and lower its key policy rate in 2020. ICU expects the key policy rate to drop from the current 8% to 7.5% by the end of the year, despite inflation may accelerate above NBU’s target range. This will mean the real key policy rate nearing zero, one of the necessary moves to help facilitate Ukraine through its painful recession. Given rising likelihood of lower inflation and more dovish policy of the NBU, ICU analysts see prevailing downside risks for their current projection of the key policy rate at the end of the year.
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