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Ukraine’s Economic and Financial
Situation
Dr. Edilberto Segura
Partner & Chief Economist
SigmaBleyzer, The Bleyzer Foundation
October 2008
W H
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Ukraine- Real Sector
10
 Over the last five years,
7.9
Ukraine has been one of the
7.3 7.1 7.0
6
6.3 6.1
fastest growing economies in
5.5 5.1
4
the region: its real GDP grew
2
by 7.9% per annum.
 In 2008 economic growth has
0
KZ
UA
RU
SK
TR
RO
BL
CZ
PL
continued: during JanuarySource: State Statistics Committee of Ukraine, IMF WEO
Database April 2008
September 2008, Ukraine
January-September 2008, % yoy expanded fast at 6.9% yoy,
6.9
GDP
showing resilience to global
15.7
Agriculture
liquidity tightening, high
9.4
Domestic Trade
energy and raw materials
10.4
Transportation/Communication
-10.3
prices, high inflation and onConstruction
5.1
Industrial Output
going political controversy.
9.6
8
Real GDP growth, %
average for 2003-2007
2
Source: State Statistics Committee of Ukraine
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Economic Growth – Demand Side
 On the demand side, in the first half
2008 GDP growth was supported by high
domestic consumption and investment
growth of 17.4% yoy and 10% yoy
respectively.
 Over this period, domestic consumption
was sustained by a 15% yoy increase in
real disposable income, 9% yoy real
increase in wages, and 30% yoy real
increase in credits (65% yoy nominal).
 Growth of investments was encouraged
by the growing profitability of firms (48%
yoy in real terms due to higher exports and
Final consumption
Investments
domestic trade) and by strong foreign
Imports
Exports
currency inflows (FDIs and debt), which
GDP, % yoy
Source: State Statistics Committee, The Bleyzer Foundation compensated for tighter domestic liquidity.
3
GDP growth by Demand Components, pps
24
21
18
15
12
12.1
7.6
9.6
7.3
9
6.5
2.7
6
3
0
-3
-6
-9
-12
-15
2003
2004
2005
2006
2007
1H 2008
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Economic Growth – Supply Side
GDP growth by Sectors, percentage points
12.5
9.6
10.0
12.1
7.3
7.6
6.9
7.5
5.0
2.7
2.5
0.0
-2.5
2003
2004
Agriculture
Services
Construction
2005
2006
2007
9mo
2008
Industry
Net taxes
GDP at market prices
Source: State Statistics Committee, The Bleyzer Foundation
 On the supply side, in 2008 agriculture
has been the growth engine (16% yoy),
harvesting 45 million tons of grains, a
15-year record. This large harvest is due
to favorable weather and larger
investments in the sector.
 Negative growth in construction
(- 10.3% yoy) this year is due to tight
economic policies (to control inflation))
 Below average growth of industry (5.1%
yoy) was due to growing production
costs (more expensive energy, raw
materials, labor, and transportation) and
weaker external demand.
 Real GDP is forecasted to grow by 6.3%
in 2008 and about 2% - 4% in 2009. 4
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Macroeconomic Performance - Inflation
 Inflation reached 17% in 2007 and surge
to 31% yoy by May 2008, caused by
increases in aggregate demand and high
food prices (poor weather in 2007).
 But during July-August 2008, the CPI
deflated somewhat due to a good harvest
and lower food prices.
 In September 2008, price growth
resumed, driven by utility tariffs.
 In annual terms, inflation continued to
Source: State Statistics Committee, The Bleyzer Foundation
slow down to 24.6%.
 Although during the last three years fiscal deficits were maintained low at
about 1%, budget expenditures grew by 20% per annum in real terms,
increasing inflationary pressures.
 Nevertheless, exchange rate and monetary policies were at the core of
the inflation problem, with large nominal increases in money supply (about
50% pa) and bank credit (about 70% pa).
Therefore, inflation was addressed by tightening monetary conditions. 5
32
28
24
20
16
12
8
Foods
Utilities
Sep
Aug
Jul
Jun
Apr
May
Mar
Jan
Feb
Dec
Oct
Nov
Sep
Jul
2007
Aug
Jun
May
Mar
Apr
Jan
0
Feb
4
2008
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Monetary Policy to Address Inflation
Selected monetary indicators
60
55
Credit stock,
% yoy, RHS
50
45
40
35
30
25
Money supply,
% yoy, RHS
20
15
Consumer Inflation,
% yoy, LHS
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
10
5
 The anti-inflationary program relied
75
heavily on monetary measures by the NBU:
70
• Switching to a managed float in order to
65
60
reduce forex interventions - the major
55
50
source of money growth.
45
• Tightening bank reserve & capital
40
35
adequacy requirements.
30
• Increasing the discount rate to 12%.
25
20
• Carrying out sizable sterilization
operations to slow down credit growth.
80
2006
Source: NBU, SSC
2007
2008
 As of September 2008, these measures reduced money supply to 38%
yoy (from 52% in 2007); and credit growth to 54% yoy (from 74%).
 Helped by larger agricultural output, annual inflation may decelerate to
20% in 2008 and may be further reduced to 15% in 2009.
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Main Economic Issues facing Ukraine Today
 Inflation is no longer the main issue facing the country today.
 Ukraine today is facing the possibility of a financial crisis in the next
few months as indicated by many international measures of default risk.
 One of the most common indicators used by investors of the risk of
default of a bond is the premium on its Credit Default Swaps (CDS).
 A CDS is an insurance-like contract that promises to cover losses on a
bond in the event of default by the bond issuer.
 Studies have shown that CDS premiums identify default risks earlier
than bond spreads or bond ratings: it is a better leading indicator for
defaults.
 A premium of more that 1,000 basis points is an indication that
investors do expect the bond to be in default.
 A few days before their collapses, CDS premiums reached 740 basis
points for Bear Stearns and 724 basis points for Lehman Brothers.
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Credit-Default Swaps (CDS) Spreads for Selected Countries
23/10/2008
3000
2750
Ukraine: 2803 bp
2500
2250
2000
1750
1500
1250
Kazakhstan: 1216 bp
Russia: 1031 bp
1000
750
500
23-Oct
3-Oct
15-Sep
26-Aug
6-Aug
17-Jul
27-Jun
9-Jun
20-May
30-Apr
10-Apr
20-Mar
29-Feb
11-Feb
22-Jan
2-Jan
12-Dec
22-Nov
2-Nov
0
15-Oct
250
Other countries with high CDS premiums include Argentina (3,900 bp),
Pakistan (3,000 bp), Ecuador (2,600 bp) and Venezuela (2,300 bp).
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Opinions of International Experts about Ukraine’s Vulnerability
 High Level NY bank officer: 80% probability that Ukraine will face a financial
crisis during the next few months.
 High Level London bank officer: 90% probability that Ukraine will face a
financial crisis.
 Economist of major investm. bank: A financial crisis in Ukraine is imminent.
 Standards and Poor’s September 2008 Review of Ukraine’s Banking sector:
Ukraine’s banking sector is in high risk and is listed in Category 10, which is
the category for the world’s weakest and most vulnerable banking sectors
(along with Bolivia and Venezuela).
 US Treasury’s Quarterly Assessment of Financial Risks, September 2008
(Ukraine was placed among the 10 top financial risks in the world): Ukraine
…. risks a sharp balance of payments adjustment or crisis within the next one
or two years.
 Fitch Rating: Ukraine’s sovereign rating downgrade to ‘B+’ reflects concern
that the risk of financial crisis in Ukraine… is significant and rising.
 In mid-October, S&P’s put Ukraine’s sovereign rating on CreditWatch with a
negative outlook.
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Three Major Reasons Why the Ukrainian Economy is
Vulnerable:
1. Large Current Account Deficits
2. External Debt Burden
3. Banking Sector Weaknesses
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1. Large Current Account Deficits
Current Account Balance and FDI Inflow in $ billion,
and CA Balance as % of GDP
10
5
0
-5
Current account
balance, % of GDP
-10
-15
FDI inflow, $ billion
Current Account Balance, $ billion
CA Balance, % of GDP
-20
-25
2001
2002
2003
2004
2005
2006
2007
2008(e)
2009(f)
- In 2009, the current account deficit is likely to widen to $24 billion (10% of
GDP.) This amount will require foreign financing.
- Of this CA gap, about $10 billion reflect the likely increase in imported gas price.
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2. External Debt Burden
2a. Gross External Debt, by Sectors, $ Billion
105
Intercompany Lending
$4
Corporate Sector
90
Banking Sector
Public Sector
$43
75
60
4
5
$38
30
15
$15
0
2004
2005
2006
2007
2008
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- In the last two years total external
debt grew 45% pa to $100 billion.
- External private debt grew to $85
billion, $29 billion of which is shortterm (classified by original maturity).
- Ukraine’s external debt is now
above the median value of countries
in similar credit rating categories:
- At 60% of GDP, Ukraine’s
external debt/GDP is above the
40% median value of similarly
rated countries.
- At 120% of current account
receipts, its ratio of external
debt/CA receipts is also above
the 84% median value for
similarly rated countries.
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2b. Sort-term Component of Gross External Debt, by Original Maturity
Breakdown, $ Billion
30
Corporate sector - ST debt
Banking sector - ST debt
25
20
15
29
10
5
9.5
0
2004
2005
2006
2007
2008
- The actual short-term debt may be much higher than the official number of $29 billion,
if we include the short-term part of the medium/long-term debt.
- The likely short-term portion of M&LT private debt is estimated at $10-15 billion,
which could bring the total short-term debt to $39 - 45 billion.
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2c. Ukraine’s External Financing Requirements in 2009
(in $ billion)
Sort-term private debt repayments*
Likely short-term portion of medium-term debt
Public sector external borrowing needs**
Forecasted current account deficit
2009
-29
-10
-2
-24
Likely external financing requirements
-65
Likely FDI inflow
10
Likely external debt requirements
-55
Available NBU reserves
35
* not including the short-term part of M&LT private debt
** according to 2009 Draft Budget Law
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External Financing Requirements
 The previous table shows that the 2009 external financing requirements
could be $55 billion (adding the short term external debt to the external
financing required to cover the CA gap, and subtracting likely FDIs).
 A portion of this debt is due by subsidiaries to parent companies or
represents more stable trade credits (about $25 billion).
 Under normal circumstances the gap of $30 billion would be manageable.
 But if global liquidity continues tight, Ukraine may not be able to secure
financing for this amount.
 Due to international liquidity constraints, since September 2008 a number
of local banks have reported increasing difficulties in rolling over their
foreign short term obligations.
 The risk of a crises in the near months is now greater, as shown by the
current high CDS premiums, with a possible major devaluation.
 Although some banks may fail and may even default, government foreign
debt (about $15 bn mostly long term) is likely to be timely served.
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3. Banking Sector Weaknesses
3a. Money Supply and Banking Sector Credits, UAH billion, 2001-2008
UAH billion
600
500
400
300
200
100
0
2001
2002
2003
Money supply, M3
2004
2005
2006
2007
2008
Sept
Loans to private sector
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• Many studies in EMs have
shown that high rates of
credit growth lead to high
levels of non-performing
assets.
• In Ukraine, bank credit
growth has been high over
the last 5 years: 60% pa.
• Credit growth was
supported by large
increases in money supply
(M3) of 44% pa and by
external debt.
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Bank Credit breakdown – August 2008
Total bank Credit
Credit to Financial Corporations
Credit to Non-Fin Corporations
Retail and Wholesale Trade
Manufacturing
Real Estate
Construction
Agriculture
Transport and Utilities
Credit to Households
Consumer Credit
Mortgages
Other
UAH bn
547
8
331
124
83
36
31
23
18
%
100%
1%
60%
23%
15%
7%
6%
4%
4%
208
144
59
5
39%
26%
12%
1%
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3b. Banking Sector Assets & Liabilities in Foreign Exchange
350
Billion UAH
300
250
200
150
100
50
2005
2006
Assets in foreign currencies
Source: NBU Financial Soundness Indicator Database.
2007
1H2008
Liabilities in foreign currency
- As of September 2008, foreign liabilities represented 51% of Total Liabilities.
- Moreover, as of September 2008, foreign currency denominated loans accounted
for more than 51% of total commercial bank credits, lion share of which were
issued to unhedged borrowers.
- Thus, even moderate currency depreciations may impair the ability of banks’
clients to pay their debts on schedule.
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3b. Commercial Banks Credit Quality: Non-Performing Loans
60
50
40
39.3
40.8
39.5
30
20
10
15.0
14.4
10.7
4.5
3.4
2.5
2005
2006
2007
0
Doubtful and Loss
Substandard
Watch
Source: NBU Financial Soundness Indicator Database, NBU Annual Banking Supervision Reports for
2006-2007.
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Non-performing Loans in Selected Emerging Markets
as % of Total Loans, 2007
14
12
10
8
6
4
2
Source: IMF Global Financial Stability Report, Jan 2008
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Ukraine
Romania
Macedonia
Croatia
Moldova
Turkey
Albania
Bosnia
Slovakia
Poland
Czech Rep.
Russia
Hungary
Bulgaria
Montenegro
Israel
Belarus
Lithuania
Estonia
Latvia
0
20
Recent Developments in the Banking Sector
 Banking weaknesses and the global financial crisis has intensified
concerns over Ukrainian banks’ ability to rollover foreign liabilities.
 Furthermore, a shareholders’ dispute over the six-largest Ukrainian bank
triggered a run in deposits in the bank.
 To support the bank, the NBU provided UAH 5 billion (about $1 billion)
of emergency refinancing and later took control over the bank.
 Although this situation is under control, it has undermined confidence of
the population in the banking system as a whole.
 Affected by distrust, commercial banks have also cut or closed their
interbank credit operations. This significantly restricted commercial
banks’ access to domestic financial resources.
 Experiencing some difficulties in withdrawing cash from several
commercial banks’ ATMs, many people rushed to empty their current
and saving accounts.
 According to NBU estimates, this run cost the banking system about
UAH18 billion ($3.5 billion) in October.
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Ukraine in the Context of Global Financial Crisis
 Ukraine is vulnerable due to a combination of large short term debt
repayments, high current account deficits, and banking weaknesses due
to non-performing loans and high foreign currency bank liabilities.
 Separately, each of the above factors looks manageable, but their
confluence amid a deteriorating world economy, easing of steel prices,
imminent energy price increase, and turbulent domestic politics have
notably affected investors risk assessment of Ukraine.
 Reflecting these risks, since mid-2008 the premiums for Ukrainian Credit
Default Swaps have risen to over 2,600 basis points in mid-October.
 High risk perceptions of emerging markets translated into a decline in
portfolio capital inflows to Ukraine: the inflow of portfolio capital
declined from US$3.3 billion in the first half of 2007 to only $350
million in the same period of 2008.
 Partly as a result, the PFTS index has declined by more than 75% yearto-date (as of October 22, 2008), one of the largest declines in the world.22
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Recent Exchange Rate Developments
 During the first half of 2008, significant inflows of short term capital took
place to take advantage of high local interest rates and the perception that
an immediate devaluation was unlikely.
 However, since mid-year, the economic weaknesses of Ukraine and its
vulnerability to the current global liquidity crisis became more evident and
foreign capital started to move away from Ukraine.
 Coupled with lower export earnings and higher demand for foreign
currency to repay imports and debt obligations, it caused sharp Hryvnia
weakening in the interbank market.
 This weakenning took place despite the fact that during October the NBU
sold foreign exchange to the extend of about $3.5 billion, reducing its
international reserves from $38.5 bn to $35 bn.
 The Hryvnia bid-ask rates depreciated in the interbank FX market from
4.60-4.65 UAH/$ in mid-August to 5.77-6.08 UAH/$ on October 24, 2008.
 To restore foreign exchange stability, the Government and the NBU are
now seeking a loan from the IMF of about $16 bn.
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Other Measures to Address the Financial Sector Turmoil
 The NBU has also actively supported banking sector liquidity through its
refinancing operations. In October, it provided UAH 20 billion (about $4
billion) of liquidity support to a number of banks.
 To build confidence, deposit guarantees were doubled to $20,000 and are
planned to increase further.
 Furthermore, the NBU has imposed a six-month freeze on the early withdrawal
of saving deposits from commercial banks.
 It introduced tough limitations on commercial banks credit portfolio growth.
However, a few days later, the NBU softened its restriction on growing
concerns that this credit squeeze was harming economic growth. The only
significant restriction is now that foreign currency loans can be made only to
borrowers that have foreign currency income.
 The NBU strengthened its monitoring of external private debt. In particular, it
required commercial banks to supply with data on their and their clients’
external debt obligations maturing each quarter over the next 12 months.
 Several state officials have advocated the need to create a stabilization fund,
which would work as a government-owned Asset Recovery Company to buy
and resolve some of the distressed assets of the banks.
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Medium Term Prospects
 Although the combination of larger current account deficits, large short
term repayments and tight international liquidity may lead to a financial
crisis in the next several months, over the medium term, Ukraine’s
economic outlook is still bright.
 In the medium term, Ukraine should enjoy higher growth in productivity
and GDP, and therefore higher asset prices for the following reasons:
• The recent membership into the WTO should stimulate exports.
• A FTA under negotiations with the EU would further encourage
exports and foreign direct investments (FDI).
• FDI will also be supported by an abundant and educated labor supply
at wages that are one-third of those in Eastern Europe.
• Ukraine large population of 46 million people is an attractive market.
• Ukraine agricultural potential is quite high and could become one of
the world’s largest grain exporters.
• Ukraine’s infrastructure is reasonable as compared to other countries
in the region.
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