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Macroeconomic Outlook

EM Research | October 2011

Ukraine macroeconomic overview

Key points

Ukraine is gradually recovering from the 2008 crisis, although it carries a high degree of vulnerability to external demand and commodity prices. Its output is still below the level in 2007 as opposed to CIS peers. GDP growth is estimated to have grown by 5.3% in Q1, slowed to 3.8% in Q2 and rebounded in H2 on a strong harvest. Growth could reach 4.5% this year and slow considerably in 2012 on global demand. Higher social expenses and state investments are expected to give short-term support to domestic demand in H2 2011. Rising imports and a likely deterioration of Ukraines terms of trade - defined as steel export versus energy import prices pose a risk to Ukraines current account balance. It stood at 2.8% of GDP in August YTD and may reach 6% in 2012 in case the current gas contract applies. These increased exchange rate risks due to Ukraines external financing constraints. NBU reserves dropped from $38.2bn to $35bn in September and without unblocking the IMF loans Ukraines external liquidity would weaken further next year. The next IMF mission is due in Oct/Nov. Deputy PM Tigipko is proposing full program compliance to avoid having to look eye-to-eye with another crisis. The freezing of capital markets for Ukraine limit the governments loan options. Ukraines fiscal position has improved and default is not a threat at present. The Jan-Aug. state budget balance is -0.4% of GDP. With 2.4% GDP cash reserves the Treasury has already pre-financed Ukraine's net borrowing need for the year. The gross issuance is, however, being increasingly monetised. Next years domestic budget (re-)financing may require higher NBU purchases. External debt service may require the use of FX reserves. UAH one-year NDF yield reached UAH 10 against the USD or nearly 30%. (compared to 8.5 in mid-summer). Domestic government bond yields rose to 14% - 17% on one-year to four-year bonds and newly issued USD-indexed three-year UAH bonds 8.2%. The market challenge highlights the importance of Ukraines IMF program.

EM Research | October 2011

Ukraines economic recovery has underperformed CIS peers..

Ukraines economic output still below pre-crisis
Real GDP level 2007=100

The inventory cycle has been driving growth

Private consumption is taking over, while net export contribution is negative. Weaker external demand should be partially offset by higher social expenses and state investments next year.
20 15 10

GDP growth has been growing at an annualised pace of c. 4% y/y. The global growth outlook made us revise Ukraines growth forecast lower to 4.5% this year. It is likely to slow considerably in 2012.



Kazakhstan Turkey Russia Ukraine



0 % -5 Net exports -10 -15 Investment Consumption Real GDP growth




85 2008 2009 2010 2011

-25 2007 2008 2009 2010 2011 E

Source: IMF, Commerzbank estimates

EM Research | October 2011

.. but has gained momentum by h1 2011

Credit to private sector % y/y
Ukraines credit markets are still impaired, but credit intermediation has resumed and domestic demand has been strengthening
100 Kazakhstan Ukraine Russia

Industrial production, 3mma % y/y

Ukraines industry posted 9% growth in H1 2011, led by manufacturing. The metallurgy sector has posted double-digit growth but could start to face headwinds from the global economy.
25 yoy (%) Ukraine Russia Kazak hs tan









-20 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

-35 Mar-07 S ep-07 Mar-08 Sep-08 Mar-09 S ep-09 Mar-10 Sep-10 Mar-11

Source: Ecowin, National Central Banks, Commerzbank estimates

EM Research | October 2011

Foreign trade
Exports, imports and trade balance
Ukraine remains exposed to commodity price risks. Trade exposure to Asia could soften the export shock in case European demand falls.
80 60 40 20 % 0 -2.0 3.0 Trade balance 6mma rhs, U$ bn Imports 6mma % y/y lhs Exports 6mma % y/y lhs

Commodity structure of exports

Other 28% Agriculture 8% Minerals 13% Chemicals 7%


-20 -40 -60 -80 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10


Machinery 11%
-12.0 Jul-11

Base metals 33%

Ukraines export market share in world imports

0.50% 0.45% 0.40% 0.35% 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% 1Q-02 1Q-03 1Q-04 1Q-05 1Q -99 1Q-00 1Q-01 1Q-92 1Q-93 1Q-94 1Q-95 1Q-96 1Q-97 1Q-98 1Q-06 1Q-07 1Q-08 1Q-09 1Q-10 1Q-11

Export structure by destination (% share)

40 35 30 25 20 15 10 5 0 CIS Europe Asia Africa A merica 7.0 5.9 5.3 30.8 36.5 31.8 26.9 25.1 26.7 2005 2010


Source: Ecowin, National Central Banks, Commerzbank estimates

EM Research | October 2011

Commodity trade balances in Europe

Net export/import(-) of key commodities, % GDP
-10 Kazakhstan Russia Ukraine South Africa Bulgaria Poland Romania Czech Republic Hungary Turkey -5 0 5 10 15 20 25 30 -12 Kazakhstan Russia Romania Poland Turkey Bulgaria Hungary South Africa Czech Republic Ukraine

Net export/import(-) of energy, % GDP

-8 -4 0 4 8 12 16 20

Source: CEIC, UN Comtrade, Commerzbank Corporates & Markets

EM Research | October 2011

Ukraines terms of trade

Minister of Economy Kliuyev stated that the 2012 budget is based on $415 gas price, calculated according to the supply contract. This would widen Ukraines energy trade deficit by $2.2bn. An additional 10% decline in steel prices would add $2bn deficit. A combined terms of trade impact would be around $4.2bn or 2.5% of GDP (*base case). If oil declines by 30% and Ukraine buys the fixed contract amount (33bcm) at c. $352, and steel prices drop by 10%, the net trade impact is c. $2bn (1.1% of GDP). A new gas deal with Russia is in the pipeline..

Gas prices by Gazprom

TTF spot average

Trade balance and energy imports

At *base case terms of trade projection
Energy import 25 Trade balanc e Energy trade balance

Average Europe

Belarus 1Q 2011

Ukraine 1Q 2011


Belarus 2Q 2011
5 U$ bn

Ukraine 2Q 2011


0 2007 2008 2009 2010 2011(janJune) 2011 F 2012 F

Belarus 3Q 2011

Ukraine actual 3Q 2011 TTF current spot price Ukraine 3Q 2011 no discount U$ 0 100 200 300





455 400 500



Source: Ecowin, National Central Banks, Commerzbank estimates

EM Research | October 2011

The steel sector challenge

The steel sectors net margin could fall below its level during the 2009 crisis in case of the combined terms of trade impact of 10% weaker steel demand/prices and unchanged gas contract. This highlights the importance of a gas new gas deal.

Steel output strong in h1, terms of trade turning

80 Steel output % y/y

Steel trade margin as % of GDP

(steel exports net of energy imports)
10.0 9.0



7.0 6.0



4.0 3.0



1.0 0.0

-60 Jan04 O ct04 Jul05 Apr06 Jan07 Oct07 J ul08 Apr09 Jan10 Oct10 Jul11







2011 F 2012 F

Source: Ecowin, Commerzbank estimates

EM Research | October 2011

The gas sector challenge

Ukraine is one of the least energy-efficient countries worldwide and highly dependent on imported gas. Investment in exploration, extraction and transportation is insufficient, domestic production is below potential. Gas transit through Ukraine is at risk due to deteriorating gas networks Transit revenues amount to c. $2bn Reforms initiated under the IMF program include (i) gradually bringing domestic gas prices to import-parity (suspended), (ii) liberalisation of the gas sector and unbundling of Naftogaz; adopting separate cost centres for gas imports, domestic gas production and gas transit, (3) modernisation of the gas transit infrastructure. Gazprom has pushed for closer working relations with Naftogaz: President Yanukovych offered Russia a share in Ukraine's gas transit network. A consortium with Russian participation would be set up to manage Ukraine's pipelines. According to Russian government sources, Ukraine would receive 20% of shares in the consortium. Another 20% will be held by one German company and the rest by Gazprom. Gas extracted domestically could be exported to Europe to offset the losses on high import gas price if those remain as per the gas contract this year and next.
300 80% 250

Domestic gas prices well below import-parity

400 % of import price, rhs Price U$, lhs 350 107% 107% 100% 100% 120%

200 46% 150


40% 100 25% 20% 50

0 Households Utility companies Budgetary institutions Industries Import price


Source: Commerzbank estimates

EM Research | October 2011

The structural challenge

Economic reforms slowly advance; (i) the pension reform will come into force on 1 October 2011, (ii) land reform and a free land market could be established next year, (iii) the restructuring of the gas sector is likely to gather momentum. Additional privatisation in the energy distribution is being tendered ($300m). Fiscal stabilisation has made substantial progress, while structural weaknesses remain:

Productivity level
GDP per person employed

World Bank doing business ranking

Singapore Hong Kong, China 1 2 5 22 54 59 65 68 79 123 127 145 0 50 100 150


United States
50,000 c onstant 1990 PPP $

Germany Azerbaijan Kazakhstan




Belarus China Russ ia


0 Brazil Turkey G ermany Hong Kong, China United States India Uk raine Russia China Azerbaijan World

Brazil Uk raine

Source: World Bank

EM Research | October 2011

Fiscal consolidation in progress

General government budget balance
The fiscal deficit has shrunk to 1.1% of GDP by Aug 2011 (12m rolling) vs. 2.8% under the revised budget due to 40% nominal increase in revenues. (The 8m deficit is $0.6bn or 0.4%). The revised 3.4% fiscal target could accommodate a wider-thanbudgeted Naftogaz deficit (0.8% GDP) and may facilitate unblocking the IMF loans.
50 % y/y 10

General Govt balance (% of GDP)

Fiscal stabilisation has advanced vs. other IMF program countries Ukraine targets 2.6% of GDP deficit (+0.8% Naftogaz) vs. 6.5% in 2010. The 2012 draft budget is conservative despite the 2012 elections at -2.5% of GDP. Fiscal conservatism has been a trademark of the Azarov government. Government reserves amount to 2.4% GDP.
3 2010

2011 1

40 -10 30 -20 20




UAH bn




-50 0 -60


Czech R.






Gen. govt. budget balance 12mma rhs Expenditures % y/y, lhs Revenues lhs -20 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10


-80 Jul-11

Source: Ecowin, IMF

EM Research | October 2011









Domestic UAH sovereign debt market

Budget execution vs. pro-rata budget target
Feb 10,000 -10,000 -20,000 -30,000 -40,000 -50,000 -60,000 UAH mn Pro-rata budget (rev ised, 2.6% G DP) 2011 2010 2009 Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Govt. reserves and net position vs. NBU (UAH m)

80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Jan-08 10,000 20,000 Jul-08 Jan-09 Jul-09 J an-10 Jul-10 Jan-11 Jul-11 Central Bank net claim on central govt. Treasury deposits at the NBU (budget pre-financing) NBU holding of gov t. s ec urities

Government bond holdings by sectors (UAH m)

100,000 NBU 80,000 Banks Others Non-residents

Avg. yield at UAH treasury auctions




15 %




0 Jul-10 May-09 Sep-09 May-10

Jul-09 O ct-09 J an-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 J ul-11

Source: Ecowin, NBU

EM Research | October 2011













The public debt service

Doable with maturity extension of IMF liabilities, higher domestic yields
Total government debt maturities
Debt redemptions cluster at the end of the year in 2011 and rise significantly next year. Foreign debt service, including a partial redemption of the $2bn VTB loan this year, would amount to nearly $2bn. Including IMF liabilities ($4bn) Ukraines external debt service is $5.5bn in 2012 and may require the use of international reserves. Ukraines external liquidity benchmarks would weaken. Ukraines short-term domestic debt is large; it has to refinance UAH 30bn in 2012. The NBU has started to monetise UAH debt and may need to increase its purchases next year when redemptions increase. In the short term, the yield that stabilises Ukraines debt is below 14%. Over the long term at standard assumptions Ukraines debt ratio is set to decline. Co-operation with Russia in the gas sector, unblocking of IMF loans and maturity extension of fund liabilities could relieve external balance pressures in the near term.
Source: IMF, Bloomberg, NBU Commerzbank estimates
12,000 Other (VTB loan, Naftogaz, Ukrexim) Projected repayments to the Fund 10,000 Domestic UAH bonds International Bonds 8,000 U$ mn




2011 2012 2013 2014 2015 2016 2017 2018 2019

Domestic debt maturities by month (as at Sep 2011)

7,000 6,000 5,000 UAH mn 4,000 1,983 3,000 1,276 1,200 1,300 2,000 1,000 5 0 5 Oc t-11 Dec-11 Nov-11 5 4,543 5,746 4,823 4,668























Source: Commerzbank, Bloomberg, Global Source, IMF

EM Research | October 2011













External balance
A moderate crawling devaluation is conceivable under a negative external balance scenario
Balance of payments deteriorating
Ukraines current account position is under market watch due to its financing constraints. Under the fixed gas contract terms and weaker steel demand/prices the current account deficit could widen to $10bn or 6% of GDP. (A pessimistic scenario).
25 Capital and fin. a/c balance 4Q cum. Current ac c. balance 4Q cum. 20

Capital flows: a fragile balance as IMF loans stalled

Ukraines capital balance is supported by Eurobond issues and inter-governmental loans (also privatisation this year). Without wholesale funding channels Ukraine may need to cover a BOP shortfall from reserves next year.

mln U$

Other capital, loans and bonds Portfolio investment, net Direct investment, net



10 U$ bn





-15 1Q-06 4Q-06 3Q-07 2Q-08 1Q -09 4Q-09 3Q-10 2Q-11

-8000 1Q-06 4Q-06 3Q-07 2Q-08 1Q-09 4Q-09 3Q-10 2Q-11

Source: Ecowin, Commerzbank

EM Research | October 2011

External liquidity may weaken

In the assumed negative balance of payments outcome..
External debt as % of GDP
100 90 80 70 60 50 40 30 20 10 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 Total external debt % of GDP

External debt as % of exports

300 250 200 150 100 50 0 2006 2007 2008 2009 2010 2011 2012 2013 External debt to exports %

Gross reserves in months of imports

8 7 6 5 4 3 2 1 0 2007 2008 2009 2010 2011 2012 Gross reserves (months of next year's imports)

Short-term debt as % of gross reserves

160 140 120 100 80 60 40 20 0 2007 2008 2009 2010 2011 2012 Short term debt as % of gross reserves

Source: IMF, Ecowin

EM Research | October 2011


The market challenge..

MSCI indices, 2008 jan.=100
Ukraines relative performance in line with Russias

Sovereign CDS spreads (bps)

at 850bps Ukraines spread is second widest after Greece
6000 Uk raine lhs Poland Greece lhs Russ ia Hungary Italy 1200















0 1/28/2008 4/28/2008 1/28/2009 4/28/2009 7/28/2009 1/28/2011 10/28/2008 4/28/2011 7/28/2008 7/28/2010 1/28/2010 4/28/2010 10/28/2009 10/28/2010 7/28/2011

0 1/28/2008 7/28/2008 4/28/2009 7/28/2009 1/28/2010 4/28/2010 1/28/2011 10/28/2008 10/28/2009 10/28/2010 7/28/2011 4/28/2008 1/28/2009 7/28/2010 4/28/2011

Source: Ecowin, Bloomberg

EM Research | October 2011


Financial sector vulnerabilities

Short-term debt and FX liabilities are high, particularly when considering BOP and FX risks
Loan/deposit ratio

Short-term debt burden

ST external debt at remaining maturity, % GDP lhs 50 ST external debt at remaining maturity, % GIR, rhs 300 250 200 150 100 50 0 Ukraine Turkey Belarus Macedonia Kazak hstan Hungary Serbia Croatia Rus sia Poland Bulgaria 45 40 35 30 25 20 15 10 5 0
Estonia Ukraine Latvia


150 100 50

0 K azakhs tan Lithuania Romania Hungary Croatia Russia Turkey

Foreign currency loans as % of GDP

90 80 70 60 50 40 30 20 10 0 B elarus Mac edonia Bulgaria A lbania Lithuania Hungary Croatia Poland Turk ey Serbia Moldova Romania Ukraine Latvia Russia

FX loans as % of total loans

100 90 80 70 60 50 40 30 20 10 0 Poland Moldova Bulgaria Lithuania Belarus Hungary Croatia Ukraine Macedonia Romania Albania Russ ia Turk ey Serbia Latvia Foreing currenc y loans to households Foreign currenc y loans to corporates Indexed

Source: Ecowin, IMF, Fitch Ratings

EM Research | October 2011


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EM Research | October 2011