Ukraine is struggling to rebound

2016 was not a kind year to the Ukrainian economy. GDP increased by 1.8 per cent. According to experts it will not be easy for Ukraine to catch up. The external and internal conditions are not conducive to economic growth.

The Prime Minister of Ukraine Volodymyr Groysman informed that according to government data from the H2’2016 the country’s economic growth was 2.2 per cent higher than in the previous year. In the Q4 GDP increased by 4.7 per cent.

According to the preliminary data of the Ukrainian Ministry of Finance, in 2016 Ukraine’s GDP increased by 1.8 per cent. The country was not able to break the negative trends in foreign trade and the imports still exceed the exports, which fell even further, despite the association agreement with the European Union which has been in force for over a year. The proceeds from exports only amounted to USD33.6bn, which is 5.2 per cent less than in 2015. Imports increased by 3.8 per cent, to USD40.4bn. As a result, the trade deficit reached USD3.4bn.

According to data from the Agency of Industrial Marketing, Ukrainian exports are dominated by the agricultural and food sector, which brought USD15.2bn, that is 42 per cent of the total revenues. It is therefore no wonder that in the last year a real war over agricultural land broke out in Ukraine, during which the owners of farms were forcibly deprived of their land. Other important components of Ukraine’s exports include metallurgy, which generated proceeds of USD8.3bn (23 per cent of total export revenues) and the machine industry with proceeds of USD4.2bn (12 per cent of total export revenues).

According to a report of the National Bank of Ukraine, in the past year foreign investment in Ukraine amounted to USD3.4bn, which is approx. USD400m more than the year before. The vast majority of the invested resources, amounting to USD2.2bn, were investments in the banking sector, mainly in the recapitalization of banks. Foreign investment in the real economy still remains at a very low level.

The (not quite) realistic budget

While preparing this year’s budget, the government assumed that GDP growth would reach 3 per cent. The IMF was more careful in its assessments, which forecast growth of 2.5 per cent. Inflation is supposed to reach 8.5 per cent, the average annual exchange rate of the USD is supposed to be UAH27.2, and the budget revenues are supposed to increase by 18 per cent in relation to last year.

“This budget is absolutely realistic,” commented Prime Minister Groysman after the document was adopted.

Just one month after the adoption of the budget, it turned out that the government’s assurances were at least partly exaggerated. At the end of January the central bank reported that according to the forecasts, annual inflation in 2017 would be 9.1 per cent, whereas during the first three quarters it would even reach two digits and would only drop at the end of the year. According to the NBU, this is the effect of the increase in the minimum wage from UAH1,600 to UAH3,200 per month, which entered into force on January 1st.

Costly gas dispute

The fate of the Ukrainian public finances will depend on a decision which should be taken in the second quarter of the year in Stockholm. This concerns the outcome of the arbitration procedure in the dispute between the State-owned Naftohaz of Ukraine and the Russian Gazprom, in which the Russian company demands from its Ukrainian counterpart the payment of USD39bn, while the Ukrainian company demands USD28bn from the Russian monopoly.

In the opinion of the economist Anders Aslund from the Atlantic Council, in order for Ukraine to really start growing again it will be necessary to change the system for the management of the state and the economy. The bureaucratized and ossified structures derived from the Soviet traditions should be simplified and should become more transparent, he argues.

According to Oleg Ustenko from the Blazer Foundation, in 2017 Ukraine will scramble to attract foreign investment, but it is not ready for that.

“The battle will be won by whoever is able to offer better conditions. The strategic task is to carry out structural reforms, improve the business climate and change the growth model towards one that is focused on innovation and investment,” he believes.

The government has indeed announced that Ukraine's model of economic development will change. The Minister of Economic Development and Trade Stepan Kubiv assured that work is underway on a program intended to transform the country from an economy based on raw materials to a more innovative economy open to new opportunities and new markets.

The margin of freedom of the ruling oligarchs on the internal market is narrowing. At the end of January war veterans blocked the railway tracks in the Luhansk Oblast and are not letting through freight trains with goods, among others coal from the Donbass mines and bootleg mines. Participants of the blockade revealed that strategic materials, machines, devices and even explosives were sent to the territories occupied by the militias in exchange for coal. And the consent for that was granted by the Security Service of Ukraine.

The citizens’ economic blockade of the occupied Donbass may deprive companies from the energy sector linked with the current ruling camp of huge revenues. Ukrainians feel betrayed and they decided to take matters in their own hands.

In June last year the electricity prices were raised. The National Commission for the Regulation of Energy and Public Utilities, which is tasked with setting the prices – and is subordinated to the president – established that the calculation of the cost of electricity was based on the price of coal in Rotterdam rather than the price of domestic coal. The “foreign” coal was supposed to guarantee the independence of the Ukrainian energy sector from the anthracite from the occupied territories.

The enormous price hikes (the electricity price was raised by 20 per cent twice) made a dent in the budgets of millions of Ukrainian households. It turned out that consumers, who were promised that they were paying more in order to become independent from the enemy, were actually paying for nothing. Half a year later the Ukrainian power plants are still using coal from Donbass. The difference in price amounts to approx. USD40 dollars per ton. As a result approx. USD900m went into the pockets of the energy companies’ owners.

There’s no such thing as a free lunch

The European Commission decided to grant aid to Ukraine in the amount of EUR600m. It was justified by the progress in the reforms carried out in Ukraine over the past several years.

In the middle of November of last year, the Fitch ratings agency raised Ukraine’s long-term credit rating from CCC to B-. Fitch assessed that Ukraine’s dependency on foreign loans has decreased and that the foreign exchange reserves have increased. According to Fitch, Ukraine's economy will grow at a faster rate – in 2017 GDP will increase by 2.5 per cent, and in 2018 by 3 per cent.

The European Union’s aid, however, is not selfless, and there are strings attached. In return for the assistance, Brussels wants Ukraine to lift the ban on the export of wood [we wrote about it few months ago].

The Ukrainian media are still publishing materials documenting the exploitative logging of forests, especially in the Carpathians, Bukovina and in Volhynia. According to official data, in 2015 timber with a value of USD1.1bn was exported from Ukraine, and in one quarter of 2016 alone the value of such exports exceeded USD260m. These data do not show the full picture, however, because they only cover legal logging and sales. The value of illegal exports of timber from Ukraine is estimated at USD100m per month. In light of this amount, the EU subsidy of EUR600m does not seem excessive.

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