2017 Results Mixed; 2018 Prospects Good
Results for 2017 were mixed. Ukraine’s economy is on the rise, and many positive achievements were reached. But 2018 begins with one awful reality: ongoing attacks against the new anti-corruption agencies have revealed to the world just how reluctant the establishment is to give up its rent-seeking activities any time soon. The IMF has made it very clear that further funding is contingent upon effective anti-corruption action. But with a presidential race looming in 2019, the latter is far from guaranteed. Uncertainty over the prospects of external funding hangs over the Poroshenko administration.
Last year started with a trade blockade of occupied Donbas. Trading across the frontline was politically ambiguous at best, and raised social tensions among ordinary Ukrainians, who saw the Petro Poroshenko administration as profiteering from the three-year-old conflict — basically, as “sleeping with the enemy.” After an unofficial blockade demonstrated just how unpopular this trade was, official supply chains with the occupied territories were officially cut. The morally dubious situation ended, but Ukrainian industry has stagnated since then.
The negative impact of the trade blockade was followed by positive news from the Stockholm Arbitration. The arbitration panel rejected Gazprom’s key demands, which included a “take-or-pay” rule, and a ban on the re-export of surplus natural gas. The panel also reduced 2014 gas prices that Russia had been charging Ukraine. The final determination of this lawsuit will be known only in February, when the arbitration panel rules on gas transit fees. In the meantime, the case has already become an important precedent for defending Ukraine’s national interests against Russia.
A visa-free regime with the EU was probably the main political achievement of 2017. Ukrainians were largely skeptical about the likelihood of visa-free travel, and the EU’s decision came as a positive surprise. For President Poroshenko, the visa-free regime was a huge political victory, and one that he will exploit heavily in his 2019 reelection campaign.
In 2017, the economy performed better than forecast, with GDP growing 2% y/y despite the trade blockade, and the CAD growing only slightly—to $3.8 billion, or 3.6% of GDP, from $3.5 billion, or 3.8% of GDP, in 2016. The hryvnia remained stronger than expected, at UAH 28.1 per dollar, and state budget revenues surged 28.8% y/y. Only inflation proved a disappointment, beating the most pessimistic projections, at +13.7% ytd by yearend.
Private consumption and local investment drove GDP growth last year — a pattern we expect to continue in 2018. The only difference is that the impact of the trade blockade should fade away. The economy should accelerate to 3% y/y in 2018. Meanwhile, the CAD will widen to $4.4 billion, or 3.8% of GDP. We expect the hryvnia to hit UAH 30 by December, although inflation should ease somewhat, to +8.2% ytd, or +11.2% y/y in 2018. Budget revenues should be in good shape, and the deficit target, of 2.5% of GDP, looks safe. Financial inflows are in question, with IMF funding stalled. However, for the baseline scenario, we have assumed that cooperation with the Fund will resume, which should bring gross reserves up to $23.4 billion, or to 4.1 months of imports in 2018.
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