Links Cut to Occupied Donbas Likely to Stymie Growth
GDP expanded 2.3% y/y in 2016, far more than we’d expected. An upsurge in local investment, of 20.1% y/y, and expansion of inventories, were the main drivers. Investment grew, despite scarce FDI, on the back of agro and state investment. An impressive +9.7% y/y grain harvest increased inventories.
Yet we expect economic growth to slow this year. The need to adjust for the cut in trade with occupied Donbas is the main reason. We have therefore lowered our 2017 GDP growth forecast, to 1.8% y/y from 2.4% y/y, to account for this.
Though the real sector is slowing, high metal prices are preventing a dramatic negative impact on external accounts. For the first two months of 2017, a $541 million CAD was reported, far below the $861 million of a year ago. By H2, we expect resource prices to roll back, amid recovering metals production, after broken connections with Donbas. We expect the impact of Donbas events on the CAD to be almost neutral, and forecast a CAD of $4.5 billion, or 4.6% of GDP, in 2017.
The hryvnia remains stable, around UAH 27 per dollar, despite the trade blockade that started two months ago. Currency shocks are unlikely, but we still expect a gradual depreciation, on the back of Ukraine’s widening trade deficit. The exchange rate should reach UAH 29 by yearend.
Fiscal prospects remain positive. General budget revenues grew 55.3% y/y in February, far above the 15.4% y/y targeted for the year. The Finance Ministry estimated an almost neutral effect on the budget from the trade blockade, counting net fiscal losses at UAH 2 billion, or 0.2% of targeted revenues. The targeted deficit of 3% of GDP looks safe.
Despite economic improvement, surveys show that business sentiment remains quite restrained. And widespread public support for the trade blockade has revealed a dangerous development: Ukrainians are disappointed with their political leadership, and ready for serious confrontation, if a strong enough black swan event takes place. The country could be sitting on a powder keg. Ukrainians’ mood is far from reformist or optimistic. The citizens are tired of painful changes, such as skyrocketing utility rates, and angry over persistent and unpunished corruption at the top. This mood will require some kind of relief or outlet. Hopefully, the lid won’t blow before the next election.
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