Muddling through a fiscal crisis
A fiscal crisis and desperate efforts by Ukraine’s leadership to eke out at least a tiny positive signal from the IMF have been the main topics of focus in recent weeks. Despite an improvement in budget collections, Finance Minister Serhiy Marchenko admitted that public coffers were missing at least $3 billion to close the 2020 fiscal year. Relations with the IMF have been spoiled, thanks to multiple bad moves, but the government tried to maintain one-sided positive communication to create the impression that everything was going well. The hope was that a positive signal from the IMF would boost a cheaper Eurobond placement. However, at the time of this writing, no signal had come from the Fund. Still, the Cabinet got lucky with a €600 million macro-financial loan from the EU, which was the first time such funding was provided without any progress in IMF negotiations. Probably, the progress with the EU was deemed a signal of upcoming IMF progress, and a $600 million Eurobond placement was quickly arranged. How the authorities plan to close the remaining UAH 60 billion (nearly $2 billion) 2020 fiscal gap remains a mystery, even three weeks before the year’s end. There’s a lot of talk about a return of non-resident demand for state bonds, which is expected to cover a solid part of hryvnia-denominated state bond issues.
The Cabinet decided to introduce a strict lockdown from January 8th to January 24th, 2021. Talk about tougher restrictions began at the end of November, when new COVID-19 cases topped 16,000 a day. However, the questionable results of the “weekend lockdown,” a drop in the number of new infections in the first weeks of December and poor compliance with lockdown measures at the local level made the Cabinet hesitant to act. Eventually, members decided to introduce a strict lockdown in 2021 -- but there’s no guarantee the restrictions will actually come into effect.
Ukraine’s economy continues to perform relatively well. Industry remains in the red, at -5% y/y in October, while retail trade, meaning consumption, is picking up pace, hitting +14% y/y in October. Inflation predictably sped up to +1.3% m/m or +3.8% y/y in November, and was at +4.1% ytd for November 2020. We expect consumer inflation to hit our forecast of +5.2% ytd or +2.8% y/y for 2020.
Budget revenues strengthened in November, up +15.2% y/y. But nearly half of this growth was based on delayed VAT refunds to exporters and ill-defined “own revenues of budget organizations.” Moreover, even this sleight of hand does not save the budget and MinFin remains in a desperate search for funds to cover a huge fiscal gap. The EU €600 million loan as well as $600 million in Eurobonds reduces the problem temporarily, but there is still no answer for how MinFin might attract up to UAH 60 billion domestically by the end of the year. Some non-residents are returning to the market, but the NBU is still expected to come to the rescue.
External accounts are strong in the trade balance, with a $5.1 billion surplus in the current account by October. But financial flows are in the red, with a $5.9 billion deficit recorded for 11m 2020. Individual foreign cash withdrawal and a non-resident exodus from hryvnia state bonds were the main reasons for this negative flow.
The hryvnia was mostly stable in November, hovering around UAH 28.10-28.60/dollar. Strong commodity exports and modest public spending preserved the currency’s stability through the month. This trend made it possible to keep gross international reserves almost unchanged by the end of November, at $26.1 billion, or 4.7 months of imports. In light of the $600 million Eurobond placement and the €600 million loan from the EU, we expect to see gross reserves recovering to $27 billion by the end of December.
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