The Cabinet of Ministers on September 10 released a document specifying the macroeconomic indicators underlying the national budget plan for fiscal year 2009. The GDP growth rate is not expected to slow down substantially, while the inflation rate will be plunging dramatically during the next 15 months, until the rate of price hikes slows down by the end of the next year to the level where it will be 2.5 times slower than today.
The Government, apparently encouraged by the results of its anti-inflation campaign (not so obvious to ordinary citizens as the government itself, however), does not seem to worry at all about ongoing political clashes with the Opposition, the imminent threat of natural gas prices increasing at least two-fold starting as soon as January, an obvious decline in foreign investors’ interest in Ukraine or the latest drop in stock market values rate which is increasingly accelerating to that of freefall. Neither does it seem to be concerned with the sharp decline in foreign markets for what constitutes the core export items for Ukraine, which had already set off a slump in production in basic industries last month. The rosy picture painted by the Government angered the Opposition so much that they even began frightening people with apocalyptic forecasts involving stagnation, stock market meltdown and those sorts of things, saying that this Government is obviously unable to clamp down on skyrocketing inflation;, neither is it in a position to secure sustainable economic growth.
The foreign experts Mirror Weekly selected to talk to in search of less biased assessments are saying that the truth, as always, is somewhere in between. Ever rising inflation can be suppressed, indeed, they say, but only on the condition that the Government pursue a very modest budgetary policy, which looks highly problematic in the current political situation.
The number-one optimist in our Government is, certainly enough, its head, Yulia Tymoshenko. In her opening remarks during the most recent Cabinet meeting, the Prime Minister optimistically proclaimed that “there is good news in this country, despite the ongoing political crisis.” This is about deflation, which, according to Tymoshenko, has been observed “for two successive months already.” Even though the deflation rate in August amounted to a meager 0.1 percentage points, Tymoshenko, without any undue modesty, announced that “the Government has almost got through the phenomenon of inflation,” and added, “it is for the first time in many years now that this country is witnessing deflation continuing for two months in a row.” True, deflation is a fairly rare phenomenon here in Ukraine, which previously saw deflation as late as in July-August 2003.
But instead, as is always the case in this country, the budget plan for the next fiscal year is being drafted as a rush and very hard job. As promised by the Government, the draft budget will have been ready for consideration and preliminary approval by the Cabinet at its session on September 13, and will be passed over for consideration and final approval to parliament on Monday, September 15 – the deadline established by law.
The 2009 budget plan has thus far been unseen by anyone but its authors. Nevertheless, some of the forecasted key indicators have already trickled out and into the press. By the end of December 2009, the inflation rate is not expected to exceed the December 2008 level by more than 9.5 percentage points, while the GDP growth rate will decline somewhat -- to 6% from the current 6.5% (as estimated by the State Statistics Committee based on the GDP growth rate posted in January through August). The industrial growth rate is forecast to be almost on par with that of the whole economy (5.7%), and direct foreign investment will be in excess of $10 billion. Consolidated budgetary receipts and outlays for 2009 have been forecast at UAH372 billion and UAH400 billion, respectively.
Social standards, certainly enough, will be on the rise, as well. The planned rate of average salary rise (32%) will be more than three times higher than the predicted inflation rate of 9.5%. The rate of pension rise is planned at a fairly modest 20%; still, it will be more than twice as high as the inflation rate.
Furthermore, 2009 will be the first year since independence to see the minimum wage raised up to the subsistence level established by law, amounting to UAH 770, an increase of 19% from the current UAH 649 for able-bodied citizens, and to UAH 568 for unemployable persons.
However, it remains unclear whether the paycheck, pension and subsidy rises are to be introduced gradually and on a step-by-step basis. An answer to this question becomes even more interesting considering that the Law “On Introducing Changes to some Legislative Enactments of Ukraine Regarding the Raising of Minimum Wage to the Subsistence Level for Able-Bodied Citizens,” adopted on December 14, 2006, demands that minimum wage be raised up to the subsistence level already beginning on January 1, 2009 already.
It might be mentioned that public-sector employee salaries are pegged to the minimum wage, and -- given the changes of the 2008 National Budget Law (approved by the legislature but still awaiting a go-ahead from the President) that introduce the revised standard wage scale for state-sector employees beginning on September 1, not November 1 as originally planned – the ratio between the average state-sector employee salary and the minimum wage will be 3.36 to 1, rather than 3.07 to 1, meaning a proportionate major rise in budgetary outlays.
As the annual inflation rate still remains as high as 26% in Ukraine, and the deflation being witnessed during the past two months is largely due to the price decline of late-crop fruits and vegetables -- any talk of suppressed inflation is premature, at least at this stage.
We have a few reasons to think so. One is a seasonal upsurge in economic activities, and the other is a huge balance of fiscal accounts. The Finance Ministry is keeping for itself as much money as it can, but it will have to splash out by year’s end as the minimum wage and pensions will rise up in December.
In such a situation, a new spiral of inflation is imminent, the more so as the subsistence level must be brought into line with the inflation rate, as the law demands. By the same token, paychecks and pensions will have to be increased in proportion to the subsistence level rise, which will inevitably set off yet another inflation spiral, until this never-ending vicious circle brings our long suffering economy into total collapse.
This economy, by the way, is still unaware of what kind of Government or natural gas prices it will have to live with in the next year. As for the new gas price, it will not become known until December at the earliest, and the same is true for the Government in case a fresh parliamentary election is called.
Rising inflation, coupled with political chaos, have further cooled down already diminished interest in Ukraine on the part of foreign investors. This could be best seen from the continuing avalanche drop in stock market values rate, which cannot be rein in other than by canceling operations at the PFTS (Ukraine’s main stock trading platform). What can provide better proof of the already plunged foreign investors’ interest in Ukrainian companies than the latest stock quotations that dropped down to a meager 30 per cent of last year’s peak (400 points from 1200 points last year)! The index ‘EBMI+Ukraine spread,’ which takes into account Ukrainian Eurobonds’ profitability as compared to same-duration American Government bonds, has never risen from where it was five years ago (593 points as of September 11, 2008).
Some expert comments on investors’ expectations of numerous corporate defaults can already be read in Ukrainian business publications. Of course, many of the “expectations” may well amount to sheer gambling. But who wants to be a potential victim, and even less so if you remember how many economies have collapsed as a result of global jobbers’ gamble.
They usually attack “the weakest link in the chain,” and this link may become still weaker if the industrial recession that began to take shape in August further continues into the following months. According to the State Statistics Committee report released on September 10, last month Ukraine saw a decline in industrial output for the first time since January 2006, which dropped 0.5% from August 2007, while the rate of industrial output growth slowed down to 6.3 percent over the first eight months of this year.
Responsible for much of this adverse trend is a major cut-down in global market prices of metal-ware, which reduced by more than 25% for some items.
In addition to metallurgy, industrial recession was registered in other industries as well, particularly the light industry (9.9%), the petrochemical industry (9.1%), coked coal production (4.9%) and the food processing industry (3.5%). In industries that saw an industrial output growth last month, the growth rate accelerated in the electric-power industry alone, while others saw a substantial slowdown in their output growth rates.
The good news is that the decline in global market prices may help to rein in galloping inflation in Ukraine, which annual growth rate accelerated to 46.3%.
The bad news is that a substantial drop in export revenues may bring about a further reduction in the supply of the American currency on the inter-bank market. This, reciprocally, will inevitably set off a decline in the Hryvnia value versus the American dollar.
Mirror Weekly approached representatives of some foreign banking institutions and a leading rating agency and asked them questions as to the threats facing the Ukrainian economy. As it turned out, the situation isn’t all bad, at least at this stage.
Hans Holzhacker, senior economist, Bank Austria (Member of UniCredit Group)
- The high inflation is definitely a very important issue in terms of its impact on the lower-income families, on borrower-creditor relations, on the competitiveness of the economy and the predictability of all monetary relations. However, the peak is over. In seasonally adjusted mom terms, inflation averaged "only" 0.9% in the last four months compared with 2.9% in the first quarter. This will reduce inflation to slightly above 20% (20.3) in December 2008. A good crop and declining global commodity prices should help.
Our own forecast for December 2009 inflation is at 10.8% -- only slightly higher than those of the Ukrainian Government (9.5%). The main forecast risk is, as usual, gas prices and how much is forwarded by the utilities. There is an impact from the political side, i.e. whether we will have early elections or a full year of administrative efforts to keep inflation down.
The economic impact of the political crisis will depend on how long the conflict lasts. The coalition is on the brink of a break up. Ukraine is always good for last minute solutions of conflicts, but either a temporary coalition between BYUT and the Regions or early parliamentary elections have become highly likely now.
Probably the political battles will mean fiscal loosening and further postponement of privatizations. The impact on investment is on the one hand adverse because uncertainty is never helpful for investment and also because Tymoshenko is in conflict with some of the tycoons, particularly in the Donbas region. On the other hand Tymoshenko’s ambitions could prompt her to seek compromises both with the Donbas and Dnjepropretovsk business elite and with Russia, especially during a coalition with the Party of the Regions; this would re-assure big business.
In the not unlikely case of prolonged uncertainty, credit growth would slow even more due to higher refinancing costs because of a higher risk perception by foreign banks and investors. 5Y CDS spreads rose to over 500 bp (?) in early September, more than double the spread at the beginning of the year. (Loan growth has eased already, to average 2.5 % mom in April–July, from 4.8 % the same period a year earlier).
There is some upward risk in our inflation forecast not only because of fiscal loosening but also because the fix-rate might weaken faster than assumed. However, it is difficult to say how much of the inflation surge of late 2007, H1 2008, was supply- and how much demand-driven.
I think that global food prices, the bad crop, and high fuel costs played the most important role. These factors willease next year andhave already begun to ease.
There is definitely a strong impact from global food prices (via exports which raise also domestic prices) and via its impact on credit and money growth from the situation in global banking. Global steel prices (and energy prices on the import side) have a significant influence on the current account and therefore on the exchange rate. Declining global commodity prices will ease food price inflation but via the current account probably also the exchange rate with some inflationary impact. However in net terms the global environment should help reduce inflation.
The effect of fiscal loosening will to some extent be mitigated by slowing credit growth and weaker corporate profitability which in turn will slow wage growth. Therefore also demand-pull inflation should be less severe than this year. However there is of course a lot of uncertainty, in part related to the uncertain political situation.
Maryan Zabolotsky, analyst, Erste Bank
- The inflation situation in Ukraine, as elsewhere in the world, ceases to be threatening. Food and energy prices have reached their peak already, surpassed it, and begun falling down. Even though Ukraine is facing yet another inflation spiral in September, the inflation rate will not exceed 3-4% over the remaining four months of the year.
Whether the Government will be able to rein in inflation at the 9.5% level set for fiscal year 2009 will depend heavily on external factors. We expect that food and energy prices will continue to decline during the next year, which will make it possible to hold back the global inflation rate at a relatively low level.
The global financial crisis did not directly affect the Central and Eastern European regions; still, it has contributed to the growth of the cost of borrowed resources. Furthermore, it has fueled inflation and further aggravated the current economic slowdown. Even though most adverse factors are going to lose much of their strength in 2009, still we expect that the economic growth rate in Ukraine will slow down to 6%.
As for investors’ sentiments, the number of their concerns regarding Ukraine has increased recently. Nevertheless, Ukraine’s image on the whole remained largely positive. Ukraine still remains a ‘dark horse’ in the eyes of potential foreign investors, which may well make it ‘a story of great success’ in Europe.
True, investors are profiteering on risks. When operating in highly developed countries, they are accustomed to certain standards of business conduct and operating standards of state institutions and economic and financial systems. Potential investors can always obtain realistic assessments of business environments in some country or another. Therefore, the only way for Ukraine to have its image in the eyes of foreign investors improved is to comply with their expectations regarding standards of business conduct.
“ZN” contacted Andrew Colquhoun, Director of Emerging Europe Sovereigns, Fitch Ratings, in London
– What is your opinion about the inflation situation in Ukraine? How dangerous is it?
– I think high inflation is a serious problem for Ukraine's economy. It damages the business climate, and in the long run could make Ukraine's exports uncompetitive on world markets. Inflation has social costs, as some groups are not able to demand higher incomes to compensate for rising prices. Even in the short run, high inflation means the market demands higher interest rates to provide finance to the government. The eventual correction towards lower inflation has sometimes involved a painful fall in output for other countries. While high food and energy prices have contributed to Ukraine's inflation, I think fast growth in government social spending and rapid money and credit growth fuelled by low real interest rates are also to a large extent responsible. Core inflation remains high, as well as headline inflation, indicating broader inflationary pressure.
– Do you evaluate the government’s forecast of inflation on 2009 (9.5%) as reliable?
– I think there is a significant risk that the government's end-2009 forecast of 9.5% inflation will be missed unless government spending and monetary policy are tightened further.
– Is there substantial dependence on the situation in global markets? What do you think about investors’ confidence in Ukraine?
– Ukraine's growing trade and current-account deficits leave the country increasingly dependent on foreign capital inflows and vulnerable to shifts in investor sentiment. Growing risks to the economy's outlook arising from the rising external deficit, high inflation, and the government's unclear economic policy strategy have damaged investor confidence. I think political developments have also increased investors' nervousness about Ukraine. To be fair, WTO entry was a positive step for Ukraine, and I think shows that concerns over political instability can be overcome? - the politicians can work together to achieve really important measures. I also think some of the market talks about risks in Ukraine's relations with Russia following the Georgia conflict are overdone.
– What kinds of actions and measures are required from Ukrainian authorities to restore investors’ confidence?
– Investor confidence would be boosted by the formation of a government with a stable majority, able to implement its policies, and a clear strategy for restoring the economy to a sustainable growth path, and for implementing structural and institutional reforms (going beyond WTO entry towards a free-trade area with the EU, for example) to improve the business climate.
– Has your agency any plans to revise our sovereign ratings in the near future?
– All our ratings are continually under review and could change at any time based on developments.
Broadly, the ratings are supported by Ukraine's strong record of economic growth, further boosted by higher FDI inflows since 2005, and very strong public finances. However, these strengths are balanced by risks building up in the economy: growth may not be sustainable as the current account deficit is rising, external debt is growing rapidly, and inflation is still high. The banking system is a source of concern because many banks are still quite weak institutions, and credit growth has been rapid, which in other countries has been associated with a build-up of bad credits that can cause problems for the banks when credit growth and the broader economy eventually slow down. Political risk also weighs on the rating, mainly through the impact on investor confidence.
Fitch rates Ukraine 'BB-' (BB minus) with a Stable outlook. The Stable outlook indicates that we currently do not expect to move Ukraine's rating in the near future.
