Ukraine in 2009

Ukrainian economy faced a serious stability test in 1H08 after a set of
negative factors: annual CPI exceeding 30%, trade deficit widening
almost 3x annually in 8M08 and government’s inability to raise funds
to cover the planned budget deficit. External factors, in particular the
end of commodities’ price boom and steel prices reversal, questioned
the ability of the largest industrial sector to adjust to a negative
demand shock. In addition, lack of credible monetary policy
conducted by NBU has undermined the investor’s confidence in
Ukrainian stock market. After hryvnya appreciation to 4.6 UAH/$ in
1Q08, which was allowed by NBU due to huge portfolio capital
inflows, lack of corporate borrowings in 3Q08 coupled with investors’
profit-taking resulted in foreign currency deficit and subsequent
devaluation above 5.00 UAH/$.

The above developments were accompanied by political instability;
break up of the parliamentary coalition in Sept 2008 and massive selloff
of Ukrainian stocks and sovereign Eurobonds, which brought their
prices to near historical lows. Negative sentiments have been
fostered by global investor’s stance to EM and search for new
investment havens like US treasuries, gold, silver. Massive sell-off of
Chinese, Russian and other equities and bonds indicated on a precrisis
situation. Against this backdrop, the Ukrainian market drop by
70.4% YTD did not look extraordinary. Decelerating industrial output
in these and other EM, brisk decline in inflation after global
inflationary shock, narrowing trade surpluses have made the term
“overheating” to be used more frequently. Yet, a number of leading
indicators say that it is still premature to talk about crisis or
overheating in Ukrainian economy.

Real GDP rose by 7.1% in 8M08. Though its growth was largely
supported by rebounding agricultural sector (+25% y-o-y increase in
the reported period), the other GDP constituents such as wholesale
and retail trade (+10.7%) and manufacturing (+5.6%) confirmed
economy’s ability to rely on global trends on a lesser extent. In fact,
exports make just below 40% of GDP compared to above 60% in
early 2000.

Two subsequent deflationary months pointed to a certain
saturation of private consumption.
Agricultural sector’s rebound from 2007 slump creates
preconditions for the food prices stabilization.
Corporate earnings growth at 83% y-o-y in 7M08. Global
commodities price boom has in part contributed to this but such a
robust growth is an indicator of enterprises’ ability to remain highly
profitable in conditions of inputs’ prices hike.

Banks’ margins remained strong. Strong corporate loans demand
in terms of global credit crunch helped domestic banks to expand
their corporate lending portfolio by 28% in 8M08, an insignificant
slowdown compared to 2007. Banks’ earnings rose by 60% in the
reported period as a result of faster increase in lending rates
compared to their cost of funds.

Improved investment climate. FDI in Russia totaled $11.1 bln in
1H08, which implies 30% y-o-y drop. In the meanwhile, Ukrainian FDI
reached another all-time high of $7 bln in the reported period, or 21%
increase. Though near a half of all FDI raised were in the banking
sector, the agriculture gained importance as 3 private placements
have been made in so far in 2008.

Increased role of investment in the economic growth. The
proportion of fixed investment in GDP surged to 27% in 2008 though
it was barely reaching 20% just a few years ago. The inevitable
overheating in consumption will thus be offset by stable growth in
fixed capital investment, which will contribute markedly to the GDP
growth in 2009-2012. Even assuming tougher lending conditions for
the corporate customers in 2009, strong growth in the corporate
earnings will enable to reinvest them with lower reliance on banks. In
fact, the proportion of own funds in total fixed capital investment has
been close to 60% in the last years, compared to 13-15% for bank
loans. Additional factor fostering the role of investment will be
preparations to Euro-2012 Football Championship where total
investments are estimated at $22 bln.