Economic Update

The uncertainty surrounding Ukrainian politics following the wholesale dismissal of the government last week comes at a challenging time for the country’s economy.

While the rift between the president and the sacked prime minister spelled out the end of the Orange movement, slowing growth figures released this week underscored the wider problem of weakening external demand and ebbing business investment confidence.

Nevertheless, with a line now apparently being drawn under the controversial re-privatisation process by the acting Prime Minister Yurii Yekhanurov, analysts are still hoping for an economic rebound towards the end of this year.

Meanwhile, GDP figures for August, released on September 14, showed a 1.6% year-on-year decrease, driving the fastest-growing East European economy of last year into the territory of negative growth this time around, the first shrinkage in six years. The total nominal GDP volume in the first eight months of this year reached UAH252.6bn ($49.1bn), only 2.8% up on the same period last year.

As a result, the acting government, led by Yekhanurov, has had to lower its GDP forecast for this year from the initial projection of 8% to 4%. Although growth is expected to accelerate in the next few months, some analysts fear an even slower pace of growth in 2005.

Investment house Dragon Capital has revised its full-year GDP forecast from 5.4% to 3.9%. In its daily briefing on September 14, as some of the variables responsible for negative growth last month, it referred to lower value-added in agriculture, and the lack of a rebound in trade and construction.

However, speaking to OBG on September 14, Viktor Luhovyk, communications director at Dragon Capital, emphasised that despite the negative GDP growth dynamics, “Ukraine’s external position remains strong, with no imminent risks to the country’s financial stability.”

Meanwhile, the acting minister of economy, Sergey Teriokhin, told the local press this week that the Ukrainian economy would face a number of external risks in 2006, such as falling metallurgical product prices, volatile oil prices and gas price hikes.

Until now, Ukraine has enjoyed a sizeable current account surplus, owed largely to its metallurgical and chemical commodity exports. Yet a sharp decrease in international prices this year, coupled with higher prices on oil and gas imported from Russia, is expected to reduce the current account surplus from 10.5% in 2004 to 3.9% forecast for the end of 2005.

The external position is also likely to deteriorate as a result of buoyant domestic demand, which has fuelled the purchase of imported goods. Excess liquidity, local economists explain, is a result of last year’s significant election-related fiscal expansion driven by pension increases. Last year’s 3.1% fiscal deficit, some analysts argue, was quite extraordinary given the 12% growth rate the country enjoyed in 2004.

Meanwhile, rising private consumption has evidently added fuel to inflationary pressures, already high from rising energy prices. According to the National Bank of Ukraine (NBU), inflation levels this year will stay in double digits – reaching 12% by the end of this year and creating another source of financial volatility.

Ultimately though, analysts say, Ukraine needs to bolster its domestic business environment and improve economic contact with the outside world to ensure sustainable growth.

It is widely agreed that the business investment climate suffered because of the unclear situation regarding the plan to review the privatisations carried out under former President Leonid Kuchma.

The former prime minister, Yulia Tymoshenko, who was dismissed last week, apparently favoured a much more rigorous re-privatisation process, involving a large number of enterprises she deemed were unjustly sold to businessmen close to former President Kuchma.

While such anti-oligarchic rhetoric proved to be popular with the Ukrainian public, the lack of a coherent government approach to this issue sent mixed messages to the business community, forcing a number of foreigners, anxious to come to Ukraine, to freeze their investment plans.

“Without clearly stated procedures, criteria and a time frame for re-privatisation, the government ended up eroding many investors’ trust in property rights in Ukraine,” one foreign official based in Kiev told OBG this week.

Fortunately, it seems that both the president and the new prime minister are signalling their willingness to end the uncertainty over re-privatisation, with the re-sale of the controversial Kryvorizhstal steelmaker perhaps marking the end of this disruptive process.

President Yushchenko told reporters on September 13 that the government was unlikely to carry out any more re-privatisations, once the auction of 93.02% of Kryvorizhstal’s shares, scheduled for October 24, was completed. Uncertainty, however, still lingers over what will happen to another controversial re-privatisation target, the 51% stake in Nikopol Ferroalloy, which was due to come up for re-sale this year.

While some infighting is still to be expected, any further foot-dragging over the mismanaged re-privatisation issue, analysts say, is likely to further alienate potential investors, weary of Ukraine’s inability to take advantage of the fresh opportunity handed to it by its apparent break with the past last year. For the time being, all eyes are on the unfolding political shakeout and the ability of the new government to anchor people’s economic expectations.