A string of factors are now holding back Ukraine’s rate of growth, from increasing prices to political question marks.
Rising gas prices, an unstable governmental environment and weak external demand for Ukraine’s export-bound steel production continue to be the principle items holding back the overall rate of growth. This is despite strong domestic consumption fuelled by rising real incomes and improved access to banking credits.
The IMF’s World Economic Outlook published last week showed that the global financial lender had slashed the growth forecast for Ukraine from an initial 5% to 2.3% in 2006 – slightly slower than 2.6% GDP expansion achieved in 2005.
According to the IMF, “Continued political uncertainties and a significant hike in import prices for natural gas will weigh on the economic activity of the country.”
The fund, however, expects that GDP growth will pick up in 2007, reaching 4.8%.
The fund also noted that the pass-through of higher energy prices is not yet complete and that the combination of strong consumption growth and weak investment has led to increasing capacity constraints in the Commonwealth of Independent States (CIS) region.
The latter is particularly true, analysts say, in Ukraine, where government-sponsored pre-election wage hikes coincided with a freeze on investment during the prolonged period of political infighting.
Meanwhile, although prospects for increased political stability are improving, with the former Orange coalition expected to appoint the new government in the next few weeks, the question of further gas hikes still looms large.
Signalling further disputes ahead, the deputy chairman of Russia's gas monopoly Gazprom, Aleksandr Medvedev, was recently cited by local media as warning that gas prices for Ukraine are due to be increased from July 1 this year.
Meanwhile, international rating agency Standard & Poor’s cited natural gas price increases as one of the principle macroeconomic risks facing Ukraine in 2006. In a slightly more optimistic vain it forecast 3% growth for Ukraine in 2006.
Some analysts argue that a 10% increase in gas prices translates into a 0.3% decrease in GDP growth. At current price levels of $95 per 1000 cu metres, GDP growth is expected to fall by 1.5 percentage points, if this base-line scenario holds.
As well as shaving off the percentages of expected GDP growth, the rise in gas prices has dramatically altered Ukraine’s current account balance. Until recently, Ukraine used to enjoy sizeable current account surpluses thanks largely to its soaring metal exports. In 2004 the current account surplus was estimated at an impressive 10.5% of GDP.
Yet, the dynamic has now changed. With higher oil and gas prices, lower value of exports and burgeoning demand for imported consumer goods, the current account is approaching the negative territory.
According to the IMF World Economic Outlook, the traditionally sizeable current account surplus will be reduced to 1.2% in 2006, while it will be negative in 2007 at -2.1% of expected GDP.
Despite these negative macroeconomic developments, Ukraine is expected to stay out of real trouble. Even at negative current account levels, it will be able to finance these with an expected surge in foreign direct investment (FDI) and portfolio investments.
Last year alone, according to the State Institute of Statistics, FDI reached a stellar $7.3bn – some 4.7 times higher than in previous years.
Although this was unusually healthy thanks to the landmark $4.8bn Kryvorizhstal steel mill reprivatisation and several significant foreign acquisitions in the banking sector, FDI levels are expected to remain higher than in previous years.
Another source of hope for financial stability, in the face of worsening trade account situation, is that Ukraine’s levels of indebtedness remain quite low – below 30% of the country’s GDP.
The National Bank of Ukraine (NBU), which still enjoys plentiful foreign currency reserves, has so far been able to ensure currency stability. Although the recent balance of NBU’s interventions on the interbank currency market has recently been negative, with increased demand for foreign currency during the election period, its current reserves were at around $18bn at the end of February – enough to cover at least five months of imports.
The main concern for monetary policy watchers, however, is whether the NBU will come under increased political pressure from any one of the victorious party factions to devalue the local currency in order to improve Ukraine’s external competitiveness. So far, the central bank has resisted such calls, staying closely within a narrow corridor of currency fluctuation.
Like gas prices, political developments remain hard to predict, yet undoubtedly one of the key factors shaping the macroeconomic situation in today’s Ukraine. One thing is certain though, much like the political situation in the country, the macroeconomic dynamics have changed irreversibly. Ukraine has entered a new stage of transition to market economics.