Possibility of Market Correction

Economic News

22 Jul 2010
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In spite of political instability, Ukraine's economy remains vibrant, led by a real estate market characterised by continued double-digit growth.

With several major Ukrainian banks already having been gobbled up by such European banks as Austria' s Raiffeisen Zentralbank, banking sector assets grew by 59.2% in 2006 and by another 11.25% in the first quarter of 2007. Virtually every Ukrainian bank, with the possible exception of market leader PrivatBank, have engaged in at least preliminary takeover discussions with foreign banks, primarily EU-based.

In addition, Russian giant Alfa-Bank, with more than 200 branches in Russia and the Commonwealth of Independent States (CIS), and subsidiaries in Kazakhstan, the Netherlands and the US, is rapidly expanding operations with its bright red-and-white outlets becoming an increasingly familiar site in malls and other high foot-traffic locations.

Ukrainian banks' foreign indebtedness doubled in 2006 from $6,748m to $13,870m. And 2007 appears to be following last year's trend. For example, Finance and Credit Bank, with assets of $1.7bn, plans to borrow about $700m abroad this year. This follows the trend in which Ukrainian banks have been replacing domestic with foreign savings, making the Ukrainian economy more vulnerable to external shocks.

The government's recent loosening of control over foreign borrowing by companies has resulted in Ukraine's foreign debt increasing by $14,667m (27%). Adding foreign direct investment, which amounted to $4.5805bn in 2006, and equity purchases, leads to the conclusion that total capital flows to Ukraine exceeded $20bn in 2006.

The last five months of 2006 were marked by an unprecedented growth in housing prices, attributable at least in part to the loose monetary policies of the National Bank of Ukraine (NBU). Changes in the discount rate and reserve requirements played a major role in the housing price explosion, but there was a perhaps even more important factor. The NBU's easy money policies sent an unmistakable signal to Ukraine's banks and finance companies. These institutions responded by a drastic increase in foreign borrowing ($6,062m in the second half of 2006). Furthermore, this led to unprecedented credit availability for both good and bad risks.

The large foreign capital inflows are being reflected in credit practices that were previously unheard of in the Ukrainian market. In 2006, Ukrainian banks offered mortgage loans with down payments of 5% and some with no down payment at all, which has stimulated an already booming market, but has also considerably increased the level of risk undertaken by lenders. The market is expected to soon reflect some of the statistics that have long been apparent in the US and Europe, i.e. that the lower the down payment, the greater the likelihood that foreclosures may be necessary.

It is not only real estate but also the auto market where the credit surge is being felt. When only a few years ago it was difficult enough to get three-year auto financing, schemes that allow a relatively small down payment and payback periods that now reach five, six or even seven years are readily available. For young professionals and officer workers who were previously showing off their latest mobile phone, today, bragging about the new car is much more in vogue. This is particularly evident in Kiev where the number of automobiles has doubled from 500,000 to 1m in a few years.

In the ongoing political battle between the president and the prime minister, the latest settlement that agreed a parliamentary election day of September 30, 2007, will certainly add fuel to the economic fires already blazing. The government has already shown itself willing to throw caution to the wind in seeking abnormally high GDP growth. The government's monetary policies in 2006 were directed at attaining a 7% GDP growth rate. Now, with an election in the offing that could set the national political course for at least five years, the government is expected to again begin priming the fiscal and monetary pumps.

There have already been some signs of unease among those agencies that monitor economic developments. For example, on April 5, 2007, Standard & Poor's said, "Ukraine's very rapidly increasing private sector leverage and the fast rising external indebtedness of the largely domestically-owned banking sector have increased Ukraine's economic vulnerability to external shocks or a worsening of the domestic political environment."

Earlier in the year, economists following the Ukrainian market were somewhat more upbeat, reflecting a consensus that within a year, Ukraine's real estate boom would see a leveling off of prices, but no serious downturn. Now, some voices are even more pessimistic, given the assumption of continued government spending and loose monetary policies, at least until after the September 30 parliamentary elections.

Pavlo Prokopovych, senior economist at Kiev Economics Institute, told OBG, "As soon as housing prices stop climbing, one can expect a meltdown to ensue, one more severe than the recent meltdown of the US subprime mortgage industry."

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