Prospects and Challenges of the Ukrainian Economy in the Second Half of 2019

Ukraine’s GDP shows growth for the 14th consecutive quarter. GDP grew by 4.6% in the second quarter of 2019. President Zelensky has promised growth of 5-7% of GDP. Under favorable circumstances, Ukraine may well expect a 5% growth in 2019. However, this growth is unlikely to be sustainable. There are many risks and challenges for the Ukrainian economy. First of all, it is about the escalation of the conflict in the East and substantial debt payments. Also, the Ukrainian economy remains highly dependent on the world price conjuncture for commodities. The key growth factor – investment – remains low. However, the implementation of the land market and the real reforms of the judiciary and reforms in the property rights system can dramatically change the situation.

President  Zelensky expects Ukraine’s economy to grow at 5-7% of GDP in the coming years. For this purpose, he will carry out a number of necessary reforms this fall, which will make Ukraine a “magnet” for foreign investors. There is nothing new in order to accelerate GDP growth – for example, the current Prime Minister, Volodymyr  Groysman, stated in July: “My goal is 5-7% growth. This requires, in particular, a new decision-making system.

The president’s statement  is facilitated by current macroeconomic statistics. The real GDP in the second quarter of 2019 increased by 4.6% relative to the second quarter of 2018. Even Poland was ahead of growth – the Polish economy in the second quarter increased by “only” 4.4%. At the same time, in 2018 the growth of the Ukrainian economy accelerated to 3.3% from 2.5% in 2017 and broke the record for seven years.

Ukraine has overcome the crisis, reached stabilization, but the economy continues to grow very slowly , as its structural problems remain unresolved. Increasing household income is driving consumer demand, which is our main driver of growth, but domestic companies, because of NBU’s expensive money policy, have no money to satisfy that demand, and are inferior to importers who willingly drive Ukrainians everything from household appliances to food . This directly affects our foreign trade balance and essentially prevents Ukraine from earning export even at the best of times, because we sell mostly cheap raw materials to other countries and buy high value goods from them. In 2016-2018, a very large contribution to GDP was made at the expense of a good harvest, which is a very volatile and difficult-to-predict factor, as there may not be a record harvest each year. Other sectors that make a big contribution to our GDP growth are those sectors that are focused on domestic consumption, which is also not the best option. Because domestic consumption does not increase our export potential, it does not help us integrate into the global value chains, increase our competitiveness, increase our productivity, that is, use all possible mechanisms that help sustainability.

Therefore, while maintaining the current  commodity, export-oriented model of the economy for growth of more than 3%, a maximum of 4% (with favorable conditions for Ukrainian goods) it is unlikely to count.

In addition, there are a number of adverse factors. In particular, it is the following:

GDP growth happened in the background of decline in industrial production.

– the growth rate of industrial production in the 2nd quarter of 2019 is 3 times behind GDP growth – 1.6% versus 4.6%. Moreover, over the past 5 years, industrial production has fallen deeper and grew more slowly than GDP. That is, deindustrialization has a pronounced tendency.

In addition in June, Industry has shown fall  – minus 2.3%, incl. processing industry – minus 6.1% (compared to June 2018), and engineering – minus 13.3%.

The situation in industry over the past six months is very unstable – 3 months growth, 3 months fall: – March (+ 2.1%), April (+ 5.2%) and May (+ 1.6%), – January (-3, 3%), February (-1.8%) and June (-2.3%).

GDP growth in the second quarter (however, as in the first), first of all, is ensured by:

– retail turnover – + 7.8% (Q2 2019 to Q2 2018). Due to mass labor migration, as a result of which the inflow of foreign currency to Ukraine increases and, due to a staff shortage due to migration, wages are temporarily raised;

– agriculture – + 6.3% (2nd quarter of 2019 to the 2nd quarter of 2018). Thanks to the good weather contributing to record yields.

Despite  the growth of  GDP, other some others  economic indicators are going down:

– Foreign direct investments ones continue to decline – minus 11.5% (from $ 1.1 billion in the 1st half of 2018 to $ 972 million in the 1st half of 2019);

– state budget revenues are not fulfilled – minus UAH 26.5 billion, and minus unscheduled revenues from the National Bank, the state budget in the 1st half of the year did not receive UAH 43.9 billion or minus 8.2% of planned revenues;

– state budget expenses are underfunded – minus 42.7 billion UAH or minus 8.5% of planned expenses for the 1st half of 2019;

– labor migration is increasing – an indirect confirmation of this is the fact that in the first half of the year, migrant workers brought $ 6.1 billion to Ukraine, which is 15% more than in the first half of 2018;

– the processing industry shows minus (-0.1% in the 1st half of the year), incl. mechanical engineering – minus 4.3%, and the production of electrical equipment – minus 26.8%.

Therefore, one of the key factors that can ensure sustainable economic growth is public and private investment. In 2018, Ukraine received $ 2.3 billion in foreign direct investment (FDI). This is better than, for example, 2014 ($ 400 million), but significantly worse than zeroed in when $ 10 billion or more went into the country (the record was in the record of 2007-2008).

What is limiting public investment today? Mostly high consumption expenditures: interest payments and social expenditures. Basically, we are eating up the money that could be invested. Ukraine cannot afford to increase its budget deficit due to high public debt repayments. Therefore, we must make every effort to stabilize it at 2–2.5% of GDP. Moreover, we must reduce our debt load, and this is only possible if we tightly control our budget deficits.

investments will not come if there is at least the least threat to them. When investors come, they talk about two issues – the rule of law and corruption. This is all formalized in the courts and law  enforcement agencies.

need to undertake a judicial reform and create a Financial Investigation Service – remove the security forces from business (National Security and Defense Council secretary Oleksandr Danylyuk recently stated that the relevant bill, which was blocked by the previous government, will soon be sent to parliament

Most likely, one such reform will be the opening of the land market. Now, we will remind, in Ukraine there is a moratorium on sale of agricultural lands. Land reform has both ardent admirers and ardent adversaries. The latter, as a rule, argue their position that, say, Ukrainian land is priced invaluable by domestic and, most importantly, foreign latifundists, and farmers will be left with nothing – and without land, and almost without money. Supporters, however, insist that large holdings already, in fact, own vast areas of farmland thanks to various “muddy” schemes, and the creation of a transparent land market will bring this business out of the “shadow”. In addition, they add, Ukraine remains the only country in Europe and one of the few in the world (in a company with the DPRK, Venezuela and Cuba), where there is still no land market – even in Belarus there is some similarity (in Russia the land market was launched yet to zero). It is known that the opening of the land market in Ukraine has long and persistently been pushed by our Western partners, including the International Monetary Fund (IMF), which should be expected to resume cooperation in the autumn.

One of the Ukrainian telegram channels recently reported that land reform would become a flagship for the new government, recently citing sources in the president’s team. According to the report, the opening of the land market “will give a situational growth of the economy”. In addition, the resource notes, further steps by the authorities will be directed to the rehabilitation of the gambling business that was outlawed in Ukraine 10 years ago by the efforts of then Prime Minister Yulia Tymoshenko, as well as to the legalization of prostitution and “easy” drugs.

2019 is the period of the largest payments on external debt. At the beginning of the year, the volume of payments for servicing and paying off the external public debt was estimated at 6.3 billion dollars. At a recent meeting of the President of Ukraine with representatives of the IMF (the main creditor of our country), they discussed, as one option, the launch of a new program of cooperation with the Fund. Journalists ask how to relate to this. There is no single answer. Continuing cooperation with the IMF is positive, but the current stand-by program involves the allocation of two tranches – $ 1.3 billion in May (the deadline is postponed) and $ 1.2 billion in November (in case our country fulfilled the terms of the Memorandum of Cooperation with the Fund, in particular, to receive the first of two tranches, only one condition out of four was met – monetization of subsidies). Add to this € 500 million of macro-financial assistance from the EU and $ 1 billion of World Bank loans (in the form of two tranches of $ 500 million each), which Ukraine would receive after the relevant tranches of the IMF loan were provided. In total – $ 4.1 billion. In the version with the new program, the timing of obtaining loans is difficult to predict. Work on a new program can take a couple of months at best. We will also take into account the fact that representatives of the Fund for their discussion will arrive no earlier than the formation of a new government following the results of the parliamentary elections. It turns out that there is no need to wait for the IMF representatives before September, so the signing of the documents should be expected no earlier than the end of September – beginning of October. And the allocation of loans does not happen immediately after signing the program.

Over the three summer months, Ukraine will need to pay $ 1.8 billion in external debts, and $ 1.7 billion in September.  Plus, the expected release of non-residents from the hryvnia government bonds in July-August, which they bought in January -April, about the equivalent of $ 1 billion, followed by the conversion of the money received into currency.

Can Ukraine handle it? Ukraine  can handle it,but  to a large extent due to the borrowings of the government, in some cases – the international reserves of the NBU, which already by the end of May will decrease due to payments on the state debt of $ 1.7 billion. Therefore, if it remains possible to continue cooperation with the IMF in the framework of the current program, it is advisable to use this. It should also be taken into account that, according to the Law of Ukraine “On the National Bank of Ukraine”, foreign exchange reserves are used exclusively to ensure the internal and external stability of the monetary unit of Ukraine. The use of the gold and foreign exchange reserve for the provision of loans and guarantees and other obligations to residents and non-residents of Ukraine is not allowed. Therefore, the government should keep these positions in mind. I think that the independence of the NBU allows a fairly balanced policy of using gold and foreign exchange reserves, independent of anyone. As they say – we live not one day.

So, smoothly move on to the risks in the foreign exchange market. A possible marked decrease in international reserves in itself is capable of giving a negative psychological signal to participants in the foreign exchange market. We must not forget that by the beginning of the heating season, that is, before October, Ukraine needs to pump 15-16 billion cubic meters into underground gas storages. m. of natural gas during the summer season (May-September). At current market prices, this will require about $ 2.5 billion, which will have to be found in the next four months (in general, $ 3 billion is needed, but Naftogaz has a credit line of $ 0.5 billion). Thus, the favorable situation in the foreign exchange market, which was observed during the spring, may be complicated.

What could be the dynamics of GDP? I have a more restrained outlook than an optimistic one. Ready to share the position of analysts at the National Bank, who believe that this year a slowdown in economic growth to 2.5-2.7% is not ruled out.

Ukraine is a country with a small open economy focused on the export of agricultural products, raw materials and semi-finished products with low added value. That is, it seriously depends on world prices for raw materials and the situation in the economies of our main trading partners.

According to forecasts by the UN food organization, in 2019, world grain production may increase by 2.7%, after a decrease observed in 2018. So, there are no serious prerequisites for  the increase in the price of grain – the main article of Ukrainian agricultural export. On the other hand, if you go into the nuances, there will be a reason for cautious optimism – according to forecasts, the global grain consumption in the season 2019-2020 will grow by 1.5%, but the increase will mostly affect feed grain, the consumption level of which will increase by 1, 7% compared to the season 2018-2019. And Ukraine is a major player in the world market of just feed grain. Farmers give forecasts for the next record crop in the 2019-2020 marketing year – 63-65 million tons, of which 43-46 million tons will be exported. Probably, due to the large volume of sales on foreign markets, the export earnings of Ukrainian agricultural producers and agricultural traders may