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Quarterly Report - Fortifying a fragile economy

01.03.2016 | Источник: ICU
Тема: Макроэкономика, стратегии, прогнозы, ICU, Инвестиционный Капитал Украина

This is a summary of our macro view for the next three-year period of 2016-18.

Recent economic performance: Out of recession and resuming recovery. On February 15th, official statistics confirmed our own view that after an 0.5% real GDP increase in 3Q15 in seasonally adjusted quarter-on-quarter terms (QoQ SA), there was another quarter of real GDP increase in 4Q15. It turned out at +1.5% QoQ SA, while our estimates were in the range of 0.5-1.0% QoQ SA. Hence, Ukraine's economy, after the severe contraction of 2014 and early 2015, emerged from recession in the third quarter of 2015. It is likely to resume its fragile slow-paced recovery in 2016, given our base-case scenario assumptions. In total, our estimates yield a 2.6% increase in real GDP for this year, followed by 2.4% and 2.6% in the following years of 2017-18, respectively. More details are to be found in the section of the report entitled, "Recent macro performance and short-term outlook" on pp.20.

Ukraine's politics: New government and coalition, no snap elections. We tend to believe that local politicians are finding a way out of the current political crisis, which happened recently, after the departure of the minister of the economy, who was allegedly accused of corruption by the authorities. Some politicians--such as Ms Tymoshenko's faction and the Self-Help faction, which are minor members of the coalition--have left the ruling coalition, as they are eager for snap elections to take place, and expect that their recent success in the public surveys will translate into bigger factions in the next parliament. However, the major factions of the ruling coalition--such as that of President Poroshenko and PM Yatsenyuk--have a more complicated modus operandi. In our base-case scenario, they refuse to promote snap elections, as this would almost certainly result in protest vote and subsequently damage rather than improve their standings. Hence, our base-case scenario envisions the following development to take place over the next few weeks: a new coalition to be confirmed along with a government reshuffling. Then, the government spends the next half-year in sustaining the economic recovery--which emerged in 2H15, and is still fragile--to prove the new government is capable before a no-confidence vote is attempted this fall.

A more detailed rationale for the above can be found in the section entitled "Ukraine's domestic politics: No snap elections this year is our base-case scenario," found on pp.8.

Geopolitics: Still complicated. Our base-case view in the geopolitical realm is that the Minsk agreements serve as a smokescreen for the Kremlin's quite complex geopolitical game, which is aimed primarily, first, at sustaining the Kremlin's high approval ratings from the Russian public; and second, at securing a smooth transition of power during the next presidential elections, which are currently scheduled for 2018. Furthermore, over the course of 2016-18, we do not expect that Ukraine's government will take over the now-occupied parts of Donbas and Crimea. Hence, we do not account for a boost to GDP for Ukraine from these territories.

More of this view can be found in the section "Russian aggression: No sign of ease; Minsk agreements a sham," on pp.6.

Global economy: A slowdown is our base case. Recent turbulence in the global financial markets has given birth to widespread discussion over the health of the developed market economies, which were believed to have seen renewed growth (albeit quite sluggish one) as early as a few months ago. In our view, this perception of heightened risk among the financial market players over macro developments is somewhat exaggerated. The US economy slowdown in 4Q15 in part provided proof of this market perception. Our past view, which we retained as late as last fall, was that due to financial market conditions in the US dollar foreign-exchange and debt markets which had tightened substantially over 2014-15, we thought the Fed's key rate increases would take place through the summer of 2016, then pause. Now we have adjusted our view bringing it closer to currently prevailing consensus in the markets: in 1H16, there will be another 25bp Fed Funds rate increase, then a pause in rate hikes through 2017. Thus, US dollar market conditions should ease somewhat--indeed, the US dollar index (DXY) has been on a downward trend recently.

In China, there is macroeconomic adjustment taking place, which is an extension of the developments of the past several years since 2012. A key element of this development is the CNY weakening, which is managed, in our view, and likely to extend inside the 6.5-7.0/USD range in 2016-17. Thus, economic growth is to slow further and gradually. In the Eurozone, there is a sense that the past model of growth as practiced by Germany, the region's leading economy, cannot work in the same way it has. The country's current account surplus hit another historical record in 2015, exceeding its pre-2008 crisis peak. This year is going to be different from 2015, however, and again, a slowdown is our base case here, too, requiring another supportive effort by the ECB, as EU mainstream thinking is wary of fiscal stimulus.

More details are to be found in the section entitled, "Global economy," on pp.10-12.

Commodities: Stabilisation eyed. In the section "Key indicators vital for Ukraine's economy" on pp.18, we explain our view on the future path of the commodities prices. We believe there is a strong correlation between these prices and the US dollar, and in fact, that they are inversely correlated. With a firmer dollar, commodities prices trend lower, and vice versa. As explained in our "Global economy" section on pp.10-12, our base-case scenario assumes that the US dollar's 1.5-year-long appreciation is reversing in 2016: it has stabilised versus the currencies of developed-market economies, and is likely to do the same versus most emerging-market economy currencies (except China's, which is forecast to weaken gradually over 2016-17). Hence, this new trend (dollar's past appreciation turning into stabilisation and some mild weakening) should impact commodities' prices, and our view on these prices for 2016-18 is for stabilisation this year and some mild recovery in the following years. This said, however, we caution that FX market developments in China might create additional disturbances in the financial markets, and hence in commodities, although these will be temporary, and not affect the general trend.

Ukraine's macro stabilisation: Should be phased out over 2016; pro-growth macro push is new theme. Indeed, Ukraine's authorities-the government and central bank-were successful in achieving macro stabilisation over 2015. By official statistical data, the outcome of the past year was better than expected by several measures. One is public debt level that in December 2015 turned out to be at 81% of GDP by our estimates (79% by the estimates of the Ministry of Finance). This is far less, however, than the approximately 94% estimated for last year by the IMF (our estimates last year tended to be in the range of 95-100%). Another is the state budget balance was maintained with the help of a cushion in the form of a primary surplus, which reached a historical high in November 2015 of 3.8% of GDP. These data underline how the government was working toward cementing a macro stabilisation of the economy, which just one year ago was experiencing acute financial distress in the form of run on the currency. Suppressing domestic liquidity to eliminate future runs on the currency was a key theme, not only for the government, but for the central bank as well. Its high interest rate policy contributed to that development. This approach had its benefits as well as costs, the latter of which were contributing to suppressed demand. In 2016, we expect a reversal of this development. This means that the government budget will run with an IMF-allowed deficit (yielding a quite small primary surplus; no more record-breaking primary surpluses) of 3.7% of GDP. At the same time, authorities would encourage banks to lend and businesses to borrow. The key policy rate should subside from the current 22% to 16.0% at the year-end 2016, despite the forecasted currency weakness. Positive bank credit flow is one of the key elements of our base-case scenario, which assumes a growing economy of more than 2% this year.

External balance: FX reserves build-up resumed. Our estimates of the balance of payments are based on the key assumption that the flow of external funding from the IMF and other donors is resumed in 2016, albeit not executed at the scheduled pace, as defined by the first review of the EFF last summer. Also, it is assumed that the controversial US$3bn debt to Russia is being restructured (its repayment is assumed to be shifting beyond 2018). Our assumption for official borrowing in 2016 is US$5.0bn, followed by US$1.8bn and US$1.8bn in 2017-18, respectively. This, together with expected current account balances for 2016-18 and private sector rollover ratios, yields for us a further build-up of FX reserves towards US$20.5bn as of year-end 2016. In 2017-18, a reduction of FX reserves is forecasted on the back of a recovery in domestic demand yielding to wider current account deficits than in the 2015-16 period.

More details on the calculation results are found in the section, "External balance: Recovering domestic demand requires more flexible FX rate" on pp.39.

UAH: Mix of domestic inflation and fluctuating dollar still spells weakness. In our view, still double-digit domestic inflation, which is by far higher than inflation rates in Ukraine's main trading partner economies, has a negative impact on hryvnia valuations. This inflation impact cannot be counterweighted by the positive factor of changing prospects for the US dollar, which is forecast to reverse partially its past appreciation versus major global currencies as seen over 2014-15. That is why we retain our past year's view on hryvnia valuation, albeit with some corrections. The latter are due to our revised forecast over, first, inflation in Ukraine and in its main trading partners; and second, projected FX rates of the currencies of the main trading partners such as the Eurozone, Turkey, China, and Russia, to name just few. In the end, our forecast eyes the UAH's average FX rate at 29.25/USD this year (a slight revision from the 30.75 cited in our previous Quarterly Report dated 1 October, 2015) and 33.75/USD, 34.00/USD in 2017-18.

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