Newsletter #4
Advantage Ukraine
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Economic Recovery in 2024
Central bank downgrades GDP growth estimate to 3.0%
After a spectacular 5.3% YoY recovery of real economy in 2023, driven by higher consumption and surge in investments, the outlook for real growth in 2024 is becoming increasingly conservative.
In late April, the National Bank of Ukraine downgraded Ukraine’s growth outlook to 3.0% in 2024, from its 3.6% estimate in January. The key driver of this downgrade is damage to Ukraine’s electricity infrastructure, which is expected to limit power consumption and growth of Ukraine’s industry sector.
Notably, the IMF and the Cabinet have recently confirmed their 2024 GDP estimates for Ukraine at 3.2% and 4.6%, respectively.
Our view is that IMF’s and NBU’s estimates for Ukraine’s economic recovery this year are more accurate than of the government, as the important growth drivers of 2023 (agricultural output, which was fueled by bumper harvest, and government consumption, which rested on generous international financial support) won’t show any positive performance in 2024.
Comparison of Output to Pre-War Levels
Retail trade, production of non-durables is catching up
During 2023, Ukraine’s GDP recovered to only 73-77% of the level shown in the pre-war year of 2021, which broadly coincides with Ukraine’s overall losses in terms of territory, population and industrial potential.
Notably, retail trade has nearly reached the pre-war levels in late 2023, having been supported by a surge in government expenditures for support of militaries and social outlays. It is very likely that retail trade will exceed pre-war levels in 2024, in real terms.
Ukraine’s industrial output failed to reach 70% of pre-war levels, which is a result of heavy losses in the metallurgical industry (due to equipment damages and logistical issues) and machinery (mainly because of broken value chains and asset damages). These sectors used to have a large concentration in eastern regions of Ukraine. Metallurgy, among the biggest victims of russian aggression, was performing at less than 40% of its pre-war level, while it has some potential to recover to about 50% level in 2024. Machinery sector could be another driver of industrial output growth this year, as military demand for its output is growing in Ukraine. At the same time, key limits for a fast machinery industry recovery are scarce financial resources for Ukraine’s budget.
Meanwhile, production of consumer staples, which is diversified geographically, underwent much lesser output decline. Supported by consumer demand, consumer-focused industries have recovered to over 80% of pre-war levels in 2023. Most likely, such sectors will further converge toward pre-war levels in 2024-2025.
Farming Sector
Remains resilient, but bumper harvest is unlikely to repeat itself in 2024
Ukraine’s total sowing area under all crops decreased by 26% in 2023 as compared to the pre-war year of 2021. This generally coincides with Ukraine’s territorial losses as of early 2023 (about 12% vs. 2021) and the fact that another 14% of Ukraine’s area is close to the front line and under severe risk of artillery attacks. That said, most of Ukraine’s territory that is neither occupied nor shelled, including the areas liberated in 2022, is used for farming operations. And this is despite the fact that farming operations remain risky in the locations liberated in 2022 in Ukraine’s northern regions.
Ukraine’s harvest of grain and leguminous crops increased 11% YoY in 2023, and it fell 31% as compared to 2021. Due to favorable weather conditions, yields of Ukraine’s grains were record-high in 2023, outperforming the previous year by 21%.
Notably, Ukrainian farmers increased their share of non-grain planting (vegetables, potato, sugar beets etc) pursuing higher economic efficiency from use of their land plots: sowing areas of crops other than grains and oilseeds decreased by just 7% in 2023 as compared to 2021.
In 2024, the total crop harvest area will likely remain flat year-on-year, while the total harvest will slightly decrease, as exceptionally favorable weather of 2023 is unlikely to repeat this time. All in all, farming is unlikely to be among the drivers of Ukraine’s economy again in 2024.
External Financing of Budget Gap
Financing commitments cover Ukraine’s 2024 needs
According to NBU estimates, Ukraine’s budget will need about $ 37.9 bn of gross external financing this year, or $ 3.2 bn monthly. This compares to average $ 3.0 bn in March-December 2022 and $ 3.6 bn in 2023. Such financing covers about 40% of the government expenditures since the start of the russian invasion.
In January-April 2024, the government only attracted $ 11.8 bn in international loans and grants (or $ 3.0 bn per month, on average), of which $ 10.6 bn came in the last two months, after EU support had been unlocked.
In late April, the US Congress approved a $ 60.7 bn support package for Ukraine, of which about $ 7.8 bn is set be directed to the financial assistance of Ukraine’s budget. With this approval, Ukraine has nearly secured full financing of its budget needs from international sources for this year. However, regularity of international financial assistance has yet to become ideal.
Ukraine’s state budget can count on following international financing sources in 2024:
The rest of the needs, or about $ 6.0 – 6.5 bn, will be covered by the American assistance and other sources.
Trade Balance
Deficit widens in March after 2-year low in February
After relatively stable numbers of $ 4.75 monthly demonstrated in December 2023 – February 2024, Ukraine’s exports of goods and services decreased to $ 4.63 bn in March, which was mostly a result of subsided food exports (solely due to weaker exports pricing).
Meanwhile, a seasonal increase of chemicals and fuel imports caused total imports to grow in March and resulted in widening the trade deficit to $ 3.0 bn, after $ 2.0 bn average in the previous two months.
Widening of the trade deficit is in line with our previous expectations. In the coming months, we expect the deficit to widen further, as food exports will continue to shrink on exhaustion of exportable stocks. That said, we expect Ukraine’s trade deficit will be closer to $ 3.5 bn in May-June.
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Consumer Prices
Inflation reaches 4-year low, to speed up due to supply factors
As food inflation, the biggest component of the consumer basket, continues to slow down, Ukraine’s CPI reached a new multi-year low of 3.2% in March.? Other CPI components are still on the decline trend as well.
Nevertheless, the NBU is expecting inflation to speed up in 2Q24 with higher prices for food and administrative services (power), as well as increased producers’ costs due to an increase of minimum regulated wages in Ukraine since April. At the same time, the NBU lowered its end-2024 CPI outlook to 8.2% YoY, from 8.6%. In our view, there is room for further downgrade of CPI estimate.
Record-low CPI, which is now below the NBU’s target of 5.0%, allowed the central bank to make two consecutive declines in its key policy rate, in March (by 0.5pp) and April (by 1.0pp), to 13.5%.
Notably, Ukraine’s reported consumer price index is significantly lower than the GDP deflator and the consumption component of the deflator. This may suggest the consumer basket that is currently used for calculation of CPI does not accurately reflect the existing consumption structure.
Gross NBU Reserves
To decline faster in near future on new wave of ForEx liberalization
After reaching a record-high level of $ 43.8 bn as of end-March, Ukraine’s gross international reserves declined by $ 1.5 bn in April as NBU’s ForEx interventions ($ 2.3 bn) were higher than net government financing in foreign currency ($ 0.7 bn). The reserves cover almost 5.8 months of future imports, far above the minimum acceptable level of three months.
The National Bank has recently upgraded its forecast of end-2024 gross reserves to $ 43.4 bn (from $ 40.4 bn), assuming some more stability of international financial assistance for Ukraine this year.
With a high level of reserves and relatively balanced ForEx market, the NBU is initiating another round of ForEx liberalization— this time for business. In particular, staring May 4, the regulator:
According to NBU estimates, the new rules will result in additional demand for foreign currency in the range of $ 5.5 bn.
Exchange Rate & ForEx Market
NBU Allows for Solid Devaluation of Hryvnia Since October
Since the shift to manageable flexibility of UAH/$ rate in early October 2023, the National Bank allowed for a slow devaluation of hryvnia. The national currency has lost 7% vs. the dollar as of the beginning of May.
The new rate policy was also followed by some liberalization of ForEx market as NBU cancelled all the limits on foreign currency purchases for households in December and announced a new liberalization for business starting May 4.
The new exchange policy raised uncertainty about hryvnia stability, so the National Bank decided to increase ForEx interventions. Since October 2023 to date, it has spent $ 17.7 bn for interventions vs. $ 15.6 bn spent for the same period a year before.
In the coming months, the NBU’s new wave of liberalization will generate additional demand for dollars from businesses, so its interventions of foreign currency will increase.
At the same time, the NBU continues to commit to its “currency stability” policy by “securing” that the expected dollar appreciation remains below the hryvnia deposit rates offered by banks (refer to the next slide for more details).
We expect that average UAH/$ will be about 40x in 2024, which is 10% higher YoY.
Interest Rates, UAH
Deposits Rates Remain Above Expected Appreciation Rate of Dollar
The National Bank made five downgrades of the key policy rate over the last ten month to lower it from 25% as of end-June to 13.5% as of end-April. However, the key rates on UAH instruments (certificates of deposit, CDs) were adjusted slower. In particular, the rates on 3-month CDs (introduced in April 2023) decreased from 25% to 16.5% as of end-April, while the rates on overnight CDs were lowered from 20% to 13.5%. Effective CD rates decreased from 21.7% as of end-June to 14.6% as of end-April.
Notably, after peaking at 12.7% in July last year, the rates on currency deposits in domestic currency (which are sensitive to average CD rates and rates on government bonds decreased to about 10.8% in April.
The most important factor that determines the central bank’s rate policy is expected devaluation of hryvnia vs. U.S. dollar. The NBU is committed to keep deposit rates of individuals at a level that exceeds expected appreciation of dollars.
There is still some margin between expected dollar appreciation and individual UAH deposit rates, meaning that there is some room for further monetary easing in Ukraine. The NBU’s base-case scenario is that its key rate will be 13.0% as of end-2024. Most likely, however, if there are no shocks in Ukraine, the NBU’s key rate will be below its plan by the year’s end.