Ukraine:Current Economic Situation

and Future Prospects

Oleg UstenkoExecutive Director, The Bleyzer Foundation

October 2012

Ukraine: Economic Growth• In 2010 and 2011, GDP grew by

4.1% and 5.2%, respectively.

• In 1H 2012, GDP rate of growth declined to 2.6% yoy, due to shaking international economy.

• Since June, economic growth has slowed affected by further weakening external environment and domestic factors.

• For the entire 2012, real GDP growth forecast is 1.5% yoy.

Sources: State Statistics Committee, The Bleyzer Foundation

Real GDP Growth by Demand, Contribution to Growth, % points

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Drivers of GDP Growth: High Consumption

* Excluding private entrepreneurs’ and informal markets. Source: SSC, TBF

Real Wage and Retail Sales Growth, % yoy

• The Euro-2012 football championship supported the construction sector and contributed to cosumption growth.

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Drivers of GDP Growth: Strong Agriculture

• For 2012, grain output is forecast at about 44 million tons.• Though lower than the 2011 record output, it will be higher than

the historical average.

Grain Production in Ukraine, million tons

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Progress in Easing Inflationary Pressures

• In Jan-Sep 2012, inflation was at a decade low 0.8% yoy due to: • a generous 2011 harvest of grains and vegetables;• easing of world energy prices;• lower rate of growth of money supply;• government reluctance to raise gas and utility tariffs ahead of elections.

Source: State Statistics Committee, NBU, TBF

Select Monetary Indicators, % yoy Contributions to CPI Growth, percentage points

Progress in Addressing Sort-Term Fiscal Needs

• State budget revenues rose by nominal 17% yoy in 1H 2012, due to advance tax and other payments. But since then they notably decelerated (9% yoy in Jan-Aug).• Expenditures grew by 14.5% yoy over Jan-

Aug. Moderate growth was mainly due to a delay in some spending programs. • As a result, the state budget deficit was

almost three times higher in Jan-Aug than in 2011.• Overall public sector deficit in 2012 is

forecast at 4% of GDP as we expect budget spending adjustment after elections.

Public Sector Fiscal Deficit, % of GDP

* State and local budget deficits** Pension Fund Loans from Single Treasury Account

• But Ukraine has secured sufficient resources to cover its short-term needs thanks to $2.6 bn Eurobonds issued in July and September, a $2 billion VTB loan rollover, $0.7 bn privatization revenues, and domestic borrowings. 6

Progress in Financing the Balance of Payments

• In 2012, the current account deficit is forecast at about 6% of GDP (compared to 5.5% of GDP in 2011).• So far, this deficit is financed by a financial account surplus (despite high

external debt service), due to capital inflows ( mainly trade credit, ST capital).

• In 8m 2012 export growth slowed down to 2.9% yoy, as a result of:• weaker foreign demand;• lower world commodity prices;• trade restrictions by Russian on dairy, cheese, meat, and other products.

• Imports also slowed down, due to lower energy imports but grew much faster than exports.

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Current Challenges: Fiscal Sustainability Concerns

• Robust revenue growth in 1H 2012 was partly achieved thanks to one-off transfer of NBU profits and stronger tax pressure on business.• Due to lower economic growth, the original revenue targets contained in

the budget law are unlikely to materialize. • Expenditures are also likely to be higher than originally planned, since

generous social payment increases were not covered by sufficient compensatory measures.• Furthermore, due to delays in energy tariffs increases, Naftogaz deficit is

forecast to remain at about 2% of GDP. • Public debt may also be strained as at the end of July, Parliament raised

the limit of state budget private credit guarantees by 4.6 times to about 4.6% of projected full-year GDP.• Though Ukraine has secured sufficient financing for ST fiscal needs, after

the October elections, the government will need to take measures to be able to finance the deficit and sustain its public debt. 8

Current Challenges: Weak External Environment

World Steel Prices, Export of Goods and Industrial Production of Ukraine, % yoy

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Outlook for 2013

• Shortly after the October elections, macroeconomic pressures will give Ukraine no choice but to resume co-operation with the IMF, most likely in the form of a new stand-by agreement.

• To secure IMF financing likely conditions would include:

• Natural gas tariffs must be raised in stages (about 50% each stage)

• The 2013 budget law must be approved with significant reduction in expenditures and a fiscal deficit of no more than 2.5% of GDP

• Foreign exchange controls will be eased and a more flexible exchange rate regime must be allowed, resulting in a Hryvnia depreciation

• Further measures to restore the health of the banking sector

• Other fiscal/energy reforms must be initiated.

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Outlook for 2013 (cont.)

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Key Macroeconomic Indicators

* Includes implicit pension fund deficit (credits from unified Treasury account (state budget) to cover pension fund expenditures) for 2007-2008 and Pension Fund and Naftogaz imbalances since 2009, excluding bank recapitalization and VAT bonds

2007 2008 2009 2010 2011 2012f 2013f

Real GDP Growth, % yoy 7.9 2.3 -14.8 4.1 5.2 1.5 4.0

Fiscal Balance, % GDP* -1.7 -2.0 -8.9 -7.0 -4.4 -4.0 -2.5

Consumer Inflation, %, eop 16.6 22.3 12.3 9.1 4.6 4.0 8.0

UAH/$ Exchange Rate, eop 5.1 7.7 8.0 8.0 8.0 8.4 8.8

Current Account, % GDP -3.7 -7.0 -1.5 -1.9 -5.5 -6.0 -5.4

Gross Int. Reserves, $ bn 32.5 31.5 26.5 34.5 31.8 26.0 25.0

Foreign Gov't Debt, % GDP 8.7 9.2 20.5 23.8 21.0 19.0 18.0

Foreign Private Debt, % GDP 47.4 47.1 67.7 62.2 55.6 48.0 48.0