Summary:

Ukraine’s economy is recovering nicely and looks forward to strong growth in 2021, but a number of uncertainties remain.

The economy has begun to grow again, but Ukraine is still struggling with getting the coronavirus (COVID-19) under control and is prone to more waves of infection that will weigh on the recovery as it has been unable to source sufficient vaccines to inoculate the population.

The other danger is the ongoing conflict with Russia as the Kremlin is taking an increasingly hard line and appears to have given up on the Minsk II process. Russia has accelerated its issuing of passports to the locals, which will result in a frozen conflict that will go on for years. The hopes for a resolution to this problem in a timely manner have now been greatly reduced.

Ukraine’s economy will also be impacted by the sanctions proposed for Belarus following Belarus' president Alexander Lukashenko’s forced landing of the Ryanair flight on May 23 and the arrest of Roman Protasevich. Ukraine relies on Belarus for the supply of power, diesel fuel and potash all of which are likely to be blocked as a result of the fracas. It is unclear where else Ukraine can source these inputs as Russia would have been an alternative source and of course that is off the list. It is likely that Ukraine will have to exempt itself from the sanctions on Belarus regime, which adds new uncertainties.

Economic growth has returned, but Ukraine appears to be under performing and the outlook has recently been downgraded. Ukraine’s Ministry of Economy lowered its real GDP forecast to 4.1% y/y from 4.6% y/y for 2021 and to 3.8% y/y from 4.3% y/y for 2022, Interfax Ukraine reported on May 21 citing ex-minister Ihor Petrashko.

The ex-minister informed that the updated forecast would be used for developing a three-year Budget Declaration. Meanwhile, the drop of the economy in the first quarter of 2021 of 2.0% y/y was less severe than the ministry expected (-3.0% y/y). The average inflation in 2021 will amount to 8.8%, the ministry predicts.

Fixed investment in Ukraine in the first quarter of 2021 is slightly up from the same period a year earlier to UAH78,179mn from UAH76,914 respectively.

However, last year fixed investment was depressed by the multiple shocks the economy received and both years were significantly down by around a quarter from the 2018 results when UAH108,298mn was invested in the first quarter of that year.

While the economy is bouncing back that has yet to feed through into fixed investment which is needed to make the recovery sustainable and turn it into progress.

The government has no break-through economic strategy, and it is less risky to ground the country’s budget on a more conservative macroeconomic forecast. In addition, the accuracy of the economic outlook for 2021 is affected by the very low and uneven comparative base of the previous year.

Ukraine’s industrial output exploded in April, increasing by 13.0% y/y from a 2.1% y/y growth in March largely thanks to the low base effect from the pandemic, the State Statistics Service reported on May 24. All the results this year will be distorted by the crisis low base effects from 2020 making it harder to understand what is going on. However, the momentum from the bounce back can be used to spur new growth.

Seasonally adjusted output advanced a much more modest 2.7% m/m in April and in the first four months of this year industrial output inched up 1.5% y/y (vs. 7.0% y/y decline in 4M20).

Having said that, Ukraine does seem to have passed a nadir as multinationals – especially in the retail sector -- are increasingly setting up shop on the expectation of long-term growth. Incomes have been rising and this sort of investment, usually a harbinger for sustain growth, is very encouraging.

Likewise, the real estate sector is starting to grow with the number of residential developments increasing. There is also a growing wave of investment into commercial real estate and warehousing, which is also usually a harbinger of sustained growth. Moreover, construction is one of the three big drivers of economic growth so the uptick in activity in real estate development can create a self fulfilling prophecy of more growth.

FDI remains in the doldrums, apart from in the renewable energy sector, and that has been stymied by the government’s failure to honour its commitments to pay renewable utilities the tariffs it owes from the generous green tariff deal. The government owes these companies some $1bn and is unable to finance it, which has soured the investment climate. Several of the producers have started arbitration proceedings. The government for its part is talking about issuing green bonds to cover the debt.

The government hopes to increase foreign investment from $420mn last year, to $3bn this year, to $15bn by 2025, according to the National Economic Strategy 2030. Other goals for 2030 are: double the economy; triple exports to $150bn; nearly triple labour productivity; cut in half the state share in the banking system; cut the debt-to-GDP ratio to 30-40%; and increase the share of small and medium-sized businesses of exports to 40%.

Ukraine remains in limbo between an aggressive Russia and a tepid EU. Ukrainian president Volodymyr Zelenskiy has been touring the region trying to drum up support and has managed to land several very big billion-dollar investment deals with France, Qatar and Turkey, among others, that will spur growth, however, politically Kyiv has been hoping for strong support from Washington to counter Moscow’s meddling.

But the Biden administration has thrown Ukraine under the bus by refusing to impose sanctions on the Nord Stream 2 gas pipeline on May 17 as a concession to Berlin that wants the pipeline. That means it is almost certain that the pipeline will be completed this summer and as soon as the end of this year Ukraine can be cut out of the Russian gas transit business to Europe.

Ukraine has a transit deal with Russia signed in 2019 that guarantees delivery for another two years that is currently earning Ukraine some $2bn a year (down from $3bn in the previous period) but from around 2023 this could drop to nothing and Ukraine will have to scale back its vast pipeline network and refocus on its domestic supplies only.

In a press briefing posted on state.gov, a State Department spokesperson stated that the impetus for the move was to shore up ties with Germany, and that “all diplomatic tools” would still be used to prevent the completion of the pipeline.

Finally, Zelenskiy's campaign against the oligarchs continued after he kicked it off with his oligarch speech in March. So far the main target has been Viktor Medvedchuk, the Ukrainian opposition leader who is a close friend of Vladimir Putin. He is now under house arrest and facing a trial on treason charges that are also highly politically motivated as Medvedchuk is also Zelenskiy leading political rival and head of a legitimate opposition party in the Rada.

Oligarch Ihor Kolomoisky is also under pressure in the US which imposed sanctions on him earlier this year. Kolomoisky is also being sued by the now state-owned PrivatBank in London and Cyprus and those cases are progressing in favour of the state, but will take several years to produce results.

And Rinat Akhmetov, Ukraine’s richest man, has also come into the government’s crosshairs with proposals to nix cheap tariffs and tax exemptions that his System Capital Management (SCM) holding has benefited form, although in Akhmetov’s case the attack, such as it is, is limited to ending some of the advantageous rent seeking schemes and has no political element to it. A list designating 13 people as “oligarchs'' has been drawn up and Zelenskiy has promised new legislation that will codify his campaign. Ironically it seems that Zelenskiy is going through his oligarch moment in the same way that Russian President Vladimir Putin held his famous “oligarch meeting” in 2001 where he told them: keep what you have, but stop the stealing. The difference is Ukraine’s oligarchs have had an extra two decades to entrench themselves and the Ukrainian state is far weaker than the Russian state was at the time. Putin came to the president’s office from running the FSB where he had built a powerbase. Zelenskiy comes to his office from a TV studio and doesn't have the same powerbase to counter influential and deep-pocketed oligarchs.