Ukraine GDP Growth to Moderate at 2% in 2017 as Reforms Progress Slowly

1
Please note the risk notifications and explanations at the end of this document
December 2016
Ukraine: Sovereign ratings
LCY rating S&P Moody's Fitch
Long-term B- Caa3 B-
Short-term B n.a. n.a.
Outlook Stable Stable n.a.
FCY rating
Long-term B- Caa3 B-
Short-term B n.a. B
Outlook Stable Stable n.a.
Latest assessment Jun-16 Nov-15 Nov-16
Source: Thomson Reuters, RBI/Raiffeisen RESEARCH
Ukraine: Key economic figures and forecasts
Real Sector 2012 2013 2014 2015 2016e 2017f
GDP (UAH bn) 1,405 1,465 1,587 1,980 2,299 2,627
GDP (% yoy) 0.2 0.0 -6.6 -9.9 1.0 2.0
Domestic demand (% yoy) 4.6 1.7 -11.6 -9.4 2.6 2.3
Terms of trade (% yoy) 5.4 2.1 2.1 -3.0 -6.8 1.1
CPI (avg, % yoy) 0.6 -0.3 12.1 48.7 13.9 10.7
CPI (eop, % yoy) -0.2 0.5 24.9 43.3 12.4 9.0
PPI (eop, % yoy) 0.3 1.7 31.8 25.4 35.7 8.8
Real disposable income (% yoy) 9.7 5.3 -8.4 -22.2 n/a n/a
External Sector
C/A Balance (% of GDP) -8.2 -9.2 -3.5 -0.1 -3.3 -4.8
Goods export (% yoy) 3.3 -8.3 -14.5 -29.9 -7.7 7.1
Goods import (% yoy) 7.3 -5.8 -29.0 -32.8 0.7 7.6
FDI (USD bn) 7.2 4.1 0.3 3.0 3.5 2.0
Total external debt (% of GDP) 77.5 79.1 95.7 131.7 133.0 129.9
Gross FX reserves (USD bn) 24.5 20.4 7.5 13.3 15.5 18.0
Fiscal Sector
Fiscal balance (% of GDP) -3.8 -4.4 -4.9 -2.3 -3.5 -4.0
Public debt (% of GDP) 37.1 40.7 52.9 72.6 75.4 78.7
Source: State Statistics Service, National Bank of Ukraine, Ministry of Finance, RBI/Raiffeisen RESEARCH
Financial Analysts
Sergii Drobot, Raiffeisen Bank Aval, Kyiv
Ukraine Economist
+380 44 5905621
sergii.drobot@aval.ua
Andreas Schwabe, CFA, RBI Vienna
Senior Economist CEE
+43 1 71707 1389
andreas.schwabe@rbinternational.com
Editor
Gunter Deuber, RBI Vienna
Source: State Statistics Service, RBI/Raiffeisen RESEARCH
GDP growth and inflation
-5
5
15
25
35
45
-15
-10
-5
0
5
10
GDP (% yoy) Inflation (eop, % yoy), r.h.s.
Highlights
 Ukraine adopted a state budget law for 2017 consistent with the IMF’s EFF
programme parameters; however, the bill significantly raises minimum social
standards which poses moderate risks for financial and price stability. Progress
in reducing the share of the shadow economy may partly mitigate these risks.
 Possible changes in the foreign policy stance of the upcoming US administration
cause uncertainty in Ukraine, as they could have challenging and complex
implications for Ukraine’s political and economic outlook and may trigger
adjustments to Ukraine policies (see our special section on page 3-4).
 GDP performance in Q3 has been revised upwards to +2% yoy, resulting in
estimated annual growth of 1-1.5% yoy in 2016. We keep our outlook for 2017
unchanged at moderate +2% yoy economic growth.
 The inflation rate in December came in at 12.4% yoy, allowing the National
Bank to reach its inflation target of 12% +/-3pp for the year. For this year, we
project some moderate further decrease to high single digit numbers.
 The UAH depreciated in late December given higher UAH liquidity during the
holiday season; gross international reserves finished the year at a mark of USD
15.5 bn, below planned 17 bn. We expect further (smooth) depreciation amidst
a widening C/A deficit in 2017, while FX reserves might increase somewhat.
 International partners welcomed the nationalization of Privatbank in December;
the IMF seemingly even demanded it. However, the significant capital injection
by the state adds some risk for financial and price stability (see our special
section on page 8).

2
Ukraine
Economic Policy
On 21 December, 4:52 a.m., the Ukrainian Parliament approved
the state budget for 2017. The law assumes real GDP growth of 3% yoy
and an inflation rate of 8.1% in 2017 (we project 2% growth and 9%
inflation). The average exchange rate is assumed at USD/UAH 27.2. The
revenues are set at a level of UAH 731 bn, while the level of expenditures
amounts to UAH 800 bn. As a result, and by taking into account loans and
transfers, the government deficit is planned at UAH 77.5 bn (or 3% of GDP,
which is in line with the IMF EFF programme). Debt operations are envisaged
to finance the deficit by 79%. The total borrowings are set at a level of UAH
191 bn, debt payments at UAH 130 bn. In 2017, the government plans to
attract UAH 104 bn (around USD 3.9 bn) via domestic borrowing and UAH
87 bn (USD 3.2 bn) from foreign donors. Due to the debt restructuring in
2015, Ukraine will repay/service only UAH 31 bn on its external obligations,
while internal payments will amount to UAH 99 bn. The privatization in 2016
failed (less than 2% of the original plan has been fulfilled), and the amount of
UAH 17.1 bn from the budget 2016 migrated to the new budget.
The VAT is the main source of revenues in 2017’s budget. It amounts to 40%
of total revenues, while the excise duties occupy around 16%. Another
significant contributor is the income tax (about 17%). On the (gross)
expenditure side, the Ministry of Finance is spending the single largest share
(around 34% of total spending) due to significant gross public debt
repayments and high subsidies to local budgets. The Ministry of Social Policy
comes in second place, with 20% of the total expenditures. The lion’s share of
its allocation will go to the Pension Fund. Given the conflict in eastern Ukraine,
it is not surprising that defence spending is high at 8% of total expenditures or
about 5% of GDP. The government is planning to increase wages in the fields
of education and healthcare in 2017, which determines (together with
significant presence of state in these sectors) the high spending in these areas
– 10% and 9% of total spending respectively.
The budget law also includes a significant hike of the minimum
wage by 100% to UAH 3,200 (equivalent to around USD 120 per month)
which in our opinion poses moderate risks for financial and price stability.
However, according to the Minister of Finance, this step is aimed at
decreasing the shadow economy (by raising the official share in wages) and
will not lead to any additional budget spending. It is noteworthy that the share
of shadow economy activities is about 40% of GDP, the increase of minimum
wage may improve tax revenues – of course only if the changes are is well
implemented (e.g. by improving tax administration). As of price stability, the
growth of wages will have an upside effect on inflation – according to the
National Bank, about +1 pp to inflation in 2017.
In order to support budget revenues the government adopted
some changes to its tax policy. First of all, some excise duties have been
hiked and are now closer to European standards. Specifically, the excise duty
for alcohol increased by 20% and for tobacco by 30%. Furthermore, the rent
for transit of ammonia went up from USD 2.4 to USD 4.8 per tonne per 100
km. However, the rent for oil extraction has been lowered from 45% to 29%
(depth up to 5000 meters) and from 21% to 14% (depth of over 5000 meters).
Probably this move is aimed to support and develop domestic production.
Moreover, the government improved VAT administration by the creation of an
electronic cabinet of taxpayers, and the administration of the VAT database bySource: Ministry of Finance, RBI/Raiffeisen RESEARCH
Budget 2017: Revenue structure (UAH bn)
VAT, 293
Income taxes,
127
Excise duties,
113
Rent, 48
National
Bank, 45
Other, 105
0
100
200
300
400
500
600
700
800
Source: Ministry of Finance, RBI/Raiffeisen RESEARCH
Planned reductions of budget deficit
3.7%
3.0%
2.5%
2.3%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
66
68
70
72
74
76
78
80
82
84
86
2016 2017 2018 2019
Budget deficit (UAH bn)
Budget deficit (% of GDP, r.h.scale)
Central state budget 2017 (UAH bn)
680
700
720
740
760
780
800
820
Budget revenues Budget spendings
DeficitofUAH77.5bn

3
Ukraine
the Ministry of Finance instead of the State Fiscal Service (it is expected that
the Ministry of Finance will provide an automatic VAT refund), and some other
changes. Thus, business climate has improved, and the VAT operations will
turn out to be more transparent and convenient.
The approval of the budget draft, which is in line with the EFF program
parameters, and changes of the tax code are positive signals for international
donors and investors. Chances of receiving the next IMF tranche in late-
January or early-February have increased. Nevertheless, some critical reforms
have been postponed. For example, there is still no pension reform, the land
market is still closed, and the privatization in 2016 failed completely. Thus,
we believe that Ukraine will receive the next tranche in Q1 due
to the positive steps taken even though the tranche volume
might be again reduced.
Uncertainty regarding future US policies towards Ukraine
The outcome of the US presidential elections triggered fears that a potential “deal” between the USA and Russia could result in
higher uncertainty and less support from the US for Eastern European countries. Especially Ukraine feels vulnerable in this respect.
With the new US administration not coming into office until 20 January, we can only speculate about the
upcoming policy moves. However, statements by Mr. Trump during the presidential race and after the election as well as some
of his key personnel appointments raised concerns in Ukraine. After the annexation of Crimea by Russia and given the smouldering
conflict in Ukraine’s southeast, Ukraine’s current administration has not only a strong policy orientation towards the US and the EU,
but also a strong drive to minimise Russian influence and dependency on Russia. Attempts to resolve the Donbass conflict under to
the Minsk I and II agreements have been largely unsuccessful given fundamentally different views and uncompromising stances on
both sides, which is Ukrainian central authorities and Russian-backed militias ruling parts of the Donbass region. It is no surprise that
Crimea, Donbass, and relations with Russia have been a major issue in Ukrainian domestic politics as well (besides the economic
crisis, fighting corruption, and the institutional reform process). Thus, any substantial changes in Russian-US relations will
have substantial and complex implications for Ukrainian domestic and foreign policy as well the country’s
economy given Ukrainian dependence on international and Western bilateral financial support and the key role of Western
institutions in reforming Ukrainian state structures.
From an economic point of view, one highly negative scenario would be any disturbance in the ongoing IMF
programme, which is scheduled to run until 2018. At some points, Ukrainian authorities have barely managed to keep the
programme afloat given the vested economic interests preventing Ukraine from fully complying with the conditionality of the
programme. Given these obstacles, we think that there has been a (geo)political component in the IMF management board’s
decisions to continue support for Ukraine until now. In our opinion, with a Trump administration and the important role of the USA in
the IMF, it could be more challenging for Ukrainian authorities to secure the continuation of the IMF programme if key conditions like
fighting corruption and moving forward with structural reforms are not fulfilled. Another negative factor is the certain degree of
Ukraine fatigue that has been present in European capitals for some time now. Ukrainian authorities may possibly assess these
challenges and increase their efforts to successfully fulfil the required minimum conditions of the ongoing programme. With regard
to reforms in Ukraine, US officials (together with their EU colleagues) on the ground have been an important
driver in past years. If the interest of the US in the success of Ukrainian reforms should weaken, the chances of the success of
such reforms could decrease.
Moreover, the US has been providing direct financial support to Ukraine by guaranteeing Ukrainian internal
debt issues (reopening the capital market and substantially reducing the risk premium for these issues). Overall, the US has
guaranteed USD 3 bn in bonds. According to the IMF programme, no additional US-guaranteed bonds are scheduled. Nevertheless,
a Trump administration could be more reluctant to provide potentially needed bilateral financial support than the previous
administration. However, with the external public debt repayment schedule still moderate this and next year due to earlier debt
restructuring and with the state budget deficit largely under control, this issue does not pose a substantial immediate risk to Ukraine’s
financial stability (though the psychological blow from a reduction in direct US support should not be underestimated).
Budget 2017: Spending (UAH bn)
0
50
100
150
200
250
300
Ministry
of Finance
Ministry
of Social
Policy
Ministry
of
Education
and
Science
Ministry
of Health
Ministry
of
Defence
Ministry
of Internal
Affairs
Rest

4
Ukraine
Real Sector
The State Statistics Service revised its estimate of Ukraine’s
economic performance in Q3 2016 to +2% yoy from +1.8% yoy,
previously. The seasonally adjusted GDP growth rate has also been
enhanced by 0.1pp to 0.5% qoq. The major drivers of growth were trade
(+0.4% qoq or +3.8% yoy) and construction (+0.4% qoq or +17.5% yoy)
reflecting the slowdown in inflation and a recovery of business activity.
Moreover, against the background of an abundant harvest this year, the
agricultural sector demonstrated a positive result (+1.5% qoq or +1.1% yoy).
On the contrary, the recession deepened in the area of education by 2.3%
qoq (-8.5% yoy), and the decline in the mining industry even accelerated from
-3.7% yoy in Q2 to -4.1% yoy in Q3. Apparently, the last was triggered by
tensions in the ATO area in Donbass and accompanying transportation
problems. The contribution of the financial sector (-5.1% qoq) to GDP growth
in Q3 was also negative, but the decline is steadily decreasing from -24.6%
yoy in Q2 to -6.3% yoy caused by clean-up and stabilization of the banking
sector. Given the fact that many large banks have completed their
recapitalization and done the provisioning, we may see a growing financial
sector in the upcoming quarters.
On the expenditure side of GDP, the fall in inflation rates and real wage
improvement (by 9.1% in the first 9 months of 2016) contributed to the
expansion of private consumption by 0.8% qoq (+4.9% yoy) in Q3. Public
spending increased by 3.2% qoq. Thus, domestic consumption grew by 1.7%
qoq or by 5.1% yoy. Moreover, a significant hike in inventories (due to good
Moreover, if US support for Ukraine were to be reduced, Ukraine could be “left” to the EU. That said, we do not
see a strong willingness to offer bold (additional) support to Ukraine at the EU level. Such a scenario of less US and limited EU
support and disappointed expectations within the EU may also lead to a state of continuous fragility in Ukraine and could also make
it difficult for the EU to push Ukrainian authorities to a more pragmatic stance towards Russia. Such an outcome could be interpreted
as an “ideal scenario” for Russia, demonstrating the incapability of the EU and the “new elites” in Ukraine. A reunification of
Ukraine remains a distant option under such a scenario. If instability in Ukraine continues, Russia may even be tempted to justify a
continued limited engagement in Donbass to “protect the Russian population from adverse developments”.
From a Ukrainian domestic policy perspective, a highly problematic scenario would be a US-Russia “deal”
forcing Ukraine to accept substantial concessions in the Minsk agreements. Such concessions would be highly
difficult to communicate to the population given the heated domestic policy climate. For example, violent protests by right wing
extremists broke out in front of the parliament in 2015, leading to the death of four National Guard officers and essentially stopping
the adoption of legislation required by the Minsk II agreements. With the current authorities being rather unpopular and populists on
the rise for some time already, internal political quarrels could be destabilising for Ukraine. However, parliamentary and
presidential elections are far off, being scheduled for 2019. Thus, if snap elections or a dissolution of the government backing
(minority) parliamentary coalition can be prevented, a major domestic political crisis could be avoided. Nevertheless, domestic
political fragility would rise substantially in such a scenario.
Likewise, a scenario where Ukraine would eventually make compromises and proceed with re-integrating
the separated parts of Donbass along terms closer to the Russian positions would have its own political and
economic risks. For example, resurging Russian influence on Ukraine policymaking would possibly be negative for the
institutional and economic reform process.
That said, our baseline scenario is still a continuation of IMF support for Ukraine. We see the situation in
Donbass rather stagnant but unresolved for the foreseeable future. Nevertheless, heated discussions on foreign
policy have already started in Ukraine given the election of Mr. Trump and will likely result in adjustments of Ukrainian political
positions in 2017.
Andreas Schwabe, CFA, RBI Vienna
GDP growth by sector (% yoy)
1.4
0.6
-3.7
3.4
-1.9
14.9
7.1
2.8
-7.9
-4.1
-24.6
2.0
1.1
-4.1
0.1
2.5
17.5
3.8
1.1
-8.5
-4.8
-6.3
-30 -20 -10 0 10 20
GDP growth rate
Agriculture
Mining
Manufacturing
Utilities
Construction
Trade
Transport
Education
Healthcare
Finance
2Q16 3Q16

5
Ukraine
harvest and accumulation of natural gas in anticipation of winter), as well as
an increase in gross fixed capital formation by 4.7% qoq, supported the
improvement of gross investments by 5.1% qoq (+32.8% yoy) in Q3.
Seasonal growth of energy imports and recovery of domestic investment
demand resulted in growing imports by 5.2% qoq (+13.9% yoy). Meanwhile,
exports fell by 0.6% qoq (-5.5% yoy) resulting in a negative contribution of net
exports to GDP growth in Q3 (approximately -4.6 pp). In 2016, we estimate
GDP to have increased by 1-1.5% yoy. In 2017, according to our
estimate, Ukraine’s economy will grow by 2% yoy, but growth may
be even higher provided the acceleration of structural reforms in the country.
Industrial production improved markedly from +0.8% yoy to
+3.7% yoy in November. Seasonally adjusted data also indicates growth
(+0.7% mom). After a 6-months-long recession, the mining industry
demonstrated an increase by 3.3% yoy against the backdrop of the surge of
coal mining and oil/gas extraction by 5.8% yoy. Furthermore, recovery of
manufacturing amplified from +1.3% yoy in October to +3.9% yoy in
November. Food industry grew by 7.8% yoy, machinery – by 6.9% yoy, and
metallurgy – by 4.9% yoy. By contrast, decline in chemical industry deepened
from -5.2% yoy to -6.4% yoy. The growth within an energy sector slightly
slowed down to 3.5% yoy from 3.7% yoy. Generally, industry hiked by 2.1%
yoy during the 11 months of 2016. In our view, industrial production
completed around the level of +2% yoy in 2016. The improved business
activity as well as the development of new business connections might push
industrial output further up to 4% yoy in 2017.
Inflation
Consumer price inflation has slightly decelerated in November –
to 12.1% yoy from 12.4% yoy in October. Nevertheless, in mom
terms, the rise in prices has been relatively high (+1.8% mom, decelerating
from +2.8% mom in October). Similar to the previous month, the major driver
was the hike of tariffs for hot water and heating (+22% mom or 0.5 pp to
mom growth). Probably due to methodological peculiarities, the effect from the
increase in tariffs was not fully reflected in October’s CPI when there was the
actual start of heating season. As a result, communal payments went up by
5.3% mom in November (by 47.2% ytd). Food prices increased by 1% mom
due to rising milk prices (by 7.3% mom) on the back of growth of global
prices and seasonal factor. Oil prices jumped by 2.8% mom. Moreover, there
was a seasonal rise in vegetable prices by 3.3% mom. By contrast, prices for
fruits dropped by 4.8% mom. As of non-foods, alcohol and tobacco prices
increased by 1.3% mom. Gasoline costs grew by 1.8% mom against the
background of growing global oil prices and UAH devaluation. However, the
seasonal rise in prices for clothing has stopped, and it became cheaper by
0.5% mom in November.
2016 is over, and with 12.4% yoy in December the overall
inflation goal of the National Bank of 12% +/- 3 percentage
points has been achieved. When looking at the average price level in
2016 compared to the previous year (this metric is more common in
developed markets), inflation has been still higher at 13.9% yoy, given higher
inflation rates in H1. In 2017, we project that the rise in consumer prices will
be driven by (smooth) depreciation of the hryvnia, further growth of tariffs (it is
planned the next phase of tariff increases for electricity in March) and the
significant increase of the minimum wage. Nevertheless, we believe that the
CPI growth will decelerate to 9% yoy until the end of 2017, but during the
GDP growth by expenditures (% yoy)
-7.2
-3.8
4.2
0.1
-2.2
0.1
-0.1
-6.5
17.6
-2.4
4.3
1.4
13.9
-5.5
24.8
3.0
4.9
2.0
-10 0 10 20 30
Import
Export
Gross fixed investment
Gov-t consumption
Private consumption
GDP growth rate
3Q16 2Q16 1Q16
Industrial output growth by sector (% yoy)
-14.0
-15.5
-13.7
-12.2
-11.1
-8.2
-12.0
-21.0
-15.8
-9.1
-8.4
-17.3
-15.9
2.1
-0.4
3.4
1.8
2.7
0.9
1.4
8.6
0.6
4.4
6.9
6.4
1.2
-30 -20 -10 0 10 20
Industrial production
Mining
Manufacuring (all)
Utilities
of manufacturing:
Food
Light industry
Woodwork and paper
Coke, refined products
Chemical
Pharmaceutical products
Rubber, plastic and mineral…
Metallurgy
Machine building
Jan-Nov 2015 to Jan-Nov 2014 Jan-Nov 2016 to Jan-Nov 2015
Inflation (% yoy)
-10
0
10
20
30
40
50
60
70
CPI Food prices PPI

6
Ukraine
upcoming 6-8 months inflation will likely hover in a range between 11-15%
yoy. The NBU set an inflation target of 8% yoy +/- 2pp for Dec-2017.
Meanwhile, producer prices jumped by 2.2% mom in November
triggered by growing energy tariffs and rising prices in metal
ore mining. The prices in the mining industry went up by 4.4% mom. The
major driver of growth was the hike of prices in metal ore mining due to a
surge in global prices. Prices in manufacturing increased by 1% mom, while in
the energy sector growth amounted to 4.5% mom due to increasing tariffs. As
a result, yoy producer price inflation accelerated to 32% yoy from 29.2% yoy
in October.
Balance of Payments
In October, the Current Account (C/A) deficit declined to USD 234
mn compared to a deficit of USD 891 mn previous month driven by the
interest payments on restructured Eurobonds. The dynamics of merchandise
exports improved whereas imports, on the contrary, deteriorated. The decline
of exports slowed down to 0.6% yoy from 7.3% yoy on the back of growth in
food exports by 2.9% yoy and metallurgical exports by 5.8% yoy (due to a
low base effect). By contrast, exports of machinery fell by 11.5% compared to
October 2015. Merchandise imports decreased by 1% yoy in October
compared to 8.2% yoy in September. This trend was caused by a reduction of
energy imports that resulted in collapsing imports of mineral products by
29.3% yoy. Meanwhile, imports of machinery accelerated to 34.6% yoy from
19.4% yoy against the background of increasing demand for foreign cars as
a consequence of the reduction in excise duties on imports of used cars.
After a strong surplus of USD 1.4 bn in September (through the issue of bonds
under the guarantee of the United States), the financial account recorded
a relatively modest positive balance of USD 310 mn in October.
Likely, the recapitalization of banks with foreign capital is over; at least, low
FDI inflow, which amounted to only USD 45 mn, provide evidence. The inflow
of funds to the "Other Investments" account amounted to USD 568 mn (half of
this volume is the reduction of currency outside the banking system). On the
contrary, due to the government’s partial repayment of its commitments in
foreign currency to non-residents (to the amount of USD 298 mn) the "Portfolio
investment" account experienced a deficit of USD 297 mn. However, in
generally, the current account surplus amounted to USD 91 mn in October.
The current account deficit reached USD 2.5 bn in Jan-Oct 2016
against the background of a growing merchandise trade deficit of almost USD
5 bn. Dynamics of imports improved faster than export dynamics (-2% yoy vs. -
8.8% yoy). Nevertheless, the financial account recorded a surplus of USD 3.5
bn due to foreign bank recapitalizations, the reduction of foreign currency
outside the banking system, and the support of foreign partners. As a result,
the Balance of Payment surplus amounted to USD 1.1 bn in Jan-Oct.
Given unfavourable export price dynamics, and the relatively rapid recovery
of imports of goods we expect the C/A deficit to amount to USD 3 to
3.5 bn in 2016 (or about 3.3% of GDP). In 2017, we expect a
C/A deficit to grow further towards 4-5% of GDP against the
backdrop of a stronger recovery in imports compared to exports.
Monetary Policy and Exchange Rate
The significant increase of local currency liquidity led to a UAH
devaluation in December. As a result, UAH lost about 6% of its value,
Source: National Bank of Ukraine, RBI/Raiffeisen RESEARCH
Balance of Payments (USD bn)
-4
-3
-2
-1
0
1
2
Current Account Financial Account
Capital Account Balance of Payments
Official USD/UAH rate
23
24
25
26
27
28
Merchandise trade (% yoy)
-50
-40
-30
-20
-10
0
10
20
Export (% yoy) Import (% yoy)

7
Ukraine
and the USD/UAH rate hiked to 27.2. The New Year and Christmas holidays
were an additional adverse factor pushing the exchange rate up as foreign
currency supply slumped. In order to manage the excessive volatility, the
National Bank (NBU) intervened in the FX market – the net foreign currency
(FCY) sales amounted to USD 119.4 mn in December.
Gross international reserves declined to USD 15.3 bn in
November given debt payments of USD 147.2 mn and a revaluation of the
reserve assets due to the USD strengthening.
Frequent domestic FCY bonds issuance helped to restore reserves in
December, but the pressure at the FX market hampered the growth. As a result,
FX reserves stood at a level close to USD 15.5 bn in the end of
2016, below autumn projections for 2016 by the IMF of USD 17.5 bn and
the NBU of USD 16.8 bn. Interestingly, the annual growth amounted to about
USD 2.2 bn, which is quite close to the EFF program financing in 2016 (USD
1 bn is the last IMF tranche and USD 1 bn guarantees from US). This means
that the economic situation still does not allow the Ukraine to replenish its
reserves on its own, but the outflow has been stopped. In 2017, we expect
gross international reserves to grow and to reach the level of
USD 18 bn, (once again) mainly given external support.
Given growing pressures in the FX market, the National Bank of Ukraine
decided to keep its monetary policy unchanged. Particularly, the surrender
requirements for export proceeds remained at 65%, there is still the 120-day
rule for settlements for export/import of goods, cash FX purchase is limited to
UAH 12,000 per day at the equivalent, and FX cash withdrawals limit is at a
level of UAH 250,000 per day. Moreover, the regulator sees a growing
risk for price stability, and decided to leave the key policy rate
at 14% at the most recent monetary policy meeting in December.
As of novelties there will be no expiration date for current restrictions
(previously they had been reviewed every 3 months). The regulator thinks that
the former system was misleading for the market participants. From now on,
the Central Bank will be able to remove market controls along the
improvement of the economic situation not being tied to time frames. In our
view, it may proceed with the liberalization policy in 2-3 months when the
seasonal pressure fades away and if there are no other obstacles.
In December, money market liquidity leaped sharply on the back
of seasonal growth of budget expenditures and the disbursement of significant
refinancing to Privatbank (UAH 25 bn). The balances on correspondent
accounts were in a range of UAH 48-53 bn in late-December, while the
volume of Certificate of Deposit (CD) jumped to UAH 60-69 bn. Growth of
liquidity resulted in decline of interest rates. Index of interbank rates overnight
collapsed by 2-2.5 pp to 10.83% in December.
Banking Sector
Total deposits shrank in November, only deposits of private individuals
(PI) in local currency (LCY) increased by 0.3% mom. PI FCY deposits fell by
0.8% mom. Corporate deposits (CO), both in LCY and FCY, declined – by
0.8% mom and by 4.5% mom respectively. Nevertheless, total deposits
increased by 7.6% yoy in Jan-Nov thanks to the stabilization of the financial
system and increased public confidence in the banks.
CO LCY lending recovered (+7.5% mom). Partially this may be
attributed to restructuring loans (conversion of FCY loans into LCY loans), as
the CO loan portfolio in USD shrank by 7.3% mom. PI loans in UAH fell by
CD – NBU Certificate of Deposit
Money market
0%
5%
10%
15%
20%
25%
30%
0
25
50
75
100
125
150
UAH bn
CDs
Balances on correspondent accounts
Index of interbank rates (overnight ), r.h.s.
FX reserves
0
2
4
6
8
10
12
14
16
18
-3,500
-3,000
-2,500
-2,000
-1,500
-1,000
-500
0
500
1,000
USD mn USD bn
NBU interventions/auctions Gross FX reserves, r.h.s.
Retail (PI) deposits dynamics
-60%
-40%
-20%
0%
20%
40%
60%
LCY PI deposits, yoy growth
FCY PI deposits, yoy growth

8
Ukraine
0.3% mom, and household FCY loans dropped by 1.4% mom. In Jan-Nov, the
total loan portfolio denominated in UAH remained unchanged (+0.3% yoy)
owing to a devaluation of the national currency.
In Jan-Nov, the banking sector’s losses amounted to UAH 18.9
bn, which is a remarkable improvement compared to the same period in
2015 (losses of UAH 57.3 bn). Also, it should be noted that VTB (Russia),
Prominvestbank (Russia), Sberbank (Russia) and Ukrsotsbank suffered the most
– they share UAH 15.4 bn losses (as of 1 October 2016). Most of the other
banks feel quite comfortable, and have even been profitable in 2016.
Privatbank nationalization story
On 21 December, Privatbank, the largest Ukrainian bank with a market share of about 20%, was
nationalized. Rumours about the nationalization had started long before, as despite the good financial results (it was profitable
from 2014 to Q3 2016 regardless of deep recession in the country) the bank had accumulated significant problems over time.
According to the governor of the National Bank Valeria Gontareva, staggering 97% of Privatbank’s CO loans are loans to related
parties, which makes Privatbank the largest “pocket” bank in Ukraine. As of 1 October 2016, 86% of total bank’s loans were
granted to the corporate sector, while the total loan portfolio consisted of 38% FCY loans. At the same time, 79% of the deposit
portfolio consists of household deposits. Moreover, the bank had one of the most attractive (i.e. highest) deposit interest rates which
also points to an elevated risk level. Thus, it is not surprising that Privatbank showed a huge gap in its capital and needed a
significant capital injection of UAH 116.8-148 bn (or around USD 4.5-5.7 bn) according to the Minister of Finance. According to
Fitch, the Ministry of Finance issued UAH 107 bn (about USD 4bn) of government bonds to recapitalize
Privatbank. Looking to government bonds statistics, this figure looks quite realistic.
In order to prevent a panic and protect the clients (about 20 mn of citizens, i.e. almost half of the population), the government took
a number of measures. First, it introduced 100% state-insured customer deposits for Privatbank (previously, only government
Oschadbank had such a privilege). Obviously, this step increased public confidence, but it also taught the population the wrong
lesson of choosing the bank with the highest interest rates (and high underlying risks) without direct negative consequences, and
thereby increasing future risks to banking sector stability. To support Privatbank’s liquidity, the NBU granted two refinancing loans
amounting to UAH 25 bn after the nationalization. Later, the National Bank monetized UAH 25.8 bn of domestic bonds issued by
the Ministry of Finance to recapitalize Privatbank, as Privatbank used the bonds to repay the refinancing loans. As a part of
Privatbank’s recapitalization process, the bank’s Eurobonds holders have been bailed-in. As a result, Fitch downgraded the bank to
‘RD’ (Restricted Default).
In conclusion, international partners welcomed the nationalization of Privatbank as an important step to
maintain financial sector stability. In our view, it was probably the best step in the current situation. However, despite the
growth of confidence in the banking sector, it may be quite costly for the state budget (given the size of capital needs). Moreover, in
case of a shortage of Privatbank’s liquidity, the NBU may monetize more domestic government bonds, which may have adverse
effects on price stability and on the FX market. Finally, the government currently owns about 50% of the banking sector which
weakens market competition. Ukraine plans to privatize the state banks in subsequent years, but due to the significant size of
government banks and the economic situation, it will not be an easy task to fulfil.
Sergii Drobot, Raiffeisen Bank Aval, Kyiv
Privatbank (gov),
271.8, 21%
Oschadbank
(gov), 191.6,
15%
Ukreximbank
(gov), 153.4,
12%
Ukrgazbank
(gov), 57.9, 4%
RB Aval, 51.7,
4%
Ukrsotsbank,
49.9, 4%
Sberbank, 47.2,
4%
Other, 473.3,
36%
Market share (UAH bn), as of 3Q16
0
50
100
150
200
250
Loans Deposits
Privatbank portfolio (as of 3Q16)
Corporate Household

9
Ukraine
[THIS PAGE WAS INTENTIONALLY LEFT BLANK]

10
Ukraine
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Acknowledgements
This report was prepared by Raiffeisen Bank Aval on 11 January 2017
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