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2 January, 2016  ▪  Oleksandr Kramar

It Looks Like Up to Us

2016 should be the year Ukraine’s economic collapse ends, but real incomes and the sectors that work predominantly on the domestic market could continue contracting

All the conditions are in place for 2016 to be a period of stabilization at the bottom. Unless there are new shocks, the effect of the low baseline and the exhaustion of the fundamental indicators behind the collapse should at least stop the decline. Not long ago, the EBRD adjusted its projections for the fall of the Ukrainian economy to 11.5% from 9% initially, but this is mostly a reflection of the hryvnia collapse during the first half of 2015. Meanwhile, government officials are suggesting that the decline had already stopped in QIII and that the economy will begin inching up during QIV and throughout next year, at 1-2%.

Still, with surplus and savings depleted, real incomes and employment levels will decline further among ordinary Ukrainians, including the fact that many companies have streamlined their workforces as much as they can by now, after having put the process off for a long time. This means economic recovery will be a mixed process. Some parts of manufacturing and even entire sectors will have the necessary conditions to grow, while others will continue to decline.

The key here is how strongly consumer demand will shrink and the impact this will have on those sectors that work for the domestic market, as these sectors are likely to become the ball and chain that keep Ukraine’s economy stalled. The standard of living and real household incomes will continue to decline because inflation has been rising at least twice as fast as income levels. Altogether, this could result in a further decline in sales of goods and services, albeit at slower pace than in 2015.

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Shrinking global markets

With world prices for gas continuing to slide, Ukraine’s chemical industry has an opportunity to pick pace. The mark-up that they traditionally overpaid, compared to competitors with substantial domestic gas extraction, will be severalfold lower in 2016 than in 2014. Overall, cheaper energy, for which Ukraine’s export-oriented producers have long been paying world prices unlike Ukraine’s households, will be a real shot in the arm, especially given how energy intensive Ukraine’s economy is. The machine-building sector’s current volumes already reflect the loss of exports of those products that Russia blithely rejected, which means that exports could grow as alternative markets come into play.

The least promising of the export-oriented sectors is Ukraine’s one-time king of the mountain, the steel industry. Interestingly, its decline is not at all connected to the loss of capacity in the Donbas. Deeper analysis shows that that’s only a convenient excuse for the real long-term reason: an oversaturated global market as developing economies all slow down, first among whom being China. In recent years, China has been expanding its own steelmaking capacities and has even begun exporting metal products. Ukraine’s plants, by comparison, are not being used to capacity, so when some plants were lost due to the conflict in the Donbas, the industry could have easily compensated for that by increasing production at other plants—had demand stayed at the same levels.

In fact, what has been happening is this: in Dnipropetrovsk Oblast, pig iron production was down from 6.9 million tonnes in the first three quarters of 2013 to 6.4mn t in the same period of 2015, while steel and semi-finished continuous cast products were down from 9.9mn t to 7.4mn t. During the same period, output of finished steel products was cut 20% while pipe production was down 45%. Recently it became known that Interpipe Stal, a modern electrocasting plant that was built just a few years ago, reduced its output of steel to 38,000 t in October. By comparison, in 2013, its average monthly output was 85,000 t. In other words, the crisis in Ukraine’s steel industry is not a case of lost capacities but of lost customers, something that is not likely to change in 2016.

Resurgent farm sector

Meanwhile, Ukraine’s farm sector has been transformed into the strongest branch of the domestic economy and its prospects for 2016 will largely depend on internal factors. Even after the current downturn, chances are very high that production will begin to grow again in 2016. The main factor, of course, is the low baseline: judging from the latest figures published by the Agricultural Policy Ministry, this year’s harvest should come in at around 60.5mn t of grain, compared to 63.0-63.9mn t in 2013-2014. The main cause for this drop was weather conditions, which means that next year could well be better. The same factors affected soy bean production, the second most important oil cultivar in Ukraine: bad weather knocked the harvest from 2014’s 21.3mn t to 17.7mn t this year.

The livestock sector is beginning to look up again. The first 10 months of 2015 saw meat, dairy and egg production bottom out. Eggs, in particular, were affected by the loss of producers in the occupied territories. Despite an anticipated fall in domestic demand in 2016 as real household incomes continue to shrink, the decline in the poultry and dairy industries is likely to slow down and even to stop. Partly this is due to the aggressive and successful export strategy adopted by major poultry and egg producers. For instance, Myronivskiy Khliboprodukt [Myronivka Grain Products] expects poultry meat exports to have increased to 180,000 t in 2015, up from 147,000 t in 2014, representing 31% of its output. The price advantage Myronivka has gained over its competition with the devaluation of the hryvnia and the fact that it has been actively entering new markets mean that the company is very likely to meet its goal of exporting 33%-50% of its products.

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On the other hand, the dairy industry—whose output level already reflects the loss of the Russian market, once its #1 buyer—should benefit from new opportunities presented by the AP Ministry’s recently-announced lifting of obstacles to the delivery of dairy products to the EU. At least a dozen Ukrainian dairy producers are counting on this.

Real vs virtual export trends

Needless to say, the prospects for Ukrainian exports are not ensured and much depends on how they are measured. For one thing, this year’s collapse was largely in relation to the dollar as the US currency gained strength against most other major currencies. It was also caused to a lesser extent by the loss of production in Donbas and of volumes delivered to the Russian Federation. However, the lower value of Ukrainian exports in one of the world currencies cannot properly be considered the cause of their decline: Ukrainian goods could not be worth the same in dollar terms as a year ago simply because this would imply a completely unjustified price rise on their main markets and the complete loss of competitive edge. As a parallel, in dollar terms, the export value of EU country goods, including Germany, also fell this past year, by about 15-20%. For instance, in September the euro rose 4.4% compared to the previous year, whereas it actually fell more than 20% relative to the dollar. Yet no one in Europe is talking about the “collapse of exports” because this collapse is entirely virtual.

So, if the dollar continues to gain strength relative to other world currencies, Ukraine’s exports in USD terms will once again look like they are shrinking. Measured, say, in euros, however, they will actually grow. This year’s baseline already reflects the loss of production in the Donbas and it looks like production on the unoccupied territories of Luhansk and Donetsk Oblasts could actually expand if massive military action is not renewed. In the event of a further trade war, the decline in exports to Russia will be softened by the relatively small share that it represents today, only 12.8%, and will be compensated for by growing exports to Africa and Asia, as well an expansion in the largest selection of goods to the EU.

With all this, it’s important to note that recent efforts to discredit the impact of Eurointegration on Ukraine’s economy are based on superficial, manipulative evaluations of the value of Ukrainian exports to the European Union based on stand-alone trade preferences. In dollar terms, exports to the EU were USD 1.23bn in October, which was really less than in October 2014, when they were worth USD 1.3bn, but in euro terms, their value actually grew more than 10% in that period, from just under EUR 1bn to EUR 1.1bn. Since the euro fell from USD 1.36 to USD 1.12 over this period—and is now down to USD 1.06— while prices on the EU market are designated in euros, the stronger dollar actually suggests the opposite trend, that Ukraine’s exports are steadily growing. And if they are properly valued in euros this coming year or in volumes, they will continue to grow.

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