The harvest of hope

Economics
25 May 2016, 20:30

As anticipated, it looks like 2016 will actually become the year of stabilization and the start of a slow recovery for Ukraine’s economy. The standard of living is also looking to stop its decline, after household incomes sharply declined in the last two years. The calm after the storm is likely to be most felt this summer—provided, of course, that we don’t see an escalation in the Donbas.

Inflation has been slowing down over the past year after reaching upwards of 60% in spring 2015. For instance, consumer price inflation compared to the previous year dropped from 40.3% in January 2016 to 9.8% in April. Food products cost just 6.1% more this April than a year ago, although in January they had jumped 36.9% over January 2015. Prices for clothing and footwear went from a high of 31.5% inflation in January this year to 19.6% in April, medicines from 31.9% to 8.4%, and transport from 25.9% to 7.3%. The same can be seen across the board.

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This summer, Ukrainians could see price inflation drop to marginal levels altogether. What’s more, this will not be a matter of seasonally adjusted prices for food compared to last winter or this spring, but relative to summer last year. Even prices for gas will be lower than a year ago, with the rate reduced from UAH 7.19 to UAH 6.88 per cu m.

Economic trends

Lately Ukraine’s economy has been more and more clearly based on two pillars, the farm sector and trade, which together constitute almost equal shares of about one third of the country’s GDP. Last year, the contribution of agriculture, UAH 236 billion, was almost identical to that of the processing industry, UAH 239.1bn. Since nearly a third of the latter comes from food processing, the overall food industry actually outstripped the trade sector, which contributed UAH 288.1bn to GDP in 2015.

Trade and agriculture also remain the main employers in Ukraine. According to Derzhstat, the statistics agency, every second Ukrainian earns a living in these two sectors. In Q1 2016, output actually shrank marginally, by 1.7%, in the farm sector, as did food processing, by 2.1%. By contrast, the remaining processing industries increased output by 4.4%, with steelmaking up 9.8%. At the same time, there’s a clear trend in the farm sector to monthly improvements in its indicators, which suggests that the slight decline will be reversed in the second half of 2016.

Retail sales are inching up slowly—1.6% in Q1’16 compared to Q1’15. With prices stabilizing and marginal improvements in social benefits and average salaries, this pace could pick up.

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Second-tier sectors remain transport, machine-building, the mining and metals complex (MMC), fuel extraction, education, and healthcare. The fuel sector’s share of GDP has been growing as the country moves to market-based pricing for natural gas, while education and healthcare each represented 3-5% of GDP in 2015. Since the beginning of 2016, metal production has grown, 9.8% in Q1, and 18.8% alone in March, compared to 2015. However, this growth was only the outcome of an adjustment in prices on world markets after the previous steep decline and is unlikely to prove sustainable. In contrast to the agricultural sector, Ukraine’s steel industry doesn’t have much of a competitive edge over a slew of other producers, especially in Asia. On the contrary, the cost of production is higher than there, especially compared to the largest producer, China, so that it is unlikely that this growth will be sustainable.

Freight carriage has been growing lately as well: in Q1’16, it was up 4.2% over 2015, and looks to pick up pace as industrial output rises. As real household incomes stop their decline and the cost of fuel goes down relative to 2015, passenger transport should also pick up pace. What’s more, internal tourism is growing ever-more dynamically as the cost of traveling abroad grew beyond the means of most domestic travelers with the devaluation of the hryvnia.

A hot season

Summer, and particularly the harvest season, should begin to play a more and more significant role in Ukraine’s economy, as the farm sector is turning into its biggest component. It ensures the biggest capital inflows into the country, which means that the quality of the harvest will largely determine the stability of the currency and finance spheres.

For the third year in a row, Ukraine’s farmers have brought in 60+ million t of grains, while domestic demand has fallen since the occupation of Crimea and parts of Donetsk and Luhansk Oblasts. And so, although the 2015 overall crop was less successful than in the previous two years, grain exports reached record volumes. By the end of April, that is, two months before the end of the 2015/2016 marketing year, over 33.5mn t had already been shipped out—not much less than the entire previous marketing year. Last year, poor weather conditions cost Ukraine a significant part of its cereal harvest, with wheat down 3.2%, corn 7.3%, sugar beets 9.0%, and soybeans down 14.3%. Even if most crops reach 2014 yield levels in 2016, there should be a considerable increase in the gross harvest of these crops. In addition to this, cultivated areas for these crops are also likely to expand significantly because the winter crop, which sprouted poorly or failed altogether and had to be re-sown. This will be largely due to sunflower, soy and maize, which yield much more per hectare.

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The devaluation of the hryvnia was compensated last year by a decline in dollar-based prices on world markets for Ukrainian farm products. As a result, profits for domestic agribusinesses remained high in 2015 and the overall sum of profits in the sector was UAH 78.2bn. Even in their dollar equivalent, it was more than in 2014.

Sunflower remains the most profitable crop, but there were a number of surprises this past year. Vegetables have moved up into second place for profitability, which grew from 16.7% to 47.5%. This has stimulated an expansion of sown areas and, most likely, a bigger harvest in 2016. Profits are nearly 40% for grains and soybeans, which also grew in 2015, spurring successful growers to invest in growing it this year as well.

The Ministry of Agricultural Policy was predicting grain exports o 37mn t this year, but the current pace of 3mn t in April suggests that in May and June considerably more than the 3.5mn t needed to reach that level is likely to be exported. The growth in grain exports is coming against a background of growing domestic elevator infrastructure and increased port facilities for handling grain. At 38-40mn t of exports of grain, Ukraine will confidently take second place in the world, ceding only to the US, which exports nearly double—around 70-80mn t a year. What’s more, Ukrainian grain not only competes successfully with other suppliers in the eastern hemisphere, but is even catching up to exporters in the western hemisphere, which includes such grain giants as the US, Canada and Argentina.

Given that the price per tonne of Ukrainian grain is already higher than 1,000 cu m of Russian natural gas sold abroad, in the next while Ukraine is likely to gain as much per capita for its grain exports as Russia gets per capita for its gas—around $1,200 per cu m.

New niches

More interestingly, the prospects for Ukraine’s farm sector on world markets are not limited to grains or oils. Lately, Ukraine has been taking on new niches for foodstuffs on the most promising markets. This process is taking place at a glacial pace, but the final result could be impressive.

Ukrainian growers are not only opening the EU market for themselves, but are also entering the biggest food markets in the world: China and Southern Asia—India, Pakistan and Bangladesh. Altogether, these represent nearly 3 billion people, so that supplying even a small fraction of their appetites, which are growing along with their economies and numbers of urban residents with cash to spend, represents a colossal opportunity for Ukraine’s farmers. In September 2015, the Chinese gave export privileges to a few dozen Ukrainian dairy producers, and in early 2016, so did the EU. Meat deliveries to these two markets have also been growing.

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Ukraine’s growers respond quickly to demand for niche produce on world markets. For instance, in recent years, legumes have been sown, harvested and exported in ever-greater volumes, especially peas. This plant is popular in the traditional cuisines of Southern Asia and has considerable prospects for sales to grow. In 2015, Ukraine exported more than 200,000 t of peas. This year, one third more territory was sown with peas in anticipation of a crop that could reach more than half a million tonnes, with about 300,000 t of that going abroad. In short, from being a second-rank product not so long ago, the pea is turning into a major item in Ukraine’s exports, because the price of peas is at least double the price of such grains as wheat, maize and barley.

Produce infrastructure is also sharply expanding: for instance, the biggest tomato processing plant in Europe is now being built in Mykolayiv Oblast. And berries have become a significant export item. Domestic demand for berries remains relatively stable, which means that any growth is aimed at expanding into the European Union. And with good reason: in 2015, this market grew an impressive 66%. Since no more than 15% of the produce grown in this sector is currently being exported, an expansion of even just 20-30% per annum could ensure severalfold growth in export volumes over the next few years. At 150-200% profit per year, berries are highly attractive. Since hand-picking them involves considerable labor, this product can also help reduce unemployment in rural areas.

Worrisome signals

Because import indicators are leading exports, however, the trade deficit is growing, a visible warning sign. So, whereas imports of goods for Q1 2015 were declining faster than exports, at 36.5% to 32.9%, in Q1 2016, they were shrinking far more slowly, at 4.1%, than exports, at 18.1%. As a result, instead of a positive balance of trade of $380mn a year ago, this year, Ukraine has a $950mn negative balance. The reason for this can be partly found in the shifting hryvnia exchange rate that is currently being caused artificially, through restrictions administered by the National Bank of Ukraine.

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At this time, the trade deficit is being compensated by other sources of capital in- and outflows, but the decline in the trade balance could represent risks down the line. Moreover, in the last few years, Ukraine saw its balance of trade in services also go down sharply. In 2016, compared to 2013, imported services only declined by $2.5bn, going from $7.609bn to $5.144bn while exports went down $5.285bn, from $14.836bn to $9.551bn, resulting in the positive balance dropping from $7.2bn to $4.4bn.

So, the current trend towards a decline in the balance of trade in goods suggests that even this year, Ukraine risks returning to a negative balance of trade in goods and services. Without a highly unlikely large-scale increase in foreign direct investment in the country, this could indicate that Ukraine is once again falling into the trap of being highly dependent on external borrowings to operate and this promises little good. To prevent this kind of situation from developing, the NBU needs to stop intervening in the currency market as soon as possible.

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