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2 November, 2012  ▪  Maksym Bugriy

The Government Hushes Up a Crisis

While the Party of Regions has been campaigning, claiming stability as one of its achievements, an increasing number of independent analysts look at ongoing economic processes and warn that Ukraine's economy may sink into recession by the end of 2012

In the past several weeks, a number of Ukrainian and international research institutions have published negative forecasts for Ukraine's economic development. On 16 October, Austria’s Erste Bank said in its analytical memo to investors that Ukraine's economy had gone into recession in the third quarter of 2012 as a result of sharply declining economic growth in July through August. Marian Zablotsky, an analyst with Erste Bank, says that national GDP dropped by one per cent in this period, year-on-year. Thus, Erste Bank cut its annual GDP growth forecast for 2012 down to zero percent. Since July, when Ukraine's economy began to slide for the first time after the 2008-2009 crisis, analytic institutions have regularly reduced their GDP growth forecasts. The World Bank lowered its forecast to two per cent in July; Fitch Ratings said in October that it expected no more than 0.5% GDP growth in Ukraine after it posted 5.2% in 2011; the Institute for Economic Research and Political Consulting estimated this index at 1.3% in early October. Overall, the average expert estimate dropped from 3.2% in April to 2.3% in August 2012. Meanwhile, the Ukrainian government based its 2012 State Budget on the premise of 3.9% growth and 7.9% inflation.

Negative trends in this area were first and foremost caused by a sharp decline in industry – by seven per cent in September as compared to September 2011 and by 1.2% in the first nine months of 2012. Despite some growth in the mining industry, machine construction saw the biggest decline – 4.8% over nine months and 20.1% in September, as compared to the same period in 2011. The food processing industry is declining on virtually every food item. The processing industries have had a mixed experience: some branches are nearing a critical point, while others have increased output somewhat. However, in the case of the chemical industry, growth was due to Dmytro Firtash’s ability to buy Russian gas at a much lower price than Ukraine does. Oil refining declined by 48.7% in January through September, leading to more fuel imports. According to the Ministry of Energy, 500,000-600,000 tonnes of petrol are sold in Ukraine every month, of which a mere 100,000-150,000 tonnes come from the two oil refining plants still operating in Ukraine; Kremenchuk and Shebelynsk. All other oil refining facilities were forced to shut down when oil refining became an unprofitable business after Belarus began buying Russian raw materials at lower-than-export prices. Currently, nearly 80% of the fuel sold in Ukraine is imported.

There was a 9.1% decline in the construction industry during the first nine months of 2012, year-on-year. A safe assumption would be that the industry posted a double-digit decline in September. Last year and in the first quarter of 2012, this sector received a boost from Euro 2012 projects, but in the last couple of months, even government-financed programmes, such as “affordable housing” are stagnating due to an almost complete lack of effective demand from Ukrainians.

Agricultural production fell by 4.6% in the first nine months of 2012, compared to the same period in 2012. Given that the harvest season began four weeks earlier than usual this year, the decline in September could also be in the double-digit region. Moreover, the output of core agribusinesses, which account for the lion’s share of the entire agricultural sector,  dropped by 7.8% in the first eight months, year-on-year.

The production crisis is a result of both an unfavourable global situation and the ineffective economic policies pursued by the Ukrainian government. Instead of stimulating business by making loans more accessible, the government is going all out to maintain the hryvnia exchange rate prior to the election and is pursuing a strict monetary policy, thus stripping banks of liquidity. In its report on Ukraine, Fitch Ratings says that the real economy crediting growth rate has been influenced by both world macroeconomic trends and some administrative decisions taken by the National Bank of Ukraine, which are more of a tactical, short-term nature. Under such conditions, bank loans are essentially inaccessible to both businesses and average citizens. This is confirmed by the NBU’s data which shows that the weighted average loan rate exceeded 20% in August. In its analytical report, Erste Bank stresses that this rate was 10 times higher than that of real GDP.

Real GDP would have plunged even further if not for the services sector. But even there, negative trends can be seen. For example, in Ukraine’s transport sector, the main component of which is, in fact, the transit of Russian energy resources, freight transport shrank by 3.4% and gas pipeline transport by 17.9% in January through September, year-on-year.

In sharp contrast, retail trade has been growing by leaps and bounds. According to the State Statistics Committee, which also takes informal markets into account, the sector grew by 16% in January through September, year-on-year. This is a result of the populist social spending that the government made before the parliamentary election. The average nominal monthly salary increased by 16.3% in January through August, year-on-year. However, retail growth may also be viewed as a negative trend in Ukrainian conditions. As The Ukrainian Week noted previously, Ukrainians largely spend their income on food. When food production slumps with the simultaneous growth in retail sales at the same rate, this means that the country is importing more. Foreign trade figures for September are yet to be publishes, but in January through August 2012, imports grew by 6.3% and exports by a mere 3%, year-on-year. Thus, the negative foreign trade balance increased by 23.7% year on year and is currently exceeds USD 10bn.

As already stated by The Ukrainian Week, the expectations of economic agents are an important indicator of a recession. Key recorded indexes are worsening. For example, Ukraine’s investment attractiveness index, calculated by the European Business Association, was 2.4 out 5 points in the third quarter of 2012, which is the lowest since 2008. A number of foreign investors say that the investment climate in the country is deteriorating for everyone except Ukrainian oligarchs.

According to GfK Ukraine, the consumer sentiment index fell by 4.8 points in September, while the devaluation expectation coefficient grew by seven points. According to the NBU, Ukrainians bought USD 1.8bn more foreign currency than they sold in September. Despite sky-high hryvnia deposit rates (20-30%) in commercial financial institutions, such deposits have grown by a mere 6.3% and foreign-currency deposits by 9.5% in 2012. Given the current economic trends in Ukraine, it is hard to find an analyst who would not expect the hryvnia’s exchange rate to plunge immediately after the election.

Moreover, most experts are certain that Ukraine’s economic performance is going to decline, plunging the country into a second recession in the past four years. “The dynamics of the GDP in the third and fourth quarters will be negative,” predicts Erste Bank. Ukrainian analysts also point out that business activity in Ukraine is at a very low level, while foreign demand for our products is constantly decreasing. Many companies also report a catastrophic shortage of working capital. Everything is just like on the eve of the 2008 crisis.

At the same time, independent economists do not see any real steps from the Azarov government that would address these negative trends. However, most experts are certain that the decline will not be nearly as severe as in 2009 when the GDP took a 15% plunge.

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