Ukraine Macroeconomic Situation: March 2012

The Ukrainian economy kept showing resilience to a challenging external environment in the first two months of 2012. The economy maintained growth momentum, expanding by about 2% yoy in February 2012, according to early NBU estimates. As in the previous month, real sector growth was primarily supported by domestic consumption. Acceleration in retail sales turnover growth to 14.6% yoy for January-February signaled an ongoing pick up in households’ spending, fueled by a 15.3% yoy increase in real wage. Severe frosts during February caused a demand spike for energy resources. Strong output growth in production of electricity and extraction of fossil fuels helped offset activity declines in export-related and weather-sensitive sectors. Thus, softening demand for Ukraine’s exports led to a 1.5% yoy decline in manufacturing. Colder-than-usual weather during February weighed on construction and cargo transportation performance, whose output and turnover declined by 0.5% yoy and 5.6% yoy for January-February respectively. Ukraine’s economic growth is likely to remain subdued during the coming months. However, it may accelerate in the second half of the year amid expectation of improving global economy. State budget execution over the first two months of the year was better than expected. State budget revenues grew by a nominal 16% yoy, generating budget surplus. Given that the 2012 state budget was developed based on rather conservative assumptions and solid budget revenue growth, the president of Ukraine announced social spending increases, which would require about $2-3 billion in 2012. As pre-election fiscal loosening was anticipated, our full-year public sector deficit forecast remains unchanged at about 3.5% of GDP in 2012. Although higher budget spending will underpin economic growth, the recurrent nature of most pre-election initiatives will make sustaining public finances a challenging task for Ukrainian authorities during the next few years. Consumer price growth moderated to 3% yoy in February, benefiting from continuing good 2011 harvest spillover and favorable base effects. Low inflation and eased Hryvnia exchange rate pressures allowed the NBU to ease monetary policy. The central bank decreased its discount rate by 250 basis points to 7.5% pa and relaxed the reserve requirement for commercial banks. These measures will help easing banking liquidity strains and encourage lending activity, supporting economic expansion. At the same time, both fiscal and monetary loosening contributes to our expectations of inflation acceleration to about 9% yoy by the end of the year. External sector data for the first two months of the year showed that the country can successfully manage its high external financing needs. January’s balance of payments deficit of about $0.9 billion was followed by a notable improvement in external debt and FDI inflows in February. The large financial account surplus almost fully covered the wider current account deficit in February, generated by higher energy imports and slower exports. This helped ease Hryvnia foreign exchange pressures, intensified during January. At the same time, given the uncertain foreign financial markets situation amid Ukraine’s high financing needs, the external sector remains one of the main sources of vulnerabilities for the Ukrainian economy.