Ukraine Macroeconomic Situation: May 2011

• A more challenging external environment caused a slowdown in industrial production in April; however, growth remained solid thanks to strengthening domestic demand.
• The state budget deficit widened to UAH 4 billion in January-April as the growth in expenditures accelerated.
• To commit to the broad fiscal deficit target of 3.5% of GDP, the government announced that the consolidated budget would be balanced in 2011. However, no details of likely fiscal adjustment measures were provided. Given the recent initiatives to increase wages and reduce excise taxes, as well as the revenue shortfall due to implementation of the Tax Code, balancing the consolidated budget looks very challenging.
• The lack of implementation of IMF requirements put IMF program resumption at risk. However, the Ukrainian authorities seem determined to revive the program.
• The current account deficit narrowed in April, but the four-month deficit reached $1.6 billion compared to a small surplus in January-April 2010.
• The capital and financial account reported a large surplus over the period. However, the risks to BoP may increase in the second half of the year if the IMF program goes off track.

In April 2011, the Ukrainian economy remained on a path of solid growth. Unlike at the beginning of the year, however, the growth was supported by strengthening domestic consumption and investment activity, while export-oriented sectors reported a deceleration in output due to more challenging external conditions. Thus, industrial production growth slowed to less than 5% yoy in April, led by weaknesses in metallurgy (up by only 3% yoy in April), machine-building (up by 13.6% yoy vs. 26.8% yoy in 1Q 2011) and coke- and oil-refining (-20.7% yoy). Weaker industry performance also explains the growth moderation in wholesale and cargo transportation sectors. However, buoyant real wage growth, reviving credit activity and improving consumer sentiment underpinned acceleration in retail trade and non-financial services. Higher earnings of Ukrainian enterprises and sizable budget financing of infrastructure projects supported a revival in the construction sector. Ukraine Macroeconomic Situation.

The economy is forecast to grow by 4.5% yoy in 2011. Although private consumption is likely to increase faster than initially projected thanks to the government’s recent upward revision of social spending, surging imports may exert a toll on growth. Indeed, during April, export growth eased to 32% yoy due to world commodity price growth and weaker Russian demand for Ukraine’s capital goods. Though imports also decelerated amid lower volumes of natural gas imports, the current account deficit reached $1.6 billion over the first four months of the year, in contrast to the small surplus in the corresponding period last year. In 2011, the current account is forecast to widen to about 3% of GDP. Furthermore, stronger domestic demand, due to higher social spending and resuming bank credit to households, is likely to keep inflation high.

Over January-April 2011, the wider current account deficit wasmore than covered by a significant surplus on the capital and financial account, thanks to privatization of Ukraine’s fixedline telecommunication monopoly, Ukrtelecom, and a number of successful Eurobonds placements by the state and corporate sector. This also allowed the NBU to augment its gross international reserves and keep the Hryvnia exchange rate virtually stable. However, due to high external debt repayments, widening current account deficit and uncertainty over resumption of IMF program, the second half of the year may see higher exchange rate volatility and Hryvnia depreciation pressures.

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