PON ys TiS il hy More emergency actions needed in Ukraine FROAY FEBRUARY, 2014 Tough political conflicts and drawn-out protest actions in Ukraine are deepening the country’s economic crisis. Extreme political uncertainty is harming both domestic demand and foreign trade. The rsk of default has again seriously increased. The Russian emergency loan received just before Christmas s probably not enough to stabilise the economy in the long tenn. One possible scenario is that Ukraine will also shortly receive an aid loan package from the EU/IMF and that the central bank will continue to let the hryvnia depreciate. Even assuming these additional aid measures, the ‘growth outlook remains weak We expect GDP to decrease by 2 per cent this year, after zero growth in 2013. Continued politcal uncertainty is hampering capital spending as wel as private consumption. Inflation, which was-0.3 per cent last year, wl ise to 4 per cent in 2014 dueto currency deprecation and increased gas prices (the IMF will require Ukraine to lower subsidies); this will also hold back private consumption. Household costs for servicing foreign currency loans will also increase due to depreciation. A slight upturnin the vital agricultural and steel sectors will, buoy the economy. Late in 2013, higher agricultural production plus base effects from a weak fourth quarter of 2012 unexpectedly ‘enabled Ukraine to end its negative GDP trend aftr five straight quarters; GDP rose 3.7 per cent year-on-year, according to official data, But the underlying economy remained weak, with a downturn in industrial production, ‘The long period of falling GDP, a large current account deficit—8-9 per cent of GDP in 2013 - and a gradually draining currency reserve are factors that led to anacute financial crisis The protests that broke out in Kievin November 2013 after President Viktor Yanukovych suddenly refused to accept a trade and integration ‘agreement with the EU, served asa catalyst in this process. Investor confidence in Ukraine and its currency {ell dramatically, which was instrumental in keeping the ‘currency reserve very low. The market feared a default, ‘and the risk premium on CDS contracts skyrocketed. Russia's unexpected December 18 emergency loan of USD 15 billion —of which USD 3 billion has been disbursed so far—removed the risk of an immediate default. After spiking, the CDS contract risk premium ‘temporarily ell quickly. But market instability resumed in late January after violent clashes in response to the president's plans to restrict freedom of assembly, which were later reversed. Right after receiving the Russian loan, Ukraine had the potential to meet its external funding needs for 2014. But continued protests and severely aggravated tensions have again worsened the economic situation. In addition, Moscow has indicated that it may freeze the loan. The ‘currency reserve remains weak covering only three months of imports in December, a critical threshold according to normal rues of thumb. The current account deficit is unsustainably largein the long run; requiring continued funding in the future. ‘Current account deficit and critically low currency reserve Uspbiton cue reese 5) —Caret our BS} ‘Our overall assessment is thus that Ukraine needs further financial aid. An agreement with the EU/IMF ‘on an emergency loan - which would probably be of the same magnitude as the one from Russia—might also help ease political tensions, since it would be perceived that the president is stil holding the door open {integration with the EU further ahead, Meanwhile the political outcome after the waves of protest is highly uncertain. A presidential election is due in 2015 but will probably take place earlier. The shape ofthe government that will succeed the current interim Tisneor speedy Sandan Eis Bae 8 pf sts sos fomtin adopt! wn hs doen 1 teen aha eb on ses eee eee we epee athe ace come Ny oa Shyam ein omer seer Cages nay mer msn re ren ot “Seton wh caf frat eet ta New Yo en heh whe dsbaes 4 ee ae Sinanlatahs anon 6iptco membre onde Sects ogden ao ein ‘enaminecabinet, appointed in January, is also unclear. Ukraine ull probably hold an early parliamentary election. Aside from seeking immediate emergency loans, Ukraine is ako trying to strengthen the growth outlook with the help of a weaker currency improving export competitiveness. For along time, the central bank has aimed at keeping the hryvnia stable against the USD. This required continued interventions in the past year. However, the hryvnia has gradually weakened from about UAH 8.00 to the dollar early in 2013 to 8208.25 at yearend and about 8.0 in February in the wake of ‘worsening political unrest. Since the start of 2013, it has depreciated by about 10 per cent. An equally large gradual additional depreciation is expected. Ucaine may eventually switch toa free floatingexchange rate regime; this has been an IMF condition since an ‘emergency loan was approved in 2010, ‘The hryvnia is weakening ‘UAH per USD ‘There isa major risk of a gloomier economic scenatiothan we have outlined. Given Ukraine's cisorderly political outlook largely connected to great uncertainty about the politcal future of President YYanukowych an uncontrolled and even weaker ‘economic and financial performance cannot be ruled ‘ut. For example, the hryvnia could plunge, resulting in ‘dramatic effects on the Ukrainian economy. [Mikael Johansson, Head of CEE Research, ‘SEB Economic Research +46 8763 8093 ‘Andes Johnson, Ukraine and Russia Analyst, ‘SEB Economic Research +46 8 763 80 32