Ukraines MacroOutlook: Risks and Prospects

1
Ukraines Macro-Outlook Risks and Prospects

• Ukraine Capital Markets Forum
• London October 3, 2007
• Martin Raiser, Economic Advisor
• World Bank

2
Ukraines Investment Profile

• Politically unstable (unlikely election will have
  made much difference)
• A laggard in structural reform (although with
  steady progress)
• A populist election campaign full of fiscally
  costly promises
• Despite recent improvements, weaknesses in
  financial supervision, and still opaque capital
  markets

3
So Why Invest?

• Strong fundamentals (public debt 14 GDP,
  relatively low fiscal and current account
  deficits better than BB- average)
• Still regionally competitive exchange rate and
  wages
• Improved transparency since 2005 banks and
  local blue chips lead
• WTO accession and EU trade agreement will provide
  strong anchors for reform
• A huge, under-served domestic market retail,
  consumer durables, finance, housing, other
  services

4
A Risk Fairly Priced?

• Gradual repricing since May 07
• Reflects shift in perceptions of political risks
  after dissolution of parliament
• Now broadly in line with other BB- sovereigns

5
Why Did Macro Performance Hold Up So Well So Far?

• Underutilized capacity what goes down must come
  up (to some extent)
• Luck strong metal price growth offsets gas price
  shock EURO and Ruble strength against the US
  keep real effective exchange rate in check
• Clever budgeting indexation of social payments
  and wages to CPI, but budget revenues grow in
  line with GDP deflator aggregate fiscal impact
  more restrained than appears from the approved
  budget
• But this benign constellation cannot continue
  forever gt signs of strain and imbalances emerging

6
Real effective exchange rate remains under
control for now
7
Indexation rules help the budget
8
But rising imbalances, driven by private sector
9
The price of a quasi-peg
10
Is the Hryvnia Still Fairly Valued?

• Current account norm says yes Ukraine can
  finance 4-6 GDP current account deficit
• Dollar wage to GDP comparisons also say yes
  Ukraines dollar wages (US250 av) roughly in
  balance with relative GDP level
• Medium-term trend is for moderate real exchange
  rate appreciation Balassa-Samuelson effect, as
  well as empirical trend
• Note all competitors appreciating at similar if
  not faster pace!

11
The European Convergence Path
12
The Macro Outlook what to watch for

• Fiscal and monetary policy mix further fiscal
  tightening may be needed
• Terms of trade shock and the costs of adjustment
• Banking sector exuberance in times of ample
  liquidity - how much credit and refinancing risk
  is hidden in strong balance sheet growth?

13
Our Base Case (June 07 update in mid-Oct 07)

• We assume ToT weakening in 2008-2010 but gradual
• We also assume fiscal policy will continue to
  remain relatively tight
• We assume Ukraine retains access to international
  capital markets and investment-led growth
  continues (at somewhat lower rates)
• Quarterly updates on www.worldbank.org.ua

14
WB Base Case
15
Implications
Risks

• Base case scenario consistent with some nominal
  depreciation within a (widening) band over
  medium-term
• Also consistent with continued political muddle
  through and modest pace of reform
• Decisions on macro framework unlikely before new
  political constellation is clear

• Sharp ToT decline (metals prices gas import
  prices)
• Access to refinancing on intl. market shuts down
• Fiscal profligacy as election promises are
  realized
• Could require sharper exchange rate adjustment
  and expose underlying credit risks