As Ukraine battles geopolitical headwinds to reboot its economy, continued EBRD funding is contingent on the country’s reform programme. But while the pandemic may have slowed reforms it should not derail them.

Ukraine

In 2015, Ukraine’s gross domestic product (GDP) plunged by 9.8% in the wake of Russia’s annexation of Crimea in 2014, as well as the ongoing military conflict with Russian-backed separatists in Ukraine’s industrial east. Since then, however, the economy has been on an upward trajectory and Ukraine’s GDP grew by 3.2% in 2019.

However, the arrival of the coronavirus pandemic in 2020 is likely to have a severe impact on the economy during the year and beyond – though many are hoping for a quick recovery, coupled with the continuation of the country’s much-needed reform programme.

In its inflation report for April 2020, the central bank, the National Bank of Ukraine (NBU), forecast an economic decline of 5% in 2020, but predicted that it would return to a growth of about 4% in the following years. According to the NBU, in April to June the economy will shrink by 11% year-on-year, with unemployment rising to about 12%, in seasonally adjusted terms.

Tough year ahead

The NBU is not alone in predicting a tougher year for Ukraine, which has a population of just under 42 million. “For now, our base scenario is that there will be a recession in 2020, followed by a rebound of the economy in 2021 – but that depends really on the development of the epidemic,” says Matteo Patrone, managing director, eastern Europe and the Caucasus at the European Bank for Reconstruction and Development (EBRD).

“The key challenge for the economy is to preserve employment and businesses,” says Oleksiy Blinov, head of research at Alfa-Bank Ukraine. “We expect a 7% year-on-year real GDP decline in the second quarter of 2020, but see a good chance of economic growth restored in the fourth quarter if Ukraine manages to get most of businesses out of quarantine in the second quarter.” 

However, Mr Blinov says the fiscal challenge for the country is a sizeable one. “Ukraine started 2020 with a state budget that was already underperforming in terms of revenue because of too-optimistic planning, and the new situation has inflicted an additional double hit.”

Rising debt

Since the economic fallout from the annexation of Crimea, Ukraine’s debt-to-GDP ratio has fallen from around 80% to roughly 52%, and as recently as January 2020, Ukraine sold €1.25bn of debt at a record-low yield, following a wave of optimism over its ongoing reform programme. However, future rounds may not be so straightforward. In fact, the country’s economic fundamentals are looking increasingly strained.

On April 22, Fitch Ratings downgraded Ukraine’s long-term foreign currency issuer default rating from positive to stable, while highlighting several issues that could strongly impact its recovery from the coronavirus pandemic.

The rating agency said it expected the general government deficit to rise to 7.1% of GDP in 2020, up from 2% in 2019 and blowing past the original target of 2.1%. This is directly linked to the impact of the coronavirus, which has resulted in lower tax collection, increased social and health spending, and the creation of a coronavirus fund worth about 1.6% of GDP. The deficit is likely to be 3.4% in 2021, Fitch added.

Reform agenda

The initial wave of optimism in Ukraine following the victory of Volodymyr Zelensky in April 2019’s presidential elections, and the subsequent parliamentary victory for his Servant of the People party in snap elections the following July, has largely dissipated. At the same time, the high turnover of personnel at the top of the government – notably the removal of influential reformers from key roles – has raised questions about the government’s ongoing commitment to the reform agenda. Overall, however, there has been positive momentum. 

“We have had two governments since the last elections [in 2019] and three ministers of finance. There’s been a bit of discontinuity in the past months, but overall I think that the reform momentum is a credible one. The parliamentary activity at the beginning of the legislature has been positive, with a number of progressive laws approved,” says EBRD’s Mr Patrone.

“However the work is far from being completed. There is still a need for us, for the International Monetary Fund (IMF), the World Bank Group, other international financial institutions (IFIs) and donors to bolster the reform of the country,” he adds.

Foreign caution

Ukraine ranked 126 out of 180 countries in Transparency International’s 2019 Corruption Perception Index, having dropped two points from the previous year. Only Russia was ranked lower among European nations, highlighting the continued need for progress on this front.

Foreign investors are still cautious when it comes to Ukraine, and foreign direct investment (FDI) into the country is nowhere close to its potential for a country of its size. FDI reached $33.7bn in equity capital during the first six months of 2019, a modest increase of 2.6% year-on-year.

Alexander McWhorter, head of Citi Ukraine, says that when talking to investors the key elements they want to see are macroeconomic stability, continued engagement with the IMF and other IFIs, and a commitment to continue the execution of reforms and integration with the economy of the West. 

“We continue to believe that there is significant growth potential in the country. There will be opportunities for Ukraine as companies re-evaluate their supply chains in the wake of the [coronavirus] crisis,” he adds.

Keeping up momentum

While there is a risk that the Covid-19 pandemic will draw attention and energy away from the reform agenda, many predict it will not blunt the reform drive. “I don’t think that reforms will be pushed to the side [in the face of the global pandemic],” says Oleksandr Pysaruk, chief executive of Raiffeisen Bank Aval. “In Ukraine, like in many other countries, crises facilitate reform. I expect the current crisis will facilitate those reforms that need to be done in order to unlock access to international financing.”

In early May, it was announced that Mikheil Saakashvili, the former president of Georgia, had been installed as the head of the executive committee of Ukraine’s National Reform Council. Mr Saakashvili told the Financial Times after his appointment that Ukraine needed to “speed up the anti-bureaucratic revolution” and that the country either tackles corruption through deregulation, removing opportunities for extortion and delivering on the crackdown on corruption, or it might “cease to exist”.

Even before the pandemic struck, shutting down businesses and leaving economic and health damage in its wake, Ukraine was in discussions with the IMF over a new round of economic assistance, with a $5.5bn extended fund facility loan deal provisionally agreed in December. However, the money is contingent on Ukraine passing legislation related to banking sector and land reforms, which have moved at a slower pace than many had hoped.

On May 7, 2020, the IMF said it was shifting its discussions with Ukraine towards providing an 18-month standby arrangement, which would come with fewer strings attached and would allow the government to respond faster to the pressing needs caused by the pandemic.

Economic challenges remain

At the same time, efforts to support businesses operating Ukraine continue. In late April, the central bank cut its main interest rate for the seventh time in a row, from 10% to 8%, to further support the economy and, in early May, the EBRD announced that it had set up a $500m swap facility with the NBU to increase the availability of local currency to businesses affected by the pandemic.

“The main focus in the short term has to be on safeguarding livelihoods and welfare, and, as part of that, employment. But one should also make sure not to let a crisis go to waste, and create the premises for a better investment climate in the medium term,” says EBRD’s Mr Patrone.

Ukraine has other financial concerns to factor in besides the rising budget deficit. The central bank has said inflation could be as high as 6% this year, and 5% for 2021-22, while at the same time the national currency is expected to depreciate sharply in 2020, by as much as 25% year-on-year, which would be a boon to export-focused companies and industries such as agriculture but would cause significant challenges elsewhere in the economy. 

Remittances from Ukrainians working abroad are also likely to be much reduced in 2020, which could have a major impact on private consumption. According to the World Bank, Ukraine is the region’s largest recipient of remittances. In 2019, it received a record high of nearly $16bn, while household remittances represented 7.8% of that year’s GDP.

The coronavirus pandemic is going to have a strong impact on the country, at least in the short term, and Ukraine, together with the rest of the world, will be looking forward to the resumption of economic normality.

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