The Ukranian Flag
The golden yellow represents fields of wheat and the blue signifies the sky, mountains, and streams of Ukraine. The mixture of blue and yellow as a sign of Ukrainian land comes from the flag of the Kingdom of Galicia used in the 12th century. As a national flag, the blue and yellow bicolor had been used from 1848. However, it was forbidden while Ukraine was part of the Soviet Union and reinstated in 1992.
Ukraine: At a glance
Structure of the economy
Ukraine has faced years of political and economic turmoil, culminating in the “Euromaidan” uprising and the conflict in the east of the country. Since the onset of the civil unrest and rolling conflict, the Ukrainian authorities have undertaken a series of reforms, with IMF support, to stabalise the country. These reforms included; significant fiscal consolidation, the introduction of a floating exchange rate, energy tariff reform and the restructuring of the banking sector. While progress has been swift, ushering in a period of rapid economic expansion over recent years, renewed political turmoil and the onset of the pandemic plunged Ukraine back into recession. Ukraine is long known as the breadbasket of Europe where the agricultural sector plays an important role in the Ukrainian economy (9% of GDP) employing more than 14% of the work force; the country is highly dependent on exports, with its main products cereals and grains (19% of total exports). Likewise, the industrial sector still plays a large role in the economy (23% of GDP) and employs 25% of the labour force, although this segment has declined in the face of the conflict in the east of the country. The service sector is playing an increasingly large role (54% of GDP) and employs almost 60% of the total labour force. The outlook in Ukraine is highly correlated to that in Europe, where almost 50% of exports were delivered to the region. Traditionally, Ukraine has been an energy transit corridor, transporting Russian and Caspian oil/gas to the Balkans and Western Europe; since the onset of the conflict with Russia, this role has diminished.
While Ukraine is expected to rebound swiftly from the pandemic, where the IMF forecasts GDP of 4% this year and 3.4% in 2022, the economy has slipped back into recession over recent quarters. The recovery continues to be undermined by one of the slowest vaccination programmes in Europe and the central bank tightening cycle to combat spiralling price pressures. Looking forward, the growth outlook remains favourable, underpinned by a pick-up in agriculture production, ongoing domestic infrastructure spending and strong external demand. That said, an escalation in the Russia-Ukrainian conflict in the east of the country remains a prominent downside risk to the economic recovery.
The National Bank of Ukraine (NBU) swiftly eased monetary policy in response to the pandemic, cutting the policy rate by 200bps to its all-time low of 6% by mid-2020. Following five consecutive meetings where policy rates were left unchanged, the NBU commenced its tightening cycle in March this year; at 10.2% in July, Ukrainian inflation is the second fastest in Europe behind Turkey. In a surprise move, the NBU raised interest rates to from 7.5% to 8% at its July meeting, contrary to market expectations of a hold, and signaled even further tightening is on the way; the central bank remarked “Fundamental inflation pressure significantly rose…the forecast envisages that the key policy rate will be raised further, to 8.5%, and maintained at that level until the second quarter of 2022, with a view to bringing inflation back to the 5% target”.
The fiscal position has deteriorated in the wake of the pandemic response packages. The IMF has estimated that fiscal deficit widened to ~5% of GDP in 2020 and is only expected to gradually improve to -4.7% in 2022 and -3.3% in 2022. As a result, the debt profile is slipping, with debt to GDP expected to reach 60.7% in 2020 and 58.1% in 2022. The recovery in Ukraine continues to be underpinned by IMF support, where a $5bn Stand-by agreement was reached in June 2020. That said, following distribution of the first $2.1bn tranche last year, further loan payments have been frozen, with the IMF citing the slow pace of reform and fears over central bank independence. In welcome news last month, the President announced that the second tranche is imminent, stating that the country has now fulfilled its IMF commitments. Looking forward, it is vital that Ukraine continues to engage with the IMF given the considerable long fiscal challenges.
Multifaceted political risks remain in Ukraine. Firstly, relations with the IMF remain under scrutiny following the controversial decision by the Ukrainian Constitutional Court to reverse key anti-corruption legislation last year; in response, the IMF suspended bail-out funding. While recent comments by the president suggest that the worst of these tensions could be in the rearview mirror, the relationship with the IMF is well worth watching going forward. Secondly, the seven-year conflict with Russia on the Eastern front continues; tensions reached critical levels in April this year when Russia amassed 100,000 troops on the border. While the military buildup did not amount to an escalation in the conflict, it was a stark reminder to western leaders that the war is far from over. With efforts to reach a peace agreement largely at an impasse, all eyes will be on the meeting between presidents Biden and Zelensky later this month.
Bottom line: Bronze medal
The situation on the ground in Ukraine remains complex, however, we are cautiously optimistic. From a bottom up standpoint, the recovery is on firm footing, reflected by favourable IMF forecasts over the next two years. That said, the domestic rebound does face headwinds as the NBU tightens policy to fight persistent price pressures. From a fiscal perspective, we are constructive; the position is likely to improve over the coming years and we welcome the news that IMF funding has resumed. While the bottom up story is broadly supportive, military tensions in the east remain a key downside risk.
From a structural perspective, as noted in our Roadmap for Q3 and Beyond, we believe that the current backdrop is complicated for emerging markets. That said, in our view, there are selective opportunities to extract alpha from EM. Firstly, under our US-Led Growth Theme, we believe that as further fiscal stimulus enters the system, at home and abroad, the foundations for the cyclical rebound are solid. This backdrop is likely to support allocations to some emerging markets; we favor the emerging markets which have a strong beta to the demand for commodities and capital goods. Likewise, as noted under our investment theme – Sticky Inflation, Structural Headwinds – we stick to our longstanding view that recent price pressures are transitory. As such, we believe that the Fed will introduce a controlled normalisation of monetary policy under the AIT framework, which will encourage extracted in selective carry positions. As such, from a structural perspective, we believe that Ukraine is well placed to benefit from the global demand for commodities and the likelihood of selective carry demand in EM.
1. United Nations;
3. The World Bank.
Olympics data: Olympiandatabase.com
All other data is ESLJ, 2021.
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