Rising credit ratings and economic growth: is Ukraine turning into an Eastern European Economic Tiger?

Source: Homebuzines 

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New Ukrainian prime-minister Oleksiy Honcharuk has upon taking office set a goal of 40% GDP growth in the next five years. That might seem too optimistic at first, but recent economic data shows that Ukraine has good prerequisites towards making such a transition. Two authoritative world ratings of creditworthiness – US FITCH and Japanese Rating and Investment Information – have upgraded Ukraine’s creditworthiness position reflecting macroeconomic stability and an unexpected rise in GDP growth to 4,6% in the second quarter of 2019 compared to the corresponding period of the previous year. What lies behind such an increase in Ukrainian economic figures and how stable can such growth remain in the near future?

What lies behind world ratings improvement for Ukraine?

On 9 August, the Japanese Rating and Investment Information raised Ukrainian creditworthiness on two positions from CCC+ to B, while on 6 September the New York-based Fitch Ratings raised Ukraine’s long-term foreign and local currency debt stability from B- to B. These ratings reflect the ability of the country to meet its financial obligations and are important for investors to decide upon the reliability of the business climate.

Tymofiy Mylovanov, new minister of economic development. Previously president of the Kyiv School of Economics. Source: lvivmediaforum

“Raising the ratings of such agencies means more confidence in the economy, more investment, and less cost of capital (interest rates on loans, etc.). Two other very important ratings haven’t raised the Ukrainian position yet, but we hope they will do soon,” Tymofiy Mylovanov, Ukrainian minister of economic development and trade wrote on Facebook.

Three main indicators determine the decision of the agencies: government debt to GDP, international reserves, and inflation rate. Ukraine is performing best of all in all of them.

According to FITCH data, Government debt to GDP should decline to 48% at the end of this year. In 2016, after the critical period where the economy was badly hit by the Russian invasion and territorial losses, this ratio was at 69%, a record high for Ukraine. Having a spike in debt repayments this year, Ukraine pays US$ 12.3 billion and has improved its debt ratio significantly. Also, according to statements from the president and ministers, Ukraine is expected to reach a new loan deal with the IMF, which will help to meet debt repayments in 2020 and 2021. The IMF loans are tied to the implementation of economic reforms such as land market liberalization and market gas price, and are therefore a good safeguard against populist economic policies.

Ukraine’s international reserves should rise by $1 billion this year to $21.8 billion, and increase further to $22.4 billion in 2021. This increase will signify the long-term economic commitment of the Zelenskyy team, headed by prime minister Honcharuk. The president’s opponents feared that Zelenskyy may lead to populist economic policies at the cost of long-term macroeconomic stability. However, since Oksana Markarova retained her position at the Ministry of Finance amid the latest cabinet reshuffle, the bad scenario appears already to have been avoided and stability preserved.

Inflation should fall to 8.5% in 2019 and 5.7% in 2021. As Ukraine is approaching its target of 5% annual inflation, opportunities for cheap loans and rapid business development are opening. However, according to the former Minister of Economy (2007-2010) Bohdan Danylyshyn, the National Bank has not yet used this possibility because it should lower the discount rate for cheap loans much further than it already has done.

Although Ukraine has reached good macroeconomic preconditions, rapid development won’t start without several key reforms

GDP growth is another important indicator showing the current pace of the country in its economic development. In 2018 Ukrainian GDP growth rose to 3.3%. In the second quarter of 2019, despite bad predictions, it hit 4.6% compared to the same period in 2018; overall predictions for 2019 were raised to 3,4%. According to Bloomberg data, this is the first time during recent years that Ukraine has achieved economic growth at a similar pace to Poland.

Ukrainian and Polish annual GDP growth. Source: Bloomberg

However, according to the former minister of economy Bohdan Danylyshyn, there are two main reasons for such an unexpectedly high level of economic growth, and neither is very promising: a sharp increase in retail turnover to 10.3% in the first half of 2019 and a good harvest this year.

The retail turnover was caused by an increase in salaries, Bohdan Danylyshyn claims. Also, according to information provided by Liga.net, in the summer of 2019 Ukrainians became subjectively more confident to make long-term purchases because of the results of elections and widespread hopes in new policies.

However, good harvests and retail cannot contribute to stable and accelerated economic growth, Bohdan Danylyshyn argues:

“The long period of wage growth observed in our country can be slowed down if not stopped without increasing productivity and labor efficiency. Moreover, one of the reasons for wage growth is mass labor migration, the potential of which has probably reached its limit… [Regarding agriculture], I keep asking the question that has been bothering me more and more – how long can agriculture remain the main trigger of economic growth in Ukraine?”

Data on industrial growth is more than modest – the pace in 2019 is 0.5%. Therefore, amid good GDP growth in 2019, the quality of that growth is disputable. The development of industry, as well as high technology production and service, are the only possibilities for Ukraine to become a successful country in the future. Right now, only tourism and IT are demonstrating a positive development in Ukraine. Other important industries show little growth or even decline. Among the recent negative examples is that British American Tobacco. The company that in 2018 paid over 65 million dollars in taxes to the state budget of Ukraine is moving its regional center from Kyiv to Romania. According to the company, the decision was due, among other things, to the unpredictable fiscal and regulatory policy of the Ukrainian government.

Although it would be unfair to judge by one company, the general tendency is that large industrial and technological companies are not considering Ukraine as the place for their offices and production yet. The solution is evident: reforms.

Some steps have already been taken: recently Ukraine became a member of the Clearstream international central securities depository, which means that Ukrainian securities, particularly government bonds in UAH, will be available to foreign investors. According to UBN, the Finance Ministry plans to create a debt agency to depoliticize foreign debt. Also, Ukraine’s central bank is liberalizing rules, dropping a monthly limit on repatriation of funds from the sale of corporate rights by foreign investors.

Yet, the most important is an independent judiciary to secure business rights. Liberalisation of the land market is also promised to contribute most of all to the Ukrainian economy. The beginning of the implementation of these long-awaited reforms is expected from the new cabinet and parliament by the end of the year, according to the country’s president, Volodymyr Zelenskyy. The market price of gas, as well as the maintenance of relative independence of the Ukrainian economy from Russian gas supply, is another major factor. Recent talks on gas issue on 19 September were favorable for Ukraine but the new contract on gas transit in 2020 from Russia through Ukraine was not yet agreed.

Having succeeded in these first-priority policies, Ukraine may use the window of opportunity that has just opened. Growth is slowing down in virtually all the 20 largest economies currently, and this is a good moment to draw investment towards alternative young economies like Ukraine.

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Edited by: Michael Garrood

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