Ukraine Monthly Economic Review, December 2016

1

Please note the risk notifications and explanations at the end of this document

December 2016

Ukraine: Sovereign ratings

LCY rating S&P Moody's Fitch

Long-term B- Caa3 B-

Short-term B n.a. n.a.

Outlook Stable Stable n.a.

FCY rating

Long-term B- Caa3 B-

Short-term B n.a. B

Outlook Stable Stable n.a.

Latest assessment Jun-16 Nov-15 Nov-16

Source: Thomson Reuters, RBI/Raiffeisen RESEARCH

Ukraine: Key economic figures and forecasts

Real Sector 2012 2013 2014 2015 2016e 2017f

GDP (UAH bn) 1,405 1,465 1,587 1,980 2,299 2,627

GDP (% yoy) 0.2 0.0 -6.6 -9.9 1.0 2.0

Domestic demand (% yoy) 4.6 1.7 -11.6 -9.4 2.6 2.3

Terms of trade (% yoy) 5.4 2.1 2.1 -3.0 -6.8 1.1

CPI (avg, % yoy) 0.6 -0.3 12.1 48.7 13.9 10.7

CPI (eop, % yoy) -0.2 0.5 24.9 43.3 12.4 9.0

PPI (eop, % yoy) 0.3 1.7 31.8 25.4 35.7 8.8

Real disposable income (% yoy) 9.7 5.3 -8.4 -22.2 n/a n/a

External Sector

C/A Balance (% of GDP) -8.2 -9.2 -3.5 -0.1 -3.3 -4.8

Goods export (% yoy) 3.3 -8.3 -14.5 -29.9 -7.7 7.1

Goods import (% yoy) 7.3 -5.8 -29.0 -32.8 0.7 7.6

FDI (USD bn) 7.2 4.1 0.3 3.0 3.5 2.0

Total external debt (% of GDP) 77.5 79.1 95.7 131.7 133.0 129.9

Gross FX reserves (USD bn) 24.5 20.4 7.5 13.3 15.5 18.0

Fiscal Sector

Fiscal balance (% of GDP) -3.8 -4.4 -4.9 -2.3 -3.5 -4.0

Public debt (% of GDP) 37.1 40.7 52.9 72.6 75.4 78.7

Source: State Statistics Service, National Bank of Ukraine, Ministry of Finance, RBI/Raiffeisen RESEARCH

Financial Analysts

Sergii Drobot, Raiffeisen Bank Aval, Kyiv Ukraine Economist +380 44 5905621 [email protected]

Andreas Schwabe, CFA, RBI Vienna Senior Economist CEE +43 1 71707 1389 [email protected]

Editor

Gunter Deuber, RBI Vienna

Source: State Statistics Service, RBI/Raiffeisen RESEARCH

GDP growth and inflation

-5

5

15

25

35

45

-15

-10

-5

0

5

10

GDP (% yoy) Inflation (eop, % yoy), r.h.s.

Highlights

Ukraine adopted a state budget law for 2017 consistent with the IMF’s EFF

programme parameters; however, the bill significantly raises minimum social

standards which poses moderate risks for financial and price stability. Progress

in reducing the share of the shadow economy may partly mitigate these risks.

Possible changes in the foreign policy stance of the upcoming US administration

cause uncertainty in Ukraine, as they could have challenging and complex

implications for Ukraine’s political and economic outlook and may trigger

adjustments to Ukraine policies (see our special section on page 3-4).

GDP performance in Q3 has been revised upwards to +2% yoy, resulting in

estimated annual growth of 1-1.5% yoy in 2016. We keep our outlook for 2017

unchanged at moderate +2% yoy economic growth.

The inflation rate in December came in at 12.4% yoy, allowing the National

Bank to reach its inflation target of 12% +/-3pp for the year. For this year, we

project some moderate further decrease to high single digit numbers.

The UAH depreciated in late December given higher UAH liquidity during the

holiday season; gross international reserves finished the year at a mark of USD

15.5 bn, below planned 17 bn. We expect further (smooth) depreciation amidst

a widening C/A deficit in 2017, while FX reserves might increase somewhat.

International partners welcomed the nationalization of Privatbank in December;

the IMF seemingly even demanded it. However, the significant capital injection

by the state adds some risk for financial and price stability (see our special

section on page 8).

mailto:[email protected]

mailto:[email protected]

2


Ukraine

Economic Policy

On 21 December, 4:52 a.m., the Ukrainian Parliament approved

the state budget for 2017. The law assumes real GDP growth of 3% yoy

and an inflation rate of 8.1% in 2017 (we project 2% growth and 9%

inflation). The average exchange rate is assumed at USD/UAH 27.2. The

revenues are set at a level of UAH 731 bn, while the level of expenditures

amounts to UAH 800 bn. As a result, and by taking into account loans and

transfers, the government deficit is planned at UAH 77.5 bn (or 3% of GDP,

which is in line with the IMF EFF programme). Debt operations are envisaged

to finance the deficit by 79%. The total borrowings are set at a level of UAH

191 bn, debt payments at UAH 130 bn. In 2017, the government plans to

attract UAH 104 bn (around USD 3.9 bn) via domestic borrowing and UAH

87 bn (USD 3.2 bn) from foreign donors. Due to the debt restructuring in

2015, Ukraine will repay/service only UAH 31 bn on its external obligations,

while internal payments will amount to UAH 99 bn. The privatization in 2016

failed (less than 2% of the original plan has been fulfilled), and the amount of

UAH 17.1 bn from the budget 2016 migrated to the new budget.

The VAT is the main source of revenues in 2017’s budget. It amounts to 40%

of total revenues, while the excise duties occupy around 16%. Another

significant contributor is the income tax (about 17%). On the (gross)

expenditure side, the Ministry of Finance is spending the single largest share

(around 34% of total spending) due to significant gross public debt

repayments and high subsidies to local budgets. The Ministry of Social Policy

comes in second place, with 20% of the total expenditures. The lion’s share of

its allocation will go to the Pension Fund. Given the conflict in eastern Ukraine,

it is not surprising that defence spending is high at 8% of total expenditures or

about 5% of GDP. The government is planning to increase wages in the fields

of education and healthcare in 2017, which determines (together with

significant presence of state in these sectors) the high spending in these areas

– 10% and 9% of total spending respectively.

The budget law also includes a significant hike of the minimum

wage by 100% to UAH 3,200 (equivalent to around USD 120 per month)

which in our opinion poses moderate risks for financial and price stability.

However, according to the Minister of Finance, this step is aimed at

decreasing the shadow economy (by raising the official share in wages) and

will not lead to any additional budget spending. It is noteworthy that the share

of shadow economy activities is about 40% of GDP, the increase of minimum

wage may improve tax revenues – of course only if the changes are is well

implemented (e.g. by improving tax administration). As of price stability, the

growth of wages will have an upside effect on inflation – according to the

National Bank, about +1 pp to inflation in 2017.

In order to support budget revenues the government adopted

some changes to its tax policy. First of all, some excise duties have been

hiked and are now closer to European standards. Specifically, the excise duty

for alcohol increased by 20% and for tobacco by 30%. Furthermore, the rent

for transit of ammonia went up from USD 2.4 to USD 4.8 per tonne per 100

km. However, the rent for oil extraction has been lowered from 45% to 29%

(depth up to 5000 meters) and from 21% to 14% (depth of over 5000 meters).

Probably this move is aimed to support and develop domestic production.

Moreover, the government improved VAT administration by the creation of an

electronic cabinet of taxpayers, and the administration of the VAT database by Source: Ministry of Finance, RBI/Raiffeisen RESEARCH

Budget 2017: Revenue structure (UAH bn)

VAT, 293

Income taxes, 127

Excise duties, 113

Rent, 48

National Bank, 45

Other, 105

0

100

200

300

400

500

600

700

800

Source: Ministry of Finance, RBI/Raiffeisen RESEARCH

Planned reductions of budget deficit

3.7%

3.0%

2.5%

2.3%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

66

68

70

72

74

76

78

80

82

84

86

2016 2017 2018 2019

Budget deficit (UAH bn)

Budget deficit (% of GDP, r.h.scale)


Central state budget 2017 (UAH bn)

680

700

720

740

760

780

800

820

Budget revenues Budget spendings

Def

icit

of U

AH

77

.5 b

n

3


Ukraine

the Ministry of Finance instead of the State Fiscal Service (it is expected that

the Ministry of Finance will provide an automatic VAT refund), and some other

changes. Thus, business climate has improved, and the VAT operations will

turn out to be more transparent and convenient.

The approval of the budget draft, which is in line with the EFF program

parameters, and changes of the tax code are positive signals for international

donors and investors. Chances of receiving the next IMF tranche in late-

January or early-February have increased. Nevertheless, some critical reforms

have been postponed. For example, there is still no pension reform, the land

market is still closed, and the privatization in 2016 failed completely. Thus,

we believe that Ukraine will receive the next tranche in Q1 due

to the positive steps taken even though the tranche volume

might be again reduced.

Uncertainty regarding future US policies towards Ukraine

The outcome of the US presidential elections triggered fears that a potential “deal” between the USA and Russia could result in

higher uncertainty and less support from the US for Eastern European countries. Especially Ukraine feels vulnerable in this respect.

With the new US administration not coming into office until 20 January, we can only speculate about the

upcoming policy moves. However, statements by Mr. Trump during the presidential race and after the election as well as some

of his key personnel appointments raised concerns in Ukraine. After the annexation of Crimea by Russia and given the smouldering

conflict in Ukraine’s southeast, Ukraine’s current administration has not only a strong policy orientation towards the US and the EU,

but also a strong drive to minimise Russian influence and dependency on Russia. Attempts to resolve the Donbass conflict under to

the Minsk I and II agreements have been largely unsuccessful given fundamentally different views and uncompromising stances on

both sides, which is Ukrainian central authorities and Russian-backed militias ruling parts of the Donbass region. It is no surprise that

Crimea, Donbass, and relations with Russia have been a major issue in Ukrainian domestic politics as well (besides the economic

crisis, fighting corruption, and the institutional reform process). Thus, any substantial changes in Russian-US relations will

have substantial and complex implications for Ukrainian domestic and foreign policy as well the country’s

economy given Ukrainian dependence on international and Western bilateral financial support and the key role of Western

institutions in reforming Ukrainian state structures.

From an economic point of view, one highly negative scenario would be any disturbance in the ongoing IMF

programme, which is scheduled to run until 2018. At some points, Ukrainian authorities have barely managed to keep the

programme afloat given the vested economic interests preventing Ukraine from fully complying with the conditionality of the

programme. Given these obstacles, we think that there has been a (geo)political component in the IMF management board’s

decisions to continue support for Ukraine until now. In our opinion, with a Trump administration and the important role of the USA in

the IMF, it could be more challenging for Ukrainian authorities to secure the continuation of the IMF programme if key conditions like

fighting corruption and moving forward with structural reforms are not fulfilled. Another negative factor is the certain degree of

Ukraine fatigue that has been present in European capitals for some time now. Ukrainian authorities may possibly assess these

challenges and increase their efforts to successfully fulfil the required minimum conditions of the ongoing programme. With regard

to reforms in Ukraine, US officials (together with their EU colleagues) on the ground have been an important

driver in past years. If the interest of the US in the success of Ukrainian reforms should weaken, the chances of the success of

such reforms could decrease.

Moreover, the US has been providing direct financial support to Ukraine by guaranteeing Ukrainian internal

debt issues (reopening the capital market and substantially reducing the risk premium for these issues). Overall, the US has

guaranteed USD 3 bn in bonds. According to the IMF programme, no additional US-guaranteed bonds are scheduled. Nevertheless,

a Trump administration could be more reluctant to provide potentially needed bilateral financial support than the previous

administration. However, with the external public debt repayment schedule still moderate this and next year due to earlier debt

restructuring and with the state budget deficit largely under control, this issue does not pose a substantial immediate risk to Ukraine’s

financial stability (though the psychological blow from a reduction in direct US support should not be underestimated).


Budget 2017: Spending (UAH bn)

0

50

100

150

200

250

300

Ministryof Finance

Ministryof Social

Policy

Ministryof

Educationand

Science

Ministryof Health

Ministryof

Defence

Ministryof Internal

Affairs

Rest

4


Ukraine

Real Sector

The State Statistics Service revised its estimate of Ukraine’s

economic performance in Q3 2016 to +2% yoy from +1.8% yoy,

previously. The seasonally adjusted GDP growth rate has also been

enhanced by 0.1pp to 0.5% qoq. The major drivers of growth were trade

(+0.4% qoq or +3.8% yoy) and construction (+0.4% qoq or +17.5% yoy)

reflecting the slowdown in inflation and a recovery of business activity.

Moreover, against the background of an abundant harvest this year, the

agricultural sector demonstrated a positive result (+1.5% qoq or +1.1% yoy).

On the contrary, the recession deepened in the area of education by 2.3%

qoq (-8.5% yoy), and the decline in the mining industry even accelerated from

-3.7% yoy in Q2 to -4.1% yoy in Q3. Apparently, the last was triggered by

tensions in the ATO area in Donbass and accompanying transportation

problems. The contribution of the financial sector (-5.1% qoq) to GDP growth

in Q3 was also negative, but the decline is steadily decreasing from -24.6%

yoy in Q2 to -6.3% yoy caused by clean-up and stabilization of the banking

sector. Given the fact that many large banks have completed their

recapitalization and done the provisioning, we may see a growing financial

sector in the upcoming quarters.

On the expenditure side of GDP, the fall in inflation rates and real wage

improvement (by 9.1% in the first 9 months of 2016) contributed to the

expansion of private consumption by 0.8% qoq (+4.9% yoy) in Q3. Public

spending increased by 3.2% qoq. Thus, domestic consumption grew by 1.7%

qoq or by 5.1% yoy. Moreover, a significant hike in inventories (due to good

Moreover, if US support for Ukraine were to be reduced, Ukraine could be “left” to the EU. That said, we do not

see a strong willingness to offer bold (additional) support to Ukraine at the EU level. Such a scenario of less US and limited EU

support and disappointed expectations within the EU may also lead to a state of continuous fragility in Ukraine and could also make

it difficult for the EU to push Ukrainian authorities to a more pragmatic stance towards Russia. Such an outcome could be interpreted

as an “ideal scenario” for Russia, demonstrating the incapability of the EU and the “new elites” in Ukraine. A reunification of

Ukraine remains a distant option under such a scenario. If instability in Ukraine continues, Russia may even be tempted to justify a

continued limited engagement in Donbass to “protect the Russian population from adverse developments”.

From a Ukrainian domestic policy perspective, a highly problematic scenario would be a US-Russia “deal”

forcing Ukraine to accept substantial concessions in the Minsk agreements. Such concessions would be highly

difficult to communicate to the population given the heated domestic policy climate. For example, violent protests by right wing

extremists broke out in front of the parliament in 2015, leading to the death of four National Guard officers and essentially stopping

the adoption of legislation required by the Minsk II agreements. With the current authorities being rather unpopular and populists on

the rise for some time already, internal political quarrels could be destabilising for Ukraine. However, parliamentary and

presidential elections are far off, being scheduled for 2019. Thus, if snap elections or a dissolution of the government backing

(minority) parliamentary coalition can be prevented, a major domestic political crisis could be avoided. Nevertheless, domestic

political fragility would rise substantially in such a scenario.

Likewise, a scenario where Ukraine would eventually make compromises and proceed with re-integrating

the separated parts of Donbass along terms closer to the Russian positions would have its own political and

economic risks. For example, resurging Russian influence on Ukraine policymaking would possibly be negative for the

institutional and economic reform process.

That said, our baseline scenario is still a continuation of IMF support for Ukraine. We see the situation in

Donbass rather stagnant but unresolved for the foreseeable future. Nevertheless, heated discussions on foreign

policy have already started in Ukraine given the election of Mr. Trump and will likely result in adjustments of Ukrainian political

positions in 2017.

Andreas Schwabe, CFA, RBI Vienna


GDP growth by sector (% yoy)

1.4

0.6

-3.7

3.4

-1.9

14.9

7.1

2.8

-7.9

-4.1

-24.6

2.0

1.1

-4.1

0.1

2.5

17.5

3.8

1.1

-8.5

-4.8

-6.3

-30 -20 -10 0 10 20

GDP growth rate

Agriculture

Mining

Manufacturing

Utilities

Construction

Trade

Transport

Education

Healthcare

Finance

2Q16 3Q16

5


Ukraine

harvest and accumulation of natural gas in anticipation of winter), as well as

an increase in gross fixed capital formation by 4.7% qoq, supported the

improvement of gross investments by 5.1% qoq (+32.8% yoy) in Q3.

Seasonal growth of energy imports and recovery of domestic investment

demand resulted in growing imports by 5.2% qoq (+13.9% yoy). Meanwhile,

exports fell by 0.6% qoq (-5.5% yoy) resulting in a negative contribution of net

exports to GDP growth in Q3 (approximately -4.6 pp). In 2016, we estimate

GDP to have increased by 1-1.5% yoy. In 2017, according to our

estimate, Ukraine’s economy will grow by 2% yoy, but growth may

be even higher provided the acceleration of structural reforms in the country.

Industrial production improved markedly from +0.8% yoy to

+3.7% yoy in November. Seasonally adjusted data also indicates growth

(+0.7% mom). After a 6-months-long recession, the mining industry

demonstrated an increase by 3.3% yoy against the backdrop of the surge of

coal mining and oil/gas extraction by 5.8% yoy. Furthermore, recovery of

manufacturing amplified from +1.3% yoy in October to +3.9% yoy in

November. Food industry grew by 7.8% yoy, machinery – by 6.9% yoy, and

metallurgy – by 4.9% yoy. By contrast, decline in chemical industry deepened

from -5.2% yoy to -6.4% yoy. The growth within an energy sector slightly

slowed down to 3.5% yoy from 3.7% yoy. Generally, industry hiked by 2.1%

yoy during the 11 months of 2016. In our view, industrial production

completed around the level of +2% yoy in 2016. The improved business

activity as well as the development of new business connections might push

industrial output further up to 4% yoy in 2017.

Inflation

Consumer price inflation has slightly decelerated in November –

to 12.1% yoy from 12.4% yoy in October. Nevertheless, in mom

terms, the rise in prices has been relatively high (+1.8% mom, decelerating

from +2.8% mom in October). Similar to the previous month, the major driver

was the hike of tariffs for hot water and heating (+22% mom or 0.5 pp to

mom growth). Probably due to methodological peculiarities, the effect from the

increase in tariffs was not fully reflected in October’s CPI when there was the

actual start of heating season. As a result, communal payments went up by

5.3% mom in November (by 47.2% ytd). Food prices increased by 1% mom

due to rising milk prices (by 7.3% mom) on the back of growth of global

prices and seasonal factor. Oil prices jumped by 2.8% mom. Moreover, there

was a seasonal rise in vegetable prices by 3.3% mom. By contrast, prices for

fruits dropped by 4.8% mom. As of non-foods, alcohol and tobacco prices

increased by 1.3% mom. Gasoline costs grew by 1.8% mom against the

background of growing global oil prices and UAH devaluation. However, the

seasonal rise in prices for clothing has stopped, and it became cheaper by

0.5% mom in November.

2016 is over, and with 12.4% yoy in December the overall

inflation goal of the National Bank of 12% +/- 3 percentage

points has been achieved. When looking at the average price level in

2016 compared to the previous year (this metric is more common in

developed markets), inflation has been still higher at 13.9% yoy, given higher

inflation rates in H1. In 2017, we project that the rise in consumer prices will

be driven by (smooth) depreciation of the hryvnia, further growth of tariffs (it is

planned the next phase of tariff increases for electricity in March) and the

significant increase of the minimum wage. Nevertheless, we believe that the

CPI growth will decelerate to 9% yoy until the end of 2017, but during the


GDP growth by expenditures (% yoy)

-7.2

-3.8

4.2

0.1

-2.2

0.1

-0.1

-6.5

17.6

-2.4

4.3

1.4

13.9

-5.5

24.8

3.0

4.9

2.0

-10 0 10 20 30

Import

Export

Gross fixed investment

Gov-t consumption

Private consumption

GDP growth rate

3Q16 2Q16 1Q16


Industrial output growth by sector (% yoy) -14.0

-15.5

-13.7

-12.2

-11.1

-8.2

-12.0 -21.0

-15.8

-9.1

-8.4

-17.3

-15.9

2.1

-0.4

3.4

1.8

2.7

0.9

1.4

8.6

0.6

4.4

6.9

6.4

1.2

-30 -20 -10 0 10 20

Industrial production

Mining

Manufacuring (all)

Utilities

of manufacturing:

Food

Light industry

Woodwork and paper

Coke, refined products

Chemical

Pharmaceutical products

Rubber, plastic and mineral…

Metallurgy

Machine building

Jan-Nov 2015 to Jan-Nov 2014 Jan-Nov 2016 to Jan-Nov 2015


Inflation (% yoy)

-10

0

10

20

30

40

50

60

70

CPI Food prices PPI

6


Ukraine

upcoming 6-8 months inflation will likely hover in a range between 11-15%

yoy. The NBU set an inflation target of 8% yoy +/- 2pp for Dec-2017.

Meanwhile, producer prices jumped by 2.2% mom in November

triggered by growing energy tariffs and rising prices in metal

ore mining. The prices in the mining industry went up by 4.4% mom. The

major driver of growth was the hike of prices in metal ore mining due to a

surge in global prices. Prices in manufacturing increased by 1% mom, while in

the energy sector growth amounted to 4.5% mom due to increasing tariffs. As

a result, yoy producer price inflation accelerated to 32% yoy from 29.2% yoy

in October.

Balance of Payments

In October, the Current Account (C/A) deficit declined to USD 234

mn compared to a deficit of USD 891 mn previous month driven by the

interest payments on restructured Eurobonds. The dynamics of merchandise

exports improved whereas imports, on the contrary, deteriorated. The decline

of exports slowed down to 0.6% yoy from 7.3% yoy on the back of growth in

food exports by 2.9% yoy and metallurgical exports by 5.8% yoy (due to a

low base effect). By contrast, exports of machinery fell by 11.5% compared to

October 2015. Merchandise imports decreased by 1% yoy in October

compared to 8.2% yoy in September. This trend was caused by a reduction of

energy imports that resulted in collapsing imports of mineral products by

29.3% yoy. Meanwhile, imports of machinery accelerated to 34.6% yoy from

19.4% yoy against the background of increasing demand for foreign cars as

a consequence of the reduction in excise duties on imports of used cars.

After a strong surplus of USD 1.4 bn in September (through the issue of bonds

under the guarantee of the United States), the financial account recorded

a relatively modest positive balance of USD 310 mn in October.

Likely, the recapitalization of banks with foreign capital is over; at least, low

FDI inflow, which amounted to only USD 45 mn, provide evidence. The inflow

of funds to the "Other Investments" account amounted to USD 568 mn (half of

this volume is the reduction of currency outside the banking system). On the

contrary, due to the government’s partial repayment of its commitments in

foreign currency to non-residents (to the amount of USD 298 mn) the "Portfolio

investment" account experienced a deficit of USD 297 mn. However, in

generally, the current account surplus amounted to USD 91 mn in October.

The current account deficit reached USD 2.5 bn in Jan-Oct 2016

against the background of a growing merchandise trade deficit of almost USD

5 bn. Dynamics of imports improved faster than export dynamics (-2% yoy vs. -

8.8% yoy). Nevertheless, the financial account recorded a surplus of USD 3.5

bn due to foreign bank recapitalizations, the reduction of foreign currency

outside the banking system, and the support of foreign partners. As a result,

the Balance of Payment surplus amounted to USD 1.1 bn in Jan-Oct.

Given unfavourable export price dynamics, and the relatively rapid recovery

of imports of goods we expect the C/A deficit to amount to USD 3 to

3.5 bn in 2016 (or about 3.3% of GDP). In 2017, we expect a

C/A deficit to grow further towards 4-5% of GDP against the

backdrop of a stronger recovery in imports compared to exports.

Monetary Policy and Exchange Rate

The significant increase of local currency liquidity led to a UAH

devaluation in December. As a result, UAH lost about 6% of its value,

Source: National Bank of Ukraine, RBI/Raiffeisen RESEARCH

Balance of Payments (USD bn)

-4

-3

-2

-1

0

1

2

Current Account Financial AccountCapital Account Balance of Payments


Official USD/UAH rate

23

24

25

26

27

28


Merchandise trade (% yoy)

-50

-40

-30

-20

-10

0

10

20

Export (% yoy) Import (% yoy)

7


Ukraine

and the USD/UAH rate hiked to 27.2. The New Year and Christmas holidays

were an additional adverse factor pushing the exchange rate up as foreign

currency supply slumped. In order to manage the excessive volatility, the

National Bank (NBU) intervened in the FX market – the net foreign currency

(FCY) sales amounted to USD 119.4 mn in December.

Gross international reserves declined to USD 15.3 bn in

November given debt payments of USD 147.2 mn and a revaluation of the

reserve assets due to the USD strengthening.

Frequent domestic FCY bonds issuance helped to restore reserves in

December, but the pressure at the FX market hampered the growth. As a result,

FX reserves stood at a level close to USD 15.5 bn in the end of

2016, below autumn projections for 2016 by the IMF of USD 17.5 bn and

the NBU of USD 16.8 bn. Interestingly, the annual growth amounted to about

USD 2.2 bn, which is quite close to the EFF program financing in 2016 (USD

1 bn is the last IMF tranche and USD 1 bn guarantees from US). This means

that the economic situation still does not allow the Ukraine to replenish its

reserves on its own, but the outflow has been stopped. In 2017, we expect

gross international reserves to grow and to reach the level of

USD 18 bn, (once again) mainly given external support.

Given growing pressures in the FX market, the National Bank of Ukraine

decided to keep its monetary policy unchanged. Particularly, the surrender

requirements for export proceeds remained at 65%, there is still the 120-day

rule for settlements for export/import of goods, cash FX purchase is limited to

UAH 12,000 per day at the equivalent, and FX cash withdrawals limit is at a

level of UAH 250,000 per day. Moreover, the regulator sees a growing

risk for price stability, and decided to leave the key policy rate

at 14% at the most recent monetary policy meeting in December.

As of novelties there will be no expiration date for current restrictions

(previously they had been reviewed every 3 months). The regulator thinks that

the former system was misleading for the market participants. From now on,

the Central Bank will be able to remove market controls along the

improvement of the economic situation not being tied to time frames. In our

view, it may proceed with the liberalization policy in 2-3 months when the

seasonal pressure fades away and if there are no other obstacles.

In December, money market liquidity leaped sharply on the back

of seasonal growth of budget expenditures and the disbursement of significant

refinancing to Privatbank (UAH 25 bn). The balances on correspondent

accounts were in a range of UAH 48-53 bn in late-December, while the

volume of Certificate of Deposit (CD) jumped to UAH 60-69 bn. Growth of

liquidity resulted in decline of interest rates. Index of interbank rates overnight

collapsed by 2-2.5 pp to 10.83% in December.

Banking Sector

Total deposits shrank in November, only deposits of private individuals

(PI) in local currency (LCY) increased by 0.3% mom. PI FCY deposits fell by

0.8% mom. Corporate deposits (CO), both in LCY and FCY, declined – by

0.8% mom and by 4.5% mom respectively. Nevertheless, total deposits

increased by 7.6% yoy in Jan-Nov thanks to the stabilization of the financial

system and increased public confidence in the banks.

CO LCY lending recovered (+7.5% mom). Partially this may be

attributed to restructuring loans (conversion of FCY loans into LCY loans), as

the CO loan portfolio in USD shrank by 7.3% mom. PI loans in UAH fell by

CD – NBU Certificate of Deposit Source: National Bank of Ukraine, RBI/Raiffeisen RESEARCH

Money market

0%

5%

10%

15%

20%

25%

30%

0

25

50

75

100

125

150

UAH bn

CDs

Balances on correspondent accounts

Index of interbank rates (overnight ), r.h.s.


FX reserves

0

2

4

6

8

10

12

14

16

18

-3,500

-3,000

-2,500

-2,000

-1,500

-1,000

-500

0

500

1,000USD mn USD bn

NBU interventions/auctions Gross FX reserves, r.h.s.


Retail (PI) deposits dynamics

-60%

-40%

-20%

0%

20%

40%

60%

LCY PI deposits, yoy growthFCY PI deposits, yoy growth

8


Ukraine

0.3% mom, and household FCY loans dropped by 1.4% mom. In Jan-Nov, the

total loan portfolio denominated in UAH remained unchanged (+0.3% yoy)

owing to a devaluation of the national currency.

In Jan-Nov, the banking sector’s losses amounted to UAH 18.9

bn, which is a remarkable improvement compared to the same period in

2015 (losses of UAH 57.3 bn). Also, it should be noted that VTB (Russia),

Prominvestbank (Russia), Sberbank (Russia) and Ukrsotsbank suffered the most

– they share UAH 15.4 bn losses (as of 1 October 2016). Most of the other

banks feel quite comfortable, and have even been profitable in 2016.

Privatbank nationalization story

On 21 December, Privatbank, the largest Ukrainian bank with a market share of about 20%, was

nationalized. Rumours about the nationalization had started long before, as despite the good financial results (it was profitable

from 2014 to Q3 2016 regardless of deep recession in the country) the bank had accumulated significant problems over time.

According to the governor of the National Bank Valeria Gontareva, staggering 97% of Privatbank’s CO loans are loans to related

parties, which makes Privatbank the largest “pocket” bank in Ukraine. As of 1 October 2016, 86% of total bank’s loans were

granted to the corporate sector, while the total loan portfolio consisted of 38% FCY loans. At the same time, 79% of the deposit

portfolio consists of household deposits. Moreover, the bank had one of the most attractive (i.e. highest) deposit interest rates which

also points to an elevated risk level. Thus, it is not surprising that Privatbank showed a huge gap in its capital and needed a

significant capital injection of UAH 116.8-148 bn (or around USD 4.5-5.7 bn) according to the Minister of Finance. According to

Fitch, the Ministry of Finance issued UAH 107 bn (about USD 4bn) of government bonds to recapitalize

Privatbank. Looking to government bonds statistics, this figure looks quite realistic.

In order to prevent a panic and protect the clients (about 20 mn of citizens, i.e. almost half of the population), the government took

a number of measures. First, it introduced 100% state-insured customer deposits for Privatbank (previously, only government

Oschadbank had such a privilege). Obviously, this step increased public confidence, but it also taught the population the wrong

lesson of choosing the bank with the highest interest rates (and high underlying risks) without direct negative consequences, and

thereby increasing future risks to banking sector stability. To support Privatbank’s liquidity, the NBU granted two refinancing loans

amounting to UAH 25 bn after the nationalization. Later, the National Bank monetized UAH 25.8 bn of domestic bonds issued by

the Ministry of Finance to recapitalize Privatbank, as Privatbank used the bonds to repay the refinancing loans. As a part of

Privatbank’s recapitalization process, the bank’s Eurobonds holders have been bailed-in. As a result, Fitch downgraded the bank to

‘RD’ (Restricted Default).

In conclusion, international partners welcomed the nationalization of Privatbank as an important step to

maintain financial sector stability. In our view, it was probably the best step in the current situation. However, despite the

growth of confidence in the banking sector, it may be quite costly for the state budget (given the size of capital needs). Moreover, in

case of a shortage of Privatbank’s liquidity, the NBU may monetize more domestic government bonds, which may have adverse

effects on price stability and on the FX market. Finally, the government currently owns about 50% of the banking sector which

weakens market competition. Ukraine plans to privatize the state banks in subsequent years, but due to the significant size of

government banks and the economic situation, it will not be an easy task to fulfil.

Sergii Drobot, Raiffeisen Bank Aval, Kyiv

Privatbank (gov), 271.8, 21%

Oschadbank (gov), 191.6,

15%

Ukreximbank (gov), 153.4,

12%

Ukrgazbank (gov), 57.9, 4%

RB Aval, 51.7, 4%

Ukrsotsbank, 49.9, 4%

Sberbank, 47.2, 4%

Other, 473.3, 36%

Market share (UAH bn), as of 3Q16


0

50

100

150

200

250

Loans DepositsSource: National Bank of Ukraine, RBI/Raiffeisen RESEARCH

Privatbank portfolio (as of 3Q16)

Corporate Household

9


Ukraine

[THIS PAGE WAS INTENTIONALLY LEFT BLANK]

10


Ukraine

Risk notifications and explanations

Warnings

Figures on performance refer to the past. Past performance is not a reliable indicator for future results and the development of a financial instrument, a financial index or a securities service. This is particularly true in cases when the financial instrument, financial index or securities service has been offered for less than 12 months. In particular, this very short comparison period is not a reliable indicator for future results.

Performance of a financial instrument, a financial index or a securities service is reduced by commissions, fees and other charges, which depend on the individual circumstances of the investor.

The return on an investment in a financial instrument, a financial or securities service can rise or fall due to exchange rate fluctuations.

Forecasts of future performance are based purely on estimates and assumptions. Actual future performance may deviate from the forecast. Consequently, forecasts are not a reliable indicator for future results and the development of a financial instrument, a financial index or a securities service.

Any information and recommendations designated as such in this publication which are contributed by analysts from RBI’s subsidiary banks or from Raiffeisen Centrobank (“RCB”) are disseminated unaltered under RBI’s responsibility.

A description of the concepts and methods used in the preparation of financial analyses is available under: www.raiffeisenresearch.com/concept_and_methods

Detailed information on sensitivity analyses (procedure for checking the stability of potential assumptions made in the context of financial analyses) is available under: www.raiffeisenresearch.com/sensitivity_analysis

Disclaimer Financial Analysis

Responsible for this publication: Raiffeisen Bank International AG („RBI“)

RBI is a credit institution according to §1 Banking Act (Bankwesengesetz) with the registered office Am Stadtpark 9, 1030 Vienna, Austria.

Raiffeisen RESEARCH is an organisational unit of RBI.

Supervisory authority: As a credit institution (acc. to § 1 Austrian Banking Act; Bankwesengesetz) Raiffeisen Bank International AG is subject to the supervision by the Austrian Financial Market Authority (FMA, Finanzmarktaufsicht) and the National Bank of Austria (OeNB, Oesterreichische Nationalbank). Additionally, RBI is subject to the supervision by the European Central Bank (ECB), which undertakes such supervision within the Single Supervisory Mechanism (SSM), which consists of the ECB and the national responsible authorities (Council Regulation (EU) No 1024/2013 - SSM Regulation). Unless set out herein explicitly otherwise, references to legal norms refer to norms enacted by the Republic of Austria.

This document is for information purposes and may not be reproduced or distributed to other persons without RBI’s permission. This document constitutes neither a solicitation of an offer nor a prospectus in the sense of the Austrian Capital Market Act (Kapitalmarktgesetz) or the Austrian Stock Exchange Act (Börsegesetz) or any other comparable foreign law. An investment decision in respect of a financial instrument, a financial product or an investment (all hereinafter “product”) must be made on the basis of an approved, published prospectus or the complete documentation for such a product in question, and not on the basis of this document.

This document does not constitute a personal recommendation to buy or sell financial instruments in the sense of the Austrian Securities Supervision Act (Wertpapieraufsichtsgesetz). Neither this document nor any of its components shall form the basis for any kind of contract or commitment whatsoever. This document is not a substitute for the necessary advice on the purchase or sale of a financial instrument, a financial product or advice on an investment. In respect of the sale or purchase of one of the above mentioned products, your banking advisor can provide individualised advice suitable for investments and financial products.

This analysis is fundamentally based on generally available information and not on confidential information which the party preparing the analysis has obtained exclusively on the basis of his/her client relationship to a person.

Unless otherwise expressly stated in this publication, RBI deems all of the information to be reliable, but does not make any assurances regarding its accuracy and completeness.

In emerging markets, there may be higher settlement and custody risk as compared to markets with established infrastructure. The liquidity of stocks/financial instruments may be influenced, amongst others, by the number of market makers. Both of these circumstances can result in elevated risk in relation to the safety of investments made in consideration of the information contained in this document.

The information in this publication is current as per the latter's creation date. It may be outdated by future developments, without the publication being changed.

Unless otherwise expressly stated (www.raiffeisenresearch.com/special_compensation) the analysts employed by RBI are not compensated for specific investment banking transactions. Compensation of the author or authors of this report is based (amongst other things) on the overall profitability of RBI, which includes, inter alia, earnings from investment banking and other transactions of RBI. In general, RBI forbids its analysts and persons reporting to the analysts from acquiring securities or other financial instruments of any enterprise which is covered by the analysts, unless such acquisition is authorised in advance by RBI’s Compliance Department.

RBI has put in place the following organisational and administrative agreements, including information barriers, to impede or prevent conflicts of interest in relation to recommendations: RBI has designated fundamentally binding confidentiality zones. These are typically units within credit institutions, which are isolated from other units by organisational measures governing the exchange of information, because compliance-relevant information is continuously or temporarily handled in these zones. Compliance-relevant information may fundamentally not leave a confidentiality zone and is to be treated as strictly confidential in internal business operations, including interaction with other units. This does not apply to the transfer of information necessary for usual business operations. Such transfer of information is limited, however, to what is absolutely necessary

http://www.raiffeisenresearch.com/sensitivity_analysis

http://www.raiffeisenresearch.com/special_compensation

11


Ukraine

(need-to-know principle). The exchange of compliance-relevant information between two confidentiality zones may only occur with the involvement of the Compliance Officer.

SPECIAL REGULATIONS FOR THE UNITED KINGDOM OF GREAT BRITAIN AND NORTHERN IRELAND (UK):

This document does not constitute either a public offer in the meaning of the Austrian Capital Market Act (Kapitalmarktgesetz; hereinafter „KMG“) nor a prospectus in the meaning of the KMG or of the Austrian Stock Exchange Act (Börsegesetz). Furthermore, this document does not intend to recommend the purchase or the sale of securities or investments in the meaning of the Austrian Supervision of Securities Act (Wertpapieraufsichtsgesetz). This document shall not replace the necessary advice concerning the purchase or the sale of securities or investments. For any advice concerning the purchase or the sale of securities of investments kindly contact your RAIFFEISENBANK. This publication has been either approved or issued by RBI in order to promote its investment business. Raiffeisen Bank International AG (“RBI”), London Branch is authorised by the Austrian Financial Market Authority and subject to limited regulation by the Financial Conduct Authority (“FCA”). Details about the extent of its regulation by the FCA are available on request. This publication is not intended for investors who are Retail Customers within the meaning of the FCA rules and shall therefore not be distributed to them. Neither the information nor the opinions expressed herein constitute or are to be construed as an offer or solicitation of an offer to buy (or sell) investments. RBI may have affected an Own Account Transaction within the meaning of FCA rules in any investment mentioned herein or related investments and/or may have a position or holding in such investments as a result. RBI may have been, or might be, acting as a manager or co-manager of a public offering of any securities mentioned in this report or in any related security.

SPECIFIC RESTRICTIONS FOR THE UNITED STATES OF AMERICA AND CANADA: This document may not be transmitted to, or distributed within, the United States of America or Canada or their respective territories or possessions, nor may it be distributed to any U.S. person or any person resident in Canada, unless it is provided directly through RB International Markets (USA) LLC (“RBIM”), a U.S. registered broker-dealer, and subject to the terms set forth below.

SPECIFIC INFORMATION FOR THE UNITED STATES OF AMERICA AND CANADA: This research document is intended only for institutional investors and is not subject to all of the independence and disclosure standards that may be applicable to research documents prepared for retail investors. This report was provided to you by RB International Markets (USA) LLC (RBIM), a U.S. registered broker-dealer, but was prepared by our non-U.S. affiliate Raiffeisen Bank International AG (RBI). Any order for the purchase or sale of securities covered by this report must be placed with RBIM. You can reach RBIM at 1133, Avenue of the Americas, 16th floor, New York, NY 10036, phone +1 212-600-2588. This document was prepared outside the United States by one or more analysts who may not have been subject to rules regarding the preparation of reports and the independence of research analysts comparable to those in effect in the United States. The analyst or analysts who prepared this research (i) are not registered or qualified as research analysts with the Financial Industry Regulatory Authority (“FINRA”) in the United States, and (ii) are not allowed to be associated persons of RBIM and are therefore not subject to FINRA regulations, including regulations related to the conduct or independence of research analysts.

The opinions, estimates and projections contained in this report are those of RBI only as of the date of this report and are subject to change without notice. The information contained in this report has been compiled from sources believed to be reliable by RBI, but no representation or warranty, express or implied, is made by RBI or its affiliated companies or any other person as to the report’s accuracy, completeness or correctness. Securities which are not registered in the United States may not be offered or sold, directly or indirectly, within the United States or to U.S. persons (within the meaning of Regulation S under the Securities Act of 1933 [“the Securities Act”]), except pursuant to an exemption under the Securities Act. This report does not constitute an offer with respect to the purchase or sale of any security within the meaning of Section 5 of the Securities Act and neither shall this report nor anything contained herein form the basis of, or be relied upon in connection with, any contract or commitment whatsoever. This report provides general information only. In Canada it may only be distributed to persons who are resident in Canada and who, by virtue of their exemption from the prospectus requirements of the applicable provincial or territorial securities laws, are entitled to conduct trades in the securities described herein.

EU REGULATION NO 833/2014 CONCERNING RESTRICTIVE MEASURES IN VIEW OF RUSSIA’S ACTIONS DESTABILISING THE SITUATION IN UKRAINE

Please note that research is done and recommendations are given only in respect of financial instruments which are not affected by the sanctions under EU regulation no 833/2014 concerning restrictive measures in view of Russia's actions destabilising the situation in Ukraine, as amended from time to time, i.e. financial instruments which have been issued before 1 August 2014.

We wish to call to your attention that the acquisition of financial instruments with a term exceeding 30 days issued after 31 July 2014 is prohibited under EU regulation no 833/2014 concerning restrictive measures in view of Russia's actions destabilising the situation in Ukraine, as amended from time to time. No opinion is given with respect to such prohibited financial instruments.

INFORMATION REGARDING THE PRINCIPALITY OF LIECHTENSTEIN: COMMISSION DIRECTIVE 2003/125/EC of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards the fair presentation of investment recommendations and the disclosure of conflicts of interest has been incorporated into national law in the Principality of Liechtenstein by the Finanzanalyse-Marktmissbrauchs-Verordnung.

If any term of this Disclaimer is found to be illegal, invalid or unenforceable under any applicable law, such term shall, insofar as it is severable from the remaining terms, be deemed omitted from this Disclaimer. It shall in no way affect the legality, validity or enforceability of the remaining terms.

12


Ukraine

Acknowledgements This report was prepared by Raiffeisen Bank Aval on 11 January 2017

Raiffeisen Bank Aval 9, Leskova Str., 01011 Kyiv, Ukraine Tel. +380 44 490 8888 Fax +380 44 285 32 31 Call center: 0 800 500 500 (free within Ukraine) www.aval.ua

Market Analysis

Sergii Drobot (+380 44 590 5621)

Treasury

Head: Vladimir Kravchenko (+380 44 4908808)

FX, MM: Yuriy Grinenko (+380 44 4908988), Olexandr Varenytsia (+380 44 4954227), Nikolay Vysotsky (+380 44 4954226)

Treasury Sales: Marina Lukashenko (+380 44 4954202), Alexander Korenev (+380 44 4954200), Tatiana Kornienko (+380 44 4954201)

Securities: Oleg Klimas (+380 44 4908939), Alexey Evdokimov (+380 44 4954206), Daria Shatskykh (+380 44 4954204)

Multinational Corporate Customers

Head: Andreas Kettlgruber (+380 44 4954110)

Relationship Managers: Anna Prydybailo (+380 44 2309981), Lesia Byba (+380 44 4954271)

Raiffeisen Bank International CEE Research Team GLOBAL HEAD OF RESEARCH, RBI

Peter Brezinschek (1517, FA*)

HEAD OF ECONOMICS / FIXED INCOME /FX RESEARCH, RBI VIENNA

Gunter Deuber (5707, FA*)

CEE MACRO, FX AND FIXED INCOME, RBI VIENNA

Wolfgang Ernst (FX Strategist, 1500, FA*)

Stephan Imre (FI Strategist, 6757, FA*)

Patrick Krizan (FI Strategist, 5644, FA*)

Matthias Reith (Economist, 6741, FA*)

Elena Romanova (Banking sector, 1378, FA*)

Andreas Schwabe (Economist, 1389, FA*)

Gintaras Shlizyhus (FI Strategist, 1343, FA*)

CEE CREDIT COMPANY RESEARCH, RBI VIENNA

Jörg Bayer (Head, 1909, FA*)

Martin Kutny (Corporates, 2013, FA*)

RBI contacts: +43 1 71707 (+ extension); [name].[surname]@rbinternational.com

*FA: Financial Analyst

RBI NETWORK BANK CEE RESEARCH

CENTRAL EUROPE (CE)

CZ: Helena Horska (+420 234 40 1413, FA*), Raiffeisenbank a.s., Prague

HU: Zoltán Török (+36 1 484 4843, FA*), Raiffeisen Bank Zrt., Budapest

PL: Dorota Strauch (+48 22 585 2461, FA*), Raiffeisen Polbank, Warsaw

SK: Robert Prega (+421 2 5919 1303, FA*), Tatra banka, a.s., Bratislava

SOUTH EAST EUROPE (SEE)

AL: Joan Canaj (+355 4 238 1000 1122, FA*), Raiffeisen Bank Sh.a., Tirana

BA: Ivona Zametica; (+387 33 287 784, FA*), Raiffeisen BANK d.d., Sarajevo

BG: Emil Kalchev (+359 2 91985 101, FA*), Raiffeisenbank (Bulgaria, FA*) Sole-owned JSC, Sofia

HR: Zrinka Zivkovic-Matijevic (+385 1 6174 338, FA*), Raiffeisenbank Austria d.d., Zagreb

RO: Ionut Dumitro (+40-730-222-953, FA*), Raiffeisen Bank S.A., Bucharest

RS: Ljiljana Grubic (+381 11 2207178, FA*), Raiffeisenbank a.d., Belgrade

EASTERN EUROPE (EE)

BY: Natalya Chernogorova +375 17 289 9231, FA*), Priorbank JSC, Minsk

RU: Anastasia Baykova (+7 495 225 9114, FA*), AO Raiffeisenbank Austria, Moscow

UA: Sergii Drobot (+380 44 5905621, FA*), Raiffeisen Bank Aval , Kyiv COMPANY EQUITY RESEARCH: RAIFFEISEN CENTROBANK AG, VIENNA Stefan Maxian (Head, +43 1 51520-710, FA*)

http://www.aval.ua/

Business

Ukraine Monthly Economic Review, December 2016