Ukraine business outlook 2012-16 Quarterly update October 2012 by Dr Daniel Thorniley.

Ukraine business outlook 2012-16

Quarterly update October 2012by Dr Daniel Thorniley

Contents

• Executive summary • Business outlook• Why do consumer companies not sell more? • Corruption update• Political outlook• Economic outlook • Inflation and interest rate outlook• Currency outlook• Statistical outlook

Executive summary (1)

• One sentence summary: Business results are ok but the business operating environment is very bad

• Can consumer spending and domestic demand compensate for falling export prices?

• Ukraine is going to experience a macroeconomic slowing over the coming months and in 2013 as the government cuts spending and presumably works closer with the IMF

• GDP will weaken to 2.0% this year from 5.2% in 2011 and then recover mildly in 2013 to 2.5%

• Inflation is climbing again and after being negative this summer will rise to average 1.7% this year and then 8.0% in 2013

• Consumer spending will necessarily slow as inflation eats into real incomes• Consumers will feel more of the pinch in 2013

Executive summary (2)

• We see the currency weakening a further 4.0% this year to end 2012 at about 8.5 to US dollar and then a further decline in 2013 to about 9.0

• Ukraine is still expected to be a relative winning market in 2013, ranking 5th in the CEE region (in terms of corporate sales and profits growth)

• But nearly all macroeconomic indicators suggest softening business in 2013• Corruption remains at extremely elevated levels and is a cause for concern• Political risk will be at the forefront as international monitors review the

fairness of the October elections• Post-election uncertainty could mean a busy and difficult final quarter to the

year• Several executives comment that business in Ukraine today is like business in

Russia 7-10 years ago

Business outlook (1)

• Ukraine ranks No 5 in terms of sales outlook in the CEE region in 2012 and 2013, behind other CIS markets and Turkey

• Fewer companies except to be flat or negative in 2013 (15% of companies instead of 21% in 2012)

• But the number of companies expecting double-digit growth falls from 34% to 29%

• This is still a very good proportion for double-digit growth compared with other core CEE markets

• There is a clustering of more companies expecting single-digit expansion (56%, up from 44%)

• Those looking to single-digits are evenly split between those expecting low and high single digits

• Again this makes Ukraine a stronger market than core CEE ones where most companies are clustered in LOW single digits


• The sectoral trends remain in place, with IT and pharmaceuticals doing relatively better than other sectors

• Consumer products and food & beverages firms perform moderately well, but with a very strong grouping in single-digit growth in 2013 (fully 77% of companies in these sectors)

• Such caution in budget planning is probably well-founded because consumers will feel the pinch in 2013

• But B2B is also in for a tough time with a huge 44% of companies not expecting any sales growth in 2013 and almost 40% anticipating just single- digit growth

• As in other markets, this stems from weakening credits and slower demand from plunging exports


• At our Kiev September meeting, the local manager of a major US IT company outlined his business as follows:

“We are doing very well and growing at good double-digit levels. But unfortunately our regional and global headquarters want higher numbers than this to compensate for weak growth across Europe. We are doing hugely

better than most CEE markets and only a bit slower than Russia, which is also quieting. IT sales to B2B customers are tough but ok. Our B2C business is

very good but you have to remember this includes sales to SMEs.”• With “only” 40% internet penetration across the whole country, IT executives

see room for expansion• And executives note that Ukrainian retailers want to develop their own online

sales


• The pharmaceutical market is trending a bit lower than in Russia with about a third of companies reporting single-digit growth and most of these in low single digits

• On the plus side, about half of companies expect double-digit growth and many are clustered at about 10-15% sales growth

• One local MD of a major European pharmaceutical company reflected these trends well when he stated last month that:

“For 2012 we budgeted 18-20% sales growth; our first reforecast came in at 11%, but our latest estimate is 14% growth. We look for 13% expansion next year, which is quite high but given the potential size of the market, perhaps not so high.”

• The problem is that the health market is not performing at potential• This executive and others noted that the market has been driven by low-cost

products and cheaper generics• One executive from a US health company reported that that “legislation is like

Russia in 2008-09”, implying there may be more regulatory turmoil to follow


• Several executives (western and Ukrainian) at our recent meeting in Kiev said that: “Ukraine today is like Russia in the 2002-05 period.”

• The reference implies that business is picking up, but against a back-drop which is wild and unpredictable, and without a proper ring-fence of effective rules

• One senior MD of a western food & beverages company said amusingly: “Unpredictability is predictable.”

• Another echoed this with: “It’s like a satellite navigation system: you know where you are and you know where you want to go, but you still get lost!”

• The MD of one consumer company, which is one of the biggest investors in the country, commented thus:

“Unpredictability is at such a level that operationally we don’t have a serious budget. Budgets are for global headquarters to play with. It’s much more important that we create a business model that can change quickly and with a structure that is flexible and staffed with capable people in the right positions.”


• An executive from a major European FMCG coined another phrase when he stated:“For us in our organisation, F is for flexibility.”

• In a discussion on corporate structures and approach to market, the MD of a European B2B firm confided that:“Do we have the right system and structure to survive the next crisis? I am curious to know and genuinely do not have the answer to that question, not yet,”

• The crisis affected Ukrainian consumers, as it did those across the world and in the CIS, as the MD of a major global US consumer goods company commented:

“The crisis has moved closer to the Ukrainian consumer and affected many of them deeply. They are more careful with their money and they want value. We western companies must get constantly closer to these consumers and understand them.”

• With the elections just weeks away, more western MDs have noticed government requests for more investment in social infrastructure and local welfare in the form of physical investments or sponsorship

Why do western consumer product companies not sell more? (1)

• Western consumer product companies are doing quite well in Ukraine, which ranks 7-8th in the region for this sector

• But it is a single-digit growth market, with 60% of firms this year and fully 75% in 2013 looking at 1-10% sales growth

• Fewer companies are looking for double-digit growth in 2013 (15%) than in 2012, where the figure is 28%

• But real wages after inflation are among the highest in the world, and nominal wages rose 16-17% in 2011-12 and could still rise 12% in 2013

• With a weak inflation background this year, when inflation was negative, real wages have peaked at 14-15%

• So the question remains: why are western consumer good companies not doing better?


• There are several answers:– Ukrainian consumers are downtrading: Ukraine ranks 9th in the region

for this indicator, with 24% of companies experiencing this trend, rising to fully 40% of FMCG firms

– In a similar vein, they are shopping in kiosks and open markets and buying non-branded products – this was a feature for food & beverages companies in particular in 2011

– Consumers are still deleveraging from a pre-crisis credit boom – consumer credit has been falling since 2009 and dipped 9% in Q2 this year

• But there is another, deeper solution to the puzzle:– It seems that a growing number of workers and executives are

“whitening” their salary/income


• The maths work like this: in the past someone was paid 1,000 hryvnia officially but received another 4,000 hryvnia “black” in an envelope

• Now they are declaring their official income as 1,500 hryvnia and still taking 3,500 black

• But these numbers make it appear that their salary has increased 50%!• When this trend is repeated often enough the official figures for nominal

wages can spike• But it does not mean that workers/executives have seen any real rise in their

income• If nominal wages are actually not rising as much as we think, then this also

applies to the bottom line of real wages • The upside is of course that falling inflation has certainly helped consumption

and confidence, but perhaps not at the levels the official figures would suggest

Corruption update (1)

• The MD of a major western investor narrated the following story:

“My marketing team came up with the idea that we should run a TV advert which would show our vitamin-enriched products making children stronger so that one of them could lift up a friend to a window so that he could see the answers to someone’s exam question, and then succeed in his exams thanks to cheating. I thought this was very inappropriate but when a focus group of Ukrainian mothers watched it, 9 out of 10 thought the advert was great!”

• One regional executive from a European B2B company wondered whether corruption in Ukraine has gone so far now that it is an engrained and cultural feature of society, which would certainly be one conclusion from the story above


• But a senior legal adviser from a major US legal firm felt that: “The extreme extent of corruption in our country stems from a failure of political

will.”• Certainly, even with good government policy implementation against corruption, it

will require many, many years to see results from a clean-up operation • There is growing public distaste about the alleged corruption within the

President’s own family • One executive did argue that Georgia had greatly reduced corruption but other

executives questioned whether this was “window dressing”• Then again, a growing number have stressed their concerns over compliance • One major law firm commented at the start of this year that,

“Corruption is the worse we have ever seen it in the past 20 years.”

• When talking about Ukraine and its track-record on corruption, the above statement is quite shocking


• Comments have been made in the international media about the propriety and legality of some of the construction tenders for the UEFA football stadia construction

• Some of these constructions were promoted by well known Ukrainian oligarchs• And recently criticisms have surfaced about the process of recent energy

privatisations where tender offers boiled down to just one bidder by the time of the final auction

• To explain cynically what’s going on:• Prior to the last elections, there were still competitive elements in the political,

administrative and commercial worlds, but with the political victory of the Party of the Regions and the effective purging (and arrest) of opposition strong-holds and activists, a monopoly for corruption has been consolidated in fewer hands

• Quite simply a monopoly for corruption has lead to monopoly prices!

Political outlook (1)

• Where does Ukraine stand? With Russia, the EU or China?!• Or to sum up: Rejected by the EU and not loved by Russia• As one western manager noted though:

“There is increasing isolation and threats of worse to come, but at the moment Ukraine is not as isolated as Belarus”

• Regarding the up-coming elections later this month, opinion polls suggest a tight race with the Party of the Regions and the opposition bloc of Fatherland (Yulia Tymoshenko) and Arseniy Yatsenyuk’s Front of Change polling in the range of 24-26%

• Vitali Klitschko’s UDAR is running on a separate list• One or two spoiler parties have been created by government sponsors• It appears that 15-20% of voters are still undecided• It may be that candidates not elected on party lists could turn to support the

existing regime in post-election negotiations

Political outlook (2)

• Even if the opposition won, the margin of victory would be crucial regarding the structure of any new coalition government

• Presumably the current government will want to avoid blatant transgressions during the elections to avoid a serious split with the EU

• It is an open question though whether there is enough popular political stamina to engage in massive street demonstrations if the elections are run with “only moderate” malpractice

• The cynical money is betting that the Party of Regions wins a small majority, engages in horse-trading and then we face more of the same in 2013

• But with shifts in policy driven by economic demands (choices for IMF/EU/Russia)

Economic outlook (1) - GDP

• Ukraine’s recent economic results have weakened, similar to many other CEE markets

• As such we have downgraded our GDP estimates• The economy has been losing momentum recently and quite noticeably,

despite pre-election stimulus• Instead of posting 2.3% this year, thanks to weak numbers during the

summer, GDP will only grow at 2.0% or even as low as 1.5%• Next year, GDP could rise by 2.8% if the European picture improves, but we

see this as a best-case – our central scenario is for 2.5% growth• And the rate of growth could stay close to 2.0% if fiscal tightening digs in• Much will depend on any resolution with the IMF and the stringency of any

program, and also on whether any agreement is reached with Russia on lower gas prices


• At the moment prospects on both fronts are gloomy, but the government will have to jump one way or the other at the turn of the year or during the first quarter of 2013

• In exchange for lower gas prices, the Russians are holding out for Ukrainian energy transit assets, which would prove an unpopular exchange in Ukraine

• Currently Ukraine is consuming less gas (at a high price) which makes the overall bill smaller

• The other option facing Ukraine is whether to join a Russia-dominated Customs Union

• “The jury is out” on this one – there are so many factors in play that it could go either way


• In July and August manufacturing figures were not good with industrial output down 4.7% year-on-year, the third consecutive month of negative industrial output

• Metal output was down even further, by 8.6%, on weaker external demand and overall manufacturing was negative 8.3%

• Industrial production will sink to 1.1% growth this year after 7.6% last year• In addition, the end of the summer football tournament will ensure weaker

investment (as in Poland)• After jumping 10% in 2011 in preparation for the tournament, investment will

slow to 2.5% this year and 3.0% next year• All this will impart downward pressure on western B2B sales• Prime Minister Mykola Azarov recognises the problem for investment and

promised recently to step up state financing for infrastructure and construction projects

Economic outlook (4) – consumer spending

• Similar to Russia but in a more extreme fashion, Ukraine is running a twin-track economy with industry/exports declining while consumer numbers spike

• But we anticipate these consumer figures will move downwards quite sharply as inflation rises and fiscal policy tightens

• The consumer sector has kept the economy afloat • Negative inflation meant that real wages in the first half of the year were 15% (one

of the highest levels in the world)• And public wages were set to be hiked again prior to the October elections • Still, retail sales were also up at record levels of 16%, so “the whitening effect”

may not be so pervasive• We expect household spending to start to slow in the last weeks of this year

unless pre-Christmas shopping supports sales• But private consumption is set to slow sharply from 15.0% in 2011 to 4.3% this

year, and down further to a rate of growth of 3.3% in 2013

Economic outlook (5) - trade

• Again similar to global markets, Ukraine is seeing a major slump in its export performance, especially to the EU but also to markets such as Russia

• In dollar terms, exports to the EU were down 13.5% in the first half of 2012

• After falling to 2.0% growth in 2011, exports this year will slow to 1.3% and some commentators feel that exports could go negative this year, and this is easily possible

• Imports are following a similar downward trend and will grow at best by 2.0% this year

• Trade figures will then rise with a bit of a bounce to 4.0% next year

Economic outlook (6) - balances

• Given that consumption has stayed solid this year, especially in the first half, imports were growing faster than exports and the current account is set to worsen from -5.6% of GDP in 2011 to -8.2% this year before recovering on overall weakness in 2013 to -6.3%

• Next year the country’s financing, twin deficits and probably the IMF will entail that fiscal tightening subdues growth

• The rolling budget deficit (net of Naftogaz operations) expanded to 2.6% in July from 1.8% in March

• We expect the budget deficit to worsen to about -3.5% of GDP this year due to government spending and then to improve marginally in 2013 as IMF-type programs kick in

Inflation and interest rate outlook (1)

• There are some similarities in Ukrainian inflationary trends with those in Russia

• In both countries inflation has hit record low levels this spring and summer as government-controlled administrative price increases were postponed and food prices slumped due to the follow through of the bumper 2011 harvest

• Prices will rise in Ukraine after the October elections and the inflation number for this year will depend whether the government bumps prices up as soon as November-December or waits until January 2013

• Inflation averaged between 8.0-9.4% in the last two years but has plunged into negative numbers for top-line inflation in May and June this year

• In May the year-on-year figure was negative by 0.5%, which was the first negative headline figure since 2003

• The August figure climbed back to zero! • However core inflation (excluding energy/food) was still positive at 3.7%


• But given these current low top-line figures, we think that the average for the whole of 2012 will now be much lower than expected, at about 1.7%

• The reason that this average number is even still positive is that food prices will start to creep back up and gas prices will be hiked after the October elections

• Also, government spending before the elections is starting to have some feed-through and will continue for the rest of the year

• The final year-end numbers for 2012 will depend on the timing of the increase in gas and any other administrative prices: If gas prices are hiked in November-December then year-end inflation could jump to 6-7% but if they are postponed until January (which seems less likely) then year-end inflation could be as low as 3% - 4%

• The government is talking up the number to an estimate of 7.9% year-end, which seems high but also suggests that gas prices will rise this year, soon after the elections


• We foresee inflation rising in 2013 to 8.0%, on the back of: 1) continued follow-through of energy price rises at the turn of 2012-13, and 2) steadily rising food prices due to a less good harvest on the bumper 2011

figures and3) thanks to a well-flagged fall in the value of the hryvnia

• The drop in the currency is also being delayed until after the October elections and we feel that during the 3-6 months after the elections the currency could fall 5-10%

• During June Central Bank interventions protecting the hryvnia were as high as $1.2bn and the Bank will not want to maintain this after the elections

• One factor holding back inflation a bit in 2013 will be the slowdown in government expenditure and social spending which ought to prevent any leap back to double digits


• In summary, 2012 sees record low inflation with average for the year at 1.7% and year-end increase of 4-6% depending on timing of gas price increase (probably towards the higher end).

• 2013 sees a well-predicted inflation increase to an average of about 8.0% while year-end will turn out lower because monthly figures at start of 2013 will be higher than those in the second half as government price increases start to slow down: we see year-end inflation in 2013 at about 5.5% - 6.0%.

• Despite low inflation (which is picking up) we do not see any interest rate cuts in the near term

• With inflation popping back up the National Bank is more concerned about the potential negative impact of any rate cuts on the currency

• In fact there is room for one more interest rate hike of 0.25% to 7.75% if inflation over-shoots

• But we then think interest rates will trend downwards in 2013 against a back-drop of slowing growth and moderating inflation

Currency outlook (1)

• The National bank has worked hard to stabilise the hryvnia this year • During the summer, interbank rates were fluctuating at high levels of 20% to

boost the currency • But the Bank did not want to strangle a weakening economy and at the end of

August provided UAH 4bn in long-term financing to local banks• This was the main reason why the currency popped down to 8.15 to the US

dollar• Simultaneously, demand for September government bonds was weak, putting

more downward pressure on the currency• To avoid any mild panic the National Bank noted that its FX reserves were still

at about $30bn• Reserves have been supported by Eurobond issues (€3bn in July and August,

at high interest rates) and also some $3-4bn of financing emanating from China

Currency outlook (2)

• The Chinese funds will finance trade agreements for Ukrainian agricultural exports and the purchase of Chinese mining equipment, etc

• At our recent executive meeting in Kiev there was a very strong consensus that the hryvnia would depreciate to 8.5 to US dollar by the end of this year (2012)

• This implies about 5% devaluation during the rest of this year • The consensus is then that the hyrvnia will creep down to 9.0 by the close of 2013

(another 5% fall) given that the IMF in any negotiations will want a more flexible (weaker) currency

• Having defended the hryvnia for so long, the National Bank may be relieved to allow some depreciation, which will help Ukrainian exports which are under price and demand pressures

• There are risks on the downside but given stable reserves, the Bank has the ability and willpower to draw a line in defense when it wants to

• Executives report that hedging is very expensive

Ukraine - economic outlook: statistics

2010 2011 2012 2013 2014 2015 2016GDP 4.2 5.2 2.0 2.5 4.0 4.6 4.8Fixed investment 4.9 10.1 2.5 3.0 5.0 5.7 5.9Industrial output 11.0 7.6 1.1 3.5 4.8 6.0 6.0Household spending 7.0 14.5 4.3 3.3 3.9 4.7 4.6Government spending 2.8 -1.5 2.5 -1.3 1.0 1.4 1.7Real wages 8.0 7.5 12.5 3.8 4.2 4.7 4.7Retail sales (year-end) 6.5 13.0 8.5 4.2 5.1 5.5 5.8Consumer prices (average) 9.4 8.0 1.7 8.0 6.7 6.0 5.5Budget deficit (% GDP) -5.9 -2.8 -3.5 -2.3 -2.0 -1.9 -2.0Current account (% GDP) -2.0 -5.6 -8.2 -6.3 -5.7 -4.8 -4.2Exports 4.5 2.0 1.3 4.5 6.9 5.9 6.3Imports 11.5 14.0 2.1 3.7 6.2 7.0 7.1Hryvnia/Euro (year-end) 10.6 10.5 10.6 11.5 11.4 11.5 11.6Hryvnia/dollar (year-end) 7.9 8.0 8.5 9.1 9.2 9.3 9.3Unemployment (%) 8.1 7.8 7.7 7.6 7.5 6.8 6.0Note: Real annual % change unless stated

© 2012 CEEMEA Business Group* *a joint venture betweenDT-Global Business Consulting GmbH, Address: Keinergasse 8/33, 1030 Vienna, Austria,Company registration: FN 331137t and GSA Global Success Advisors GmbH, Hoffeldstraße 5, 2522 Oberwaltersdorf, AustriaCompany registration: FN 331082k Source: DT-Global Business Consulting GmbH and CEEMEA Business Group researchBasic data sources come from central banks, own intelligence network, CEEMEA Business Group corporate survey, governments and other public sources. Interpretation, views, forecasts, business quotes and business outlooks by DT-Global Business Consulting GmbH and CEEMEA Business Group.

This material is provided for information purposes only. It is not a recommendation or advice of any investment or commercial activity whatsoever. The CEEMEA Business Group accepts no liability for any commercial losses incurred by any party acting on information in these materials.

Contact: Dr Daniel Thorniley, President, DT-Global Business Consulting GmbHM: +43 676 534 6852 / E: [email protected] / W: www.ceemeabusinessgroup.com

Ukraine business outlook 2012-16 Quarterly update October 2012 by Dr Daniel Thorniley.

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Transcript of Ukraine business outlook 2012-16 Quarterly update October 2012 by Dr Daniel Thorniley.