Ukraine Business outlook 2015-18 Quarterly update – July 2015 by Dr Daniel Thorniley.

UkraineBusiness outlook 2015-18

Quarterly update – July 2015by Dr Daniel Thorniley

Content

• Executive summary• How senior executives see things• Some assumptions• Key factors• Business outlook• What are Ukrainian companies saying?• Business features• Human resources and salaries• Bad blood?• Where do you put Ukraine in your structure?• The latest IMF deal and debt restructuring• Economic outlook• Inflation outlook• Currency outlook• Ukraine - statistics

Executive summary (1)

• Executive perceptions changed negatively in late autumn last year and February this year as “reality-checks” hit hard

• Business will for most companies be very bleak this year and most predict only a mild recovery next year

• It is still remarkable that a handful of companies report good business in hryvnia and even not bad business in FX (we discuss possible reasons below)

• Recent economic indicators suggest that possibly the very worst may be over; for example with the exchange rate and inflation but there is no naïve optimism

• We presume there will be no further military escalation and that the Ukraine-Russia conflict will settle into a messy, nasty frozen conflict that does harm to both countries

• If there were any intense escalation of fighting in eastern Ukraine, the economy could implode for 3-6 months

• Cross border trade is being hampered: some Russian regulations are blocking Ukrainian exports into Russia while some western companies are no longer supplying Ukraine from Russia. This is not a complete freeze on cross border trade but does indicate that the trend is in the wrong direction


• The IMF has finally done the right thing and provided financial support even when the debt negotiations with private creditors have not been finalised

• Putting Ukraine “on the hook” to obtain by itself some $10-15bn in debt write-offs from stubborn private creditors was and is a bizarre and untenable position for the IMF and EU representatives

• Support from the IMF and international institutions still seems insufficient• 2015 is going to be a tougher/worse year than 2014 because it will not have the

relatively good/moderate start that 2014 experienced: in fact just the opposite as the first half of 2015 will be worse than the second half

• economically there are the very first signs of some stabilisation and equilibrium at deflated levels: but the good news is that several indicators did not deteriorate further in May-June after slumping badly in the first quarter of this year


• The government’s own worst case for GDP this year is -12% versus our central forecast of minus -9.4%

• The Ukrainian government's best case is -6.8%, mid-case is -9% and worst case -12%• The free-float of the hryvnia in February saw the currency collapse further and then rally

somewhat• But the official numbers for the exchange rate do not reflect reality and for companies and

citizens, even when they can exchange hryvnia, the effective rate is often 15-20% worse than the official figure

• Top-line Inflation surged to over 61% in April after the currency collapse and as gas prices were liberalised (by 800% in April) but the June figure decelerated to 57%

• Core inflation (excluding food and energy prices) was only 40% in April • Top-line inflation will average 45% this year and be down to 16% in 2016• High inflation and weak currency are feeding off each other with blow-back effects on the

economy• If there is further compromise militarily, then there is always the possibility even of some

strong positive upside on the FX rate which would run through positively into business results. But this seems unlikely for now


• Maybe the political and military outlook is stable or better (maybe) BUT the economy is now experiencing the deeper negative impacts from the 2014 crisis year and recession is kicking in deeper now with soaring inflation

• We predicted that the start of 2015 was going to be bleak for the Ukrainian economy and sadly this has happened

• The short-term outlook is fixed and will be bad as the existing negatives will affect the economy and business at least for the next 4-7 months no matter what happens

• A very mild economic recovery ought to kick-in late autumn or year-end 2015 with positive GDP of about 1.4% in 2016

• If politics and military situation stabilises and improves and if IMF/EU financing continues, then the bounce-back could be accelerated by a few months and the jump in GDP growth in 2016 could rise as much as 3-5%, but this is NOT our central forecast.

• We then see GDP trending later at 4% in 2017-2020


• It is important to note that executives in our Surveys do not expect or budget for any strong bounce back in 2015 and then only a mild, moderate one in 2016

• Ukraine will be the worst performing market in the CEE and CEEMEA region for sales and profits in 2015 and one of the worst in 2016 although the second half of 2016 ought to see business recovery

• Plans and forecasts are rightly very conservative. One should plan for an economic and business recovery starting very slowly in autumn 2015 (at best) and only picking up through 2016

• Much of the business outlook will depend on the FX rate and there are divergent estimates for this in 2015 and 2016

• We are slightly more negative than the consensus which expects average levels to the US dollar of about 22-24 to the dollar in both 2015 and 2016. This level is similar to the current July rate or even slightly better

• We see the hryvnia somewhat weaker at an average of 26 this year and 28 next year• Risks though and volatility could be quite extreme both to the up or downside

How senior executives see things (1)

• The local MD of a major consumer product firm: “We were seeing a further 50% drop in the Euro top-line and some weeks ago I thought it would be worse but the currency stabilisation has helped a little. But the numbers are still very bad”

• Another MD in the same sector confirmed: “We could see top-line sales fall by 10-25% this year and any consumer resilience could collapse this year compared with some relative support in 2014. I am also seeing the start of a collapse in premium products (which is not surprising) but the speed of the move to value and discounts is extreme now. We and other companies are losing share now to the discounters as the Ukrainian consumers move en masse to the bottom. We see only a small recovery taking shape this year and only perhaps in spring 2016”

• The MD of one industrial company noted that: "We are obliged to take more severe steps regarding costs and we will be slashing most operational costs and cutting deep into the corporate structure. I could protect most of the staff for a12-15 month period but the demands of European headquarters are now too severe. We will cut staff by 25-40% in the coming months”.


• “Given the cold bath that we and other companies took last year on profits, cost management is now “Scrooge-lie” and we are expected to stay in the black this year. To achieve this we will probably exacerbate our worsening market share position”

• Comment: we are seeing similar concerns being raised in Russia where other managing directors fear that an over-obsession with profit management will threaten to damage market share the long-term perspectives of the business

• One of the executives commented on a well known feature regarding exchange rates: “The average and spot rates bear no resemblance to the actual FX rates we can attain assuming the purchase applications are approved in the first place”. Liquidity is very scarce for Euros and a little better for dollars and the actual rate is 10-15% weaker than the published, official rates. The National Bank rates are not achievable which depresses our profitability and cash- flows further and means we have to explain these details to European-based corporate finance colleagues who ask rationally “What’s going on with your FX rates?. There has been a modest FX improvement in recent weeks and let’s see if that proves sustainable. Every little bit helps but we will be hunkering down for the next 9-15 months for sure”

• This executive did note the important point that: “We have to be ready though for whenever the market turns round and that could be sometime in 2016”


• Several companies have had internal debates about how to invoice and on what terms. Some companies feel that they cannot continue with FX- denominated invoices and need to get more localised and absorb some risk themselves. Conversely finance directors in Europe are extremely cautious about doing just that. Some companies compromise by invoicing in FX but by using special and agreed exchange rates

• All this is a challenge as we note below that Ukraine reports the worst receivables situation in the CEE region

• But not is all bad news• The regional director of a global apparel brand stated last week in Moscow that: “Our

Ukraine business is remarkable. We are up 70-80% in hryvnia which means of course that we are solid in FX when we combine that with some price rises. To be able to stay steady in FX when the currency collapsed and inflation shot through the roof is quite special”.

• The regional MD of one industrial conglomerate also noted: “Our sales are up 50% in local currency and some how our customers find money some where. They have been able to protect their previous FX earnings and not turn them into hryvnia. To be honest I don’t ask them where they get the Euros and we continue a reasonable business against this frightening background”

Some assumptions (1)

We stick with the following features of our central scenario: • Crimea has seceded de facto from Ukraine• This will not be accepted by Ukraine or the West and will remain a frozen conflict • The conflict with Russia will not escalate or worsen from here • The entire Donetsk and Lugansk regions (not just separatist bits) are 18% of Ukrainian

GDP and 23% of industrial output. But the separatist parts are smaller than this• Any eventual agreement will not prevent a future poisoned atmosphere remaining• IMF/EU funding will have to be increased in order to rebalance the debt profile • Ukraine will have to restructure or write-off part of its sovereign debt in 2015 • But any variant of the IMF program will entail structural reforms which in the short-

term will hurt GDP growth, consumption patterns and western business results• The key to success is for any new regime to tackle genuinely and seriously endemic

institutionalised and socialised corruption and malpractice• Yanukovich’s kleptocracy has destroyed the commercial fibre of the country

Some assumptions (2)

Our economic assumptions for 2015 include:– GDP shrinks by -9.4%– Consumer prices rise by 51% on average trending downwards in final months of

year – High inflation will crush real wages by -33% to -45% this year– Consumer spending will decline by at least -11.8% – Investment will decline by -18% and is currently down minus 25-30% – The currency is following the path we predicated i.e. deep crash and with IMF

support some stabilisation. It is just possible that the very worst may be over on the currency front as well as on the inflation side of things

Key factors

• The Ukrainian economy and business was coming under downward pressure in any case prior to the demonstrations on Maidan and prior to events in early March

• The economy was steadily deflating from a massive economic bubble • At the turn of 2012-2013, Ukraine was reporting some of the highest retail sales and highest

real wages in the world in some cases surpassing figures in China• This was clearly unsustainable and while the average numbers for these indicators held up

moderately well in 2013, the year-end figure (and the real trend) showed a negative picture• Surprisingly some companies reported their business holding up reasonably well into June-

September this year but this cannot continue with spiking inflation• This can be attributable to consumers buying up products in December and the first months

of 2014 fearing an economic collapse and a spike in prices. Such buying made logical sense• We should always be aware that especially in the Ukraine the real sales of companies can

belie official figures• This is because so much economic activity takes place in the grey and black economies• That said, the economy and business outlook is for a very cold shower for the next 6-9

months and even revenue in the black economy will not provide sufficient compensation

Business outlook (1)

• Many companies were surprised that they survived the first 6-7 months of 2014 in reasonably good shape as consumers stocked up, “buying against future inflation” and “investing in products” rather than holding on to cash and these were wise measures

• By autumn 2015 harsh reality had sunk in for the huge majority of companies and the start of 2015 has seen some brutal business trends with only small islands of decent business or small niches

• There has been recent currency recovery and the peak of inflation may have passedThere are some key points for 2015:1. Ukraine will be the worst performing market in the CEEMEA region excluding only Syria2. Business results will depend on the FX rate and that will depend in part on inflation and the sovereign debt

outlook and the extent of EU/IMF support. This was very bleak/disastrous in February-March. But we have seen the first signs of some stabilisation

3. Executives turned much more pessimistic in February and have since seemed slightly more upbeat in the last 1-2 months

4. There is a growing East-West division in sales with more companies reporting relatively better sales in Kiev and the western regions compared with weak current and future sales outlook in the East and South of the country. This was the case to the start of spring 2015 but all regions are trending downwards now. Perhaps the relative strength of the western market will remain.


• In terms of forecast organic sales growth in 2015 Ukraine ranks bottom of our Survey of 23 CEE markets

• Currently 15% of executives predict flat sales in hryvnia in 2015 and hefty 53% look to negative hryvnia sales growth while 15% predict single-digit growth and 18% forecast double-digit sales increases presumably from recent deep lows

• If the hryvnia is falling further this year, then of course even such “sales growth” is massively poor in FX terms

• But there is a possible positive scenario: some companies could be seeing their hryvnia sales rising this year and if there is stabilisation or mild appreciation of the currency, then sales in FX could start to look at least acceptable

• That’s the potential good news • And to some extent this has started to happen in late spring• BUT companies will not have been able to raise their prices sufficiently to bridge the FX gap

and also companies will probably have accounted for a stronger exchange rate in their budgets and forecast

• So, any FX bounce back is positive but unlikely to be sufficient to help the FX corporate results so much This would help shorten the length of the economic crisis but would not prevent it


• But executives are planning for an eventual mild recovery even if they are pushing back the date a bit: some weeks ago many predicted that the economic and business rally would kick in from late autumn 2015 running through 2016 when GDP growth in the latter year could rise to 3-4% range and bring business along with it. But such expectations have been postponed more to year-end and the GDP outlook from 2016 is now down to just 1.4% growth on middle scenario

• But current “mini-signs” suggest that the economy could be helping in 2016• Executives are forecasting better sales in local currency and if the hryvnia can

stabilise over the next 18 months, then corporate results could prove “ok” in 2016 in hryvnia and then also in FX

• Currently companies across all sectors forecast the following sales growth in 2016:• 19% still expect negative sales, 30% forecast flat sales growth while 32% budget for

single-digit sales and 13% look to double-digit sales• As with sales in Russia now, all depends on that exchange rate and how much you

can raise prices to match local and FX sales

Business outlook (4) – 2015 sales projections

Latest 2015 sales projections main CIS markets (in local currencies)

Russia Ukraine Kazakhstan BelarusGrowth of 10%+ 35% 18% 27%

27%Growth of 5-10% 20% 8% 28%

16%Growth of 1-5% 14% 7% 11%

11%Zero growth 9% 14% 23%

28%Decline 1-10% 11% 31% 11%

16%Decline of 10%+ 9% 22% 0%

1%Source: Business Russia/CIS Group Surveys

Business outlook (5) – sales by sector

• Some 26% of consumer goods companies this year look to negative sales with 36% clustered around flat sales but then 27% predict single-digit growth and 12% look to double digit sales expansion. These figures for 2015 are better than estimates made for 2015 some 6 months ago

• This may stem from “natural” bounce back because inflation and real wages are going to do few favours this year

• However, the estimates for 2016 for consumer products are noticeably stronger with 30% predicting double-digit sales; and another 28% forecasting single-digit sales increases with another 30% expecting flat terns and only 7% estimating negative sales

• B2B is relatively much worse this year and Ukraine ranks bottom of 23 markets in this sector with fully 87% predicting negative sales and 13% flat growth

• These figures follow a deep recession in 2014 but will depend on inflows of financing and local bank restructuring

• B2B sales are under more pressure because of the lack of financing and we fear that this sector and IT will take a huge hit in the coming months and our survey results have substantiated this

Business outlook (6) – sales by sector

• Obtaining finance for B2B sales is becoming immensely difficult and often impossible and hence why sales will fall by -25% to -45% for many companies in B2B and the IT sectors this year

• Some B2B firms report that they are able to make some sales to companies that still have “grey financing” or are able to export their products. B2B sales are also tending to perform better in Kiev and the West of the country compared with weaker sales in the East

• The IT industry was already struggling badly and executives in this sector and others are talking more frequently about bad debts on receivables

• The depth of the crisis is seen in the fact that even the usually resilient pharmaceutical sector is under tsarina and again Ukraine ranks bottom of our 23 surveyed markets

• This year 51% of firms predict negative sales and 8% flat growth while one quarter look to high-single digit increases

• The latter probably comes from some life critical government tenders and some from pharmacy (OTC) sales

• A moderate recovery is predicted in 2016 and Ukraine rises into the top 10 markets for sales growth with 36% seeing flat outlook but 27% in single digits and 18% bouncing back in double digits

What are Ukrainian companies saying?

• Other trends among Ukrainian companies are a little worrisome: some western partners have reported that these firms do not want to have anything to do with Russian partners working with the western company: “One Ukrainian managing director told us he didn’t want any third party links with Russians and he didn’t want any Russian supplies in the deal. All our activities and even travel had to stem from the West”.

• But nothing is fixed: some Ukrainians say “Business is business and we will always work with Russian companies and we are obliged to. We’ve known each other too long to let stupid politics get in the way”.

• One Italian manufacturer alluded to some western firms being over-protective: “The Ukrainians wanted to buy processing equipment and the German company executives refused to fly to Kiev (not Donetsk!). This company sent some Dutch junior executives and the Ukrainians basically told them to go to hell. We said we would do almost anything for the business and we got the contracts”.

• As we have noted above though, increasingly there are formal and informal trade restrictions across the border or local parties in Ukraine and Russia do not want to receive products/inputs from the other country. This is not sweeping or comprehensive but a growing marginal issue

Business features (1)

• As we would expect, on most business indicators Ukraine features close to the bottom of the 23 markets we survey twice each year and this includes sales and profits where it ranks the worst in the region for 2014 and 2015 but climbs up to 19th in 2016

• Western companies will make longer-term plans for business development in 2016-20• This is reflected by the remarkable fact that 17% of companies rate Ukraine as a priority

market in the next 3 years• This is a multiple answer in the Survey in question and so the total is above 100%: for

comparison 79% rank Russia, 44% Poland, 39% Kazakhstan and 27% Turkey• Given the question relates to just a 3-year time horizon, this is surprising and suggests

that some companies will be looking to get back into the market and be prepared for any possible bounce back in 2018

• But Ukraine also ranks joint-first with Russia for companies planning cuts in marketing/sales at 31%, whereas in core CEE markets this number is only 12-13%

• Some of the cuts already made have been fairly substantial with almost 30% of firms cutting back by 30% or more on marketing and sales activity

Business features (2)

• When it comes to changing route to market, Ukraine ranks second behind Russia with 28% of respondents referring to this trend. In the past it was a high ranker because companies wanted to diversify their distribution in a big, growing market. Now companies are simply hunkering down and cutting back on distribution costs

• As ever in any crisis, best practice here see companies maintain as good relations as possible with the supply chain because western players will need them again in the medium term and local distributors will remember how they are treated in this crisis

• Not surprisingly, Ukraine ranks worst for growing issues with receivables and bad debts with 55% facing such problems ranging from delays to likely future write-offs

• Given that the crisis is set to continue through most of 2015 and into 2016, we presume that increasingly more local companies and partners will need some kind of debt write-off and some will go under

• Cash management was and remains critical and corporate debts will almost certainly rise as the banking system comes under increased pressure

• Our survey also substantiates anecdotes regarding downtrading and with inflation spiking and wages slumping, Ukrainian consumers will downtrade, look for value and discounts, make less frequent purchases and stress all products to delay renewal purchases. Ukraine ranks second behind Russia with 51% of companies noticing this trend

Human resources and salaries (1)

• Generally companies are/were trying to retain staff and keep salaries in tight control • But as the market worsens, further headcount reductions and this situation is

intensifying through the first months of 2015• Last autumn 40% of companies had already started to make staff cuts but many stated

that such cuts were marginal• But as the market deteriorates and the hryvnia falls further and as the start of the

recovery is pushed further back and as headquarters lose patience and demand profit stabilisation or even profit growth, then local managers are faced with deeper and accelerated staff cuts

• One CEE regional MD noted this last week: We have been able to retain nearly all staff in Ukraine and just a bit of natural attrition. I could keep this situation going for a 12-15 month period after the Crimea incident last March. But now annual numbers are kicking in and there is no place to hide. Regrettably, we will have to let 20-40% of the staff go as there is simply no business or certainly only massive profits losses and not much sign of any profit recovery soon”.

Human resources and salaries (2)

• Another regional MD of a B2B company echoed this: “We will be obliged to let 20 people go in the coming weeks. There is a bit of mini-recovery but it’s tiny and at hugely deflated levels. I am, for what it’s worth, telling our local team to inform people that they should stay in touch and hopefully in 9-15 months we could be hiring again”.

• Most companies (70%) are not making any salary increases to compensate for the hryvnia depreciation.

• As the business recession proves more long-lasting, we imagine that the majority of companies will continue to refrain from such compensatory payments

• In 2015-16, with the longevity of the recession, companies will ensure that any salary increases remain significantly below inflation

• Of course if the hryvnia stabilises and inflation as an average stabilises or even falls, then local staff will feel much better-off but in the coming 6 months the salary outlook is very tough for employees in western companies, in Ukrainian ones and within the civil service and state sector

• Then again, many will be glad to hold on to their job with a western company and be willing to wait for a rally in 2016

Bad blood?

• There are no moral, value judgments in the following remarks, just business analysis• There are mixed messages from companies regarding bad feelings and break downs within

teams among Ukrainian and Russian staff• Several western managing directors told me last week that, “We are seeing serious

tensions and break downs of relationships among our Russian and Ukrainian staff and this is a real tragedy”

• A few companies have started to take Ukrainians out of Moscow offices and Russians out of Kiev at the request of their staff; no one is being obliged to transfer

• The numbers from our survey are as follows:– 68% of companies spot heightened tension and 32% do not– 83% are NOT transferring staff while 17% are doing so

• All this has consequences for promotion and succession planning and could turn into a serious medium-term HR problem

• Conversely several western executives told me this last week that, “Tensions are actually quite minor (or below the surface)”

• So in summary, some disconcerting trends for sure but also not exclusively bad news. But also quite sad and depressing

Where do you put Ukraine in your structure? (1)

• Firstly, whereas in the past many companies had structural links between their Kiev and Moscow offices or dotted lines even when formal links were detached, this will “presumably” disappear as Ukraine is detached organisationally from Moscow reporting lines

• But many companies have a vested interest in keeping a CIS structure including Ukraine and do not want to disrupt a working structure which is also convenient

• In our latest survey (surprisingly to me), 46% of companies are retaining a CIS structure with Ukraine while another 22% do so with Ukraine “more autonomous” within that structure

• “Only” 32% are taking or have taken Ukraine out of the CIS structure• One MD for the CIS region explained to me in powerful detail all the rational and

commercial reasons why Ukraine should remain in the structure include trade ties, customs regulations, legislation, practicality, synergies etc.

• But conversely the senior partner of major service company commented in London last week that: “There were many synergies but frankly many of these are disappearing”

Where do you put Ukraine in your structure? (2)

• We are also witnessing increasing pressure from Ukrainian-based executives demanding to be detached from any structure which contains Russia

• Our assumption is that with a cease-fire in place and hopefully the shooting war at an end (this is not a certainty) that as “things calm down” , then companies will not tamper with their structures and leave things alone

• On the other hand, pressures from the Ukrainian business community should ensure that at least some companies start to detach Ukraine from their CIS structure

• Some increasing trade difficulties across the Russo-Ukrainian border in both directions (not yet systemic) could undermine mutual business and act as another reason to create separate corporate structures

The latest IMF deal and debt restructuring (1)

• The numbers for international assistance to Ukraine sound good but in fact they are not• On 11 March the IMF approved a 4-year assistance program of $17.5bn under the so-called

Extended Fund Facility (EEF). The new program replaces an earlier two-year program of $17bn (of which some $5bn were disbursed)

• In fact $15bn of the $40bn package is predicted to be saved (by 2018) in on-going debt negotiations: so 40% of the total support is presumed to come from debt restructuring which as we noted several months ago was extremely optimistic or fanciful

• Furthermore the $40bn headline number includes supposed financial aid from a batch of sources including international organisations, the EU, the EIB, the EBRD and the World Bank amounting to $7-10bn of the total (another 20% or so of the total)

• Thus almost 60% of the total looks a bit like “funny money” or will only come in dribs and drabs (little pieces)

• In fact by mid-June the Ukrainian government had not reached a resolution with its private creditors but the IMF went ahead with the next tranche of $1.7bn under the EFF

The latest IMF deal and debt restructuring (2)

• As with negotiations with Greece, the stumbling block relates to a haircut of the principal private debt (total of $23bn) which creditors refuse to accept preferring instead an extension of the maturity

• With the IMF stepping in to disburse the latest tranche despite the technical possibility of default, the negotiating position of the Ukraine government is certainly strengthened

• There is another interest payment deadline on 24 July and this will be used by the IMF to exert pressure on private creditors but they may not capitulate this month

• Our central scenario is that a deal with private creditors will be reached by 23 September when Ukraine faces the maturity of $500mn Eurobond

• The government also has an outstanding $3bn Eurobond held by the Russian government which matures in December this year and our assessment is that for all sorts of financial-technical reason that this bond will be repaid

• FX reserves doubled to $10bn in March as the IMF disbursed its first $5bn tranche and also thanks to some improvement in the current account due to sharp cuts in imports

• Thanks to better tax collection we expect the budget deficit to improve to -3.9% this year from -4.6% last year

Economic outlook (1) - GDP

• GDP this year will be weaker than in 2014 and any recovery in 2016 will be mild: GDP will fall this year by -9.4, after -6.8% last year and then will rise by about 1.4% in 2016

• The government’s own worst case for GDP this year is -12% • Annual average indicators for 2014 by the way appear “not too bad” but all these

indicators were on a steeply declining curve through the year and year-end numbers were worse than the annual averages

• As we predicted, all indicators will continue to fall through the first 9 months of 2015• But by May-June we have seen the speed of the collapse decelerate and actually

improve a tiny amount• But there is little chance of a strong bounce-back recovery in 2016 as the challenges are

more fundamental; 2016 will see only a mild recovery • A significant improvement in eastern Ukraine would create a “best case outlook” but

we are already in June 2015 and even an “over-night sensation” would not be able to turn around the 2015 picture quickly enough: 2015 will be bad in almost any scenario

• It is too alter to much improve the 2015 numbers


• The drivers of weak growth are well documented: the military conflict in eastern Ukraine, the collapse of the economy even prior to the Crimean events as the Yanukovich economic bubble deflated, rising debt levels, IMF-imposed austerity measures, collapsing domestic investment, virtually zero western corporate investment, overall economic downsizing, spiking inflation getting close to 50% and consumer incomes and wages among the worst in the world after being among the highest in there world just two years ago

• In addition the new coalition government is not inspiring confidence in the international community and among western companies operating in the country; admittedly it faces a huge task and is an improvement on the pervious regime

• We make the presumption that there will be no further escalation in eastern Ukraine otherwise our estimates will need to be revised downwards

• We also assume that the gas deal will flow at an agreed price around $365-380, a number higher than previously but also just below open market rates i.e. some sort of compromise


• Gas prices are set to rise by 1,000%+ over the next two years and this will inevitably hit consumers and corporations

• But we also know that there is scope for better efficiency in energy usage so there is some compensation here

• With spiking inflation and tumbling real wages and the shrinking hryvnia, there are estimates that GDP per capita will fall to just $1,500 from $4,000 in 2012 (denominated in dollars of course)

• In theory the falling hryvnia ought to help Ukrainian exports but there will be little help from a recessionary Russia and a still weak (but improving) Eurozone

• Exports collapsed -23% in 2014 and still look set to decline a further -15 to -20% this year before recovering by 5.0% in 2016; imports fell -30% last year and will be still negative this year by at least -18% and then increase by 5.5% in 2016

• With collapsing domestic confidence, little foreign investor interest, no access to capital markets for long-term investments and still elevated political and military risks and rising credit risk, it is little wonder that the collapse is being led by investment and particularly with no Russian inward funds for the near-term future


• Fixed investment was down -25% in the first 5 months of 2015 (after -23% for all of 2014) and we estimate at best case this year of -18.0% and then reverting to positive 2% next year and at 5% in 2017-18 as the economy does experience some bounce-back effects

• Industrial output fell -4.3% in 2013 and then slumped -11% for 2014 and through the first 5 months of this year the decline has been -20%

• These are all the worst figures since 2009• But we do expect some improvement in the coming months as average industrial output will

“only” fall by -16% this year and then turn positive in 2016 by 3% • Inventories have been slumping through all of 2014 and into 2015• The only major positive in 2014 was agricultural output but so far this year the sector is down

-7% although the prospects for a good grain harvest still exist with possible decent exports • These trends in industry and investment inevitably mean that B2B sales and profits will be

damaged this year and this is what executives are expecting• And finally the construction sector in the first 5 months of this year is down -32% • Cargo transportation was down by -9% last year but has recently collapsed by -22% in the first

5 months of 2015

Economic outlook (5) - wages

• Nominal wage growth and real wage growth (after inflation) in 2010-2012 were among the highest in the world and certainly the highest in Europe

• But these were already trending downwards from +20% in 2010 to +17% in 2011, +15% in 2012 and +7.9% in 2013

• But real wages have faced a catastrophic collapse in 2014 and through into 2015 • As inflation jumped to “only” an average of 12% last year, real wages fell by -4% as

nominal wages started to soften • But with nominal wages fluctuating in a range of 8-13% last year and 12-22% this year

as inflation leaps to 50-60%, then real wages are been destroyed by -30% to -40%, one of the worst figures in recent global history

• It seems the peak of inflation may have been hit in April at 60.9% and as prices decelerate, then real wages in 2016 will improve but still be in negative territory at minus -4.8% before turning positive by +3.0% in 2017

• Real wage trends will hurt consumer confidence and ensure that retail and household expenditure will drop downwards sharply as they did through the first half of this year

Economic outlook (6) – retail/consumer

• Retail sales followed the pattern of wages bouncing around at +17% in 2012 but was already down to 8% in 2013 and last year they turned negative at -9.5% on downward trend (without the positive start to that year they could have been much worse)

• Retail sales were down year-on-year by over 30% in March and at -25.6% in may; the average for the first 5 months of the year is minus -25%

• Such sales are slightly better than the inflation and real wages figures because consumers can turn o savings and income from the black economy which represents at least 40% of official GDP

• As inflation decelerates, we expect retail sales to rise by 3% in 2016• Total household spending will fall by -12% his year with downside risks after a fall of almost -

10% last year and we then see a rise of 1.3% next year• Consumer confidence has averaged 80-82 in the last two years with a recent low of 70 in

early 2010 after it had collapsed disastrously to 40 in early 2009 for a few months• But through the first half of this year, the worst numbers of 2009 have been matched with

the indicator hovering at 41 in April with a tick-up in May to 46 • Unemployment averaged 10.5% last year and we think this could tick up to 12% this year as

companies make tougher decisions

Inflation outlook

• Inflation slid negative in 2013 at -0.3% and averaged 12% in 2014 on an upward curve at 25% by December

• But the flow-through effects of the crumbling currency combined with a 800% hike in gas prices in April and the impact of sizeable monetary financing of the budget deficit (printing money) ensured that inflation leapt to 60.9% in April averaging 45% in the first half of 2015

• As we anticipated, it took a month or two for inflation to then start what will probably be a steady deceleration: price had improved to “just” 57.5% in June for example

• Inflation was up across the board with food and utility prices all impacted as well as imported items; producer prices were also elevated as the prices for chemicals, coal and sugar soared

• In fact while top-line inflation was touching 60%, core inflation (excluding volatile food and energy prices) was “only” 40%

• We expect prices to decelerate further through the second half of his year as the hryvnia stabilises or stops crashing and inflation to average about 45% on a downward trend and year-end inflation (December 2015) could reach 25-30%.

• Inflation is expected to average about 16% next year

Currency outlook (1)

• In the second half of 2013 the hryvnia was stable against the dollar at 7.87 and averaged 11.0 to the Euro in the first half of 2014. It then moved as follows:

Dollar Euro1 Jan 2014 8.03 11.016 March 9.03 12.7712 October 12.7 16.11 January 2015 15.6 18.91 March 2015 28.6 32.38 July 20.7

23.2

• In the first quarter of 2015 the currency virtually halved in value against the dollar and fell by 78% against the Euro; the difference is obviously explained by the strengthening of the US dollar

• The February free float caused the currency collapse but then we witnessed some moderate recovery thanks to 1) some FX controls 2) some stabilisation in eastern Ukraine and 3) and the announcement of the IMF program and proposed negotiations with private creditors


• There is a wide range of estimates for the FX rate this year and with some significant outliers• Much depends on political/military risk and also on the debt negotiations • The consensus for the average dollar/hryvnia rate in 2015-16 is in a range of 23-26• But some commentators predict a much sharper fall back down to 30 i.e. worse than its

recent march 2015 level while some experts foresee very strong strengthening to 16-18 • We do see the positive current trends of decelerating inflation but at still very high levels and

a variety of government polices and IMF support have restored the currency • But with a severe recession this year and with possible downward pressure on all emerging

market currencies as US interest rates climb, we estimate a somewhat softer FX rate than the consensus in the next 2-3 years

• Our estimates of the FX rate versus the dollar averaging 26 this year and reaching 30 by 2018 suggests a further depreciation of 13-20% in the next 9-24 months rather than the more upbeat view of stabilisation

• We stress that nearly all the risks are to the downside• However, if the market mood changes, then a strong appreciation could set in, as we have

seen with the Russian rouble recently


• But much will depend how long the current inflation spike persists and whether the annual average for inflation settles around 45% (our central view) or whether it improves more quickly or stays sticky

• Bank interest rates remain nominally high (at 30%) but this is well below inflation levels, although on the other hand real market rates are much higher

• We do expect rate cuts of 3% in 2015 and a further 9% next year as inflation decelerates

• FX reserves tumbled as the currency weakened and slumped to a recent all time low of $5.5bn in February but thanks to IMF support have rallied to $10.3bn in June

• We presume for calculation purposes that the Euro/dollar will fluctuate at about 1.09 for the next 12 months but there is some risk that the dollar could rise to 1.00/1.05 range in the next 6-9 months

Ukraine - economic outlook: statistics

2012 2013 2014 2015 2016 2017 2018GDP 0.2 0.0 -6.8 -9.4 1.4 3.6 4.5Fixed investment 0.9 -6.6 -23.0 -18.0 2.0 5.2 5.8Industrial output -0.5 -4.3 -11.0 -16.0 3.0 4.5 4.8Household spending 9.1 7.8 -9.6 -11.8 1.3 3.0 3.7Government spending 3.6 2.7 -5.0 -4.0 0.8 1.4 1.4Real wages 13.5 7.9 -4.0 -38.0 -4.8 3.0 3.2Retail sales 17.4 8.0 -9.5 -17.0 3.0 3.7 4.7Consumer prices (average) 0.6 -0.3 12.5 45.0 16.0 8.6 7.5Budget deficit (% GDP) -3.8 -4.4 -4.6 -3.9 -3.7 -2.8 -2.8Current account (% GDP) -8.2 -9.3 -3.8 -2.7 -2.5 -2.9 -4.0Exports -6.0 -8.0 -23.0 -15.0 6.0 8.0 8.2Imports 1.9 -6.0 -34.0 -20.0 7.5 7.2 7.8Hryvnia/Euro (average) 10.5 10.7 15.7 27.5 30.0 31.0 32.5Hryvnia/dollar (average) 8.08 8.1 11.9 26.0 28.5 29.5 31.0Unemployment (%) 7.9 8.7 10.5 12.0 11.0 9.8 8.5

Note: Real annual % change unless stated

© 2015 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 1, 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

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Ukraine Business outlook 2015-18 Quarterly update – July 2015 by Dr Daniel Thorniley.

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Transcript of Ukraine Business outlook 2015-18 Quarterly update – July 2015 by Dr Daniel Thorniley.