Ukraine Macro Presentation Commerz

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EM Research | October 2011

Macroeconomic OutlookUkraine


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1EM Research | October 2011

Ukraine macroeconomic overviewKey points

Ukraine is gradually recovering from the 2008 crisis, although it carries a high degree of vulnerability to external demand andcommodity prices. Its output is still below the level in 2007 as opposed to CIS peers.

GDP growth is estimated to have grown by 5.3% in Q1, slowed to 3.8% in Q2 and rebounded in H2 on a strong harvest.Growth could reach 4.5% this year and slow considerably in 2012 on global demand. Higher social expenses and stateinvestments are expected to give short-term support to domestic demand in H2 2011.

Rising imports and a likely deterioration of Ukraines terms of trade - defined as steel export versus energy import prices -pose a risk to Ukraines current account balance. It stood at 2.8% of GDP in August YTD and may reach 6% in 2012 in casethe current gas contract applies. These increased exchange rate risks due to Ukraines external financing constraints.

NBU reserves dropped from $38.2bn to $35bn in September and without unblocking the IMF loans Ukraines external liquiditywould weaken further next year. The next IMF mission is due in Oct/Nov. Deputy PM Tigipko is proposing full programcompliance to avoid having to look eye-to-eye with another crisis. The freezing of capital markets for Ukraine limit thegovernments loan options.

Ukraines fiscal position has improved and default is not a threat at present. The Jan-Aug. state budget balance is -0.4% of

GDP. With 2.4% GDP cash reserves the Treasury has already pre-financed Ukraine's net borrowing need for the year. Thegross issuance is, however, being increasingly monetised. Next years domestic budget (re-)financing may require higherNBU purchases. External debt service may require the use of FX reserves.

UAH one-year NDF yield reached UAH 10 against the USD or nearly 30%. (compared to 8.5 in mid-summer). Domesticgovernment bond yields rose to 14% - 17% on one-year to four-year bonds and newly issued USD-indexed three-year UAHbonds 8.2%. The market challenge highlights the importance of Ukraines IMF program.


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Ukraines economic recovery has underperformed CIS peers..Ukraines economic output still below pre-crisisReal GDP level 2007=100

Source: IMF, Commerzbank estimates

-25

-20

-15

-10

-5

0

5

10

15

20

2007 2008 2009 2010 2011 E

%

Net exports

Investment

ConsumptionReal GDP growth

The inventory cycle has been driving growthPrivate consumption is taking over, while net exportcontribution is negative.Weaker external demand should be partially offset by highersocial expenses and state investments next year.

GDP growth has been growing at an annualised pace of c. 4% y/y.The global growth outlook made us revise Ukraines growth forecastlower to 4.5% this year. It is likely to slow considerably in 2012.

85

90

95

100

105

110

115

120

2008 2009 2010 2011

KazakhstanTurkeyRussiaUkraine


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.. but has gained momentum by h1 2011

Credit to private sector % y/yUkraines credit markets are still impaired, but credit intermediationhas resumed and domestic demand has been strengthening

Industrial production, 3mma % y/yUkraines industry posted 9% growth in H1 2011, led by manufacturing.The metallurgy sector has posted double-digit growth but could start toface headwinds from the global economy.

Source: Ecowin, National Central Banks, Commerzbank estimates

-20

0

20

40

60

80

100

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Kazakhstan Ukraine Russia

-35

-25

-15

-5

5

15

25

Mar -0 7 S ep- 07 M ar-08 Sep -0 8 Mar- 09 S ep- 09 M ar -10 Se p- 10 Mar- 11

yoy (%) UkraineRussiaKazakhstan


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Foreign trade

Commodity structure of exports

Export structure by destination (% share)

Chemicals7%

Minerals13%

Agriculture8%Other

28%

Machinery11%

Base metals33%

30.8 31.8

25.1

7.05.3

36.5

26.9 26.7

5.93.9

0

5

10

1520

25

30

35

40

CIS Europe Asia Africa America

2005 2010

Exports, imports and trade balanceUkraine remains exposed to commodity price risks. Trade exposure toAsia could soften the export shock in case European demand falls.

-80

-60

-40

-20

0

20

40

60

80

Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11

%

-12.0

-7.0

-2.0

3.0

8.0

Trade balance 6mma rhs, U$ bnImports 6mma % y/y lhsExports 6mma % y/y lhs

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

0.35%

0.40%

0.45%

0.50%

1 Q - 9

2

1 Q - 9

3

1 Q - 9

4

1 Q - 9

5

1 Q - 9

6

1 Q - 9

7

1 Q - 9

8

1 Q - 9

9

1 Q - 0

0

1 Q - 0

1

1 Q - 0

2

1 Q - 0

3

1 Q - 0

4

1 Q - 0

5

1 Q - 0

6

1 Q - 0

7

1 Q - 0

8

1 Q - 0

9

1 Q - 1

0

1 Q - 1

1

Ukraines export market share in world imports



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Commodity trade balances in Europe

Source: CEIC, UN Comtrade, Commerzbank Corporates & Markets

Net export/import(-) of key commodities, % GDP Net export/import(-) of energy, % GDP

-10 -5 0 5 10 15 20 25 30

Kazakhstan

Russia

Ukraine

South Africa

Bulgaria

Poland

Romania

Czech Republic

Hungary

Turkey

-12 -8 -4 0 4 8 12 16 20

Kazakhstan

Russia

Romania

Poland

Turkey

Bulgaria

Hungary

South Africa

Czech Republic

Ukraine


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Ukraines terms of trade

Gas prices by Gazprom

Minister of Economy Kliuyev stated that the 2012 budget is based on $415 gas price, calculated according to the supply contract. Thiswould widen Ukraines energy trade deficit by $2.2bn. An additional 10% decline in steel prices would add $2bn deficit. A combinedterms of trade impact would be around $4.2bn or 2.5% of GDP (*base case).

If oil declines by 30% and Ukraine buys the fixed contract amount (33bcm) at c. $352, and steel prices drop by 10%, the net tradeimpact is c. $2bn (1.1% of GDP). A new gas deal with Russia is in the pipeline..

Trade balance and energy imports

At *base case terms of trade projection

264

295

355

455

372

0 100 200 300 400 500

Ukraine 3Q 2011no discount

TTF current spotprice

Ukraine actual 3Q

2011

Belarus 3Q 2011

Ukraine 2Q 2011

Belarus 2Q 2011

Ukraine 1Q 2011

Belarus 1Q 2011

Average Europe

TTF spot average

U$-25

-20

-15

-10

-5

0

5

10

15

20

25

2007 2008 2009 2010 2011(jan-June)

2011 F 2012 F U $ b n

Energy import Trade balanc e Energy trade balance



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The steel sector challenge

The steel sectors net margin could fall below its level during the 2009 crisis in case of the combined terms of trade impact of10% weaker steel demand/prices and unchanged gas contract. This highlights the importance of a gas new gas deal.

Steel output strong in h1, terms of trade turning Steel trade margin as % of GDP(steel exports net of energy imports)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

2005 2006 2007 2008 2009 2010 2011 F 2012 F-60

-40

-20

0

20

40

60

80

Jan-04

Oct-04

Jul-05

Apr-06

Jan-07

Oct-07

Jul-08

Apr-09

Jan-10

Oct-10

Jul-11

Steel output % y/y

Source: Ecowin, Commerzbank estimates


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The gas sector challenge

Ukraine is one of the least energy-efficient countries worldwideand highly dependent on imported gas.

Investment in exploration, extraction and transportation isinsufficient, domestic production is below potential. Gas transitthrough Ukraine is at risk due to deteriorating gas networks

Transit revenues amount to c. $2bn

Reforms initiated under the IMF program include (i) graduallybringing domestic gas prices to import-parity (suspended), (ii)liberalisation of the gas sector and unbundling of Naftogaz;adopting separate cost centres for gas imports, domestic gasproduction and gas transit, (3) modernisation of the gas transitinfrastructure.

Gazprom has pushed for closer working relations with Naftogaz:President Yanukovych offered Russia a share in Ukraine's gastransit network. A consortium with Russian participation would beset up to manage Ukraine's pipelines. According to Russiangovernment sources, Ukraine would receive 20% of shares in theconsortium. Another 20% will be held by one German companyand the rest by Gazprom.

Gas extracted domestically could be exported to Europe to offsetthe losses on high import gas price if those remain as per the gascontract this year and next.

25%

46%

107% 107%

100%

0

50

100

150

200

250

300

350

400

Households Utilitycompanies

Budgetaryinstitutions

Industries Import pr ice0%

20%

40%

60%

80%

100%

120%% of import price, rhs

Price U$, lhs

Domestic gas prices well below import-parity

Source: Commerzbank estimates


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The structural challenge

Productivity levelGDP per person employed

World Bank doing business ranking

Economic reforms slowly advance; (i) the pension reform will come into force on 1 October 2011, (ii) land reform and a free landmarket could be established next year, (iii) the restructuring of the gas sector is likely to gather momentum. Additionalprivatisation in the energy distribution is being tendered ($300m).Fiscal stabilisation has made substantial progress, while structural weaknesses remain:

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

I n d i a

C h i n a

U k r a i n e

B r a z i

l

W o r

l d

R u s s i a

A z e r b a i

j a n

T u r k e y

G e r m a n y

H o n g

K o n g ,

C h i n a

U n i

t e d S t a t e s

c o n s

t a n t

1 9 9 0 P P P $

145

127

123

79

68

65

59

54

22

5

2

1

0 50 100 150

Ukraine

Brazil

Russia

China

Belarus

Turkey

Kazakhstan

Azerbaijan

Germany

United States

Hong Kong, China

Singapore

Source: World Bank


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Fiscal consolidation in progressGeneral Govt balance (% of GDP)Fiscal stabilisation has advanced vs. other IMF program countriesUkraine targets 2.6% of GDP deficit (+0.8% Naftogaz) vs. 6.5% in2010. The 2012 draft budget is conservative despite the 2012elections at -2.5% of GDP. Fiscal conservatism has been atrademark of the Azarov government. Government reservesamount to 2.4% GDP.

General government budget balanceThe fiscal deficit has shrunk to 1.1% of GDP by Aug 2011 (12mrolling) vs. 2.8% under the revised budget due to 40% nominalincrease in revenues. (The 8m deficit is $0.6bn or 0.4%). Therevised 3.4% fiscal target could accommodate a wider-than-budgeted Naftogaz deficit (0.8% GDP) and may facilitateunblocking the IMF loans.

Source: Ecowin, IMF

-9

-7

-5

-3

-1

1

3

L a t v i a

P o l a n

d

U k r a i n e

L i t h u a n i a

C r o a t

i a

S e r

b i a

C z e c h

R .

H u n g a r y

R u s s i a

T u r k e y

K a z a k

h s t a n

20102011

-20

-10

0

10

20

30

40

50

Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11

% y/y

-80

-70

-60

-50

-40

-30

-20

-10

0

10

U A H b n

Gen. govt. budget balance 12mma rhsExpenditures % y/y, lhsRevenues lhs


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Domestic UAH sovereign debt market

-60,000

-50,000

-40,000

-30,000

-20,000

-10,000

-

10,000Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

UAH mn

Pro-rata budget (revised, 2.6% GDP)2011

20102009

0

5

10

15

20

25

J a n -

0 9

M a r - 0

9

M a y - 0

9

J u l - 0 9

S e p - 0

9

N o v - 0

9

J a n -

1 0

M a r - 1

0

M a y - 1

0

J u l - 1 0

S e p - 1

0

N o v - 1

0

J a n -

1 1

M a r - 1

1

M a y - 1

1

J u l - 1 1

%

-

20,000

40,000

60,000

80,000

100,000

Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

NBU Banks Others Non-residents

20,000

10,000

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Central Bank net claim on c entral govt.Treasury deposits at the NBU (budget pre-financing)NBU holding of govt. securities

Budget execution vs. pro-rata budget target Govt. reserves and net position vs. NBU (UAH m)

Government bond holdings by sectors (UAH m) Avg. yield at UAH treasury auctions

Source: Ecowin, NBU


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The public debt serviceDoable with maturity extension of IMF liabilities, higher domestic yields

Debt redemptions cluster at the end of the year in2011 and rise significantly next year.

Foreign debt service, including a partialredemption of the $2bn VTB loan this year, wouldamount to nearly $2bn.

Including IMF liabilities ($4bn) Ukraines externaldebt service is $5.5bn in 2012 and may requirethe use of international reserves.

Ukraines external liquidity benchmarks wouldweaken.

Ukraines short-term domestic debt is large; it hasto refinance UAH 30bn in 2012. The NBU hasstarted to monetise UAH debt and may need toincrease its purchases next year whenredemptions increase.

In the short term, the yield that stabilisesUkraines debt is below 14%. Over the long term

at standard assumptions Ukraines debt ratio isset to decline.

Co-operation with Russia in the gas sector,unblocking of IMF loans and maturity extensionof fund liabilities could relieve external balancepressures in the near term.

Source: Commerzbank, Bloomberg, Global Source, IMF

Total government debt maturities

Source: IMF, Bloomberg, NBU Commerzbank estimates

1 , 2 7 6

1 , 2 0 0

1 , 3 0 0

5

4 , 5 4 3

4 , 8 2 3

1 , 9 8 3

0

1 , 2 3 4

5

1 , 6 3 9

5 , 7 4 6

3 , 0 1 2

2 , 5 0 0

4 , 6 6 8

5

3 , 6 6 0

3 , 5 6 0

2 , 1 4 3

5 2 5

3 3

2 , 1 4 7 2 , 5

9 0

2 , 7

5 3

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

O c t - 1

1

N o v - 1

1

D e c - 1

1

J a n -

1 2

F e b - 1 2

M a r - 1

2

A p r - 1

2

M a y - 1

2

J u n -

1 2

J u l - 1 2

A u g - 1

2

S e p - 1

2

O c t - 1

2

N o v - 1

2

D e c - 1

2

J a n -

1 3

F e b - 1 3

M a r - 1

3

A p r - 1

3

M a y - 1

3

J u n -

1 3

J u l - 1 3

A u g - 1

3

S e p - 1

3

U A H m n

-

2,000

4,000

6,000

8,000

10,000

12,000

2011 2012 2013 2014 2015 2016 2017 2018 2019

U $ m n

Other (VTB loan, Naftogaz, Ukrexim)

Projected repayments to the Fund

Domestic UAH bonds

International Bonds

Domestic debt maturities by month (as at Sep 2011)


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External balance

A moderate crawling devaluation is conceivable under a negative external balance scenario

Ukraines current account position is under market watch due to itsfinancing constraints.Under the fixed gas contract terms and weaker steel demand/pricesthe current account deficit could widen to $10bn or 6% of GDP. (Apessimistic scenario).

Capital flows: a fragile balance as IMF loans stalled

Source: Ecowin, Commerzbank

-15

-10

-5

-

5

10

15

20

25

1Q-06 4Q-06 3Q-07 2Q-08 1Q-09 4Q-09 3Q-10 2Q-11

U $ b n

Capital and fin. a/c balance 4Q cum.

Current acc. balance 4Q cum.

Balance of payments deteriorating

Ukraines capital balance is supported by Eurobond issues andinter-governmental loans (also privatisation this year). Withoutwholesale funding channels Ukraine may need to cover a BOPshortfall from reserves next year.

-8000

-6000

-4000

-2000

0

2000

4000

6000

8000

1Q-06 4Q-06 3Q-07 2Q-08 1Q-09 4Q-09 3Q-10 2Q-11

m ln U$ Other c apital, loans and bonds

Portfolio investment, net

Direct investment, net


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External liquidity may weaken

In the assumed negative balance of payments outcome..External debt as % of GDP External debt as % of exports

Gross reserves in months of imports Short-term debt as % of gross reserves

0

1

2

3

4

5

6

7

8

2007 2008 2009 2010 2011 2012

Gross reserves (mon ths of next year's imports)

0

20

40

60

80

100

120

140

160

2007 2008 2009 2010 2011 2012

Short term debt as % of gross reserves

0

10

20

30

40

50

60

70

80

90

100

2006 2007 2008 2009 2010 2011 2012 2013 2014

Total external debt % of GDP

0

50

100

150

200

250

300

2006 2007 2008 2009 2010 2011 2012 2013

External debt to exports %

Source: IMF, Ecowin


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The market challenge..

MSCI indices, 2008 jan.=100Ukraines relative performance in line with Russias

Sovereign CDS spreads (bps)at 850bps Ukraines spread is second widest after Greece

0

20

40

60

80

100

120

140

1 / 2 8 / 2 0 0 8

4 / 2 8 / 2 0 0 8

7 / 2 8 / 2 0 0 8

1 0 / 2 8 / 2 0 0 8

1 / 2 8 / 2 0 0 9

4 / 2 8 / 2 0 0 9

7 / 2 8 / 2 0 0 9

1 0 / 2 8 / 2 0 0 9

1 / 2 8 / 2 0 1 0

4 / 2 8 / 2 0 1 0

7 / 2 8 / 2 0 1 0

1 0 / 2 8 / 2 0 1 0

1 / 2 8 / 2 0 1 1

4 / 2 8 / 2 0 1 1

7 / 2 8 / 2 0 1 1

MSCI RU MSCI EM PFTS Ukraine

0

1000

2000

3000

4000

5000

6000

1 / 2 8 / 2 0 0 8

4 / 2 8 / 2 0 0 8

7 / 2 8 / 2 0 0 8

1 0 / 2 8 / 2 0 0 8

1 / 2 8 / 2 0 0 9

4 / 2 8 / 2 0 0 9

7 / 2 8 / 2 0 0 9

1 0 / 2 8 / 2 0 0 9

1 / 2 8 / 2 0 1 0

4 / 2 8 / 2 0 1 0

7 / 2 8 / 2 0 1 0

1 0 / 2 8 / 2 0 1 0

1 / 2 8 / 2 0 1 1

4 / 2 8 / 2 0 1 1

7 / 2 8 / 2 0 1 1

0

200

400

600

800

1000

1200Ukraine lhs Greece lhs Hungary

Poland Russia Italy

Source: Ecowin, Bloomberg


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Financial sector vulnerabilities

Short-term debt and FX liabilities are high, particularly when considering BOP and FX risks

FX loans as % of total loansForeign currency loans as % of GDP

Short-term debt burden

0

50

100

150

200

250

T u r k e y

R u s s i a

C r o a t

i a

R o m a n

i a

H u n g a r y

K a z a k

h s t a n

L i t h u a n i a

E s t o n

i a

U k r a i n e

L a t v i a

Loan/deposit ratio

0

10

20

30

40

50

60

70

80

90

B e l a r u s

R u s s i a

T u r k e y

M o l

d o v a

P o l a n

d

M a c e d o n

i a

R o m a n

i a

A l b a n

i a

U k r a i n e

S e r

b i a

H u n g a r y

B u l g a r i a

L i t h u a n i a

C r o a t

i a

L a t v i a

0

102030

405060708090

100

B e l a r u s

R u s s i a

T u r k e y

P o l a n

d

M o l

d o v a

U k r a i n e

M a c e d o n

i a

B u l g a r i a

R o m a n

i a

H u n g a r y

A l b a n

i a

S e r

b i a

L i t h u a n i a

C r o a t

i a

L a t v i a

Foreing currency loans to households

Foreign currency loans to corporatesIndexed

05

10152025

3035

404550

R u s s i a

K a z a k

h s t a n

T u r

k e y

S e r

b i a

B e l a r u s

P o l a n

d

M a c e d o n

i a

U k r a i n e

C r o a t

i a

B u l g a r i a

H u n g a r y

0

50

100

150

200

250

300ST external debt at remaining maturity, % GDP lhsST external debt at remaining maturity, % GIR, rhs

Source: Ecowin, IMF, Fitch Ratings


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Ukraine Macro Presentation Commerz