A dan­ger­ous eu­pho­ria

Re­newed growth will ex­haust its po­ten­tial in 2020 with noth­ing cre­ated to re­place it

The Ukrainian Week - - CONTENTS - Olek­sandr Kra­mar

On the po­ten­tial of re­newed growth in 2020

Ukraine’s econ­omy has been restor­ing fast in the past four years af­ter it plum­meted in 2014-2015 as a re­sult of Rus­sia’s ag­gres­sion. This restora­tion has not been lin­ear: some in­dus­tries and re­gions de­vel­oped faster, while oth­ers lagged be­hind. Still, the main in­di­ca­tors were ei­ther re­stored to the level of 2012-2013 or higher in 2019.

This pro­voked a very mis­lead­ing eu­pho­ria that has been espe­cially vis­i­ble since the change of gov­ern­ment. Am­bi­tious claims of 40% real GDP growth dur­ing the pres­i­dency of Volodymyr Ze­len­skiy; ex­pected eco­nomic growth be­tween 3.7% and 4.8% in the bud­get, de­pend­ing on dif­fer­ent sce­nar­ios, in 2020; a dis­cus­sion of threats from sharing the skin of an un­killed bear with ex­ter­nal len­ders ac­cord­ing to the terms of for­eign debt re­struc­tur­ing con­ducted in 2015 by then-Fi­nance Min­is­ter Natalia Jaresko — all th­ese man­i­fes­ta­tions of eu­pho­ria merely dis­tract the at­ten­tion from the ma­jor threat. It is quite likely that 2020 will be the end of the growth of all th­ese years. And main­tain­ing it with­out a dra­matic change of eco­nomic pol­icy will be im­pos­si­ble.

The down­ward spi­ral ex­pe­ri­ence seen in Ukraine in the past decades has proven more than once that short restora­tions are fol­lowed by se­ri­ous down­falls. For ex­am­ple, real GDP in 2013 and 2019, af­ter two pe­ri­ods of growth in 2010-2012 and 2016-2018, was lower than in 2007-2008, the cri­sis years.

This time, the end of re­stored growth ef­fect af­ter the 2014-2015 decline in Ukraine will likely layer over a se­ri­ous ex­ter­nal chal­lenge as the global econ­omy is ap­proach­ing yet an­other big cri­sis of the 2007-2009 scale.

An in­creas­ing num­ber of sig­nals point to this. In the US, in­dus­trial decline has ac­cel­er­ated to -1.1% an­nu­ally. In­dus­trial out­put in the euro­zone fell 1.7% in Septem­ber. GDP of Ger­many, its most pow­er­ful econ­omy, grew a mere 0.5% in Q3 com­pared to the same pe­riod of 2018. In Ja­pan, one of the world’s big­gest economies, GDP growth in Q3 slowed down to 0.2%. An­nual growth of in­dus­trial out­put in China fell 4.7% in Oc­to­ber 2018 com­pared to 5.8% in Oc­to­ber 2018, and re­tail sales fell to 7.2% com­pared to 7.8% in 2018. In­vest­ment in cap­i­tal as­sets hit the ab­so­lute min­i­mum since 1998.

THE ECON­OMY OF CAN­NI­BAL­ISM

Ukraine’s in­dus­trial out­put started fall­ing in Q2’2019 while eco­nomic ac­tiv­ity was mostly driven by bet­ter fig­ures from agri­cul­ture, con­struc­tion, pas­sen­ger trans­port, re­tail trade and dif­fer­ent ser­vices. Wages were still grow­ing fast in nom­i­nal and real terms. In 2020, th­ese fac­tors will be ex­hausted. Point­ing to the wors­en­ing sit­u­a­tion in the in­dus­trial sec­tor is the fact that the growth of pro­duc­ers’ prices has slowed down dra­mat­i­cally, hit­ting the low­est level since early 2014. A stronger hryv­nia and the in­flow of cheap im­ported goods to the vul­ner­a­ble do­mes­tic mar­ket will only ag­gra­vate this process.

Re­tail trade is the ben­e­fi­ciary of this for now as it has the op­por­tu­nity to max­i­mize the mar­gin be­tween buy­ing and sell­ing goods to fi­nal con­sumers who are now in a boom as con­sumer sen­ti­ment is the high­est in 12 years af­ter the cri­sis of 2008-2009.

Still, the gap be­tween con­sumer lend­ing and bank lend­ing to com­pa­nies grew through­out 2019. Con­sumer lend­ing had pos­i­tive dy­nam­ics, grow­ing from UAH 203.7bn to UAH 212.5bn, while lend­ing to com­pa­nies shrank from UAH 88.53bn to UAH 765.9bn over the same pe­riod. Growth rate for de­posits ac­cu­mu­lated by busi­nesses on bank ac­counts ex­ceeded growth pace of de­posits from the pop­u­la­tion by fall. For ex­am­ple, de­posits by in­di­vid­u­als grew from UAH 528.9bn in Septem­ber 2018 to UAH 540bn in Septem­ber 2019, while non-fi­nan­cial cor­po­ra­tions de­posited UAH 365.4bn in Septem­ber 2019 com­pared to UAH 333bn in Septem­ber 2018.

This is be­cause of the dou­ble gap in prof­itabil­ity be­tween con­sumer loans and loans to the busi­ness, and this gap keeps grow­ing. While con­sumer loans were is­sued at an av­er­age of 35.5% in Septem­ber 2019 (com­pared to 32% in Septem­ber 2018), com­pa­nies were lent money at 17.7% in hryv­nia (com­pared to 19.8% in Septem­ber 2018). Mean­while, the cit­i­zens are driven by con­sumer ex­cite­ment and do not want to save even as de­posit in­ter­est rates grow rapidly from 10.6% in Septem­ber 2018 to 14.5% in Septem­ber 2019. In­ter­est rates for loans to busi­nesses is lower at 13%, un­changed since Septem­ber 2018.

It is in­creas­ingly ob­vi­ous that the lend­ing sys­tem works up­side down. In­stead of lend­ing to busi­ness devel­op­ment at the cost of in­di­vid­ual de­posits, it funds con­sumer loans – mostly for im­ported goods – us­ing the de­posits ac­cu­mu­lated by com­pa­nies. This lays a time bomb un­der eco­nomic growth in the fu­ture and man­i­fests it­self in a steep decline of in­vest­ment in key in­dus­tries. More­over, this ce­ments the econ­omy of con­sum­ing its cur­rent po­ten­tial in­stead of de­vel­op­ing it.

PARTY OVER

Mean­while, the con­di­tions are ripe for a steep decline of con­sumer de­mand. This will hit re­tail trade and ser­vices hard.

In the past few years, it has been driven by the ro­bust growth of pub­lic spend­ing, in­clud­ing pay­ments to peo­ple em­ployed in gov­ern­ment-funded seg­ments (see The lost driver of growth), pen­sion­ers and other re­cip­i­ents of

THE DOWN­WARD SPI­RAL EX­PE­RI­ENCE SEEN IN UKRAINE IN THE PAST DECADES HAS PROVEN MORE THAN ONCE THAT SHORT RESTORA­TIONS

ARE FOL­LOWED BY SE­RI­OUS DOWN­FALLS. FOR EX­AM­PLE, REAL GDP IN 2013 AND 2019, AF­TER TWO PE­RI­ODS OF GROWTH IN 2010-2012 AND 20162018, WAS LOWER THAN IN 2007-2008, THE CRI­SIS YEARS

so­cial ben­e­fits. Rapid growth of la­bor migration in 20162018 is an­other con­trib­u­tor. Per­sonal in­come tax be­came the main source of rev­enues to the bud­get. For ex­am­ple, it grew to UAH 8.9bn in Septem­ber 2019 com­pared to UAH 7.5bn in Septem­ber 2018, while cor­po­rate in­come tax al­most halved from UAH 2bn to UAH 1.2bn over that pe­riod. VAT grew only slightly from UAH 31.1bn to UAH 32.2bn, while ex­cise duty in­creased from UAH 11bn to UAH 11.4bn.

Ac­cord­ing to the Na­tional Bank of Ukraine, the growth of per­sonal in­come and con­sumer de­mand in 2019 boosted pub­lic spend­ing on so­cial ben­e­fits from UAH 115.3bn in the first three quar­ters of 2018 to UAH 156.5bn in the same pe­riod of 2019 re­spec­tively. In Septem­ber 2019, wages in the ed­u­ca­tion sec­tor were 17.6% higher than in Septem­ber 2018 and 36.3% higher than in Septem­ber 2017. The in­crease in health­care was 21% and 42% re­spec­tively. The growth in civil ser­vice and de­fense was 16.5% and 53.2%. This growth hap­pened along­side slower in­fla­tion and a stronger hryv­nia com­pared to the key cur­ren­cies in Septem­ber 2019 com­pared to Septem­ber 2017, fu­el­ing steep growth of con­sump­tion and re­ju­ve­nat­ing trade and ser­vices.

Yet, the 2020 bud­get shows that most con­trib­u­tors to that eco­nomic growth re­sult­ing from do­mes­tic con­sump­tion will wear out. Wages in the key sec­tors are in­dexed at the level that is slightly above in­fla­tion and two-three times be­low the lev­els of 2017-2019. As a re­sult of hryv­nia reval­u­a­tion, the hryv­nia equiv­a­lent of trans­fers from la­bor mi­grants will shrink and nom­i­nal wages in the pro­duc­tion sec­tor will grow slower as Ukrainian pro­duc­ers grow less com­pet­i­tive com­pared to their for­eign peers. This will in­evitably un­der­mine con­sumer de­mand and hit growth in the sec­tors linked to ser­vices – from trans­porta­tion to ev­ery­day ser­vices. As a re­sult, this will also hit the in­come of peo­ple em­ployed in th­ese sec­tors.

THE WORLD WON’T HELP

The sit­u­a­tion on the global com­modi­ties mar­kets keeps de­te­ri­o­rat­ing. Prices of steel and iron ore are fall­ing, even if grains have risen some­what. And Ukraine is ex­haust­ing its ca­pac­ity to in­crease ex­ports of com­modi­ties. In 10 months of 2019 avail­able when this ar­ti­cle was writ­ten, com­modi­ties ex­port growth slowed down to 7.4% com­pared to 10.3% and 20.9% in the same pe­riod of 2018 and 2017. This is de­spite the un­ex­pect­edly record-break­ing har­vest of 2019.

Mean­while, out­put in agri­cul­ture has been grow­ing for two years al­ready. In 10 months of 2019, the in­dus­try’s out­put was 12.6% higher than in the same pe­riod of 2017. Col­lec­tion of grain grew from 61.2mn t in 2017 to 70.1mn t in 2018 and 75mn t in 2019, while crop yield in­creased from 4.25 t per hectare in 2017 to 4.9 t per hectare in 2019. This growth is nor­mally fol­lowed by a back­slide, at least for plants as crops de­te­ri­o­rate for nat­u­ral rea­sons. The devel­op­ment of Ukrainian agri­cul­ture over the past two decades shows this, and so does agri­cul­tural pro­duc­tion of most other pro­duc­ers in the world.

In ad­di­tion to that, in­vest­ment in the agri­cul­tural sec­tor have been de­clin­ing lately af­ter their growth peaked in 2015-2017 en­sur­ing two record-break­ing years in a row in 2018 and 2019. While cap­i­tal in­vest­ment in the in­dus­try grew 26.1% in 2015, 51.4% in 2016 and 31.2% in 2017, it fell to just 8.5% in 2018, and was down by 8.2% af­ter H1’2019 com­pared to the same pe­riod of 2018, ac­cord­ing to the lat­est data avail­able. As a re­sult, cap­i­tal in­vest­ment into agri­cul­ture in H1’2019 proved lower than they were in H1’2017.

Ukraine’s agri­cul­ture will likely pause in 2020 as a driver of eco­nomic growth or se­ri­ously go into neg­a­tive growth ter­ri­tory, pulling down all of Ukraine’s econ­omy that re­lies on it lately. With fur­ther stag­na­tion or down­fall of prices on global mar­kets for com­modi­ties and steel in 2020, Ukraine will hardly ex­port more com­modi­ties and goods than it did in 2019. Espe­cially as Ukrainian non­com­mod­ity goods are grow­ing less com­pet­i­tive with a stronger hryv­nia in the pe­riod of trade and cur­rency wars in the world.

The prospects of growth for Ukrainian ser­vices are un­clear too. Firstly, just like with ex­ports of goods, ex­ports of ser­vices have been slow­ing down in re­cent years. It was 4.8% af­ter three quar­ters of 2019 com­pared to 11.6% and 11.2% in the same pe­ri­ods of 2018 and 2017. Se­condly, the prospects of gas tran­sit, one of the big­gest items in Ukrainian ex­ports of ser­vices, re­main un­cer­tain. It is likely to lose a dou­ble-digit per­cent­age com­pared to 2019 with the launch of the Turk­ish Stream that will meet the needs of Turkey first and fore­most, as well as other South­East­ern Eu­ro­pean coun­tries.

Rev­enues may fall from the main tran­sit to the EU. Even if tran­sit via Ukrainian pipe­lines does not stop as the launch of Nord Stream 2 fails by the end of 2020, the like­li­hood of a more or less last­ing halt in the tran­sit re­mains high. Ukraine should also ex­pect that the EU buys lower amounts of Rus­sian gas as its stor­age fa­cil­i­ties were filled this year in ex­pec­ta­tion of pos­si­ble break­downs as a re­sult of a Rus­sia-Ukraine gas war.

In this en­vi­ron­ment, the “gu­rus of econ­omy” promised by the new Pres­i­dent bet on squeez­ing do­mes­tic de­mand via aus­ter­ity bud­get in­stead of anti-cy­cle mea­sures to stim­u­late the econ­omy and pro­tec­tion mech­a­nisms for do­mes­tic pro­duc­ers nec­es­sary in the sit­u­a­tion where the fight for mar­kets in the world in­ten­sify. They en­cour­age the in­flow of con­sumer im­ports to Ukraine, un­der­min­ing the com­pet­i­tive­ness of Ukrainian pro­duc­ers by strength­en­ing the hryv­nia and pre­serv­ing a min­i­mum tar­iff pro­tec­tion for the do­mes­tic mar­ket. Their way to com­pen­sate for this is via more debts and mas­sive sell­out of as­sets via pri­va­ti­za­tion of en­ter­prises and sale of land to for­eign­ers.

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