Economic & Risks Monitoring Review. Highlights. Monthly. Issue 14 November Analyst: Dimitry Sologoub

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1 Economic & Risks Monitoring Review Monthly Issue 14 November 28 Highlights 2 GDP growth and inflation Ukraine got USD 16.4 bn loan from the IMF to finance external financing gap. 2 1 The exit of foreign portfolio investors, the confidence crisis in the banking sector and falling export proceeds triggered large-scale hryvnia depreciation. 1 Industrial output contracted by 2 yoy in October due to production slump in the key industries e 29f GDP Inflation, eop Consumer prices grew 1.7 in October mostly driven by administrative tariff increases and seasonal hike in food prices. The confidence crisis in the banking system triggered a deposit run and hampered credit growth. Source: State Statistics Committee, RB Aval Research Ukraine: Key economic figures and forecasts e 29f Real Sector GDP (UAH bn) GDP (USD bn) Ukraine: Sovereign ratings LCY rating S&P Moody's Fitch Long-term B+ B1 B+ Short-term B --- Outlook Negative Stable Negative FCY rating Long-term B B1 B+ Short-term B B Outlook Negative Stable Negative Latest assessment Source: Reuters, Cbonds GDP ( yoy) * Domestic demand ( yoy) Terms of trade ( yoy) CPI (avg, yoy) CPI (eop, yoy) PPI (eop, yoy) Real disposable income ( yoy) n/a n/a External Sector C/A Balance ( of GDP) * FDI (USD bn) Monetary Sector Base money ( yoy) Broad money ( yoy) USD/UAH (eop) Analyst: Dimitry Sologoub dmytro.sologub@aval.ua USD/UAH (avg) * EUR/UAH (avg) * Fiscal Sector Fiscal balance ( of GDP) Public debt ( of GDP) * Under revision Source: State Statistics Committee, National Bank of Ukraine, Ministry of Finance, RB Aval Research 1

2 Politics N ov -6 D ec -6 J an-7 M ar-7 Apr-7 J un-7 J ul-7 CDS spreads Aug-7 O c t-7 N ov -7 D ec -7 J an-8 M ar-8 Apr-8 J un-8 J ul-8 Aug-8 RUSSIA HUNGARY POLAND ROMANIA UKRAINE Source: Reuters (GFI group) GDP and industrial output growth (cumulative) 1Q2 2Q2 3Q2 4Q2 1Q26 2Q26 GDP Source: State Statistics Committee Meta llurgy 3Q26 4Q26 1Q27 2Q27 3Q27 Industrial output Industrial output growth in selected industries Machine building Constr materials Chemical Ene rgy Jan-Oct 28 Source: State Statistics Committee O c t-8 N ov -8 4Q27 1Q28 2Q28 3Q28 Oct-28 Food industry Snap parliamentary elections are postponed due to the economic turbulences. A few weeks after calling for snap parliamentary elections the President has temporarily suspended his decree due to the sharply worsening economic situation. So far no new date for the elections has been announced (the earliest possible date at the moment is late January next year). It is obvious that the elections would be extremely harmful in the current economic environment. Moreover, it looks like early elections will not bring substantial benefits to the main political players, while their financial resources are severely constrained at the moment given difficult economic situation. Therefore, we believe the chances for snap parliamentary elections are falling. Nevertheless, the political situation is likely to remain unstable until the next round of presidential elections scheduled for early 21. Macroeconomic Situation Sharp deterioration of the economic situation resulted in hryvnia depreciation, households run on deposits and urged the authorities to seek an emergency financing from the IMF. Consequently, on November IMF Management and Executive Board approved a 24-month USD 16.4 bn stand-by arrangement for Ukraine. The first tranche of USD 4. bn has already been disbursed. The IMF Program is designed to help the authorities to stabilize the economy against the background of deteriorating external position (due to the falling prices for Ukraine s major exports steel and chemicals and blocked access to the external financing) and domestic crisis of confidence. Under the loan agreement the authorities committed to implement a number of policy measures, namely the transition to flexible exchange rate regime (including a change in the methodology of official exchange rate calculation - it will be defined as the preceding day's interbank market exchange rate), the establishment of a recapitalization mechanism for banks, the adoption of deficit-free budget for the next year, an increase in maximal deposit insurance coverage, a freeze in real terms of public wages, pensions and other social payments. To fulfill the IMF program requirements, the Ukrainian Parliament has adopted the law on anti-crisis measures that accounts for most of the IMF recommendations. We see several positive effects from the adoption of the anti-crisis law. First, it demonstrates the ability of Ukrainian politicians to make necessary and painful decisions in the face of economic crisis despite ongoing political turmoil. Second, it opens the door for IMF loan, which will probably allow to sustain Ukraine s external position in The loan volume amounts to 4- of Ukraine s necessary external financing for the next four quarters (defined as short term debt, maturing long term liabilities and expected C/A deficit net of corporate short-term trade finance and parent funding of foreign owned banks). Finally, we welcome the introduction of such measures as banks recapitalization mechanism, the increase of guarantees on deposits, tighter fiscal policy, and the changes in NBU profit transfer rule. Country risk indicators benefited from the news on IMF program and adoption of anti-crisis law. The y CDS spread level decreased to 1 basis points from its peak of 28bp. Although the absolute level is still several times higher than for its western neighbors, the reversal of the trend marks an end to the recent panic. 2

3 Real Sector Inflation, yoy Jan-4 May-4 Sep-4 Jan- May- Sep- Jan-6 May-6 Sep-6 Jan-7 May-7 Sep-7 Jan-8 May-8 Sep-8-1 CPI Food prices PPI Source: State Statistics Committee, RB Aval Research Food prices growth, eop Jan-4 May-4 Sep-4 Jan- May- Sep- Jan-6 May-6 Sep-6 Jan-7 May-7 Sep-7 Jan-8 May-8 Sep-8 Bread Meat Diary products Fruits Source: State Statistics Committee, RB Aval Research Index of producer prices in steel industry M ar-8 J un-8 J ul-8 Aug-8 Sep-8 O c t-8 Source: State Statistics Committee, RB Aval Research Industrial output contracted by 2 yoy in October due to production slump in the key industries. As a result, cumulative growth rate fell from.1 in Jan-Sep to 2.2 in Jan-Oct. The nose-dive in global commodities prices (accompanied by the large fall in demand for Ukrainian exports) and frozen credit activity pushed the producers to cut their output substantially. In October the output fell in all industries except for wood production and pulp and paper industry. The most severe contraction was observed in the production of coke and petroleum products and steel industry (43.9 yoy and 3.6 yoy decline respectively). The output in machine building industry has fallen for the first time in the last 6 years (11.2 yoy) that might be related not only to the domestic factors but also signal on the lowering demand from Russia for Ukrainian machinery. In our opinion, production in the key industries is not likely to revive in the next few months, thus industrial output growth will be negative this year. Following severe output fall in the key industries GDP growth has sharply decelerated in October. GDP fell 2.1 in real terms in October (comparing to Oct-27), while cumulative growth rate declined from 6.9 in Jan-Sep to.8 in Jan-Oct. Given our expectations of further decline in industrial output, GDP growth rate is likely to fall further as well in the rest of the year. According to our revised projections, GDP will grow 4.2 in 28. Consumer prices grew 1.7 in October mostly driven by administrative tariff increases and seasonal hike in food prices. Yoy CPI growth rate stands at 23.2 as of end-october (falling from 24.6 at end-september). Bountiful harvest and lowering demand pressures had a downward effect on prices for key food products bread prices grew just.1 in October, while yoy growth rate fell from 39.1 at end-june to 33.9 at the moment. Meat prices fell by.6 in October (after zero growth in September) and their yoy growth rate fell from 4.3 to 3.9 in July-Oct. Following the usual seasonal pattern, the prices for diary products and fruits shot up last month (.6 and 3. mom growth respectively) explaining nearly 3 of CPI increase. Another major contribution to CPI growth in October came from administrative tariff increases the upward adjustment of communal, transport, and communication tariffs accounted for 4 of consumer prices growth. Tariff increases are expected to be the main driving force of CPI growth for the rest of the year given fourfold increase in transport tariffs in Kiev in November and forthcoming (on 1 December) 3 increase in retail gas tariffs. Moreover, consumer prices growth will also be fuelled by 2 UAH depreciation in Sep-Oct that will drive up the prices of imported goods (according to our estimates, the share of imported goods in CPI basket constitutes about 1-2). Therefore, we expect inflation rate to end up around 23 in 28. Producer prices are falling for the second month in a row due to tumbling commodity prices on the global scale. PPI fell by 1.4 on a monthly basis in October (after 1.8 decrease in September). As a result, yoy PPI growth rate fell from its peak of 47 (at end-august) to currently Against the background of nose-dive in global commodity prices, domestic producer prices in oil processing, chemical and steel industries fell by.7, 8.3 and 9.9 respectively in October. Producer prices in steel industry fell by 1 in the last two months, however, given skyrocketing growth in the previous months, year-to-date prices growth rate in this sector is still extremely high 42. as of end-october. 3

4 External Sector Q24 Goods' export and import growth (qoq) 2Q24 3Q24 4Q24 1Q2 2Q2 3Q2 4Q2 1Q26 Export 2Q26 3Q26 4Q26 1Q27 2Q27 3Q27 4Q27 Import Source: National Bank of Ukraine, RB Aval Research UAH exchange rate 1Q28 2Q28 3Q28 Jan-8 Feb-8 Mar-8 Apr-8 May -8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov -8 USD/UAH USD/UAH NBU Fixing EUR/UAH (r.h.s.) Source: Reuters Emerging market currencies depreciation vs USD, October Year-to-date (till Nov 12) RAND (South Africa) LIRA (Turkey LEU(Romania) FORINT (Hungary) REAL (Brazil) ZLOTY (Poland) HRYVNIA (Ukraine) KORUNA (Czech Rep) ROUBLE (Russia) Source: Reuters Balance of payments surplus has risen from USD 2.3 bn in H1 28 to USD 6.3 bn in Jan-Sep thanks to strong capital inflows and seasonal boost in the grain exports. In the 3 rd quarter of 28 goods export growth rate (quarter-on-quarter) exceeded import growth rate (67.4 and 62 respectively) thanks to the large grain exports, surge in global steel prices in the summer months, and seasonally lower energy imports. As a result, the deficit of merchandise trade balance in the 3 rd quarter constituted USD 3.7 bn (compared to USD 4.6 bn and USD 4.1 bn in the 1 st and 2 nd quarters respectively). In Jan-Sep 28 the current account deficit constituted USD 8. bn (.8 of GDP). At the same time, capital inflows are still booming: in Jan-Sep net FDI inflow grew 18 in yoy terms (and reached USD 8.9 bn), while the volume of long-term foreign borrowings (net) has risen by 68 (USD 12.9 bn inflow in Jan-Sep). However, we expect the balance of payments surplus to shrink substantially in the last quarter due to fall in global steel prices, seasonal hike in energy imports, and blocked access to the external financing. According to our projections, current account deficit in 28 will constitute USD 13. bn (7.2 of GDP), while overall balance of payments will still be in surplus around USD 1-1. bn. Monetary and Exchange Rate Policy The exit of foreign portfolio investors, the confidence crisis in the banking sector and falling export proceeds triggered largescale hryvnia depreciation. In October, the financial crisis hit the UAH, pushing the currency to an all-time low of USD/UAH 7. on 29 October. On the one hand, the Ukrainian currency (along with Polish zloty, Hungarian forint, and Turkish lira) fell a victim to the confidence crisis in emerging markets currencies spurred by investors flight to quality. On the other hand, a lack of transparency regarding the future exchange rate policy of the National Bank and concerns about the stability of the banking sector increased demand for foreign currency, while the decline in (export) metals prices and speculation on further depreciation dampened FX supply. Since 3 October, the NBU has changed its policy from limited, selective FX interventions, to the sale of unlimited quantities of USD, thereby successfully bringing the rate back to the intervention level of currently.78. In October the volume of NBU FX interventions constituted USD 4.1 bn, while gross international reserves fell from USD 37. bn to 31.9 bn (additional reserves loss of USD 1.4 bn was caused by large-scale dollar appreciation against other reserve currencies). To comply with the IMF program requirements, the National Bank changed its exchange rate policy: the official exchange rate and NBU intervention level were gradually brought closer to the market rate. At the same time, the NBU introduced a number of administrative restrictions on FX market operations (both on cash and non-cash) aiming at restoring the stability in the market and reducing exchange rate volatility. Specifically, the banks are obliged to sell cash FX at exchange rate not higher than official rate + 1., while the difference between cash purchase and sale rates should not exceed 3. To reduce pressure on the interbank FX market, the NBU introduced T+ rule for the conversion of repatriated investment income by non-residents and obliged residents to use purchased foreign currency within days. Finally, the National Bank changed operating rules of the interbank FX market. Banks are now obliged to pass all FX orders of clients directly to the marketplace (without netting of sell and buy orders). Thus, problems matching the orders arose and induced market participants to trade close to 4

5 4, 3, 2, 1, -1, -2, -3, -4, USD mn Jan- 6 Apr- 6 Jul-6 Oct- 6 FX market indicators Jan- 7 NBU interventions Apr- 7 Source: National Bank of Ukraine Jul-7 Oct- 7 Banking sector liquidity Jan- 8 Apr- 8 USD bn Jul-8 Oct- 8 Gross International Reserves J a n - 7 F e b - 7 M a r - 7 A p r- 7 M a y - 7 J u n - 7 J u l- 7 A ug - 7 S e p - 7 O c t- 7 N o v - 7 D e c - 7 J a n - 8 F e b - 8 M a r - 8 A p r- 8 M a y - 8 J u n - 8 J u l- 8 A ug - 8 S e p - 8 O c t- 8 J a n-4 UAH bn Obligatory bank reserves Deposit certificates Free liquidity Source: National Bank of Ukraine, RB Aval Research M a y -4 S e p-4 Base and broad money growth, yoy J a n- M a y - S e p- J a n-6 Base money M a y -6 Source: National Bank of Ukraine S e p-6 J a n-7 M a y -7 S e p-7 J a n-8 Broad money M a y S e p-8 the intervention level. It allowed to reduce the volatility of market exchange rate (it is now fluctuating in the narrow range of 4- kopecks while in October intra-day fluctuations reached 2-3 kopecks) but raised concerns at the excessive administrative regulation of the FX market. The run on deposits, blocked access to external financing and the hunt for the dollar (triggered by fast hryvnia depreciation) led to the dramatic fall in liquidity. After quite healthy levels in the first half of the month (UAH 2-22 bn) the total volume of banks correspondent accounts fell to UAH bn in late October early November virtually implying the meltdown of all free liquidity in the system. Consequently, money market rates shot up to 2-3. The National Bank has been very active in injecting liquidity into the system total turnover of refinancing operations constituted UAH 29.2 bn in October (3 of total turnover for 1 months of 28). Along with traditional overnight loans, the Central Bank has also provided substantial amount of long-term liquidity to the banking system via stabilization loans and regular refinancing facilities. Large-scale NBU refinancing operations and active spending policy of the government (in October the stock of government funds at the Single Treasury Account fell by 28) stimulated base money growth (it grew 1. mom, yoy growth rate stands at 33.2 at end-october). At the same time, broad money grew just.6 last month due to the large-scale deposit outflow. Financial Sector Domestic Debt Market In the third quarter we have witnessed unprecedented sell-off in the domestic debt market as foreign investors were rushing out of hryvnia assets against the background of investors exodus from emerging markets and skyrocketing country risk. As a result, most of foreign portfolio investors exited the market despite very attractive yields. Yields of bonds issued by some large Ukrainian banks jumped as high as 1-1 p.a., best credits have been traded at 3- p.a. Foreign investors were squeezed from three sides by internal problems (i.e. global financial market turmoil), by large costs of hryvnia risks hedging and skyrocketing country risk hedging costs. For example, following large-scale depreciation of USD/UAH spot exchange rate, forward rates jumped upwards as well (at the moment 3-month nondeliverable forward (NDF) USD/UAH rate stays at ), thus raising hryvnia hedging costs dramatically. At the same time, mounting worries on worsening economy and messy politics have resulted in an explosion-like rise of Ukraine s CDS. To hedge Ukrainian Y risk the one had to pay up to one third of underlying! At the moment domestic debt market is stuck between potential foreign sellers confusion about chaotic exchange rate changes and tight liquidity of potential Ukrainian buyers. Yield on the market are floating in wide range that opens opportunities for arbitrage. But only banks which are able to buy on own position can benefit from the current situation. Anyway, we believe markets have overpriced risks of Ukraine s default because the country will surely benefit from energy prices collapse and expected fall in import. National Bank of Ukraine has restarted purchases of government bonds after years of efforts to get rid of previously bought ones. In the beginning of November Ministry of Finance have sold government bonds for almost UAH 6 bn with yield of 1.6 (in previous 1 months the government attracted around UAH 1. bn at the domestic debt market). Given tight liquidity situation and very high

6 Government bond issues 3, UAH mn 18 3, , 12 2, 1 1, 8 6 1, 4 2 J an 8 F eb 8 M ar 8 Apr 8 M ay 8 J un 8 J ul 8 Aug 8 Sep 8 O c t 8 N ov 8 Amount sold Average Yield Source: Ministry of Finance CO and PI loans yoy growth rates J an-4 May -4 Sep-4 J an- May - Sep- J an-6 May -6 Sep-6 J an-7 May -7 Sep-7 J an-8 May -8 Sep-8 CO loans PI loans Source: National Bank of Ukraine CO and PI deposits yoy growth rates Dec -4 Mar- Jun- Sep- Dec - Mar-6 Jun-6 Sep-6 Dec -6 Mar-7 Jun-7 Sep-7 Dec -7 Mar-8 Jun-8 Sep-8 yields in the secondary market, we do not believe that this was a common market transaction. Instead, according to anecdotal evidence, it was a scheme of budget financing by the Central Bank, as these bonds were indirectly bought by the NBU. Banking Sector General Information and Market Structure As of end-september 28 there have been 181 banks operating in Ukraine, banks had foreign capital, and 18 of them were 1 foreign owned. The share of foreign capital in total capital of the banking system stands at 39.8 at end-september, while in terms of assets foreign-owned banks control more than of the market. Assets and Liabilities The confidence crisis in the banking system triggered a deposit run in October. Last month total deposits volume in the banking system fell by 2.3 causing yoy growth rate to fall from 37.1 to Against the background of Prominvestbank troubles, alleged rumours on possible problems in a number of other banks, and sharp hryvnia depreciation, private depositors ran to the banks to withdraw their funds and exchange them for USD or spend on durables. As a result, the total volume of household (PI) deposits fell by UAH 8.3 bn (4.1) in October including UAH 12.3 bn reduction in hryvnia PI deposits. FX household deposits grew UAH 4 bn, but in dollar terms they fell by nearly USD 1.8 bn last month (if we account for 18 hryvnia depreciation in October). According to the authorities, the situation has stabilized in the recent weeks as deposits started to flow in again. If the situation remains normal in the coming weeks the NBU may reportedly lift the moratorium on early deposit withdrawal in early December. The severe liquidity shortage and the NBU stabilization measures hampered credit growth in October. In hryvnia terms total loans portfolio of the banking system has risen by 9.3 in October (and yoy growth rate went up from 4 to 62). However, this is just a statistical effect caused by revaluation of FX loans following large-scale hryvnia depreciation last month. The volume of FX loans nominated in the national currency has risen by 17.4 in October, but declined in dollar terms by.9 (around USD. bn). So, given blocked access to foreign funding and the cap on FX loans to unhedged borrowers imposed by the NBU, the banks had to cut FX lending. The loans in the national currency grew just marginally (by.6) in October. Retail lending segment has apparently got a major hit as most of mortgage and consumer lending is frozen. The conditions on new mortgage loans reportedly have been tightened substantially the interest rates on hryvnia loans (no FX loans are disbursed) are revised upwards, loan-to-value ratios lowered from 7-8 to, while the requirements on income have been tightened as well. We expect slump in the credit activity to persist in the coming months against the background of tight liquidity situation and uncertain economic outlook. CO deposits PI deposits Source: National Bank of Ukraine 6

7 Economic & Risks Monitoring Review Monthly Acknowledgements This report was prepared by Raiffeisen Bank Aval on 17 th November 28 Raiffeisen Bank Aval 9, Leskova Str., 111 Kyiv, Ukraine Tel Fax Call center: 8 8 (toll free within Ukraine) Corporate Communications and Research Head: Angela Prigozhina ( ) Research Department: Dimitry Sologoub ( ), Ludmila Zagoruyko ( ) Treasury Head: Vladimir Kravchenko ( ) FX, MM & Securities: Alexander Deinega ( ), Yuriy Grinenko ( ), Nikolay Vysotsky ( ) Treasury Sales and Capital Markets Head: Roland Vizner ( ) Treasury Sales: Marina Lukashenko ( ), Alexander Korenev ( ), Tatiana Kornienko ( ), Larisa Kolesnikova ( ) Capital Markets: Sergii Shvets ( ), Alexey Evdokimov ( ), Oleg Klimas ( ), Galina Stoiko ( ), Nataliia Nazarenko ( ) Multinational Corporate Customers Head: Johannes Riepl ( ) Relationship Managers: Oksana Volchko ( ), Elvira Pylypenko ( ) This report does not constitute an offer or invitation to subscribe for or purchase any securities and neither this document nor anything contained herein shall form the basis of any form of contract or commitment whatsoever. This document is being furnished to you solely for your information. Unless otherwise stated, all views (including statements and forecasts) are solely those of Raiffeisen Bank Aval and are subject to change without notice. Any investment or other decision must not be made based on this document and RBAV makes no representation and warranty in respect of the reliability, accuracy or completeness of the information provided herein and takes no responsibility or liability for any loss or damage resulting from the use of this information. 7

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