Ukraine advances but still faces big challenges
Ukraine advances but still faces big challenges
Last year’s asset rally continues but investors should demand more progress on reform
MARCH 22, 2017 by: Chris Weafer
Ukraine equity indices and debt prices were among the best performing in the world last year with, for example, the euro-denominated WIG-Ukraine Index up more than 40 per cent while the MSCI EM Index gained just under 9 per cent. This year, the positive momentum has continued with the WIG-Ukraine and the UX index of Kiev-listed stocks up almost 20 per cent each.
The MSCI EM Index is up just under 10 per cent. Sovereign debt yields have settled close to 9 per cent and look stuck after the finance minister indicated the government may test investor sentiment with a $500m eurobond later this year with an indicated yield of 9 per cent. The question investors have to ask themselves after such a strong run is whether it is nearing an end or whether the indices have more to give? With any emerging market, this question comes down to two factors: positive economic predictability and political stability. If an economy can demonstrate both of these that is usually a positive backdrop for continued strong relative performance within the asset class at least.
So, where are we with regard to those factors in Ukraine? On the economic front the story is generally positive, albeit facing into more headwinds this year. Last year, the pace of economic growth picked up steadily as the year progressed. The fourth quarter was the strongest, with GDP rising 4.7 per cent, helping the full-year result reach 2.2 per cent. That was a considerable improvement over the near 10 per cent contraction of 2015 and also better than predictions made earlier in the year. The big drivers of headline growth were agriculture, which saw a near 30 per cent increase in grain production and a big boost to food exports to the EU; retail spending, which recovered from a 20 per cent collapse in 2015; and the manufacturing sector, which is benefiting from more competitive economic conditions as a result of the 12 per cent fall in the value of the hryvnia last year.
The economy has started the year strongly on the back of a further boost to consumer spending. In January, the government doubled the minimum wage for almost 4m workers, and that helped boost overall real wages by 21 per cent year on year. The downside is that the pace of inflation has picked up, to almost 13 per cent annualised, and the next rate cut by the National Bank is probably delayed until midyear. But, in general, the economy looks in good shape and should support good earnings growth in stocks in the agriculture, manufacturing and consumer sectors again this year. The main area of concern is politics. Public frustration with the slow pace of reform and, in some areas, the lack of it has sent the approval rating of the president and the ruling coalition to the lowest point since the elections. But the opposition leaders and their parties, which had picked up support last year, have also seen a big drop in public approval. Almost two-thirds of people asked in a recent survey said they did not have a positive opinion about any politician or party. Hopefully, that message will act as a spur for a more serious approach to reform, although the next election is not scheduled until 2019.
For investors there are four key areas that, depending on how they are resolved, will be critical determinants of how the markets and the hryvnia perform this year:
• The highly respected governor of the National Bank of Ukraine has effectively challenged the government to support her in actions she is taking against two oligarch-owned banks. If she does not get that support, it is reported, she will resign. That would hurt investor confidence.
• The big test of the reform process may come with land reform legislation expected to go before the Rada in May. This will be fiercely opposed by nationalist and vested interest groups and, if passed, will give a significant boost to agriculture and to the overall economy
• The NBU is already warning that a blockade of goods on the border with Donbass may soon affect the economy if power cuts, as a result of coal shortages, become widespread. This issue has become highly politicised and a mis-step could cost growth and endanger political stability.
• The clean-up of the banking sector is well progressed and the NBU has done a great job to date. But the sector is fragile and needs to be more transparent in terms of connected parties and non-performing loans. It is also clear that the Russian-owned banks have no future in Ukraine. But they account for 9 per cent of the banking sector so how this problem is addressed will be a big challenge. There is little doubt that Ukraine is one of the best long-term stories for investors. Despite the challenges and setbacks it is making progress and has a considerable amount of value to unlock, especially when the association agreement with the EU comes into force. Meanwhile, after such a strong march forward we are more likely to see a few steps sideways in 2017.
Chris Weafer is senior partner at Macro-Advisory, a Moscow-based consultancy. @beyondbrics