Economy and politics

The Ukrainian Parliament has passed the 2009 budget on Friday, December 26, 2008. The bill was supported by 226 MPs, exactly the number needed to pass the budget.

While the exact text of the document is still pending, Parliament Speaker Volodymyr Lytvyn has reported that budget revenues have been increased by UAH 2 bln (USD 257 mln), compared to the earlier version of the budget, which failed to pass in Parliament on Thursday. The previous draft assumed UAH 237.6 bln (USD 30.5 bln) budget in revenues, which is 2.4% higher than budget revenues in 2008. Budget expenses were proposed to increase 4.9%, compared to this year’s budget, to UAH 265.6 bln (USD 34.1 bln). The previous version of the budget bill suggested a UAH 28 bln (USD 3.6 bln) budget deficit with a maximum permissible budget deficit of UAH 31 bln (USD 4.0 bln).

The proposed budget assumed GDP growth at 0.4% in 2009 and consumer inflation at 9.5%.

Our view: Sokrat was correct in its previous daily when predicting that the previous failure of the budget draft was a political decision and the budget will be passed through the Parliament soon.

As we view the government’s macroeconomic forecast as overly optimistic, we believe the accepted budget draft is hardly accomplishable, especially with respect to the part on revenues.

Sokrat anticipates a GDP decline of 6.5% in 2009 and inflation at 16.5%.

Late Christmas day State Statistics Committee of Ukraine announced that the average salary in Ukraine fell 4.9% MoM and the volume of delayed wages grew by 66.4%.

The average salary in Ukraine dropped to UAH 1,823 (USD 234). The highest average salary of UAH 3,140 (USD 403) was witnessed in the city of Kyiv, representing a 2.2% MoM decline, while the lowest average salary of UAH 1,410 (USD 181) was registered in Ternopil region , which represents a 0.7% MoM decline. Still, the average salary in Ukraine has grown 22.7% YoY.

Sector-wise, the highest average salary of UAH 4,471 (USD 574) was in aviation, representing a growth of 0.1%. The lowest average salary of UAH 1,036 (USD 133) was in the textile industry, representing a 5.2% decline. The greatest MoM decline of 18.7% occurred in the transport machinery sector, where the average salary dropped UAH 1,656 (USD 213). The biggest MoM growth of 13.3% was observed in fisheries, where the average salary grew to UAH 1,103 (USD 142).

At the same time, the volume of delayed salaries grew 66.4% MoM, thus reaching UAH 1,737 mln (USD 223 mln). The biggest deficit was registered in Donetsk region (UAH 499 mln or USD 64 mln), Luhansk region (UAH 224 mln or USD 29 mln), and Kharkiv region (UAH 124 mln or USD 16 mln).

Sector-wise, the biggest MoM growth in the wage deficit was observed in forestry (326.2%), transportation and communications (204.9%), and education (137%).

Our view: We see a drop in average wages and an increase in the volume of delayed wages as a consequence of the unwinding economic downturn in the country, as industrial output and GDP continues to demonstrate negative dynamics in the past few months. Industrial output fell 15.2% MoM and 28.6% YoY in November, as GDP declined by 14.4% YoY, with the pessimistic trend expected to continue until at least 2Q09. As the current and anticipated revenues of Ukrainian companies decline, employers have decided to cut existing salaries and delay wage payments.

We also believe that part of these negative wage statistics is a result of employers deciding to pay wages unofficially, thus saving on tax payments.

The recently-announced increase in official unemployment figures is an additional factor of the real sector’s influence on the labor market.

Notably, the strategically important metallurgical sector demonstrated a higher than average salary decline at 12.8%, on average, as some of metallurgical companies announced they would scale down operations to a 24-hour working week.

Overall, we anticipate an increase in unemployment in 1Q09, the further decline of official salaries, and an increase of debt. We anticipate that the Ukrainian economy will soon enter a recession, which will continue until 3Q09, and that the economic situation will be highly vulnerable with respect to the global steel market and negotiations about the price for imported natural gas.

Ukraine’s Parliament has failed to pass the 2009 draft budget proposed by the government. The draft budget proposed expenses of UAH 265.6 bln (USD 34.1 bln) and profits of UAH 237.5 bln (USD 30.5 bln). The project was supported by 223 MPs while 226 votes were needed for this bill to pass.

Previously, in September 2008, the government had proposed a budget with UAH 302.2 bln in expenses and UAH 288.1 bln in profits. In November 2008, however, the government retracted that draft budget in order to revise it, taking the global financial crisis into consideration.

Our view: We view the current draft budget’s failure as an outcome of politically-driven voting. At the moment, tensions in Parliament are high enough to potentially lead to the dismissal of current Prime Minister Yulia Tymoshenko.

While we believe that the budget that will eventually be accepted will not differ much from the one that failed yesterday and that Yulia Tymoshenko will stay in power until at least spring, we anticipate that extensive negotiations with opposition forces will be required before the budget is finally accepted. Overall, we believe that the government will make every possible effort not to leave power amidst this economic downturn, especially given the potentially negative influence of such a movement on Tymoshenko’s rating just a year before the Presidential elections.

We also allow for the possibility that current Minister of Finance Viktor Pynzenyk will resign, as he made statements on a number of occasions that he disagrees with the current policy of the government and since the failure of the state budget may be the last step towards his resignation. While we do not exclude such a possibility, we do not view the odds of this happening to be significantly high.

The Ukrainian Parliament has passed a bill that temporarily imposes an additional 13% tariff on all imports except critical imports (to be defined by the government). The bill was supported by 269 MPs from the governing coalition and Communist Party. The bill is to stay in force for six months with a possible six-month extension. While the exact list of critical imports is pending, MPs have banned frozen beef, all types of pork, meat products, canned seafood and liquors from the critical imports listing. The critical imports will also not include coal, some categories of textiles, nor machinery products, including cars and trucks.

Officials have confirmed that the measures were coordinated with the IMF and WTO and are aimed at straightening out Ukraine’s trade balance and increasing budget profits as Ukraine anticipates entering a recession in 2009.

An earlier reported figure for the trade balance in January-October 2008 is negative USD 14 bln, constituting a 19.6% YoY increase. It was also announced that, due to the global financial crisis, the financial account balance was negative in January-October, causing a double deficit.

Our view: We believe that the bill will somewhat suppress imports and, thus, stimulate domestic production and will, overall, be beneficial for the Ukrainian balance of payments. We also anticipate that the devaluation of the UAH in late 2008 – early 2009 will be also support straightening out Ukraine’s trade balance.

Nevertheless, we recognize that the main determinant of the trade balance deficit – imported oil and natural gas – will be most likely be included in the list of critical imports and will not be a subject of tariff increase. However, we expect that the bill may somewhat improve the trade balance in other sectors of the economy, including food production, machinery and the textile industry. In addition to improving the balance of payments, the bill will also spur demand for domestically-produced goods, thus supporting domestic producers, which may be the right step to make on the part of the government as we anticipate an overall curb of Ukrainians’ purchasing power that will trigger a downturn in consumer demand. The bill, therefore, will counteract the negative impact of a purchasing power drop and will support Ukrainian producers.

In our view, such agricultural companies as sugar producers (e.g. Astarta, Ukrros) and companies involved in cattle, pig-breeding and poultry (e.g. MHP) will benefit the most from the bill. Besides, according to our estimates, Ukrainian poultry producers will be able to fully cover the domestic demand for poultry in 2009. We also hold a positive view with respect to local motor vehicle producers (e.g. LUAZ and UkrAvto). An increase in import duties on foreign cars, together with the virtual end of retail loans programs focusing on the car segment, will be a supporting factor for local vehicle manufacturers. Besides sectors above we think that local household appliance (NORD) will receive benefits.

Overall, we view the bill as a timely and appropriate step, leading to a triple dividend of improving the balance of payments, supporting domestic producers, and increasing budget profits in 2009.

The gross external debt grew 42.0% or USD 31.2 bln between October 2007 and October 2009 and reached USD 105.4 bln.

The sovereign debt grew 6.8% and reached USD 14.2 bln. The external debt of the banking sector grew 63.2% and reached USD 42.1 bln. The external debt of other sectors grew 40.2%, reaching USD 44.3 bln.

Our view: We view the modest dynamics of the sovereign debt as somewhat comforting in light of the anticipated drop of Ukraine’s foreign reserves in 2009 that were spent on supporting the UAH and the Ukrainian banking system. The foreign reserves of Ukraine remain above USD 30 bln, which, coupled with the outstanding balance of 11.9 bln of the IMF standby loan, will suffice to allow for coverage of the sovereign debt.

We further view the currency reserves of the banking system as fully sufficient to cover the banking system’s foreign debts. Additionally, we see most of the foreign debt accumulated in the banking system falling on those banks that are affiliates of foreign banks, which can provide support for their daughter banks denominated in foreign currency, decreasing their sensitivity to the UAH’s devaluation.

We find companies in the real sector of the Ukrainian economy as the potential victims of the increased foreign debt. We further view those companies oriented towards the domestic market as the most vulnerable to their foreign debt increase given the unprecedented UAH devaluation. Nevertheless, we still view the Ukrainian real sector’s Eurobonds issuers, such as Interpipe (INPIP), Azovstal (AZOVTL) and Mironivskiy hliboprodukt (MHPSA) as fully capable of servicing their foreign debt, as these companies export much of their output. At this point, we would like to recommend treating another real sector Eurobond issuer – Naftogaz Ukrayiny (NAFTA) – with caution as we believe that its default risks and vulnerability to the currency risks are higher than those for other Ukrainian Eurobonds with a similar yield.