Fall economy 2013 – bet of hryvnia depreciation

Макроэкономика 01.10.2013 A fiscal crisis, coupled with a continued foreign currency deficit, outlines another season of elevated risks for Ukraine. The potential for improving trade and fiscal balances looks elusive in view of QE3 tapering plans, the trade conflict with Russia and cooling domestic demand. With a recent sovereign debt rating downgrade, attracting a new public loan looks to be not an option for the government. What’s more, Ukraine did little this year to renew IMF cooperation. We bet on depreciation starting to unfold already in the coming two months, thus seeing a high risk related to investments into UAH-denominated papers. The trade balance will expand sharply in 2H13 on the back of increased natural gas imports. At the year’s start, trade statistics improved due to delayed gas imports. However, the government has scheduled for 2H13 a minimum 60% h/h increase in gas purchases. We project the current account (C/A) deficit at USD 14.8 bln (flat yoy, 8.8% of GDP). Gross reserves will decrease to the USD 20 bln mark by the year end, in the best-case scenario. National Bank of Ukraine (NBU) reserves declined USD 3.6 bln in May-August to UAH 21.65 bln, or 2.4 months of imports, caused by external debt redemptions and closed access to external markets. We see further gross reserves declines as inevitable, with anticipated seasonal upsurge in individual demand for dollars and a rising energy bill, against the background of continued redemptions to the IMF through the fall. We see this pressure on NBU reserves and the currency will peak in October-November, and point there is a high probability that the hryvnia will start depreciating very soon. Our estimates show that nearly a 20% depreciation is needed to balance external accounts, but our base-case scenario now is the hryvnia will lose no more than 10% to trade at 8.5-8.8/USD by end-2013. No visible progress on renewed IMF cooperation is another factor that discourages potential lenders to Ukraine and plays in favor of a devaluation scenario. Yet we see a high chance the IMF program will resume as soon as our devaluation bet works out (which the government will demonstrate as an eased ForEx market control). In turn, we expect some improvement in trade accounts in 1H14 (on high grain exports), which coupled with possible IMF support will allow the government to consider a national currency revaluation option – a vital step for the president to gain political support on the eve of his re-election campaign.