August 31, 2015

This week in focus: No growth drivers

Plunge in Ukraines industrial production slowed to -13.4% y/y last month, as compared to -18.8% y/y in Jun 2015. Apart of that, drop in retail sales slowed to -22.1% y/y (-24.0% in the previous month), while agricultural output grew by 1.9% y/y last month (following a -17.2% y/y drop reported in Jun 2015). All Jul data is in line with our expectations. Looking ahead, we therefore retain our 3Q GDP forecast at -11.0% y/y (annual forecast is also maintained at -13.6%). While the overall economic activity appears to have reached its bottom, favorable comparison base will stay the main driver, however, with no real growth drivers in sight. On top of the domestic drawbacks (weak institutional environment, security issues, restricted credit), further headwinds may also stem from outside Ukraine, which include Chinas slowdown and threats by Russia to impose a ban on its food imports from Ukraine. 

Currency market: Most of FX controls likely to be retained

USD/UAH retreated to 21 on by end Friday. Local currency strengthening was driven by large FX offerings (export proceeds) in the 2H of the week, however, rather than improved moods following the announcement on the debt restructuring deal. Central banks capital and FX restrictions (Regulation #354) expire this Thursday (Sep 3). We however expect them to be extended, by and large, until further signs of stabilization of Ukraines financial system come in sight. Certain symbolic softening is still very likely, in our view, as several weeks ago NBU Head Gontareva claimed restrictions will be mitigated once the debt operation is completed / agreed. Given an expected weakening of the UAH following a material relaxation of the restrictions, we would rather expect such material relaxation to get started no sooner than after the end of Oct elections. Current account remained positive in Jul (USD 65mn). Going forward, we expect the current account to get negative again this fall, driven by a seasonal spike of imports (both non-energy and that of natural gas). 

Money market: NBU makes symbolic step towards looser monetary policy

NBU slashed its main policy rate to 27% from previous 30%, saying the policymaker said the move was prompted by reduced devaluation expectations and anchored inflation. In line with the policy rate cut, the regulator also decreased the cost of its ON refinancing (secured by OVDP) to 29% from previous 33%. Depo rates were left unchanged, though. This implies that this policy rate cut was a symbolic move, rather than real monetary easing. Moreover, given the need to relax the FX restrictions and a subsequent weakening of the UAH (as well as inflationary, political and other economic risks associated with such wakening), we believe that real monetary softening is unlikely to be quick and to come sooner than in 4Q 2015. Money market rates stay unchanged in line with the current NBU depo rates (ON at 17/19%, 1 week at 18/20%, 1M at 20/23%). NBUs 1M and 3M depo rates have also been left unchanged at nearly 22% and 23%, respectively. Banking liquidity stays over UAH 70bn.

Local debt market: Holiday season continued

Market activity stays low. Both FX OVDP and the VAT bonds see only bids, no offers. Trades will likely get more active since early Sep with most of the market participant returning from their summer vacations. On top of that, activity on Ukraines domestic debt market may get slightly higher following completion of Ukraines debt operation (many market participants have suspended / limited their trades in anticipation of the outcome of the debt operation). We would nevertheless not expect any serious spike of activity as OVDP supply remains scarce and will likely get thinner against the backdrop of the fiscal gap running substantially below the governments cap. Yields on OVDP offered from the NBU portfolio have also been below the market and will likely stay so going forward.

Global markets: Ukraine agrees to a sweet restructuring deal (continued)

Ukraines MinFin and the creditor group have reached an agreement. Its terms do not look that appealing for Ukraine, in our view, as coupon rate remains sufficiently high (7.75% vs. current 7.2% weighted average), 4Y maturity extension is quite moderate, and the 20% debt reduction may prove to be too small (while the 20% debt write-down will result in the debt/GDP ratio slashed by around 4%, every UAH 1 of further devaluation would bring Ukraines debt/GDP nearly 2% higher, by our estimates). Moreover, according to our estimates, all the 20% haircut (USD 3.6bn) will be returned to creditors if in 2019-2038 Ukraine grows 3.5% on average and its GDP deflator (overall price growth rate) average at 5% in the same period. No surprise, sweet restructuring terms were immediately reflected in Ukraines sovereign bond rallying 10-15% in a matter of hours. In the meantime, prospects of higher interest rates in the USA (combined with China's slowdown) have diminished the appeal of emerging markets as investors have dumped riskier assets. Investors will also watch the ECB policy meeting this Thursday to see if it will be inclined to ease monetary policy further in the wake of the recent global turmoil. Following the last weeks spin, Brent recovered to around USD 49 per barrel, with favorable implications for the RUB (67 per USD this midday). 

For more information: UkrSibbank_310815.pdf