According to the results of the first two days, IMF Group Ukraine has already draw a preliminary conclusion that the so-called Kerch Crisis, which has arisen and the subsequent transition to a hybrid martial law, will have no fundamental influence on the economic growth of Ukraine in 2018/19.
The observed short-term hryvnia devaluation is purely hype and not supported by any objective factors. Therefore, with a competent response from the National Bank of Ukraine (NBU), the exchange rate in the next 7–10 days should stabilize and return to previous values.
By indirect evidence, one can also say that martial law in no way affected the stability of the banking system and the level of interest rates will remain on a declining trend. As for the quotations of Ukrainian public companies, both listed on the Ukrainian stock exchanges and on foreign stocks should soon recover after a 3–5% drop, because, as in the case of the exchange rate, such a drop has no objective economic prerequisites.
In parallel, international experience suggests that the International Monetary Fund will continue to cooperate with Ukraine and the hybrid position format introduced should not affect the scope and timing of the financing program.
At the same time, the blockade of the Azov Sea is compensated by the additional load on the railways and the subsequent export of goods through the ports of the Black Sea. Considering the recent deliveries of locomotives from General Electric, Ukrzaliznytsia will be able to cope with the additional load.
1) Foreign exchange market
Growing demand for cash from the population is accompanied by a corresponding increase in trading in the interbank foreign exchange market. The selling rate (asking rate) of a cash dollar in exchange offices for a number of regions has already grown to UAH 29–29.5/USD 1. At the same time, the rate at which the dollar can be bought in banks does not exceed the level of UAH 28.15–28.2/USD 1. The average NBU rate increased from UAH 27.8 to only 28.1/USD 1 (+ 1.07%). In addition, a seasonal factor unrelated to these events, the sale of foreign currency earnings by Naftogaz Ukrainy increased by more than USD 250 million.
For managers of banks with sufficient liquidity, the current situation presents a good opportunity to earn high profits by buying dollars in the interbank foreign exchange market and reselling currency to exchange networks or to private individuals — currency changers.
Panic demand of the population for currency in the next few days is likely to continue to support trading volumes and the rate on the interbank market. However, the possibilities for buying currency both from the public and from banks are extremely limited. So, in spite of the emerging panic demand, there is no investment resource for buying currency from households, and each dollar purchased is consumption deferred for a few weeks that can only be achieved by converting it into hryvnia.
It is important to recall that, starting in 2015, the balance of purchases of cash currency by the population continues to remain negative. To maintain a higher standard of living than current incomes can provide, households use previously formed savings. Net currency purchases by the population in 2015 was USD 1.55 billion, in 2016 — USD 2.5 billion, in 2017 — USD 2.14 billion and for the first 10 months of 2018 — USD 1.68 billion.
Banks are now limited in their ability to buy out currency with the existing standard of open long currency position at 5% of regulatory capital. If we build on the data for 11/01/2018, then the maximum amount by which banks can increase their currency position is only UAH 2.5 billion/USD 88.7 million. Considering that none of the banks will be able to sell the acquired currency on exchange networks daily — even under a pessimistic scenario, trading volumes on the interbank market in this period of increased rush demand should not grow by more than USD 40–50 million daily.
With the average daily trading volume on the interbank foreign exchange market for the previous week at USD 268 million and a pronounced readiness of the NBU to maintain the exchange rate, currency fluctuations should ease within 7–10 days, after which the exchange rate will return to the previous equilibrium value (up to UAH 28).
The unpredictable factor of exchange rate formation is the probability of speculative attacks on the course by large banks, bypassing the existing standards. Therefore, the NBU should prohibit market participants who violate the norm of the open currency position — to increase this to bring it to the standards. According to the same principle, applications for the purchase of foreign currency on the interbank market should be cut off.
2) Banking sector and interest rates
Despite the lack of daily banking statistics on the outflow/influx of deposits, from indirect signs we see that yesterday’s uncertainty regarding the future martial law format failed to provoke the flight of depositors and increase the likelihood of a banking crisis. This is evidenced by the growth of balances on correspondent accounts of banks at the NBU, which, as of the beginning of November 27, amounted to UAH 59 billion, against UAH 50.7 billion as of November 23, 2018. Indeed, the growth of balances on correspondent accounts is not caused by the influx of new deposits, but by the redemption of NBU deposit certificates. However, if banks were faced with a significant outflow of funds, they would use for payment, first of all, their own and cheapest resource in the form of surplus balances on the correspondent account with the NBU.
At the same time, on November 26, 2018:
· Only one bank received a refinancing loan (overnight) in the amount of UAH 2 billion. This is the traditional NBU credit activity for the last month.
· Ukrainian interbank rate index rose by 0.02% from 18.35% (Nov 23) to 18.37% (Nov 26), which can be considered normal fluctuations in a stable market
· Effective rates of government bonds on the secondary market remained unchanged, and the volume of operations at UAH 263.2 million was lower than the standard average daily trading volume (for Nov 22 and Nov 23 volume of operations was UAH 716 and UAH 1339 million, respectively).
There is no need to introduce a moratorium on early withdrawal of deposits and such a step can only reduce the level of confidence in the banking system.
3) Stock market and capitalization of Ukrainian companies
Estimating the consequences of introducing an uncertain martial law format, we definitely cannot focus on the Ukrainian Exchange Index due to its too low capitalization and liquidity. However, in the Ukrainian economy there are a number of large companies that are listed on foreign stock exchanges: Warsaw, London, Frankfurt, Paris and others. By tracking the dynamics of shares of such companies over the past 2 days, we can understand how international investors assess the likelihood of Russian aggression and the possible influence of martial law on economic activity.
So, despite its record harvest over the past 2 days, Ukrainian farmers have significantly lost in capitalization. Including shares of Agroliga, which fell by 9.9%, Kernel by 7.2%, Astarta by 2.4%, Industrial Milk Company fell by 14.5%, Ovostar Union by 3 , 5%, as well as Coal Energy by 9.6% and Ferrexpo by 2.2%. This dynamics is related to the activity of international investors, based on their expectations that Ukrainian companies will not be able to export the entire harvest.
At the same time, MHP shares rose by 1.5%, due to the high applicability of meat products in both civilian and military conditions. Accordingly, an external investor believes that with the exacerbation of military risks — the revenue and income of MHP as a whole will remain stable.
We predict that within 7–10 days, most likely the shares that have fallen against the background of political risks will be played back, since the adopted format of the hybrid position does not bear any risks for the Ukrainian economy.
Dynamics of foreign listed shares of Ukrainian companies (%)
But if we analyze the dynamics of the index during the month, we will clearly see that today’s decline of 1.97% is not a result of the imposition of martial law in Ukraine, but simply a continuation of its fall trajectory, which began on November 18 due to the natural seasonal trend.
4) Investment and economic activity
This section was written before the vote of the parliament for a hybrid format of martial law, which should not be reflected on economic activity in Ukraine, due to the level of restrictions applied to civil relations. The scenario described below examines the behavior of the Ukrainian economy while maintaining the current activity of the conflict with the Russian Federation and, in parallel, strengthening the leadership positions of the president and the Bloc Petro Poroshenko (BPP) in the unchanged political landscape of the next five years.
Obviously, economic activity directly depends on the level of political risks. For Ukraine, where large business makes up at least 70% of the economy, and small and medium-sized enterprises function as outsourcing enterprises targeted at shareholders and employees, the economy’s dependence on the political landscape is particularly high. Because the lion’s majority of large business, in one way or another, depends on the state machine of the national level and cannot be isolated from political risks.
Consequently, any changes in the political climate of Ukraine, against the background of the introduction of martial law and the strengthening of BPP’s position and the president directly, will have a direct impact on economic activity.
Traditionally, three quarters before the start of the presidential election, growth rates of Ukraine’s economy begins slowing down with big businesses holding off on investments. At the same time, as a result of a substantial inflow of money for elections (on average, UAD 1.5–2 billion) and a corresponding increase in domestic demand, the economy can continue to grow. But in general, due to lower investment, this growth is unstable and short-term. And is only the result of a disproportionately high cash flow for elections.
Thus, if the future martial law acts as a guarantee for strengthening BPP’s positions in parliament and Poroshenko’s second term as president, the entire investment potential accumulated over the current year will be realized over the next 2–3 quarters, instead of as expected, with the same temporary lag — only after the planned presidential elections. According to our estimates, this represents a 3.3% growth in real GDP. We do not claim that martial law favors the investment climate, but in the situation of the current political tension and the dependence of property rights on cooperation with one or another political force, the hybrid martial law may indeed have a positive effect on economic growth.
In connection with the adjustment of the trend growth of real GDP in 2018–on year (6.4%) on the uncertainty factor before the presidential election — actual growth will be only 3.1%. The above table is a matrix with trend values of real GDP growth, depending on a different combination of growth factors. Legend: cpi — Commodity Price Index, cpi gr — the growth rate of the commodity price index, tax2gdp — the share of taxes in WFP, rate — the NBU discount rate. The final growth is defined as a trend based on the global dynamics of commodity prices, fiscal% of GDP and the discount rate of the NBU, adjusted after the discounting factor of non-economic factors, based on 2017.
Source: IMF Group Ukraine
5) IMF cooperation
The IMF’s position on cooperation with Ukraine after the introduction of martial law became known this week. In the current situation, statements were made about the termination of cooperation before the end of the conflict, which would threaten the economic stability of Ukraine. However, Gosta Ljungman, IMF Resident Representative in Ukraine, stated: “The IMF has no legal restrictions to continue cooperation with Ukraine in this situation.”
The imposition of martial law, as follows from the statement, against expectations did not in any way affect our cooperation with the IMF. Note that the Fund does not have any formal prohibitions on cooperation with countries involved in military conflicts. The example of Ukraine, where the five-year armed conflict in the east of the country does not impede active cooperation with the IMF, confirms this statement.
In such a decision, the IMF relies on already established international practice. The IMF did not stop cooperation with Georgia in 2008, when the country was embraced by two at once — the Georgian-Abkhaz and Georgian-Ossetian conflicts. In the same year, Georgia received a stand-by loan from the IMF in the amount of USD 223.8 million. Egypt, where martial law was imposed in connection with the terrorist attacks in April 2017 and will be valid until January 2019, agreed with the IMF two loan programs under the EFF program in 2017 and 2018 at USD 3.18 and USD 1.93 billion, respectively.
The most illustrative example of this practice is the cooperation of the IMF with Iraq and Afghanistan. Despite the continuing political and social instability of the Middle East, Iraq after the war in 2003 received USD 5.19 billion in assistance from the IMF, and Afghanistan after the war of 2001–2014. — USD 274.5 million
Thus, it is safe to say that the Ukrainian-Russian conflict and the aggravation of military tension in the Kerch Strait zone do not pose a threat to cooperation between Ukraine and the IMF.
6) Changes in logistics due to the blockade of the Sea of Azov
Russia’s military aggression against for more than four years has negatively influenced the transshipment of goods: both through the railway and through the ports of the Ukrainian Azov Sea. In total, shipments from Berdiansk from 2014 to 2017 fell by 30%, or 2.4 million tonnes, the number of ship calls — by 32% or 342 ships. The transshipment of goods through Mariupol fell by 50% or 6.5 million tonnes, the number of ship calls — by 58% or 532 ships. Transportation via the Donetsk railway fell from 99.3 million tonnes to 48.6 million tonnes in 2014–2017. According to the results of 10 months of 2018, the total transshipment of goods through the ports of Ukraine amounted to 108 million tonnes. In this volume, the share of Berdiansk was only 1.48%, Mariupol — 4.64%.
However, quite large shipments of ferrous metals continue to be exported through Mariupol — 3.6 million tonnes in 10 months of 2018 (66% of the entire transshipment of the port), through Berdiansk — agricultural products — 0.82 million tonnes (30% of the entire transshipment of the port).
Thus, the complete blockade by the Russian military fleet of the ports of Mariupol and Berdiansk can adversely affect the export potential of Ukraine, and completely cease commercial shipping in the Ukrainian part of the Sea of Azov.
The lakes system of the Perekopsky isthmus, which separates Ukraine from the occupied Crimea, is not suitable for coastal shipping for at least two reasons: these lakes are not connected to each other; their average depth is only two meters, while river boats need a depth of at least four meters.
Ukraine has no other alternative, except for the export of all goods from the Donbas by land by rail.
If necessary, the railway has all the chances to cope with the export of the entire volume of cargoes, which the Berdiansk and Mariupol harbors are now crossing, both to the ports of “Big Odesa,” Mykolaiv and Kherson, and to other parts of our country.
The transfer additional locomotives and wagons to railway stations of the Azov region.
For the Donetsk railroad, which operates at the Mariupol port, a minimum of 8 additional locomotives to 57 existing ones, as well as a minimum of 966 freight cars will be required.
For the Dnieper railway, which operates the port of Berdiansk — at least 5 additional locomotives should be added to the existing 122 units, as well as at least an additional 74 freight cars. Our calculations proceed from the assumption that the ports and the railway in 2018 will retain cargo handling and other performance indicators at the 2017 level.
Mariupol Port in 2017 handled 6.5 million tonnes of cargo. This is 14.3% of the total freight traffic of the Donetsk Railway in 2017 to 45.5 million tonnes.
In 2016, the Donetsk railway traffic was 32% higher than in 2017, or 71.7 million tonnes of cargo. For the same 32% in 2016–2017, the volume of daily transshipment of cargo through the Donetsk railway fell from 195,940 tonnes to 133,170 tonnes, as well as the average daily number of wagons processed — from 3,089 cars to 2,123 cars per day. The main reason for such a sinking of indicators is the “blockade of Donbas” in February 2017, after which the legal supply of coal from the occupied territories of Ukraine stopped.
The number of locomotives at the disposal of the Donetsk Railway for 2016–2017 fell by 51.35%, or from 80 to 42 electric locomotives and from 31 to 15 diesel locomotives. That is, the railway workers were able to double the efficiency of the use of the locomotive fleet in the region.
Blocking shipping to Mariupol will result in 14.3% additional freight traffic for the Donetsk Railway. Consequently, in order to take an additional 6.5 million tonnes of cargo from the Donbas to the Black Sea ports, Donetsk Railways will need to transfer at least 8 additional locomotives (if we start from the performance of locomotive use achieved in 2017).
Berdiansk Port in 2017 handled 2.4 million tonnes, which is 2.47% of the freight traffic of the Pridneprovskaya railway (PZhD) to 97.6 million tonnes last year. In turn, the transportation of goods by railways in 2016–2017 decreased by 1.4%, or from 99.4 million tonnes to 97.6 million tonnes. In the same 1.4% in 2016–2017, the average daily transshipment of cargo decreased from 267.42 thousand tonnes to 271.66 thousand tonnes, as well as the average daily number of processed wagons from 4,113 cars to 4,039 cars.
The last two years, the number of the fleet of locomotives and electric locomotives of the Dnieper railway was the same 122 units. Therefore, if the Berdiansk port becomes blocked, freight traffic of the Dnieper railway will grow only by 2.47%, for which at least 5 additional locomotives and 97 freight cars mentioned above will be needed.
There are two factors that can artificially slow down the export of goods from the Azov Sea to other regions of Ukraine:
1) The “bottleneck” of the railway is at the Kamysh-Zorya-Palogi, an intermediate link in the Zaporozhia-Mariupol traffic. This stage is single-track, it operates on diesel locomotive, therefore its carrying capacity is less than double-track stage on diesel Kamysh-Zorya-Volnovakha, which is able to miss 24 freight trains per day (actually, according to the stage Kamysh-Zorya-Volnovakha, only 18 trains pass per day) .
2) In the case of the introduction of martial law for railway workers, the priority will be military cargo transportation, rather than civilian. Defense Ministry Advisor Yuri Biryukov has warned about this option.
Thus, the blockade of the Azov Sea and the corresponding loss of transshipment through the Mariupol and Berdiansk ports, which accounted for only 6.1% of the cargo turnover, could well be compensated for by the additional load on the railway and the further export of products through the ports of the Black Sea. To do this, you need to increase the locomotive park of the Donetsk and Pridneprovsk railways with a total of 13 locomotives. The regularities discovered by us earlier show that even if this does not happen, the negative effect of the blockade of the Sea of Azov will not exceed 0.1% of GDP.
Research adviser — Mykhailo Kukhar, IMG Group Ukraine
Researchers Hrihoriy Kukuruza, Ivan Kyrychevsky, Serhiy Mykolaenko, Mykola Lesyk
Original Russian-language version: http://bit.ly/2Q1JPVW