Ukraine: More rebalancing needed, currency at risk

In August, Ukraine saw its monthly current account deficit reach its highest this year, driven by
renewed energy purchases. The outlook for exports is bleak while imports are supported by domestic demand and the expectation of new taxes.

We have recently revised our forecast for Ukraines current account deficit for 2013 from 6.2%
of GDP to 7.1% of GDP.

Considering Ukraines huge need to cover its current account deficit, the country is
increasingly reliant on financial inflows. These could be difficult to secure, in the light of Moodys recent downgrade.

We expect FX reserves to nosedive to USD 18bn by year-end, underlining the case for weaker
local currency. Imports of gas soared, so c/a deficit at record levels In August, Ukraines current account deficit reached its highest level since December 2012, hitting USD 1.5bn. The level did not come as a surprise, as Ukraine has continued to step up its gas imports. In August, according to preliminary estimates, imports of gas increased to 2.9bn cubic metres (compared with 2.7bn cubic metres in July 2013). The outlook for exports remains bleak. Exports of goods continued to decrease in August (10.2% y/y), weighed down by falling demand from the CIS region, tension in the Middle East and high gas prices. As a result, metal exports contracted by 14.8%, while exports of machinery and fertilizers were down 33.2% and 46.1%, respectively. Looking ahead, with no growth drivers in sight, we expect the decline in exports to remain in double digits. Imports fell less dramatically (-5.8% y/y) amid growing domestic retail sales. Imports of machinery (including vehicles) shrank by only 3.8% y/y, underpinned by an expected car use tax on new vehicles, introduced on 1 September. The overall decline in imports continues to be less than that dictated by the poor macroeconomic conditions in Ukraine. Imports continue to be supported by retail sales growth and rose 6.7% y/y in August. Rebalancing in external trade is insufficient We have recently downgraded our forecast for Ukraines current account deficit for 2013 from 6.2% of GDP to 7.1% of GDP. In the first eight months of 2013 the deficit reached USD 8.2bn, compared to USD 8.4bn in the same period of 2012. This represents a miserable 2.6% contraction year-to-date, implying that rebalancing of the current account has been virtually zero over the last few months.

Chart 1: Ukraines current account vs. UAH/USD rate

Current account, 12-month trailing

Chart 2: Ukraines GDP growth breakdown (production)

Gas imports (RHS) Current account 4.0 3.5 2.5 2.0 1.5 1.0 0.5 -May-12 Sep-12 Jan-13 May-13 Bn cubic meters 3.0 USD bn

--2 -4 -6 -8 -10 -12 -14 -16 -18 1Q 07 3Q 08 1Q 10 3Q 11 1Q 13

3.00

USD bn

1 0 -1 -2

5.00

7.00

9.00

-3 Jan-12

Source: National Bank of Ukraine, BNP Paribas

Source: National Bank of Ukraine, BNP Paribas

IMPORTANT DISCLOSURE: This analysis has been produced by UkrSibbank and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is the principle shareholder of UkrSibbank, with an 84.99% stake. This analysis does not contain investment research recommendations.
Serhii Yahnych CEEMEAnomics 02 October 2013 www.GlobalMarkets.bnpparibas.com

UAH/USD average (RHS)

Financial inflows difficult to secure after downgrade

Considering Ukraines huge need to cover its current account deficit, the country is increasingly reliant on financial inflows. These will be difficult to secure, considering the recent downgrade by Moodys, which has rated Ukraine as Caa1 (very high risk). Immediately following the downgrade, Ukraines CDS soared to record levels, exceeding 1000bp. In such an environment, Eurobond market issues seem to be completely closed, especially as Ukraine is failing to come up with a clear plan to rebalance its current account in order to remove pressure on the balance of payments and FX reserves, which currently stand at USD 21.7 bn (2.6 months of imports). Fortunately, Ukraine still enjoys some bilateral financial inflows in the form of pre-export financing and flows between related parties. In August 2013, these were able to cover a large chunk of the current account deficit (USD 1.3bn). However, should the countrys fundamentals continue to deteriorate, we might see a reversal of these flows.

FX reserves to fall to USD 18bn calling for weaker currency

We expect FX reserves to nosedive to USD 18bn by the end of 2013, underlining the case for a weaker local currency. Ukraine badly needs to rebalance its current account, with calls for a more flexible (and weaker) FX rate getting louder.

Chart 3: Current account components

Balance of goods Net income Current account 1 USD bn 0 -1 -2 -3 Jan-12 Apr-12
.

Chart 4: Current account, cumulative YTD

2013 2012

Balance of services Net transfers

1 --1 -2 -3 -4 -5 -6 -7 -8 -9 -10 Jan Feb Mar Apr May Jun Jul Aug

Jul-12

Oct-12 Jan-13 Apr-13

Jul-13

Source: National Bank of Ukraine, BNP Paribas

Source: National Bank of Ukraine, BNP Paribas

IMPORTANT DISCLOSURE: This analysis has been produced by UkrSibbank and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is the principle shareholder of UkrSibbank, with an 84.99% stake. This analysis does not contain investment research recommendations.
Serhii Yahnych CEEMEAnomics 02 October 2013 www.GlobalMarkets.bnpparibas.com

USD bn

Table 1: Ukraines balance of payments (USD mn) 1Q 12 Current account balance Trade balance of goods Exports of goods Imports of goods Balance of services Net revenues Net transfers Capital and finance account balance Net FDI Net portfolio investments Net loans Other capital Balance of payments -1 934 -3 621 16 504 -20 125 1 172 -168 683 1 365 1 663 -3 615 -948 -569 2Q 12 -3 680 -5 322 17 853 -23 175 1 217 -380 805 3 130 1 091 74 -861 2 823 -550 Jul 12 -1 316 -1 791 5 871 -7 662 507 -309 277 2 124 663 16 2 247 -782 808 Aug 13 -1 463 -1 795 5 952 -7 747 741 -687 278 2 079 866 51 539 619 616 Jan-Aug 12 -8 393 -12 529 46 180 -58 709 3 637 -1 544 2 043 8 698 4 283 138 2 540 1 712 305 1Q 13 -2 918 -3 790 15 633 -19 423 768 -444 548 4 739 4 703 705 1 966 1 212 1 821 2Q 13 -2 253 -3 032 15 873 -18 905 858 -683 604 2 613 2 646 683 -437 1 932 360 Jul 13 -1 483 -1 965 5 351 -7 316 685 -382 179 1 185 1 165 353 -471 378 -298 Aug 13 -1 521 -1 953 5 342 -7 295 757 -486 161 1 289 1 317 265 413 319 -232 Jan-Aug 13 -8 175 -10 740 42 199 -52 939 3 068 -1 995 1 492 9 826 9 831 2 006 1 471 3 841 1 651

Source: Ukraines Statistics Committee, BNP Paribas

IMPORTANT DISCLOSURE: This analysis has been produced by UkrSibbank and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is the principle shareholder of UkrSibbank, with an 84.99% stake. This analysis does not contain investment research recommendations.
Serhii Yahnych CEEMEAnomics 02 October 2013 www.GlobalMarkets.bnpparibas.com