Page 6 - UKRRptSept18

Another welcome development was inflation’s dip into single digits in the second quarter and will remain stable through the year-end. CPI slowed to 8.9% y/y in July, the lowest reading in almost two years as inflationary pressures have eased substantially in recent months.
Good weather conditions, in contrast to last year’s late frosts, have resulted in a bumper harvest, which in turn, has pushed food price growth down to 7.1% y/y. However, fundamental inflationary demand-side pressures are still material because of the high growth of salaries and other incomes.
The NBU’s tight approach to monetary policy (the regulator raised its key rate to 17.5% in mid-July) is gradually pushing commercial rates up. As a result, a larger proportion of incomes is flowing into deposit accounts rather than being spent on current consumption. Looking ahead, a possible increase in regulated gas prices could significantly contribute to inflation. SP Advisors maintain its end-2018 CPI forecast at 8.9%.
The risk to external accounts is minimal, as long as IMF cooperation restarts. Ukraine’s external accounts remain fairly balanced for now. The 12-month trailing C/A deficit remains just above 2% of GDP, substantially better than the historical average. The gap is still being covered by financial account inflows to the private sector.
The current level of the C/A gap looks sustainable, as the widening of the trade balance is being offset with larger migrant remittances. However, the financial account is at risk; a significant amount of state debt is to be redeemed in 2H18 and 2019, which could push the financial account into deficit and require a significant adjustment of the hryvnia exchange rate. With no external official funding available to Ukraine since 1H17, the authorities have used NBU reserves (-5.6% YTD) to repay sovereign debt. Recent FX market imbalances have resulted in a 5% depreciation of the hryvnia since the start of July. The prospects for the hryvnia exchange rate and broader FX market stability are largely dependent on Ukraine’s return to the IMF-backed reform path, which would unlock the next loan tranche.
September’s IMF mission represents Ukraine’s last chance to relaunch the stalled loan program. The current turbulence in the FX market, tolerable for now, combined with government liquidity pressures (both in hryvnia and foreign currency) are a signal that the situation could turn on a dime at any time through the end of 2018 if the IMF’s return is delayed.
The IMF mission will visit Ukraine in September, which could mean that a compromise on the contentious gas price deal is on the table. However, the risk is still substantial that the mission will not attain its goal. That would spell the end of the current IMF program.
The stakes for Ukraine are huge – the World Bank has reiterated that it will only provide its loans and guarantees to Ukraine if the
6 UKRAINE Country Report September 2018 www.intellinews.com