Ukraine Economics - Budget Revised, Now Depends on IMF Support

The Covid-19 outbreak has led to a significant deterioration in Ukraine's economic outlook. With quarantine measures tightened considerably and likely to be extended into May, we now expect GDP to contract 5% this year. The government has amended the budget and now expects the deficit to reach $11 bln. Whereas prior to the epidemic Ukraine was in a comfortable position to service its external debt and cover its budget deficit even if a new funding deal was delayed, we now see procuring IMF funding as more paramount on both fronts, especially if raising money from the global market continues to not be possible. We remain positive on Ukraine's ability to repay its external debt and see covering the budget deficit as the greater challenge.> Our previous negative scenario was too optimistic... In a previous report titled "Gauging the Unknowns," we wrote that Ukraine, faced with a deteriorating global situation, would still be able to service its debt, even without IMF support. At that time, our base scenario envisaged a 0.5% contraction in GDP, while in the negative scenario we expected a 3% drop. However, the last several weeks have seen a significant deterioration, as tighter and longer quarantines have been introduced across the EU and in Ukraine, making even our negative scenario look too optimistic. As a result, we now expect a 5% contraction, although this is still better than the new IMF forecast of a 7.7% decline.> ... but we remain positive on Ukraine's ability to service its debt. Prior to the epidemic having worsened, Ukraine needed around $5 bln to finance its budget deficit and around $4 bln to repay external public debt. Taking into account Ukraine's almost $27 bln of FX reserves as of end-February, the government could meet all its obligations even without an IMF deal. However, now that the economy is sliding toward recession and the government has approved a new budget that includes measures to counteract the negative effects from the virus and associated quarantine measures, the deficit will balloon to $11 bln, which looks more challenging. On the other hand, it is quite likely that when the government introduced the new budget, some kind of preliminary agreement with the IMF was already in mind.> Further monetary easing is possible this year. We believe that the hryvnia could weaken a little bit from the current levels but should remain around USD/UAH 28-29 on average this year. The weaker currency will add some upward pressure on inflation this year, but this will be counterbalanced by a decline in energy prices and weaker demand. As a result, we expect inflation to remain close to 5.5% this year, in line with the target. This means that when the situation stabilizes in 2H20, the NBU will have some room to cut the key rate further. However, we expect the bank to follow a more gradual approach, possibly delivering 100-150 bps in cuts in 2H20.