The Ukraine Macroeconomic Situation March 2011 analytical report prepared by the SigmaBleyzer Emerging Markets Private Equity Investment Management Group and The Bleyzer Foundation, Kyiv, Ukraine members of the US and Ukraine Business Council is found below.

Summary Points
[1] Industrial production growth accelerated to 10.5% YoY in February 2011.

[2] Despite a later spring sowing campaign and smaller area sown under winter crops, Ukraine’s grain harvest is forecast to be slightly better than last year.

[3] The State budget reported UAH 4.1 billion surpluses over January and February 2011 amid spectacular growth in tax revenues and moderate spending.

[4] Weaker reform implementation led to a delay in March’s IMF tranche release. However the impact of the current delay is likely to be neutral.

[5] Annual consumer price growth accelerated to 7.7% in March 2011.

[6] The government decided on state intervened bank resolution plans.

[7] The current account balance switched to a large deficit in February 2011, but the financial account was in surplus mainly thanks to a successful sovereign Eurobonds placement in February 2011.

[8] Ukraine has intensified trade negotiations with its main trading partners Russia and the EU raising confusion over its current foreign policy.

Executive Summary
In February 2011, the Ukrainian economy maintained a good pace of growth. Most of the sectors improved their performance compared to the previous month thanks to high world prices on steel, robust growth in Ukraine’s main trade partner countries and strengthening domestic demand. Industrial production growth accelerated to 10.5% YoY in February as stronger increases in metallurgy, machine building and production of utilities compensated for some deceleration in the chemical industry and stagnation in food processing.

Retail trade turnover, typically used to gauge private consumption patterns, picked up by a solid 12.7% YoY. Due to colder weather during February-March 2011, Ukraine started the spring sowing campaign later than projected. While the delay may negatively affect yields, better conditions than last year for winter crops allowed the government to project a slightly higher grain harvest at about 41 million tonnes to 42 million tonnes in 2011. Despite better than forecast growth momentum in the first 2 months of 2011 we maintain our real GDP growth forecast at 4% YoY in 2011.

Robust real sector growth, higher tax rates the improving financial stance of Ukrainian corporate enterprises and banks as well as abolishment of the 11 month reporting period for corporate profit tax helped raise budget revenues by an impressive 44.5% YoY for the first two months of the year. Larger VAT refunds in March and a vanishing EPT base effect were likely the main reasons of more moderate but still impressive growth in budget revenues over the first quarter. As government spending grew quite moderately over January to February 2011 period, the state budget was in a large surplus over the period.

Budget performance could weaken in the coming periods. Revenue growth may continue decelerating due to enforcement of EPT rate reduction and small business privileges on April 1st 2011 and government plans to reduce excises in order to soften inflation pressures. Expenditures, on the other hand, may increase amid postponement of reform measures and initiatives to relax budget spending.

In contrast, close trade relations with Russia and high dependence on natural gas imports hold near-term benefits for Ukraine as participation in the Customs Union is likely to bring a notable reduction in the price of imported natural gas, abolishment of Russia’s export duties on crude oil and gasoline products and improved opportunities for Ukraine’s heavy machinery industry. This may be a strong argument for Ukraine, as its trade and current account balances started to worsen in 2011, following notable improvements in 2009 to 2010.

Economic Growth
Following a good start in January, the Ukrainian economy continued to increase in February, supported by a favorable external environment. Industrial production accelerated to 10.5% YoY in February 2011 up from 9.7% YoY in the previous month. The acceleration was prompted by faster growth in metallurgy, machine building and utilities which more than compensated for some deceleration in chemicals and mining and continuing depression in food processing.

As world steel prices kept rallying on international commodity markets, Ukraine’s production of metallurgical products went up by 17.4% YoY in February, up from 13.3% YoY a month before. Robust growth in Russia, one of the main destination markets for Ukraine’s export of heavy machinery, underpinned a 30.1% YoY increase in machine building in February.

Production of electricity, gas and water grew by about 6% YoY in February amid cold weather that month and resumption of electricity exports to Belarus. Although in monthly terms Ukraine’s oil refineries kept cutting production in February 2011, the industry reported a 1% growth in annual terms thanks to a favorable statistical base effect. Underpinned by strong growth in metallurgy, production of coke and iron ore grew by 9.2% YoY and 3.7% YoY in February respectively.

Fiscal Policy
Over the Q1 of 2011, Ukraine’s fiscal revenue growth has surprised on the upside. However a deeper data reading, the introduction of the corporate profit tax rate reduction and other tax privileges and the government response to growing social tensions suggest that successful fiscal execution will remain challenging this year.

Over the first 2 months of 2011, state budget revenues grew by 44.5% YoY mainly on account of a 67% growth in tax proceeds. Such a spectacular increase in the latter was achieved thanks to higher excise taxes and import duties and buoyant domestic demand. At the same time, collections from the corporate profit tax picked up by an impressive 74.5% YoY over January and February. While such an increase is partially attributed to the improving financial stance of Ukrainian enterprises, its main reason lies in a change in the corporate tax reporting period for profits received in the last quarter of the previous year. As this was a one off event, the growth in EPT proceeds is likely to decelerate thereafter.

Favorable budget revenue figures for the first two months of the year, however, were overshadowed by VAT claims. According to the State Tax Administration, VAT refunds amounted to about UAH 5.2 billion for January to February 2011. At the same time, developments with the stock of VAT claims as well as VAT refund arrears were not reported. In mid-March, the government introduced an automatic VAT refund system.

However, only a small number of enterprises, whose total claims amounted to about 15% of average monthly VAT refunds, were eligible to participate in the system in March. The government committed to phase out all VAT arrears by the end of March 2011 and increase the share of VAT refunded through the automatic system to about 60% by the middle of the year. Due to likely larger amounts of VAT refunds, the growth of VAT proceeds may decline. Already in March 2011, VAT refunds grew to UAH 3.7 billion, which was more than 40% higher than the average monthly amount for the first two months of the year.

Monetary Policy
Following unexpectedly low inflation during the first two months of 2011, price growth accelerated to 1.4% MoM in March. The growth in the consumer price index was led by higher food prices, utility and gasoline costs. Soaring world food prices, domestic shortages and seasonal factors caused domestic prices of foodstuffs to rise by 1.8% mom in March. Within the group, the highest price increases were registered for vegetables, fruit and bread and bakery.

Despite faster monthly growth that month, in annual terms food prices were only 5.7% lower than in March 2010. Relatively moderate domestic food inflation over the last six months sharply differs from world food trends and may be explained by tight administrative price controls as well as export restrictions. Continuing adjustment of utility tariffs to cost covering levels was another source of consumer price inflation. Advancing by 1.2% MoM, utility services were 21.5% more expensive in March 2011 than a year ago. High world crude oil prices and excise taxes kept spurring the growth of domestic gasoline prices and road transportation costs which grew by 9.3% MoM and 2.1% MoM respectively.

Scheduled increases in electricity tariffs, natural gas and heating, telecommunication tariffs and high world commodity prices will continue to pressure consumer prices upwards in the coming months. At the same time, the recent government decision to reduce excise taxes on gasoline products may bring some relief to consumers. However, we maintain our inflation forecast at 12% for 2011.

Faster money supply growth amid gradually resuming bank credit activity will also contribute to price growth this year. Over the first three months of 2011, money supply rose by 26% YoY. The growth was underpinned by a 30% YoY increase in the stock of deposits and an almost 7% YoY rise in credit. Monetary base growth decelerated to 13.7% YoY in March as sizable NBU sterilization compensated for Hryvnia injections related to net NBU purchases of foreign currency on the interbank forex market, large principal payments on domestic debt and a reduction in cash balances on government accounts with the NBU.

International Trade and Capital
During February 2011, high world commodity prices and solid growth in the main trading partner countries kept supporting Ukraine’s exports. However, tensions in the MENA region, an outlet for about 14% of Ukraine's merchandise exports, may explain moderation of export growth to 39.5% YoY in February compared to 53.6% YoY a month before. Traditionally, the growth was led by exports of metallurgical products machinery and transport equipment and chemicals.

On the import side, high energy prices and larger volumes of natural gas imports led to import growth acceleration to 70% YoY in February. A surge in natural gas imports is related to large gas deliveries to RosUkrEnergo, expropriated from the gas trader at the beginning of 2009. As the Ukrainian authorities plan to return all gas due to RosUkrEnergy by the end of April, energy import growth is likely to lose momentum in May.

At the same time, non-energy imports also reported buoyant growth. In particular imports of machinery and transport vehicles rose by 90% YoY in February 2011, though a low statistical base effect partially explains such an impressive growth rate in the group. With imports growth notably exceeding exports, Ukraine’s foreign trade in goods balance notably widened to USD 1.5 billion in February 2011, bringing the cumulative balance to USD 2.0 billion. Widening of the foreign trade deficit caused the current account to switch from USD 0.3 billion surplus in January 2011 to USD 1.1 billion deficit in February. As was anticipated, the financial account balance improved in February, reporting USD 2.5 billion surplus.

Footnotes
[1] During January, Ukraine and Belarus were negotiating the price for Ukraine’s electricity exports. During that month, exports of electricity fell by 56% YoY.

[2] At the end of March 2011, the government extended grain export quotas until the end of June 2011, though a few days earlier representatives of the Presidential administration signaled the quotas would be abolished at the beginning of April 2011, likely replacing them with tariff regulation measures. The quota volumes on most crops except corn were left unchanged. Mixed signals from top Ukrainian officials on quota issues, a non-transparent quota distribution system as well as government plans to create a state-run grain export monopoly, a state owned agrarian insurance company etc. have raised uncertainty among agricultural producers and traders, constraining investments in and development of the sector.

[3] The aggregate figures show consumer lending is still declining in 2011. However, available research shows that consumer demand growth is more dependent on the flow of credit rather than the stock of credit. According to NBU data, 12 month cumulative consumer credit grew by 4.1% YoY in February 2011.

[4] MENA countries accounted for about 14% of Ukraine’s total export of goods in 2010.

[5] According to current legislation, corporate profit tax returns are filed on a quarterly basis. The tax payments are due within 40 calendar days following the last day of the reporting quarter and must be paid within the next 10 calendar days. However, in previous years, there was an additional reporting period of 11 months due within 20 calendar days following the end of November. This rule was abolished in 2010. This means that tax returns for corporate profits received in Q4 2010 should have been fully paid during February 9th to 19th 2011. At the same time, in February 2010, corporate enterprises paid taxes only on profits received in December 2009. This created an abnormally low base for comparison for February 2011.

[6] Average monthly wages in education and health care sectors are among the lowest, representing about 80% and 68% of the average monthly wage across all economic sectors of Ukraine respectively in February 2011, down from 84% and 72% respectively in February 2010.

(Sourced from UNIAN News Agency)