Ukraine Market Report — Q4 2006

Overview

The year closed with industrial output well above the previous year, consumer demand strong, construction booming and credit expanding rapidly.

It also closed with the current account in deficit for the first time in several years, and with the country's external funding requirement therefore becoming a live variable rather than a theoretical one.

Macro position

The trade balance had deteriorated through the year on two counts: the higher gas import bill, and consumer goods imports growing with credit-financed demand.

The deficit was financed easily, because international capital was abundant and Ukrainian banks could borrow externally at rates that made the arbitrage attractive. That ease was the problem — external financing available on easy terms removes the discipline that a deficit would otherwise impose.

Inflation ended the year around low double digits.

What the numbers were saying

Three indicators were flashing and none was being treated as urgent.

Credit growth at a large multiple of output growth. Foreign-currency lending to unhedged household borrowers as a mainstream product. And an external deficit funded by short-term wholesale borrowing rather than by foreign direct investment.

Any one of these is manageable. All three together describe an economy where a change in external funding conditions transmits directly to households, and there was no mechanism in place to interrupt that transmission.

Sectors

Metals — a good year, output up strongly.

Agriculture — a weaker harvest than the previous year; export restrictions were being discussed as a response to domestic grain prices.

Construction and real estate — the peak of the cycle in retrospect, though nobody described it that way at the time.

Banking — record profitability, record growth, and the underwriting standards of a market that had never experienced a downturn in its credit portfolio.

What the quarter settled

That Ukraine had built, in eighteen months, an economy whose principal vulnerability was no longer political but financial, and whose financial vulnerability depended entirely on conditions in external capital markets.

The consequences of that structure would be measured in 2008. Everything necessary to predict them was in the published data at the end of 2006.

Related in this archive

• Ukraine Market Report — Q3 2006
• Ukraine Market Report — Q1 2007
• Ukraine Annual Review 2006: the year the cost base changed
• Ukraine Annual Review 2005: a mandate spent and a precedent set