Ukraine Market Report — Q4 2007
The strongest year since 2004 ended with inflation in the mid-teens, an external deficit at a record, and a credit structure entirely dependent on funding conditions that were already changing.
Overview
The quarter closed the strongest year since 2004 by output, and the year with the largest accumulated imbalances of the period.
A new government took office in December after the September election.
Macro position
Growth close to eight percent for the full year. Inflation ending the year in the mid-teens, the highest since the early 2000s.
The current account deficit reached a level that required substantial continuous external financing, and that financing was increasingly short-term and wholesale rather than long-term and direct.
Reserves were high in absolute terms and modest relative to short-term external liabilities — a distinction that matters enormously and is invisible in the headline reserve figure.
The three exposures
By the end of 2007 the Ukrainian economy carried three exposures simultaneously, and each amplified the others.
Currency mismatch in household balance sheets. A large share of mortgage and consumer debt was denominated in foreign currency and owed by borrowers earning hryvnia.
Funding mismatch in bank balance sheets. Banks had lent long in foreign currency and funded short in wholesale markets.
Commodity concentration in export earnings. The foreign exchange that ultimately serviced all of it came predominantly from steel.
A fall in steel prices would reduce export earnings, pressure the currency, raise the local-currency value of household debt, damage bank asset quality and coincide with wholesale funding markets closing. Each channel reinforced the others, and all four could move together.
Sectors
Metals — an excellent year at prices near an all-time peak.
Construction and real estate — the peak.
Banking — record growth and record vulnerability.
Consumer — strong.
What the quarter settled
That Ukraine had assembled, without any single bad decision, an economy in which one external price movement could trigger a simultaneous currency, banking and household debt crisis.
The trigger arrived in the third quarter of the following year.
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