Alexander Paraschiy
Head of Research
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About the future price rises, prospects of the economy and “rescuers” of Ukraine: interview with Olexandr Paraschiy

The analyst of the one of largest investment companies gave a forecast for 2016 and summarized economic results of 2015

Olexandr Paraschiy, analyst of Concorde Capital, believes that the next year will still be difficult for Ukraine. According to the Company’s forecasts, inflation will reach 14% by the end of 2016. And the national currency rate may reach 26 hryvna per dollar. The expert gives detailed economic forecasts for the current year in his interview to

On the situation in the country and transformation of the economy

- Last year was very difficult for us: we lost GDP, production facilities and markets. Which sectors of the economy came off the worst, and which one coped with this complex situation?

- The most negative factors, which determined the last year occurred in the year before. Or rather, since the late summer of 2014. Then the part of our territory was occupied, and about 15% of our industry was actually cut off. Last year was a very difficult year; it was a year of restructuring or rebuilding of our industry when many resources was available (mainly coal), we lost access to consumer markets (primarily the Crimean market and the Eastern Ukraine). Consequently, many enterprises had to readjust, look for new suppliers, and find new markets.

In addition, the economy was affected with a conflict with Russia: suspended deliveries of many products to Russia also made us look for new markets. In fact, the expected GDP contraction (around 10-11%) was caused by problems that occurred in the second half of 2014. The financial sector also faced great challenges.

2015 was relatively smooth for agriculture, as it was not particularly affected by this conflict. Another major factor that negatively affected this year was fall in external global prices: prices for iron ore, metal and partly for agrarian products. Nevertheless, agriculture is probably stands better than any other industry, especially those not credited in a foreign currency.

"Nevertheless, agriculture is probably stands better than any other industry, especially those not credited in a foreign currency."

Primarily, they have a long production cycle. That is actually they sowed at one dollar exchange rate, and harvested at another. Accordingly, they earned a bit of inflation and devaluation.

- Can you say that the economy has reoriented?

- It's not so easy to do because Donbas - at least the occupied part - brought about 10% of the Ukrainian GDP, and that was direct inflow. Basically what we have 10% contraction, is probably a sign that some Ukrainian players have managed to shift. But it is early to say that Ukraine has fully recovered of this shock.

- Before, Ukraine was recognized as an industrial state. Has this model changed, what is the locomotive of the Ukrainian economy?

- Speaking about the structure of our exports, this year agriculture was the leader, the main driving force, as agricultural exports this year surpassed exports of metals and clearly exceeded the export of engineering products.

Yes, indeed, the agriculture is our future. The growth potential is very large. But it will not happen tomorrow. That is, we have a potential to increase the yield from 1.5 to 2 times, but this requires large investments, which the agriculture in principle does not have today.

Therefore, it will grow, but most likely it will grow slowly. Speaking of the driving forces of growth, the engine of our growth should be new enterprise, which Ukraine may not have now. But I believe, it will be and should be created when Ukraine improves its investment climate.

"Speaking of the driving forces of growth, the engine of our growth should be new enterprise, which Ukraine may not have now. But I believe, it will be and should be created when Ukraine improves its investment climate"

- Example?

For example, on January 1, 2016 we enter the unlimited free trade area with the EU. What does it mean? This means that we’ll have a common market with the European Union. This means that, for example, Russian businessmen, Chinese businessmen, businessmen from the Middle East willing to make products that can move freely in the European market - they can already bring their investments here, establish enterprises focused on Europe.

- So, Ukraine is still attractive in the eyes of foreign investors?

- The attractiveness of Ukraine in terms of the common market with Europe will increase. But we also have internal problems that limit this investment appeal. If we solve these problems (primary, corruption), in fact, I think our country can actually become a good stepping stone for businesses that want to be present in the European market.

- How has the banking sector survived the hard times?

- In a market economy, the stability of the banking system is a must. The banking system is the blood of the economy. It takes financial resources from those who do not temporarily need them and provides to those who need it most.

“But over the last eighteenths months we saw that the banking system actually stopped working for the economy. This is also a big problem. It actually works for itself, for its survival.”

But over the last eighteenths months we saw that the banking system actually stopped working for the economy. This is also a big problem. It actually works for itself, for its survival. What happened the last year in the banking system, the National Bank - in fact, I think it was the right process, which would allow us to quickly improve the system.

That is, banks couldn’t handle the crisis - they disappear, and the system recovers. Plus, the banks, the shareholders of banks that have decided to stay in the market, they bring the capital, they reinforce banks, they adapt to the new rules of the game, to new economic realities - and thus obviously become stronger.

If they survived this crisis, in principle, they have shown their exceptional reliability. Those who could not solve their problems - Finance and Credit, Delta, VAB-Bank, Financial Initiative - they have gone. Those who remained - they have definitely became stronger. Basically, they will, most likely, recover crediting the next year in full.

- So, the banking system will work for the economy next year?

- Yes, definitely. Because the banking system is not isolated from the economy. It has to work for the economy; otherwise it just will not make money. Now both the country and the banking system - they are basically survivors. They have accumulated some internal reserves, survived. But then we must begin to develop, otherwise owners of these banks decide that they do not need these banks. I mean, they should begin to earn or what they do there?

On the macroeconomic forecasts for 2016

- Speaking about the next year. Your company gave a forecast of 0.6% GDP growth. This is one of the most conservative forecasts. For example, the Cabinet laid down the 2% GDP growth in the budget.

- After falling for more than 10%, in principle, the range of growth may actually be quite broad. If you look at different forecasts produced by various analysts, the range for the next year will be from -3 to +3. While the majority really agrees that growth will be about 2%.

Rather, it is because the official forecast is around 2%. Can it be so? I think yes, maybe. But we use a very conservative approach because we do not see factors that can ensure this growth. All say we just grow because we have dropped too deep. It will be an upside movement against the low statistical base. So I think that the 2% increase is possible. But we personally do not see the factors supporting this growth.

- What factors can ensure the 2% GDP growth?

- If you break the GDP growth into components, then you see that the domestic consumption is used to be the main growth engine. That is, when the population earns more than it spends more. Accordingly, it creates demand for products; enterprises produce more and sell more. Currently, the dynamics of income does not allow us to say that the domestic consumption will grow the next year.

We expect that most likely earnings will not begin to grow this year - real income, and, respectively, domestic demand will not promote the economic growth.

Another important growth factor used to be the so-called investment consumption. That is when not people but businesses buy something. Here we also do not see a positive trend, because, according to the statistics of enterprises, in 2015 companies suffered a great loss – so, respectively, they do not have money to invest in their development, purchase new equipment.

Therefore, the only growth factor that can provide 2% increase in real GDP may be the banking system, if we really resume lending, consumer and corporate debt financing - than we will see serious growth. Serious is about 2-3%. But currently we adhere to the more conservative position, because we do not sure that this funding will start very soon. If it starts in six months, most likely, the growth will be 1% or lower.

Another factor could theoretically be foreign investment. But again, our investment climate (one we have today) does not allow us to be optimistic, because we do not the massive inflow of foreign investors.

- Let's talk about another macroeconomic indicator: the hryvna exchange rate. You predict 26 hryvna / USD, the National Bank today announced 24. There is also a forecast of 30 hryvna per dollar. In your opinion, which of these predictions is more realistic?

- You are absolutely right. There is a range of 24 to 32 per dollar, which give our colleagues. Basically, it all depends on assumptions. There are two important factors that can greatly affect the rate. The first factor is an international creditor, i.e. the IMF, EU and the United States - whether they continue cooperation with Ukraine? So far, based on the fact that they adopted a budget last week, we can say that the risk of suspension of cooperation with the IMF is quite low.

Another very important factor is resource external markets. First of all, it is the price for steel and iron ore in the international markets. Those prices, which have been formed - they, unfortunately, do not allow our companies involved in production of ore and steel, make a profit. What does it mean? If prices will fall further, some companies will have to stop. Whatever it was, steel and ore are an important source of foreign exchange earnings. If inflow of foreign exchange earnings decreases seriously, then we’ll have a strong pressure on the hryvna.

- That is, given forecasts for foreign markets, the currency depreciation will continue?

- If we take the scenario that prices for steel and iron ore will continue to fall, it is possible that our forecast of the 26 hryvna / dollar exchange rate will not be realized, that is the hryvna will be weaker. In our forecasts, we took into account prices for steel and iron ore at the current level throughout 2016.

- So, it turns out, the budget has been formed on the basis of higher prices for steel and iron ore is than current prices?

- In our case, for example, the hryvna exchange rate is defined by currency restrictions imposed by the National Bank. Therefore, it is not a single-factor model: low prices do not always mean the weak hryvna.

- How realistic is a forecast of 24.1-24.4 hryvna per one dollar in 2016?

- Realistic. It is not a fantastic scenario. Moreover, it is the rate provided by the Memorandum with the International Monetary Fund. It's a different matter that these forecasts were updated six months ago. Perhaps the new documents to be signed with the International Monetary Fund will contain other figures. But so far, if we consider various scenarios in resource markets and cooperation with international organizations, the rate 24-24.2 looks realistic.

- And do you forecast an inflation rate?

- As far as I remember, the Ministry of Finance provides about 12%. We estimate 14% for the current year. Again, this is due to different assumptions about the hryvna rate. 12% - it's meant from the beginning to the end of the year. But if we take average prices for 2015 year and average prices for 2016, the effect will be more serious. The main inflation factor, as shown by the recent two years, was devaluation of the hryvna. That is, we have a lot of imported goods in the consumer basket. Accordingly, if the dollar becomes more expensive, then all the products tied to the dollar rise in price too. And there's nothing you can do.

About taxes and a special VAT regime for farmers

- Some experts point out, that the budget has a relatively high income part - 595.1 billion UAH. This is almost 16% more than the last year. What may generate such income?

- The main characteristic of the 2016 budget and laws adopted in the budgetary package is an expanded tax base. That is, the majority of companies will pay taxes. Mainly, it was the demand of the International Monetary Fund. Accordingly, the first factor affecting the growth of income is inflation. Obviously it will be. And second – the major part of enterprises and individual entrepreneurs will pay taxes. From this perspective, in principle, the budget looks quite realistic. Even in view of the moderate inflation parameters, embedded into it. The best test of this is the position of the International Monetary Fund, which basically says that the budget revenues are feasible. As the Ministry of Finance informs, the International Monetary Fund has checked all the figures and assumptions.

- Today, as you know, farmers are actively protesting against the new Tax Code, namely the abolition of the special VAT mode and establishment of two registries for the tax refund. Can our Cabinet back down on it and meet requirements of farmers despite recommendations of the IMF?

- Two registers is a very strange measure. I think, a revolt is quite justified here. But abolition of the special VAT treatment or VAT exemptions for farmers – this, in fact, is one of the key requirements of the International Monetary Fund. Perhaps, no concessions will go here.

- Will our farmers get through cancellation of the special mode?

- If we are talking about the crop growing, the effect on crops will be minimal. Now they sell at lower prices, but keep a portion of the tax; this year, they will not receive this tax benefit, but they will be able to increase domestic prices for grain procurement at about the same amount. Accordingly, the net effect will be negligible for them. It should be noted that we’ll reduce the tax burden on wages. Accordingly those who paid high wages in the sector, they will be able to save on this. Farmers will still be able to keep 15% VAT. Speaking about poultry that is really... Since the most manufacturers focus on the domestic market, for them it will be a big problem. The impact on them will be more serious.

- Because of their higher profitability?

- Because of the greater return, they get great benefits on VAT. And they do not export. They export a small part of products. They will not receive VAT refunds.

- How changes to the Tax Code, in particular, increased tax rates, will affect the business? Or some industries will not stand without the government support and benefits?

- The state cannot support the business because the state has no resources. That is, if we are talking about supporting someone from the state, we must understand that this support will be rendered at someone’s cost.

All pay taxes, but someone gets benefits or support. We always have to seek a balance. If the state determines that someone should receive benefits, then, accordingly, it must find someone to pay for it. Therefore, ideally no one should receive any benefits, except for cases when a manufacturer loses its competitive power without such benefits.

For example, we know that the agricultural sector is greatly subsidized in Europe. Accordingly, if we do not subsidize our agricultural sector, it may become uncompetitive. So maybe benefits in the agricultural sector are worth keeping. In the current situation, our products remain competitive in all foreign markets simply because of the great devaluation.

- Can we expect that Ukrainians feel a sensible change for the better for themselves, for their wallets this year?

- We started our conversation with a forecast that most likely this year will not be a year of growth, because to grow, to move, you need a resource. We have not got this resource yet. Now, unfortunately, the export market will not feed us. In our best years, when we were growing very rapidly - we just grew up on good export markets.

"Most likely this year will not be a year of growth, because to grow, to move, you need a resource. We have not got this resource yet. Now, unfortunately, the export market will not feed us. In our best years, when we were growing very rapidly - we just grew up on good export markets"

2016 is not promising so far. Thus, the external resource market would hardly support us. But we may rely either on internal resources (i.e. the banking system will gradually work on business lending, consumer lending), or we’ll get a strong support from foreign investment. But we have a lot more to do.