ICU Weekly Insight: June 13, 2022 – GDP falls dramatically in 1Q22

Bond market frozen waiting for new price signals

The Ministry of Finance hiked the rate on bonds sold to the NBU last week. This move fuelled the expectations of investors that an increase in interest rates on bonds on the primary market will follow. Last week, demand on the primary auction fell to Hr 856m ($29m). The state budget received only Hr 810m ($27.4m), but interest rates have not changed since the beginning of martial law (for more details, see the auction review). It was the lowest amount of funds raised via a primary auction since the full-scale Russian invasion began.

Since rates on bonds remained unchanged despite the NBU’s hike in key policy rate, the activity on the secondary market shrank. The number of deals slid by about 10% compared with the previous week, but the volume declined more than fourfold, from Hr 906m ($31m) to Hr 231m ($8m) for bonds in local currency.

ICU view: The Ministry of Finance reiterated early last week that it considers military bills to be a tool that investors choose to support the country during the wartime rather than a tool that guarantees investors market yields. The gap in expectations of the Ministry of Finance and investors prompted a fall in the purchases of paper whose yield remained unchanged from the week before.

Given the significant budget deficit and shrinking volume of new placements, the Ministry of Finance had to raise more funds from the NBU. On Thursday, June 9 the NBU purchased military bonds worth Hr 70bn ($2.4bn), so the total amount of bonds purchased by the central bank since the beginning of the war increased to Hr 190bn ($6.5bn).

New bonds sold to the NBU carry a floating annual coupon linked to the NBU’s key policy rate. Thus, it is likely that in June 2023, the realized yield will exceed 20%. This level is now indicative for investors.

Demand from banks and private investors for new placements will likely remain low if yields do not rise. Banks will buy only symbolic volumes of securities simply to be present in the auction and meet the requirements they have as primary dealers rather than implement an investment strategy.

Bonds: Eurobond prices continue to decline

The lack of news about the prospects of the war ending is keeping pressure on Ukrainian Eurobond prices. Over the past week, the prices of all Eurobonds and VRIs slid once again. Eurobonds maturing in 2025 fell by almost three cents, while instruments maturing in 2024 and 2028 declined by slightly less by two cents. The remaining Eurobond prices slid by less than two cents, and only Eurobonds due this September edged down half a cent and on June 10 was priced at almost 70 cents. VRIs, which at the end of last week was priced at less than 37 cents, also lost less than a cent.

ICU view: In general, the situation on the Ukrainian Eurobond market remains unchanged. Investors are closely monitoring news from the front, and in the absence of positive news, prices continue to correct.

FX: FX market stabilizing
Last week, the FX market remained broadly stable both in the interbank and cash segments after the NBU eased some of its exchange regulations for the retail market. In the interbank market, the volume of hard currency sales by banks and the NBU remained almost unchanged at close to $200m per day. At the same time, NBU interventions declined slightly from $827m to $775m per week, which means that banks could increase the sale of hard currency. The cash exchange rate set by banks did not change at all and remained in the range of Hr34.5‒35.5/$.

ICU view: Generally, the FX market remains relatively stable in all segments. The cash market already seems to have fully adjusted to current regulations. In the absence of important news, it should maintain equilibrium at current levels.

Economics: Inflation reaches 18% in May
Annual inflation reached 18.0% YoY in May, up from 16.4% in April. Core CPI accelerated to 13.8% YoY from 13.0%.The key drivers of rapid consumer inflation remain unchanged: surging food prices and fuel prices.

The two consumer basket components that hold back CPI growth are clothing and utilities. The prices for the latter continue to decelerate as the government has kept gas and electricity tariffs for households unchanged for the past 12 months.

ICU view: The May CPI reading indicates inflationary pressures remain strong, and we reconfirm our projection of CPI reaching the 25‒30% range in the fall. The key inflation drivers remain on the supply side as the delivery of many goods and services is complicated by impaired logistics. Surging fuel prices and a deficit of gas add cost pressures across the board. We expect inflation in Ukraine to pick up further and remain elevated above 20% through end-2023 as the economy is adjusting to supply-side shocks and heightened exchange rate risks.

Economics: GDP falls dramatically in 1Q22

In 1Q22, Ukraine’s GDP shrank 19.3% QoQ in seasonally-adjusted terms and 15.1% YoY.

ICU view: The numbers are fully in line with preliminary estimates released by the Ministry of the Economy in April. The 15.1% YoY decline for the full 1Q22 implies that GDP fell by 45‒50% YoY in March, the first full month when the economy suffered severe contraction due to Russia’s invasion of Ukraine. GDP recovered only moderately since March. We expect real GDP contraction of 35‒45% YoY for full 2022 depending on whether Ukraine will be able to improve its export capacities via railroads.

Economics: NBU reserves down 6.8% in May

The NBU gross international reserve declined 6.8% to $25.1bn in May. The central bank had to sell the net sum of $3.4bn on the interbank market to meet excessive demand that was likely driven by widening trade in the goods deficit and the continued strong demand for FX cash from households. The NBU indicated that withdrawal of FX cash abroad from hryvnia card accounts remained strong in May. Inflows of international aid were not impressive in May at just $1.7bn, including EUR 0.6bn from the World Bank and EUR 0.6bn from the European Union.

ICU view: We expect the significant deficit of hard currency will persist on the interbank market in the foreseeable future. Demand for FX is recovering faster than supply as exports remain depressed due to logistical bottlenecks.

The NBU will, thus, have to keep selling its reserves to keep the market balanced. We expect the central bank will seriously consider adding some flexibility to the hryvnia exchange rate in autumn to allow the hryvnia to gradually depreciate and alleviate at least part of the excessive demand. We also expect NBU reserves to recover somewhat by the end of the year thanks to growing inflows of international financial aid.

RESEARCH TEAM

Vitaliy Vavryshchuk, Alexander Martynenko, Taras Kotovych

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