Investment company Dragon Capital has revised its economic growth projection for Ukraine in 2023 to 5.2%, up by 0.7 percentage points, despite external financing risks, the company reported on Dec. 8.
The Ukrainian economy’s faster-than-expected recovery is attributed to increased exports through seaports, a stable electricity supply, and better-than-anticipated harvests, according to Dragon Capital’s macroeconomic update.
Ukraine exported approximately 4 million tons of raw materials through a “temporary” sea corridor, doubling the October figure of 2 million tons. Agricultural products comprised 60-70% of total exports, with the remainder being iron ore and steel exports.
Dragon Capital acknowledges that while some of the increase in port shipments resulted from a shift from costlier land routes, overall export volumes are expanding.
The stable functioning of the energy sector also contributed to the economy’s robust performance in October-November. Despite potential winter attacks on Ukrainian energy infrastructure by Russia, the absence of electricity shortages during these months prevented a decline in production volumes across various sectors compared to the same period last year.
“Taking into account the latest data on the yield of major agricultural crops, we expect that the harvest of grains and oilseeds this year will reach 80 million tons, +11% year-on-year, compared to the 77 million tons we previously expected,” the company said.
“An unexpectedly unfavorable event was the blockade of the main crossing points between Ukraine and Poland by Polish carriers in early November. However, we believe that it will have a limited negative impact on economic activity.”
Since imports of goods from the EU to Ukraine by road exceed exports by $1.1 billion per month, the blockade leads to a reduction in the trade deficit, which has fluctuated in the range of $2.8-3 billion/month in recent months. However, the blockade reduces budget revenues and negatively affects producers of high-value goods oriented to the EU market, in particular in the food industry, woodworking, and the production of automotive electronics.
Other negative consequences include a shortage of certain energy materials, such as car fuel, delays in humanitarian aid to the front, and financial losses for enterprises due to queues at checkpoints, although due to the reduction in imports, some Ukrainian manufacturers of consumer goods are receiving a temporary competitive advantage, according to Dragon Capital.
In light of these factors, Dragon Capital has increased its forecast for real GDP growth in 2023 by 0.7 percentage points to +5.2% year-on-year. They expect a slowdown from the +10.5% growth estimated by the Ministry of Economy in October, mainly due to fluctuations in agricultural production. However, the updated estimate predicts real GDP growth of 5.0% year-on-year in the fourth quarter of 2023.
“One of the key drivers of growth will be the partial recovery of exports through seaports,” the company said.
“And, accordingly, the increase in production in related sectors (mining, metallurgy, cargo transportation, domestic trade). The economy will also be supported by the development of the domestic defense industry.”
Despite the expected economic recovery in 2023-2024, Dragon Capital emphasizes that it does not compensate for the 29% year-on-year decline in 2022. The decline was attributed to the occupation of Ukrainian territories, disruption of supply chains, damage to production facilities, and mass emigration. Real GDP in 2024 is estimated to remain 22% below its pre-war level.
External financing remains crucial for the Ukrainian economy, with Dragon Capital highlighting the need for around $40 billion in direct budget financing in 2024 to cover the budget deficit. They anticipate new packages of economic support from international partners, with the EU contributing the largest share (EUR 18 billion) within a 4-year support package of EUR 50 billion. Other expected contributions include $12 billion from the United States, $5.4 billion in planned IMF loans, and $4 billion from other partners.
External financing also helps to compensate for the trade deficit, which remains high due to the loss of export potential and significant needs for the import of equipment, raw materials, and military goods. The financing provided by international partners was the main reason for the growth of National Bank of Ukraine (NBU) reserves to a record $41.7 billion in July of 2023 and the strengthening of Ukraine’s external position, which allowed the NBU to begin normalizing monetary policy and easing currency restrictions.
If external financing inflows are significantly less than needed, the Ukrainian government will have to resort to counterproductive and risky economic policy measures, including monetization of the budget deficit and/or increasing the tax burden, Dragon Capital said.
Regarding the exchange rate, Dragon Capital notes that after the NBU’s decision to adopt managed flexibility in October, the UAH/USD exchange rate remained stable. The NBU is expected to gradually increase the range of fluctuations in the exchange rate, aiming for an average hryvnia exchange rate to the US dollar of UAH 37.3 for 2024, reaching UAH 39.0 at the year-end. The company anticipates NBU reserves to reach $45 billion by the end of 2024, provided sufficient international financial support is received.