LONDON -- Guess the state of the market: Ukraine GDP warrants rallied back up to 68 cents last week - up 13 points over the past month (doubling in price over the year).
* Real GDP growth has stalled, with growth moderating through the course of 2017, from 2.5% in Q1 (despite the blockade in the east), then 2.3% in Q2 and just 2.1% in Q3, and with most estimates now putting full year growth at just 2.1-2.2%.
Remember, this is from the low base of a 17% real GDP decline between 2014-2015. Note the GDP warrant formula only begins to "pay" with real GDP growth above 3%, and only sees real performance with growth above 4% when the 40% kicker comes into play.
Official forecasts for 2018 (EBRD, NBU, WB) have growth at 3-3.5% for 2018. But this looks optimistic at this stage, unless there is a lot of pre-election pump priming, which I think will deteriorate the budget and balance of payment.
Without meaningful structural reform -- progress in the fight against corruption -- then 4%+ growth looks like pie in the sky.
* Ukraine has had no IMF monies now since April 2017. The program is seriously off track.
Over the weekend, Finance Minister Oleksandr Danylyuk and Deputy NBU Governor Dima Sologub, both warned that there could be a formal break in the relationship, unless key reforms - read here the anti-corruption bill - are pushed through the Rada.
True, last week the Rada passed an IMF compliant privatization bill, but that was unfinished business from last year. And Poroshenko finally nominated a new governor for the NBU, acting governor, Yakiv Smoliy. It is likely he will go for approval to the Rada on Feb 7.
But it’s hard really to see the nomination of Smoliy will win that many plaudits with the IMF. The Fund will surely ask: well, why has it taken so long? What happened to Volodymyr Lavrenchuk, whom Poroshenko promised to Lagarde last April?
Smoliy has done a good job as acting governor, no doubt. At this stage, he is likely the best person for the job. He has good relations with the Rada, and is trusted by NBU staff and the IMF. But the IMF will likely just see through Poroshenko, as having played games with the IMF over the NBU governorship for almost a year -- and for what purpose?
The key issue for the IMF -- and reformers in the administration -- is the anti-corruption court.
On that, Poroshenko has tabled a version with the Rada, which is not compliant with the demands of the Venice Commission, or the IMF. The IMF has made known its concerns. So why does Poroshenko not just make the changes to get the IMF back on track?
The fear is that the Venice Commission/IMF requirements would make the anti-corruption courts independent, beyond "elite capture" and actually effective. People would actually go to jail. This is precisely why Ukraine's elites are fighting tooth and nail for this not to happen.
It is likely -- as with pension reform -- Poroshenko will push the existing, non-compliant anti-corruption draft through the Rada. Then he will try and sell the line that he has passed anti-corruption legislation. Having thrown the IMF a new NBU governor, a privatization bill, and possibly an agreement on gas price liberalization (stalled from the 3rd review, but which could be green-lighted for the next heating season), he assumes the IMF will eventually roll over.
But, actually, this time around I don't think the IMF will budge. At the IMF, there are enough experienced Ukraine watchers -- with the scars to prove it -- to understand the strategy of Ukraine's elites. They also understand how important the anti-corruption bill is, and that fighting corruption and improving the business environment is so important to getting domestic and foreign investment moving enough to bolster real GDP growth to 3% plus.
It is ironic that the market is trading on any glimmer of hope of a resumption in IMF lending. It is likely, the market would rally on the back of news of lending coming on stream, even without agreement over the anti-corruption bill. But, ultimately, the performance of Ukraine GDP warrants should be critically tied to the passage of this bill.
So, the longer the IMF holds out to ensure Ukrainian compliance, the better for these instruments. Only this will ensure higher real GDP growth over the longer term.
* The UAH is struggling, and seems to be on something more than the usual seasonal trend towards weakness. This might reflect the lack of official financing, and no news on new issuance.
But the NBU likely is minded not to be overly aggressive in supporting the UAH, given limited FX reserves and mindful that this might be a more permanent trend. The UAH has not yet found a level that can be defended without extreme loss of NBU reserves.
Timothy Ash is senior sovereign strategist for emerging markets at BlueBay Asset Management in London and a member of the UBJ Editorial Board.
Posted Jan. 22, 2018