Economists on the risks for Ukraine in the new year — from high debt rates, Kremlin aggression, inflation to problems in energy.
The time of cheap money in the world is coming to an end. Developed countries, flooding the economy with loans and having significantly increased public debt, are moving away from this distance. After record inflation, the US and EU central banks begin to tighten monetary policy. And for countries like Ukraine, the main question is not whether money will leave the markets, but how quickly and abruptly this will happen.
Printing press slows down
Investors around the world are holding their breath for every message from the US Federal Reserve. The Fed has been buying back $120 billion in Treasury and mortgage bonds every month, saturating the markets with money. This is how America fought the damage that the pandemic and lockdowns caused to its economy.
«Freshly printed» the dollar diverged around the world, accelerating the prices of raw materials, energy resources and food. World markets were also fueled by demand from the EU and China, which also generously supplied their economies with cheap money. In addition, due to quarantine, there were problems with logistics, which raised the cost of transporting goods.
«Rich countries printed a lot of money in order to quickly recover from the economic downturn caused by quarantine restrictions. Commodity-exporting countries, including Ukraine, have benefited from this, as prices have risen», explains Maria Repko, deputy director of the Center for Economic Strategy (CES).
In the US, fearing inflation, in November they announced a reduction in the quantitative easing (QE) program. The Fed originally planned to reduce asset buybacks by $15 billion per month. But soon the Fed changed its mind, deciding to «cut» $30 billion program at once to end QE a few months early.
«Inflation has its consequences. If it ceases to be temporary, then for the global economy it will be even worse than starting to pump out liquidity», – Dmitry Boyarchuk, Executive Director of CASE-Ukraine, explains the logic of the Fed.
Another important message from the American central bank is that the Fed will raise its discount rate three times this year and the same number of times in the 23rd. Whereas earlier the tightening of monetary policy was planned not so fast.
Why is it important? The higher the Fed rate, the less risky investors are, preferring to «sit out» in dollars — in the same treasury bonds. Therefore, as soon as rates begin to rise, an outflow of funds from other markets will inevitably occur. The IMF called this one of the key risks for developing countries, which include Ukraine.
«The monetary policy of the regulators could not remain «supersoft» indefinitely, so now the question is in how quickly economic processes in the world adapt to the higher cost of money», — explains Dmitry Churin, director of the analytical department of the investment company Eavex Capital.
Higher rates will slow down inflation, which is exactly what rich-country central banks are trying to achieve. And if this happens gradually, then the fund economists believe that the consequences for emerging markets are likely to be favorable.
«A faster Fed rate hike in response could shock financial markets and tighten financial conditions worldwide. These events could be accompanied by a slowdown in US demand and trade and could lead to capital flight and currency depreciation in emerging markets, the IMF warns.
What to expect for Ukraine: expensive government debt and falling exports
Investors are already leaving emerging markets, but this is happening slowly, says Dmitry Boyarchuk. And although this risk was obvious, it could become the main one for the Ukrainian economy before the year 24, the economist believes.
«It was clear that the last year was exceptional for us. And, probably, it was the last year in the period «happy prices» for our economy», he argues.
There are several problems for Ukraine here. The departure of money from the markets will lead to a decrease in prices for Ukrainian exports, primarily for metallurgical products and iron ore, where there has already been a rollback. Later, this will affect the rate of foreign exchange earnings in the country, putting pressure on the hryvnia exchange rate.
Due to the outflow of investor money, it will become more difficult for the government to borrow to finance budget programs. Therefore, it is worth preparing for higher rates on public debt, including government bonds.
«The transition of the central banks of developed countries to tighten monetary policy always causes concern for investors. Both risk-free rates of return and risk premiums for developing countries are growing,” explained Vitaliy Vavryshchuk, Head of Macroeconomic Research at ICU Group.
The increase in risk premiums, he said, in this case is especially noticeable for countries that have weak macroeconomic indicators. But the Ukrainian economy has formed a sufficient margin of safety, its credit risks have significantly decreased in recent years, he specified.
In the case of Ukraine, in his opinion, the role of the factor of Russian aggression is much more significant. This is what previously led to a sharp increase in yields on Ukrainian Eurobonds, the expert recalled.
«The biggest risk is a repeated escalation of Russian aggression during the year. This is a very unfavorable scenario, which will keep the cost of borrowing for Ukraine at a very high level and make it impossible to attract funds on private capital markets», Vitaliy Vavryshchuk is sure.
The constant presence of Russian troops near the border is a possible factor outflow of private foreign capital. This, according to Vavryshchuk, is both about the accelerated withdrawal of profits received in Ukraine by enterprises with foreign investments, and about the withdrawal of non-residents on investments in government bonds.
«Obviously, this will lead to pressure on the exchange hryvnia exchange rate», he says.
The only chance for Ukraine not to fall into serious problems is to remain in the IMF program, Dmitry Boyarchuk believes. «Even last year, non-residents looked at us with caution. And this is against the backdrop of a favorable external situation, which says a lot. This caution will only intensify. A smooth exit of investors is already noticeable, and I think it will continue», predicts Boyarchuk.
Since the beginning of 2022, non-residents have reduced their government bonds portfolio by almost UAH 3.5 billion, to just over UAH 89.1 billion. For example, back in October, the volume of their portfolio was over UAH 98 billion (in summer, at the peak of the year, it was more than UAH 110 billion). But after the news about a possible escalation on the border with the Russian Federation, investors gradually began to reduce their share in the Ukrainian domestic public debt.
Where to get gas and coal: risks in the energy sector
Another problem for Ukraine is the need to find coal and natural gas at affordable prices, Dmitry Churin from Eavex Capital is sure.
Energy prices have reached an unreasonably high level, which, according to the interlocutor, makes the entire economy of the country dependent from the possibility of importing both gas and coal. As, however, and electricity during peak hours of load on the power system.
Energy security should be among the government's top priorities, he said. «There is absolutely no understanding where financial resources will be found to pump gas into storage facilities for the next season. Similarly, there is a lot of uncertainty regarding the supply of coal to power plants», Churin noted.
Maria Repko from the Central Economic Commission also calls world energy prices a much bigger problem for Ukraine than the risks of borrowing and falling export earnings.< /p>
«This is our import, we buy it. So far, Ukrainians have not felt the high prices due to state regulation. But companies that buy gas at the market price feel it with might and main. And the Ukrainian state budget will feel it, because due to price regulation, many things will fall on it», she explained.
Producers will certainly be forced to transfer high energy prices to the end consumer over time, Vitaliy Vavryshchuk is sure. Whereas the growth in food prices, according to the economist, may slow down significantly by the end of the year, as food inflation in the world began to decline.
The persistence of high inflation is in itself one of the significant risks for the Ukrainian economy in 2022, the expert says. «High inflation devalues the savings of the population, demotivates these savings to keep and accumulate, and therefore deprives the economy of an investment resource», — he says.
At the end of the year, as Vavrishchuk explained, referring to the forecast ICU, consumer inflation in Ukraine will not return to the NBU target range of 5% (+/- 1%), amounting to 7.2%.
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The key risk is not only for Ukraine, but for the whole world, the coronavirus pandemic remains. The IMF warns that emerging market countries like ours should brace for possible outbreaks of economic instability if a new round of «covid» problems will be superimposed on a more rapid tightening of monetary policy in the US.
Another common problem for the world, which economists are already talking about, is the inequality in the distribution of vaccines. Because of this, economies are recovering unevenly, risking exacerbating the already tense geopolitical situation and the gap between countries.