Welcome to boomtown Kiev. Residential property is $3,000 per square metre – more expensive than any in central Europe. Consumer spending is galloping ahead. And largely on the back of the young retail market, the banking sector has been growing at 40% per year.
The domestic demand you see reflected in every shop window has combined with high prices for Ukraine’s main exports – steel and steel products, chemical fertilizers and agricultural produce – to make market participants optimistic. But, like all boomtown stories, this one has its downsides. Inflation, which is inching beyond 20% per year, could ruin the macroeconomics. The lack of liquidity could savage the embryonic local stock market. And political instability has been wreaking havoc on long-term reform efforts for a long time.
Consume, consume, consume and export
Kiev’s runaway real estate market, second only to Moscow’s, is the most visible sign of the consumer spending boom. The huge demand for commercial and residential property – and for other attributes of a consumer society such as shopping centres, hotels and entertainment complexes – is matched by a dearth of supply left over from the Soviet Union.
Analysts expect both industrial and residential property portfolios to double in size over the medium term, even though shares of some real estate companies may already be overvalued. “We see strong demand through to 2010-11, with minimal downside risk for rentals”, says Elena Rogovina, property analyst at UBS.
The domestic consumption boom, and good performance by the exporting industries, should carry Ukraine through possible storms ahead, analysts believe. Iryna Piontkivska, economist at the Kiev office of Troika Dialog, the Russian investment house, says consumer spending is a key contributor to economic health. “Growth outlook is less bright than it was last year. We expect a slowdown to 6.5%, from 7.3% last year, but that is still pretty good. Industrial performance is strong: it grew by an annual rate of 11.5% in February. The machinery, food processing and metallurgy sectors are doing well.”
Despite inflation, there is “no visible slowdown in private consumption”, Piontkivska says. “The government’s financial policy is drifting towards populism, and increases in wages and pensions have been promised,” Piontkivska adds. “On the one hand this will spur inflation; on the other hand it will support consumption. The purchasing power of the population remains strong.” The risks are from the external situation, she believes.
Peter Keller, head of research at Millennium Capital investment house, agrees. Recession in the US could impact world steel prices, and Ukraine would be hit by the knock-on effect. “But in any case there will be growth, although not at such extraordinary rates as last year.”
Ukraine’s fertilizer producers have already gained from the EU’s biofuels development programme, and will benefit further from WTO entry, says Keller. And domestic consumption will boost the motorcar industry, which is now selling 450,000 cars a year to Ukrainians, as well as telecoms, utilities and the banking market.
Economic headaches
Inflation is the big economic problem for Ukraine, like many other countries. It rose from 19.4% in January to 21.9% in February (annual rate), buoyed by steep food price increases and hikes in the minimum wage and pensions.
The trend has been exacerbated by a rare example of politicians keeping promises. Oshchadbank, the legal successor to the USSR savings bank, has started paying out compensation to people who lost savings in the hyperinflationary crisis of 1990-91. It is under orders from prime minister Yulia Timoshenko, for whom the payout was an election pledge. Although the bank urges recipients, mostly pensioners, to save, the money – $300 million so far, due to total $1.2 billion this year – is mostly finding its way into the economy.
The National Bank of Ukraine (NBU), like its Russian counterpart, is trying to soak up excess liquidity without choking the economy. In February it toughened banks’ capital adequacy requirements to address liquidity risks. “The NBU has warned that current trends show that the economy is unable to absorb further excess liquidity,” Geoffrey Smith, head of research at Renaissance Capital, says. The NBU, like the Russian central bank, regulates the money supply mainly by buying foreign exchange – but unlike its Russian counterpart does not have an offshore stabilization fund, and moreover keeps the hryvna exchange rate in a band of $1:4.95–5.25.
“The NBU’s hands are tied. It has few tools with which to work,” Smith argues. “We believe Ukraine needs stronger institutions – and specifically, a strong, independent NBU with a clear mandate to keep inflation low.”
There are other ongoing economic risks, mostly external, Troika’s Iryna Piontkivska points out. “Investment, which relies quite heavily on borrowed funds, may slow down. And the trade balance and current account deficit continue to deteriorate.”
Banks strong, stock market weak
One of the sharpest weapons in Ukraine’s armoury is its banking system, in which western European banks now account for more than 50% of capital. The latest buyer, Intesa Sanpaolo of Italy, snapped up Pravex Bank, formerly controlled by Kiev’s besieged mayor Leonid Chernovetsky and his relatives, for $750 million in February – shortly after UniCredit’s $2.2 billion purchase of Ukrsotsbank, initialled in July last year, was completed. Kreditprombank, ranked 13th by assets, is rumoured to be next in line for an acquisition.
Dominique Menu, head of Ukraine at BNP Paribas – which bought a 51% stake in Ukrsibbank in 2006 – says: “The level of foreign ownership is unprecedented for the former Soviet states. State-owned banks comprise only 12% of the system. Then there are foreign-owned banks, those linked to major financial-industrial groups, and other local ‘orphan’ banks – who do not have any strong owners and who are in a much more fragile position.”
In a sector that has been growing rapidly, and borrowing to fund growth, it is these orphan banks who will be most vulnerable to the funding constraints imposed by international market conditions.
Peter Baron, vice-president at VA Bank, a top 10 institution with part foreign ownership, says: “It has become more difficult to raise money abroad. But our focus has always been on raising funds on the domestic market, and this is true of many other banks.” The sector’s outlook is good, he believes, above all because demand for retail loans will “stay strong”.
The strength of the banking system strikes a contrast with the still primitive Ukrainian stock market, which dismays investors with its slim liquidity. The PFTS trading system in Kiev, which accounts for almost all open trades in Ukraine, sees a daily turnover of about $10 million, compared to $2 billion and more in Moscow.
The problem, investors say, is the reluctance of most large Ukrainian companies to float more than a negligible proportion of their shares. Those that have bitten the bullet – Ferrexpo, the iron ore producer, the real estate company XXI Century and, coming soon, the steel pipe maker Interpipe – go for western European market listings.
The solution, says Keller at Millennium, could be to assign shares from forthcoming privatizations for floating, and to amend corporate law, removing the concept of a 25% + one share blocking stake, which deters owners from selling shares.
The political x-factor
Along with gusts of external economic storms, Ukraine’s political squalls could blow business off course – especially with the presidential election, due in late 2009, in sight.
The rivalry between prime minister Timoshenko and president Yushchenko, and the long periods during which parliament is paralyzed, could become more than an irritating distraction, some observers warn. Parliament remains split over Nato and relations with Russia, and Kiev is perceived to have weakened its own bargaining position during the talks with Moscow over gas prices and contracts in February by displaying internal divisions.
It’s been fashionable for business people to say that politics is best ignored all together, but Smith at Renaissance says that attitude has become untenable. “The state is not absent,” he points out. “Through excessive, badly designed regulation it interferes where it shouldn’t – and on the other hand government does not do the things it should do, such as ensure law and order and make the judicial system effective. Of course there is a very negative effect on business activity.”