Recent Economic Developments
GDP grew by 3.5 percent in the first half of 2019 compared to 3.3 percent in 2018. The solid growth was driven by a strong agricultural harvest as well as sectors dependent on domestic demand, including services (domestic trade, transport, and the financial sector) and construction.
Household consumption continued to grow rapidly in the first half of the year, supported by (i) one-off social transfers during the election cycle; (ii) continued strong remittances from labor migration to EU countries; and (iii) a resumption of consumer lending. At the same time, manufacturing and investment growth remained weak, with a level of fixed investment (only 20 percent of GDP) that is insufficient for sustainable growth. Investment was limited by (i) low foreign direct investment of just 0.6 percent of fiscal year GDP in the first half of 2019, (ii) high interest rates and structural weaknesses in the financial sector (little progress has thus far been made in resolving nonperforming loans), and (iii) market distortions from the absence of an agricultural land market, an anticompetitive environment, and the large number of state-owned enterprises (SOEs).
Higher consumption helped reduce poverty. Real wages continued to grow in 2019 due to economic growth and persistent outward labor migration. As a result, poverty (consumption per capita below US$5.5/day in 2011 purchasing power parity) declined to 3.5 percent in 2018 from 4.9 percent in 2017 and 6.4 percent in 2016.
Strong domestic demand, together with real exchange rate appreciation (by 13.2 percent in 2018), contributed to a pickup in imports and a widening of the current account deficit to 3.3 percent of GDP in 2018 (compared 1.9 percent in 2017).
Remittances reached 9 percent of GDP in 2018. In the first half of 2019, Ukraine’s terms of trade improved due to higher iron ore and wheat prices, with exports growing 6 percent year-on-year (y-o-y).
Imports, however, continued to grow faster at 8.6 percent y-o-y, driven by intermediate goods. The merchandise trade deficit grew by 13 percent y-o-y in the first half of 2019, but growth in the surplus of the services trade and primary incomes (mostly remittances) brought the current account deficit down to just US$0.2 billion, one-third of the amount in the first half of 2018.
The growth outlook going forward depends critically on accelerating the reform momentum to address the bottlenecks in investment and productivity. Given the strong performance in the first half of 2019, growth is projected to remain at 3.3 percent this year.
Going forward, if the new Government is able to deliver on its ambitious reform goals, growth could increase to 4 percent by 2021.
This will require progress in the following areas: (i) reviving sound bank lending to the enterprise sector by completing the reform of state-owned banks; (ii) attracting private investment in the tradable sectors by establishing a transparent market for agricultural land, demonopolizing key sectors and strengthening antimonopoly policy and enforcement, privatizing SOEs, and tackling corruption; and (iii) safeguarding macroeconomic stability by addressing current expenditure pressures, securing adequate financing, further reducing inflation, and rebuilding international reserves.
If reforms do not progress and adequate financing is not mobilized, growth could fall below 2 percent as investor confidence deteriorates, macroeconomic vulnerabilities intensify, and financing difficulties force a compression in domestic demand.
Ukraine will need to safeguard macroeconomic stability and manage fiscal risks. The key to safeguarding fiscal sustainability going forward is to address the current expenditure pressures and keep the fiscal deficit below 2.5 percent of GDP to ensure a sustainable debt reduction.
This will require (i) avoiding any additional hikes in wages in education and health that are not linked to productivity growth in these sectors, (ii) resisting populist pressures to tinker with the newly established pension indexation, and (iii) further targeting social assistance programs.