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Emerging Perspectives

Ukraine: serious decisions

5 March 2019
Author: Grant WebsterPortfolio Manager, Fixed Income

With Ukraine’s presidential race heating up, portfolio manager Grant Webster reports from the country and sizes up the investment backdrop.

Ukrainians head to the polls this month, but it’s too close to call who they’ll choose as president. With three very different candidates in the running – including a comedy actor who has played the president in a TV show – the election result is no joke for a country that is recovering from war and remains reliant on external financial support.

A mixed picture on structural reforms

Away from the hustings, Ukraine’s Ministry of Finance is serious about reform and making impressive progress. An independent Debt Management Office is under construction, and the legislation to implement medium-term budgeting has been passed well ahead of schedule. The first three-year budget will be set this May and will include hard-to-breach fiscal-deficit ceilings. Also encouraging is the central bank’s implementation of orthodox inflation targeting, as well as its efforts to clean up the banking sector.

Away from the hustings, Ukraine’s Ministry of Finance is serious about reform and making impressive progress.

However, efforts to tackle graft have been somewhat disappointing. While legislation was passed to create a new anti-corruption court (an IMF requirement), we are still seeing serious efforts to water down the effectiveness of this court. And given this is an election year we think there’s likely to be limited progress on other initiatives, such as privatisation and land reform — the latter is essential to unlock Ukraine’s growth potential.

Financial support

Ukraine’s financing has been bolstered by the IMF’s recent approval of a $3.9 billion stand-by arrangement, a stop-gap financing to replace a previous aid-package that was never fully completed because reforms were progressing too slowly. The new facility will be regularly reviewed through the year and the conditionality for IMF disbursements is relatively light.

Nevertheless, Ukraine’s funding requirements remain substantial. Foreign inflows into local debt have reduced the need for external issuance, though Ukraine will still need to tap international markets this year. We think that a debut EUR-denominated Eurobond would make sense. Going forward Ukraine’s ability to access local currency financing is set to improve: Ukrainian government bonds are on track to be added to Clearstream, the international settlements system, within the next few months, improving liquidity and accessibility for international investors.

Overall, the IMF is broadly positive on Ukraine’s economic prospects.

Overall, the IMF is broadly positive on Ukraine’s economic prospects. GDP growth is tracking at almost 3% and inflation should slow to around 7.5% by year end, from close to 10%. The central bank has room to lower interest rates by about 2-3 percentage points, but it may wait until after the elections to make a significant cut.

Decision time

That brings us back to political risk — a key dimension for investors in a country that is otherwise making solid, albeit slow, progress. A meeting with challenger Yulia Tymoshenko’s team rang alarm bells: some proposed policies could undermine confidence in Ukraine’s financial system. Incumbent Petro Poroshenko’s policies are more orthodox, though like Tymoshenko he has strikingly high public disapproval ratings. It’s not entirely clear what actor/director Volodymyr Zelensky stands for — his popularity, primarily with the young, is of an anti-establishment, none-of-the-above kind.

A potential flash-point concerns any future leader’s commitment to maintaining higher gas tariffs (previously, households paid well below the market rate). That is one of the IMF’s non-negotiables, and any move to cut charges would jeopardise the stand-by arrangement.

Parliamentary elections in October may be more crucial as they will determine the extent to which the new president can enact his/her policies.

According to recent polls, Zelensky has pulled into the lead while Tymoshenko’s support has fallen. At the time of writing, it looks like Zelensky and the incumbent, President Poroshenko, stand the highest chance of making it through to the second round. But it’s a tricky race to call – polling is unreliable and we are already seeing a number of smear campaigns (no doubt with significant support from outside actors).

2019 will be the first critical test for Ukraine since the Maidan revolution of 2014.

While the winner of these elections will be key to future policy developments, the parliamentary elections in October may be more crucial as they will determine the extent to which the new president can enact his/her policies.

2019 will be the first critical test for Ukraine since the Maidan revolution of 2014, which claimed dozens of lives and overthrew the government.

Five years on from the revolution, we own Ukrainian US dollar bonds across some of our strategies. We believe valuations do not fully reflect the dynamics at play in this country, even taking into account the political uncertainty around the forthcoming election.

Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.

Grant Webster
Grant Webster Portfolio Manager, Fixed Income

Important Information:

This material is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual results may differ materially from those stated herein.

All rights reserved. Issued by Investec Asset Management, issued March 2019.

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