News Analysis: Ukrainian economy emerges from recession, but long-term risks persist

The Ukrainian economy has emerged from more than two years of recession after showing two consecutive quarters of growth. Yet, uncertainties still remain, posing long-term risks to a sustainable recovery.

WORST RECESSION OVER

In August, official data showed that the Ukrainian gross domestic product (GDP) went up by 1.3 percent year-on-year in the second quarter of 2016, after rising 0.1 percent in the first quarter.

Although the figure was lower than the preliminary official estimates of 2.3-percent GDP growth in the second quarter, it has indicated that the economy had emerged from the crisis that started in the first quarter of 2014.

"This data suggested good news for all Ukrainians. First of all, we have officially emerged from the recession, and secondly, the second quarter results show that the economic recovery is accelerating," said Vitaly Shapran, an expert at the Ukrainian Association of Financial Analysts.

Apart from the GDP increase, some other key Ukraine's economic indicators have also returned to the positive territory in the first two quarters of the year, inspiring hopes for a sustainable recovery.

Industrial output, a traditional growth engine of Ukraine, in January through June rose 2 percent on an annual basis, which marked the first increase since 2012.

Meanwhile, the retail sales, another drive of the economy, went up 2.3 percent in the first half against the backdrop of easing inflation and a 22.4-percent increase in average wages.

The country's financial system has also seen a moderate rebound as evidenced by the fact that the central bank has eased its monetary restrictions, including limits on foreign currency purchases and a ban on withdrawing investment profits from the country. Besides, the bank has reduced the key interest rate to 15.5 percent in July 2016 from 22 percent in December 2015.

The positive economic data has raised optimism that the worst recession in Ukraine could be over.

"Today, we can safely say that after two years of the severe crisis, the economic environment has become calmer and more favorable. Still, there are many challenges in the budget sector, but a possible default and the financial collapse are not on the agenda," said Natalia Leshchenko, an analyst at the Center for Social and Economic Research "CASE Ukraine."

RECOVERY STILL FRAGILE

Even though the latest economic data is encouraging, some analysts warned against premature celebration as the overall picture of the recovery is still mixed.

Many key macroeconomic indicators continued the downward trend in the first half of the year. For instance, the export, which is one of the main factors of the GDP growth, has shrunk 9.2 percent from a year earlier, while the state debt has increased 2.5 percent in January through June.

In addition, some analysts also believe that the formal recovery could not be considered as a full emerge from the crisis because of the low comparable base -- in the second quarter of 2015, the yearly reduction rate of Ukraine's economy was 14.7 percent, while in the first quarter it was 17 percent.

"We are stuck in a state of a stalled recession, and the economy is gradually adapting to the existing risks. There are certain economic indicators that showed the growth, but unfortunately, the situation can not yet be called a recovery," said Yaroslav Zhalilo, an economist at the Institute of Economics and Forecasting of the National Academy of Sciences.

Moreover, there is a widespread view that Ukraine is facing a risk of entering another recession.

The biggest factor that could tip the country back to the crisis is the uncertainties related to the political instability and escalation of the conflict in eastern regions, which scares away potential investors.

While before the start of the crisis in 2013, the inflow of foreign direct investment in Ukraine totaled 5.7 billion U.S. dollars, it was only 3.7 billion dollars last year.

"Now, we have poor investment ratings, and the investment attractiveness of Ukraine is on the extremely low level. Although we have some promising areas to invest in, the poor institutional environment, problems with the judicial protection and instability are forming a huge negative trend," said Vladislav Zimovets, a doctor of Economics at Kiev Mohyla Academy.

The unstable political and security situation in Ukraine has already disrupted its cooperation with the International Monetary Fund (IMF), the country's largest foreign creditor.

The third disbursement from the IMF's 17.5-billion-dollar bailout package for Kiev has been suspended since last year and till now there is no clear sign that the global lender is ready to uphold the cooperation.

If the new tranche of the aid is not agreed in the nearest future, Ukraine may face another wave of inflation, a decrease in the consumer demand and thus -- the GDP reduction.

MIXED OUTLOOK

Under the current internal and external environment, the most likely scenario is that Ukraine's economy will continue a weak growth until the end of the year. In the same time, its long-term outlook remains uncertain.

According to the government projection, the nation's GDP, which bogged down 9.9 percent in 2015, will probably grow 1.5 percent this year.

The cabinet predictions are in line with the estimations of most local experts and a string of international organizations, including the IMF and the World Bank, which predict a 1-percent to 1.5-percent growth in 2016.

The projected good grain harvest and increasing demand for Ukraine's main exports commodities on the global market, which will make new injections of the foreign currency into the economy, are expected to offset the damage caused by falling investment and the possible delay of the next portion of the IMF aid.

"In the third quarter, the economic activity will be supported, first of all, by the agriculture, while in the fourth quarter, the economy will benefit from the so-called fiscal impulse as spending in this period will significantly increase," said Alexander Valchyshen, head of the analytical department at the Investment Capital Ukraine group.

In the same time, the long-term forecast for the economic performance is not so definite. While the government estimated that the country's GDP would increase by 3 percent in 2017 and go up by 4 percent in each of the two following years, analysts are less optimistic.

Many experts believe that the economy may face stagnation or even a free fall in the coming years if progress is not achieved in implementing much-delayed reforms and establishing a stable political system.

Despite the initial signs of recovery, the economy still remains in a very precarious state and any volatility of prices on the global market on Ukraine's exports or any internal instability may trigger the domino effect.

Another key thing that has to be understood is that Ukraine would not achieve the economic stability until it solves the conflict in eastern regions.

"If within the next year or a year and a half a lasting peace in Donbas is not achieved, Ukraine would inevitably declare a default, because the economy will not manage to survive without new investment," said Andrey Golovachev, an independent economic analyst. Endi