Dragon Capital gloomier on Ukrainian debt, hryvnia in 2024

MOSCOW. May 29 (Interfax) - Investment group Dragon Capital has revised its forecast for the Ukrainian hryvnia's average annual exchange rate against the U.S. dollar in 2024 to UAH40/$1 from UAH37.30/$1 and its rate at the end of the year to UAH42/$1 from UAH39/$1, but left the forecast for Ukraine's GDP growth at 4%.

"We expect that the hryvnia will continue its controlled depreciation against the U.S. dollar. We revised the forecast due to changes in the National Bank's approaches to managing the exchange rate at the beginning of 2024," Ukrainian media report the group as saying in a press release.

Dragon Capital now expects external financial support for Ukraine's budget from partners to total $37 billion and that it will support the stability of the economy.

"Although the approval of support packages has been significantly delayed and the overall amount of financing will be somewhat lower than expected ($40 billion), these funds will be sufficient to keep the [National Bank of Ukraine's (NBU)] reserves around the current record levels of $43 billion (the previous forecast was $45 billion) and finance the budget deficit without monetary financing," the press release said.

Nonetheless, the situation with the budget remains tight and requires mobilization of internal resources, the group said. The law on the state budget for 2024 requires significant revisions, as it provides insufficient spending on defense and security, Dragon Capital analysts believe.

"The updated law must also take into account the effect from the intensification of mobilization, which according to our estimates will cost the budget at all levels $1.5 billion-$2 billion (taking into account indirect influence on revenues). Overall, the military spending of the state budget's general fund will need to be increased by at least $9 billion in order to keep it at last year's level," the group said.

However, this increase could be partially financed by cutting non-military spending, such as on servicing external commercial debt after its restructuring, and additional revenues, such as the tax on banks' windfall profits, increased transfers from the NBU and higher excises on fuel, the group said.

Overall, it expects the government will manage to slightly reduce the general government budget deficit to about UAH1.6 billion this year from UAH1.7 billion last year (not including grants) thanks to organic growth of tax revenues on the back of economic growth, additional measures to boost revenues and a restrained approach to non-defense spending.

"The weakening of the hryvnia's exchange rate will not have a decisive influence on the dynamic of the budget deficit, as a portion of military spending is used to buy imported goods and is compensated with tax revenues that depend on the hryvnia's exchange rate. However, a weaker hryvnia helps reduce the need for budget deficit financing with domestic borrowing, as it increases the hryvnia equivalent of international aid," the group said.

However, the revision of the exchange rate forecast has led to the reduction of the estimate for Ukraine's nominal GDP this year to $190 billion from $201 billion and increase of the forecast for the state debt at the end of the year to 92% of GDP from 85% of GDP, although the forecast for the actual debt figure was raised only slightly to $166 billion from $164 billion.

Dragon Capital does not rule out that the NBU might change its approach to managing the exchange rate in line with its own assessment of the balance of risks for financial stability. However, its record international reserves will enable the NBU to keep the situation on the forex market under control and avoid an uncontrolled devaluation if domestic economic policy is aimed at maintaining macroeconomic stability and international partners continue to provide financial support in the minimum necessary amounts, the group said.

Given the slowdown of inflation and stable inflation expectations, a moderate depreciation does not carry risks for macrofinancial stability, but it does support the competitiveness of Ukrainian exports, helps the budget by reducing the need for financing and makes it possible to reduce reserve losses from the primary effects of currency liberalization, Dragon Capital said.

The group lowered its inflation forecast for 2024 to 7.6% from 8% and its forecast for the discount rate at the end of the year to 13% from 15%.

The GDP growth forecast was left at 4% because of the resumption of exports through seaports and the development of the defense industry, which together will be the main drivers of growth this year and outweigh the negative impact of increased mobilization and electricity shortages, assuming the authorities organize mobilization in a way that will limit the negative impact on businesses, the group said.

"By our estimates, if the existing capacity of the energy system is maintained and taking into account current import capabilities, the electricity deficit will be fairly moderate in the summer and fall, which will enable businesses in most sectors to maintain production volumes at levels close to current ones, and therefore increase them compared to 2023," the group said.

Growth will be particularly evident in sectors that were hit by the lack of marine exports, meaning ore production, metals and freight transport, Dragon Capital said.

The company also expects that, thanks to the resumption of seaport operations and a bigger than expected harvest last year, Ukraine's exports of key commodities will grow by 35% to 109 million tonnes this year, which will keep the foreign trade deficit from expanding further despite the growth of imports and drop in world prices for agricultural commodities. The forecast for the trade deficit was lowered to $29 billion from $32.9 billion.

The NBU recently lowered its GDP growth forecast for this year to 3% from 3.6% and the Finance Ministry lowered its to 3.5% from 4.6%. Ukraine's economy grew by 5.3% in 2023. The Ukrainian government forecast economic growth of 4.6% this year when parliament passed the draft state budget in the second reading at the beginning of last November.

GDP growth slowed to 4.3% year-on-year in April from 4.6% in March and to 4.4% in the first four months of 2024 from 4.5% in the first quarter, according to preliminary estimates from the Economy Ministry.

On May 3, the NBU announced the biggest package of measures to ease forex restrictions for businesses since the start of the military operation in the country. They include the lifting of all forex restrictions for imports of work and services, and allow businesses to repatriate "new" dividends and transfer funds abroad to pay for leases and rent.

In addition, the new measures ease restrictions on repayment of "new" external loans and interest on "old" external loans, as well as ease restrictions on transferring forex from representative offices to parent companies.

The official exchange rate for May 28 was UAH40.30/$1.