Ukraine Watch: weekly update – economy in war (week 150)

There were extremely high risks of insufficient external financing at the beginning of 2024 amid the lack of a decision from the EU and significant problems with approving a new aid package from the United States. Therefore, our initial forecast of receiving external financing of USD 37 bn looked somewhat optimistic then. Instead, Ukraine received USD 41.7 bn over the whole year, which exceeded our initial forecast and budget plans. The signals of additional expansion in the package of external financing started to appear in autumn, which increased our estimates to USD 40.5 bn. But the first USD 1 bn of assistance from the United States under the new ERA programme (i.e. G7 loans secured by the proceeds of frozen assets of the country-aggressor) came a little earlier (i.e. in late December), which raised the total package of fund received from external partners to almost USD 42 bn last year.

The inflow of solid external financing at the end of the year not only positively impacted NBU FX reserves but also created a certain balance in the government's Single treasury account and foreign currency accounts. We think this creates good preconditions for the financing of budget expenditures in the first months of 2025, i.e., when budget revenues are seasonally low.

The implementation of the USD 50 bn ERA initiative has significantly improved the prospects for external financing not only for 2025 but also for 2026. At the same time, it will replace the external assistance previously provided separately by the United States, Japan, the United Kingdom, and Canada. However, we see a set of advantages here, with the most valuable being the provision of funds from our partners as grants, thus not increasing either the public debt or its servicing costs.

External funding in 2022-2024 by sources (in USD bn)

Source: Ministry of Finance of Ukraine, IMF, RBI/Raiffeisen Research

We do not yet have all the information about the specifics of the ERA deal (whether this would be a direct budgetary funding or partial funding of arms’ supplies) and the schedule of receipts under this programme. Hence, we expect total revenues from it at USD 19 bn in 2025 in the baseline scenario, which supports our expectations of USD 38 bn in inflows from our external partners. However, if considering rather good chances to see higher volumes of foreign currency inflows from the ERA program, the total volume of external aid this year may exceed the USD 38 bn level.

We anticipated a hike in NBU foreign currency reserves by the end of 2024 due to a rather substantial inflow of foreign aid then. However, their upward movement slightly above the previous historical maximum (recorded in March 2024) came with some surprise, probably, because Ukraine received more external aid in December than was planned, due to the early start of tranches under the ERA program. Therefore, the total volume of foreign currency inflows under external aid also hit the record and reached USD 9.5 bn, with the most contribution received from EU macrofinancial aid, special DPL mechanism through the World Bank and the IMF.

Even though servicing costs of existing debt were rather small in December (USD 0.39 bn), this has not caused a corresponding spike in NBU reserves. Indeed, the bulk of the incremental inflow of foreign currency from external aid was substantially offset by the huge volume of foreign currency NBU spent for FX market support. The regulator sold a record volume of USD 5.3 bn over one month, which allowed hryvnia to keep a controlled devaluation track, thus ending the year even at a level slightly behind our forecast. In any case, a visible hike in NBU reserves has improved their imports’ coverage to 5.8 months of imports, which is a fairly good indicator of the ability of regulators to keep the FX market under almost full control.

Even though we estimate smaller volumes of FX market support by the NBU in January due to milder imbalances, we think they would still exceed the expected volumes of external aid, which may be seasonally smaller, thus not covering fully NBU FX market interventions. Hence, there could be a minor decline in NBU reserves over January, while not harming the ability of the regulator to avoid excessive fluctuations in the FX market.

FX Reserves (in USD bn) on historically high level

Source: NBU, RBI/Raiffeisen Research

NBU FX reserves recorded a visible hike over the year in 2024, thus growing by 8% in yoy terms and outpacing our forecasts of USD 42.0 bn. This became possible due to a net inflow of external aid worth USD 35.5 bn. However, it was almost fully exhausted by solid support of the FX market through interventions. Definitely, the decision of the regulator to start the strongest wave of FX market liberalization in May added about USD 5-7 bn to foreign currency demand last year, thus forcing NBU to be more active in its interventions afterwards.

We keep our view that the NBU would follow its strategy to support the FX market with interventions especially considering recent communications from NBU officials that the regulator would smooth any excessive exchange rate fluctuations, thus securing a stable situation on the FX market throughout the whole of 2025. However, we adjusted our forecast of NBU FX reserves at the end of this year upwards, to USD 44.2 bn, due to better-than-expected reserves at the end of 2024. Hence, disregarding the expected inflow of at least USD 38 bn from external financial aid, we still see a marginal hike in NBU FX reserves by 1% yoy by the end of 2025. However, considering the relatively solid probability of higher inflows of external aid under the ERA program, we see a potential for NBU reserves to be higher than our projections.

A slight deterioration in business sentiment in December was in line with our projections due to relatively high risks and seasonality. Indeed, the Index of business expectations dropped by 3% mom to 45.9 points, while remaining just marginally above the level recorded in December 2023 (45.6 points). However, the rate of decline in business sentiment in December of last year (-2.8% mom) looks much smaller than a year before (-6.9%), which should provide additional arguments towards the resilience of business sentiment to current risks, including the much smaller risk of electricity cut-offs vs its projected level. We also think that growing talks on the end of the war in the coming few months (especially after elections in the US) might positively influence business estimates regarding the economic environment in the medium term, thus also weakening the declining pattern in business expectations index correspondingly.

The deterioration in business sentiment affected all four major sectors but not in the same manner. A visible downward movement was recorded in industry (-4%) and trade (-3%), while the decline in sectoral indices was rather marginal in construction and services. In our view, this partly reflects expectations of a seasonal decline due to colder weather and weaker business activity after the Christmas holidays. On the other hand, fears of power outages following the massive shelling in late December might have hurt the business outlook in the industrial sector mostly. However, it can already be noted that these risks did not materialize within the first ten days of January, including because of rather warm weather.

Business Activity Expectations Index (BAEI) and its components

In points, 50 denotes a neutral level

Source: NBU, RBI/Raiffeisen Research

Business sentiment usually faces a rather noticeable seasonal deterioration in its expectations in January with a similar pattern recorded all the years since the NBU started calculating its business sentiment index. Moreover, in the absence of additional extremely negative factors, business sentiment in January usually drops to a minimum value in a calendar year. Therefore, we expect a similar dynamic in business sentiment this month. However, milder weather conditions, weaker risks of electricity cut-offs and some potential decisions from the US administration may smooth some negative mood of business in January, while the latter factor may have an impact on business mood in either direction.

In its recently released final reading of GDP data, the Ukrainian Statistics Office improved economic growth from 5.3% (released in March 2024) to the current level of 5.5%, thus simultaneously recalculating a higher GDP deflator at 19.9%. All these changes allowed to improve the nominal GDP figure by 1.4% to UAH 6,628 bn, thus reducing slightly some crucial ratios tied to GDP, like budget deficit (from 20.3% to 20.1%) and public debt (from 84.4% to 83.3%).

Improving the GDP dynamic became possible due to a positive revision of the growth dynamic in expenditure components of GDP, such as investments (from 33.9% yoy to 48.1%). On the other hand, the contribution of growth in private consumption has been revised downwards from 6.2% to 4.3%, the same as net exports. However, the combined negative influence of both these components (-1.9pp) was weaker than a positive contribution from investments (by 2.1pp).

The revision of the economic growth figure for 2023 has slightly increased the comparison base for the corresponding figure for 2024. However, we are keeping our estimate of a 3.4% upturn unchanged, as the balance of risks to this projection has improved slightly on better-than-expected energy supply in the fourth quarter and the rather strong fiscal impetus in the last weeks of the year. Therefore, the upward revision (made by the Statistical Office) almost fully balances the risks to our economic growth estimate for 2024.

The high volume of external financing in November helped to reduce the current account deficit to a nine-month low of USD 0.8 bn and to generate a solid financial account surplus of USD 4.4 bn (which is the second-highest in Ukrainian history after the figure recorded in March 2024).

In addition to the positive impact of external financing on the balance of payments in November, it is also worth noting the smallest deficit (- USD 3.0 bn) of external trade in goods and services over the past six months. The key factor here was a 4% mom decline in imports of services, while the monthly dynamic of exports/imports of goods and exports of services fully followed the calendar effect for November (i.e. -3% mom). Nevertheless, we can consider recent changes in the components of external trade as insignificant to indicate any new fundamental patterns. Hence, the structural deficit of external trade has remained rather stable over the past four months, fluctuating in the small range of USD 3.0-3.2 bn per month. Because we did not notice any substantial patterns of improvement in components of external trade, rather good balance of the current account is entirely the result of a visibly higher inflow of foreign currency through grants from our partners. Indeed, grants increased in November to USD 1.5 bn, which raised the surplus of secondary income to USD 2.1 bn.

Current account components (in USD bn)

Source: NBU, RBI/Raiffeisen Research

A substantial inflow of foreign aid through loans (USD 5.1 bn) allowed the financial account’s surplus to reach volumes nearing historical maximums. It was also quite unusual to see a positive contribution to the financial account from the side of the highest net positive portfolio investments (USD 0.28 bn) since the beginning of the war, which was usually negative during the war. The inflow of foreign currency through trade credits also improved. At the same time, foreign currency outflows through cash channels stayed quite strong in November (USD 1.6 bn).

The surplus in the balance of payments increased to USD 3.5 bn in November, which definitely translated into a corresponding increase in NBU FX reserves. We can see some expansion of the external trade deficit in December due to seasonally greater imports and smaller exports. However, the current account deficit may be still relatively small due to inflow of grants from external donors. The same factor (i.e. the provision of external loans) should be the core supporting factor, in our view, for the financial account surplus in December. Therefore, we estimate the consolidated balance of payments surplus at around USD 2.7 bn then.

Even though the FX market ended 2024 with USD/UAH of 42.04 (which was just marginally smaller than our year-end forecast of 42.20), the further dynamic of the exchange rate at the beginning of 2025 was rather straightforward backed mostly by seasonal factors. In particular, the USD/UAH followed a steady growing pattern from the start of the year onwards, thus renewing its historical maximum almost every new day in 2025.

We do not see any negative patterns here so far, because the USD/UAH dynamic is tied mostly to several seasonal patterns. First, accumulated hryvnia inflows of importers on the eve and during of Christmas holidays raised foreign currency demand visibly. Second, active spending of the budget at the end of the year (including payments to households) also raised pressure on foreign currency demand. Third, the renewal of limits for non-residents to buy foreign currency for dividends’ repatriation and repayment of interest on intercompany loans strengthened foreign currency bids within the first few days of 2025. Finally, long holidays (as well as VAT reimbursements by the end of December) have seriously bound the activity of exporters in selling their foreign currency proceeds at the start of 2025. The average daily trading volume this year at around USD 230 mn is not substantially different from the average volumes recorded in December, which indicates on still high activity of importers.

Preservation of visible foreign currency deficit on the FX market (mostly backed by seasonal factors) and the necessity to reduce FX market interventions from reserves (after the historically highest interventions of USD 5.3 bn in December) might drive the growing pattern in the USD/UAH this week. Moreover, the current level of hryvnia devaluation is almost fully in line with the pattern recorded a year ago. This allows keeping yoy hryvnia devaluation in the range of 10.2-10.8% this year, thus not allowing it to go above the rates on local financial instruments.

Net weekly NBU interventions in 2023-2025 (in USD bn)

Source: NBU, RBI/Raiffeisen Research

Definitely, we see visibly smaller imbalances on the FX market this week vs the volumes recorded at the end of December. Even though an estimated volume of interventions this week at around USD 0.9-1.0 bn would look moderately greater than the average weekly interventions in 2024 (USD 0.66 bn), they are still much milder than the average weekly interventions of USD 1.2 bn recorded in December. This provides a clear indication to us that the situation on the FX market does not look dangerous currently, thus mostly representing seasonal patterns.

We can see some revival in the activity of exporters next week, which should raise foreign currency supply on the market. Additionally, exhaustion of some hryvnia stocks (accumulated by importers at the end of 2024) should lower volumes of FC demand then. This would stabilise the exchange rate and induce some limited downward corrections to it. The same patterns were recorded just a year before, but the situation with potential market imbalances was much worse back then, because Ukraine had no commitments on the packages of external aid from external donors. Therefore, the prospects for improving the market situation look substantially more optimistic this year. However, we think a stabilising trend in the exchange rate would be valid only in case the NBU shows the signals of market stabilization through stable interventions enough to compensate for excessive demand for several days in a row. Otherwise, foreign currency demand would be strengthened additionally by speculative bids, thus posing additional pressure on the exchange rate and moving it further up.