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Kazakhstan

We expect GDP growth to ease from 4.1% in 2017 to 3.1% in 2020

Banking sector clean-up and recapitalisation well underway

After picking up to an estimated 4.1%y/y in 2017, GDP growth is likely to gradually cool to 3.8%y/y this year (+4.2%y/y in H1'18) and to 3.5% and 3.1% in 2019-20. The surge in oil output after the launch of the giant Kashagan field is levelling off, so growth is going to be driven more by the non-oil sectors. Consumption in 2019 is likely to be supported by the 50% hike in minimum wage, some public-sector salary increases, and further growth in credit to households.

Higher oil exports helped to reduce the current account deficit from -6.5% of GDP in 2016 to -3.4% in 2017 and we expect a gap of under 1% in 2018, gradually widening to 1.5% by 2020 if oil prices are flat. The KZT, however, remains sensitive to the RUB volatility and capital outflows; the NBK sold $0.5bn in September to stabilise the exchange rate. Based on UBS's weak-USD view and our expectations of a firmer RUB/USD in 2018, we forecast KZT/USD at 345-350 in 2019-20. The fiscal stimulus rolled out in 2015-2017 to cushion the impact of falling oil prices and a recession in Russia, and the bailout of banks, widened the government budget deficit to 6.5% of GDP in 2017. Higher oil prices and lower spending needs this year have likely lifted the budget into a surplus of c. 1.5% of GDP and we expect the government budget to stay in small surplus in 2019-20. This should also allow it to replenish the National Oil Fund assets (currently at $56.3bn, down from a $77bn peak in 2014).

In 2017, the government and the NBK allocated c. 6% of GDP to a package of measures to clean up, re-capitalise and further consolidate the long-ailing banking sector. A merger of the two largest banks was completed in 2018 (with the state injecting 4.5% of GDP into the Problem Loan Fund to take over non-performing loans), and the NBK provided KZT 650bn in long-term loans to another five large banks, to invest in NBK notes. Over 2017-18, the NBK has also been withdrawing licences from smaller players for breaking regulatory requirements. New legislation was also passed to strengthen the NBK's supervisory powers. The banking system clean-up has not yet produced a rebound in private-sector credit, although a declining overall credit stock reflects bad asset write-downs, while credit to households is growing at c. 15% y/y. Earlier this year the government also launched a subsidised mortgage program "7-20-25".

Following the KZT sell-off in H2 2018, sparked by the RUB weakness and capital outflows in a relatively thin FX market, the NBK raised the base rate by 25bps to 9.25%. With the KZT remaining weak despite the rise in oil prices and against the background of rising global interest rates, we think the NBK may need to hike again to 9.5% in December. We forecast inflation to decline only gradually, from an average of 6% in 2018 to 5.6%y/y in 2019 and 5.4%y/y in 2020. Reaching the 4% inflation target by the end of 2020 will likely be challenging if wage growth continues to accelerate. Maintaining the interest differential with USD rates is also desirable to promote deposit de-dollarisation. Therefore, we think that in the absence of a significant withdrawal of fiscal support from the economy or a KZT rally, the NBK will have only limited room to cut rates in 2019-20, to 8.75%. The NBK liquidity injections into the banking system and still-stagnant credit growth contribute to the KZT liquidity surplus, keeping the interbank market rates near the bottom of the 9.25% +/-1% interest rate corridor; thus, further tightening may take form of narrowing the corridor.

Boost to GDP growth from oil output increase fading, private consumption growth picking up

Higher oil exports closed fiscal and external gaps and should allow for replenishment of the National Oil Fund

Government spent 6% of GDP on bank-sector clean-up and support; credit growth is yet to rebound

Rising global interest rates and faster wage growth to limit room for interest rate cuts

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Figure 93: IP growth moderating, consumption picking up

20	% y/y, 3m MA
15
10
5
0
(5)
(10)
(15)
Mar/09		Nov/10	Jul/12	Mar/14	Nov/15	Jul/17
		IP
		Retail sales
		Short-term economic indicator, %y/y

Source: Haver, UBS

Figure 94: External and fiscal imbalances closing

15
%
10							Forecast
5
0
(5)
(10)
2005	2007	2009	2011	2013	2015	2017	2019F

C/A balance, % of GDP

Budget balance, % of GDP (incl Oil Fund accumulation) Real GDP growth, %

Source: Haver, UBS

Figure 95: Credit rebound driven by household loans

Figure 96: Bank non-performing loans

60%					40%
50%					35%
40%		Bank loans, %y/y			30%
30%					25%
20%					20%
10%					15%
0%					10%
-10%					5%
-20%					0%
					Apr-07	Apr-09	Apr-11	Apr-13	Apr-15	Apr-17
		bad asset writedowns
-30%							Overdue loans as % of total
Jan-08	Jul-09	Jan-11 Jul-12 Jan-14	Jul-15	Jan-17	Jul-18		90+ days overdue loans as % total
	Nonbanking Legal Entities			Individuals			Provisions, % of total loans

Source: NBK, Haver, UBS Source: NBK, Haver, UBS

Figure 97: Limited room for policy rate cuts Figure 98: National Oil Fund and NBK reserves

20	%											120
16												100
12												80
8												60
												40
4
												20
0												0
09	10	11	12	13	14	15	16	17	18	19	20
		NBK base rate						Headline inflation, %y/y

NBK refinancing rate

NBK target range

$bn

06			07	08	09	10	11	12	13	14		15	16	17	18
		NBK gross international reserves										National Oil Fund

Source: Haver, NBK, UBS

Source: Haver, UBS

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Figure 99: KAZAKHSTAN

	2013	2014	2015	2016	2017	2018F	2019F	2020F
Economic Activity and Employment
GDP, local currency bn	35999	39676	40884	46971	52028	60065	65235	69623
GDP, USD bn	237	221	184	137	160	175	185	200
GDP per capita, USD	13789	12712	10435	7658	8772	9479	9894	10530
Real GDP growth, %	6.0	4.2	1.2	1.1	4.1	3.8	3.5	3.1
Private consumption, % y/y	10.6	1.1	1.8	1.2	1.5	3.7	3.0	2.6
Government consumption, % y/y	1.7	9.8	2.4	2.3	2.1	-10.0	12.0	3.0
Gross Fixed Capital formation, % y/y	5.5	4.4	4.2	3.0	4.0	4.5	4.0	4.5
Exports, % y/y	2.7	-2.5	-4.1	-4.5	2.2	6.5	2.3	2.0
Imports, % y/y	7.8	-4.0	-0.1	-2.0	-4.5	2.5	4.1	2.5
Unemployment rate, %	5.2	5.0	5.0	5.0	4.9	4.9	4.8	4.8
Industrial Production (%)	1.3	0.2	-1.7	-2.5	8.4	4.7	4.3	3.7
Prices, interest rates and money
CPI inflation, % y/y (average)	5.8	6.6	6.7	14.6	7.4	6.0	5.6	5.4
CPI inflation, % y/y (year-end)	4.6	7.3	13.8	8.5	7.0	5.3	5.6	5.3
Broad money M2, % y/y (end-year)	1.5	-8.2	8.0	46.2	7.5	-5.0	10.0	7.0
Domestic private credit, % y/y	12.8	5.9	4.6	0.1	0.9	3.0	3.0	5.0
Domestic bank credit/GDP	40.9	39.1	45.0	38.6	32.6	29.7	28.2	27.7
Base rate, % (end-year)	5.5	5.5	16.0	12.0	10.25	9.50	9.00	8.75
>5y bond yield, % (year-end)***	5.8	6.4	7.1	7.1	7.3	7.75	8.25	7.75
USD/KZT (year-end)	153.6	182.4	339.5	333.3	331.3	360.0	345.0	350.0
EUR/KZT (year-end)	211.8	221.4	370.0	349.9	392.1	414.0	424.4	455.0
Fiscal accounts
General govt budget balance, % GDP*	5.2	6.1	-3.8	-4.4	-6.5	1.5	0.6	0.3
Revenue, % GDP	21.6	23.7	13.4	12.4	14.0	18.4	17.2	18.2
Expenditure, % GDP	16.4	17.6	17.2	16.8	20.5	16.9	16.6	17.9
of which interest expenditure, % GDP	0.5	0.5	0.5	1.1	0.9	0.8	0.8	0.8
Primary balance, % GDP	5.7	6.6	-3.3	-3.3	-5.6	2.3	1.4	1.1
Public sector debt (gross),% GDP	12.9	14.6	18.8	24.7	26.3	24.2	24.5	23.9
of which domestic public debt, % GDP	10.1	10.7	11.5	14.5	17.2	16.0	16.0	16.0
of which external public debt,% GDP	2.8	4.0	7.2	10.2	9.1	8.3	8.5	7.9
% general govt debt held by non-residents	16.4	15.7	28.0	45.0	36.4	38.0	38.0	40.0
Public debt held by the central bank, % GDP	0.6	1.1	0.8	0.6	0.7	0.7	0.7	0.6
Balance of payments
Trade balance, USD bn	34.8	36.2	12.7	9.2	17.3	27.4	28.0	26.8
Exports, USD bn	85.6	80.3	46.5	37.3	49.5	62.9	65.6	66.7
Imports, USD bn	50.8	44.1	33.8	28.1	32.1	35.6	37.7	39.9
Current account balance, USD bn	1.3	6.1	-5.1	-8.9	-5.4	-1.3	-1.9	-3.1
as % of GDP	0.5	2.8	-2.8	-6.5	-3.4	-0.7	-1.0	-1.5
Foreign direct investment (net), USD bn	8.0	4.6	3.1	13.4	3.7	4.0	4.0	4.0
Total FX reserves, USD bn	24.7	29.2	27.9	29.7	30.7	30.0	32.0	35.0
Foreign exchange reserves excl gold, USD bn	19.2	21.8	20.3	20.1	18.2	17.5	19.5	22.5
Total FX reserves, % GDP	10.4	13.2	15.1	21.6	19.3	17.1	17.3	17.5
Total external debt, % GDP**	32.1	35.2	30.8	42.9	39.5	36.4	36.1	35.1
Net International Investment Position, % GDP	-14.1	-18.2	-20.6	-20.5	-26.3	-29.1	-30.0	-31.4
Credit ratings
Moody's	Baa2	Baa2	Baa2 (st)	Baa3 (n)	Baa3 (st)	Baa3 (st)	n/a	n/a
S&P	BBB+	BBB+	BBB (n)	BBB- (n)	BBB- (st)	BBB- (st)	n/a	n/a
Fitch	BBB+	BBB+	BBB+ (st)	BBB (st)	BBB (st)	BBB (st)	n/a	n/a

Source: NBK, IMF, Haver, Bloomberg, UBS. *Republican budget + National Oil Fund. **Excluding intercompany debt. ***No 10-year KZT bond available, data is for MEUKAM treasury bills with over 5y maturity.

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Ukraine

We expect GDP growth to slow from 3.4% in 2018 to 2.5% in 2019 and 2.8% in 2020.

Key uncertainty is how cooperation with the IMF will proceed around and after presidential and parliamentary elections in 2019.

GDP growth picked up pace to 3.6%y/y in Q2 2018, from 2.5% in 2017, thanks to a rebound in consumption and investment; exports, however, remain soft. We expect growth to slow to 2.5% in 2019 and 2.8% in 2020 as the government had to rein in spending and financial conditions are tightening.

The key uncertainty for investors, in our view, is around economic policies and the cooperation with the IMF in the run-up and after the presidential (March) and parliamentary (October) elections in 2019. We believe the most market-friendly result would be a president willing to continue reforms and maintain a working IMF programme, supported by a ruling coalition in the parliament with a sufficiently wide majority. Current opinion polls, however, suggest a fragmented political landscape, so the outcome remains highly uncertain.

Last month, the authorities and the IMF reached a staff-level agreement on a new 14-month Stand-By Arragement of SDR 2.8bn ($3.9bn). The new SBA will replace the $17.5bn EFF program set to expire next March, out of which only SDR 6.2bn ($8.6bn) has been disbursed. A hike in household heating and gas tariffs and Rada's approval of the 2019 budget were put as pre-conditions. The government approved a 23.5% tariff hike from 1 November, and passed the 2019 budget in the first reading with a deficit of 2.3% of GDP. The IMF mission to discuss the 2019 budget is in Kyiv over 4-9 November. If the budget is passed in line with the IMF recommendations by early December (the Speaker of the State Rada said 22 November was possible), the IMF Executive Board may consider the SBA before Christmas. The NBU expects the first tranche of $1.5bn-1.9bn.

We assume that the authorities will get one tranche from the new SBA by early 2019, which should help to bring the NBU reserves back to the level of early 2018. More importantly, the agreement with the IMF should allow the government to draw on other official creditors and the external debt markets (Finance Ministry recently issued a $2bn Eurobond and state gas company Naftogaz also announced plans to issue), to line up foreign financing before a peak in external debt repayments in 2019-20. We think that the authorities will likely struggle to meet the requirements for further SBA tranches in the electoral period, so we don’t anticipate a sustained improvement in the external financing picture until 2020 when we would expect the newly elected President and government to re-engage with the Fund.

Weaker UAH and risks to external financing due to the IMF program extension delays caused the NBU to hike rates by a cumulative 450bps from October 2017 to 18%. We expect inflation to end 2018 near 10%y/y due to higher tariffs and the exchange-rate weakness, and to decline to the upper range of the 5%+/-1% inflation target only in 2020. We expect a tightening labour market to put upward pressure on wages, the UAH to again come under pressure to depreciate in 2019, and we see some risks of a fiscal slippage in 2019. Therefore we expect the NBU to continue to keep a tight policy stance (and potentially even hike further in the near term) until late 2019, returning the key rate back to 14.5% only by the end of 2020.

Tighter fiscal and monetary stance to cool GDP growth in 2019

Approaching presidential and parliamentary elections raise uncertainty about government economic policies

We expect the new SBA to help tide the government over increased external debt repayments in 2019 but don't expect a sustained improvement in the external financing until after the 2019 elections

The NBU will likely have to keep a tight policy stance into 2020

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Figure 100: Domestic demand driving the recovery

Figure 101: Real GDP growth, fiscal and external balances

150								15
Index, seas. adj., 2007=100								10
130
110								5
90								0
70								(5)
50								(10)
30								(15)
2001	2003	2005	2007	2009	2011	2013	2015	2017

GDP

Household consumption

Fixed nvestment

Exports

Imports

																			UBS
																			forecast
1999	2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018F	2019F	2020F
						C/A, % of GDP
						Budget balance, % of GDP
						Real GDP growth, %

Source: Haver, UBS Source: Haver, IMF, UBS

Figure 102: Basic balance deterioration driven by C/A gap Figure 103: NBU reserves started to decline

10				USD bn, 12m sum		5	$ mn								$ bn	45
5						4										40
0						3										35
(5)						2										30
						1										25
(10)						0										20
(15)						(1)										15
(20)						(2)										10
(25)						(3)										5
						Jan/08		Jul/09		Jan/11	Jul/12	Jan/14	Jul/15	Jan/17	Jul/18
Jan-11	Jul-12	Jan-14	Jul-15	Jan-17	Jul-18
									NBU interventions, USD bn (+ means USD selling) (lhs)
	C/A balance			FDI

		Debt securities		Basic balance				NBU gross reserves, USD bn (rhs)
Source: Haver, UBS						Source: NBU, Haver, UBS

Figure 104: Service schedule of FX-denominated ext debt* Figure 105: Estimated government debt schedule*

6,000 USD mn

5,000
4,000
3,000
2,000
1,000
0
2018Q3	2018Q4	2019Q1	2019Q2	2019Q3	2019Q4

400 bn, UAH

350

300

250

200

150

100

50

0

Direct investment: intercompany lending

Other sectors (inc. guaranteed by state)

Deposit-taking corporations, except the central bank

Central bank Government

Source: NBU, UBS. *Including interest

Internal debt: service payments	Internal debt: redemption
External debt: service payments	External debt: redemption

Source: Ministry of Finance, UBS. *As of 1 Oct 2018, incl payments up to 1 Oct.

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Figure 106: UKRAINE

	2013	2014	2015	2016	2017	2018F	2019F	2020F
Economic Activity and Employment
GDP, local currency bn	1465	1587	1989	2385	2983	3417	3795	4220
GDP, USD bn	181	134	91	93	112	121	129	139
GDP per capita, USD	3979	2951	2129	2192	2644	2862	3070	3302
Real GDP growth, %	0.0	-6.6	-9.8	2.4	2.5	3.4	2.5	2.8
Unemployment rate, (avg)%	8.0	9.4	9.6	9.9	10.0	9.5	9.3	9.0
Industrial Production (%)	-4.3	-10.1	-13.0	2.8	0.4	1.5	2.0	2.5
Prices, interest rates and money
CPI inflation, % y/y (average)	-0.3	12.1	48.7	13.9	14.4	11.6	8.8	6.8
CPI inflation, % y/y (year-end)	-0.2	24.9	43.3	12.4	13.7	9.5	8.0	6.0
Broad money M2, % y/y (end-year)	17.5	5.4	4.0	10.9	8.0	10.0	9.0	10.0
Domestic private credit, % y/y	12.9	11.3	-2.9	-1.9	1.1	15.0	8.0	10.0
Domestic bank credit/GDP	82.3	95.3	75.8	70.3	58.7	58.9	57.3	56.6
Key policy rate, % (end-year)	6.50	14.00	22.00	14.00	14.50	18.00	17.00	14.50
UAH/USD (year-end)	8.2	15.8	24.0	27.2	28.1	28.5	30.2	30.6
UAH/EUR (year-end)	11.4	19.1	26.2	28.6	33.2	33.1	37.4	39.8
Fiscal accounts
General government budget balance, % GDP*	-6.7	-12.1	-4.4	-8.1	-6.4	-2.5	-2.8	-2.3
of which interest expenditure, % GDP	2.5	3.3	4.4	4.1	3.7	3.9	4.1	4.1
Primary balance, % GDP	-2.3	-1.2	3.1	1.9	0.8	1.4	1.6	1.6
Public sector debt (gross),% GDP	39.9	65.4	79.1	80.9	71.8	67.9	65.2	64.4
of which domestic public debt, % GDP	19.4	26.6	26.6	28.9	25.7	25.4	25.7	25.4
of which external public debt,% GDP	20.5	38.8	52.4	52.0	46.1	42.5	39.5	39.0
% domestic public debt held by non-residents	4.8	4.7	4.4	1.0	0.7	1.0	0.6	1.5
Public debt held by the central bank, % GDP	59.4	69.5	77.2	57.2	48.1	46.0	45.0	42.0
Balance of payments
Trade balance, USD bn	-22.1	-7.1	-3.5	-6.9	-9.7	-13.0	-14.0	-17.0
Exports, USD bn	59.1	50.6	35.4	33.6	39.7	43.0	48.0	53.0
Imports, USD bn	81.2	57.7	38.9	40.5	49.4	56.0	62.0	70.0
Current account balance, USD bn	-16.5	-4.6	1.6	-1.3	-2.4	-4.7	-5.2	-6.0
as % of GDP	-9.2	-3.4	1.8	-1.4	-2.2	-3.9	-4.0	-4.3
Foreign direct investment (net), USD bn	4.1	0.3	3.0	3.3	2.6	2.0	2.0	3.5
Total FX reserves, USD bn	20.4	7.5	13.3	15.5	18.8	18.2	17.0	22.0
Foreign exchange reserves excl gold, USD bn	18.8	6.6	12.4	14.6	17.7	17.1	15.9	20.9
Total FX reserves, % GDP	11.3	5.6	14.6	16.6	16.8	15.1	13.1	15.8
Total external debt, % GDP	78.7	103.0	129.3	120.5	102.9	101.0	96.7	93.7
Net International Investment Position, % GDP	-37.1	-37.6	-36.1	-29.1	-31.3	-35.2	-39.2	-43.5
Credit ratings
Moody's	Caa1	Caa3	Caa3	Caa3 (st)	Caa2 (p)	Caa2 (p)	n/a	n/a
S&P	B-	CCC-	B-	B- (st)	B- (st)	B- (st)	n/a	n/a
Fitch	B-	CCC	CCC	B- (st)	B- (st)	B- (st)	n/a	n/a

Source: NBU, State Statistics Service, IMF, IIF, UBS. *Including Naftogaz and bank recapitalisation

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