The economy is demonstrating moderate growth, the situ-ation on the currency exchange market has stabilized, andthe official inflation rate stays within the NBU target.

Reforms were conducted not intensively enough, but stillthere are several positive outcomes. Particular attentionshould be given to the reform of the energy market, as itsconduction is a prerequisite for the energy independenceof Ukraine.

This report is aimed at evaluating the current economicsituation in Ukraine, making a preliminary overview of 2016and forecasting economic development in 2017.

A number of positive changes took place in the Ukrainianeconomy in 2016.

A revival of economic growth, positive trends on the labormarket, and a renewal of consumer lending is observed.

ECONOMY OF UKRAINE. 2016 OVERALL RESULTS. FORECAST FOR 2017Anatoliy Amelin

Head of Economic Programs, UIF

Yana Lavryk, Olga KhomenkoEconomic Programs Experts, UIF.

2016 Results: TOP-10 Economic Events

From 38%-44% (average level) до 22% (unified rate)

Revival of economic growth

Reduction of the NBU refinancing rate From 22% (January 2016) to 14% (October 2016)

Receiving of the IMF tranche In September, the IMF granted a $1 billion tranche to Ukraine

UAH exchange rate stabilization The official exchange rate ranged within 24,25-26,40 UAH/USD.

Energy market reform Reduction of the ad valorem charge, increase in gas tariffs and gas prices of PJSC “Ukrgazvydobuvannya”

Rise in Doing Business ranking

Reduction of the requirement criterion of compulsory sale of currency earnings from 75% to 65%, repeal of a ban on repatriation of dividends for 2014-2015

The projected Budget 2017 made public

$1 billion Eurobond emission against US guarantee

Total amount - $1 billion, rate - 1,471%

An increase in the minimum wage by 2 times up to UAH 3 200

Currency liberalization

Upraise by 3 positions, 80th position among 190 countries

After declining during 2 consecutive years Ukrainian economy is back to reviving

Reduction of the unified social tax

1

The growth in gas tariffs for the population up to the eco-nomically feasible level allowed liquidating the hidden sub-sidization of the industry. According to “Naftogaz”estimations, the funding of schemes with “cheap” gas forpopulation amounted to $60 billion over 10 years. At thesame time, according to the Institute for the Future esti-mations, Ukraine could have provided itself with gasin 5 years with investments of up to $5 billion.

Increase in gas tariffs allowed tripling the gas selling priceof PJSC “Ukrgazvydobuvannya”. In a result of gas price in-crease and drop of the rental rate the company generatedan investment resource. “Ukrgazvydobuvannya” announcesthe doubling of gas-well drilling volumes for a prompt in-crease in production (from 14.5 billion cubic meters to 20billion cubic meters in 2020). However, the issue of furtherreduction of ad valorem charge for gas producers remains open.

The tax burden remains high: charge for private gas pro-ducing companies is 29%/14%, for state ones - 50%. In ouropinion, for achieving energy independence the chargeshould be reduced to 20% (for all types of companies).Firstly, this would provide the increase in working capital

for generation of the investment funds of gas producers,and secondly, this would create equal opportunities forboth private and state companies.

In September, Ukraine received a tranche from the IMF inthe amount of $1 billion. It allowed to replenish NBU FX re-serves and provided a psychological support to the ex-change rate. Although the amount was significantly lowerthan the $6-7 billion planned at the beginning of the year.

The IMF tranche was followed by a $1 billion Eurobondtransaction with a US guarantee. The funds were allocatedfor social support.

This year, Ukraine has risen by 3 positions in the Doing Busi-ness rating and took 80th place among 190 countries.

The project of the budget for 2017 was made public in au-tumn. A doubling of the minimum wage is foreseen. On theone hand, it is a tool of unshadowing the economy, and onthe other it is a potential increase in social spending of thebudget, business spending on payroll , and boost to inflation.

2

Key problems of the Ukrainian economy in 2016 remainedthe same. Firstly, it has a high dependency upon commod-ity cycles (correlation between GDP and Commodity PriceIndex amounts to 87%). Ukraine continues to export mainlyMMC and AIC products with low value added, maintaining astatus of a resource colony in the global economy. Ukrain-ian products lose competitiveness on foreign markets.

The turbulence in commodity markets further strengthenedUkraine’s dependence on external donors. IMF and EU fundsare the main sources of replenishment of FX reserves andbacking of the fiscal deficit. External loans increase the debtburden. External direct and state guaranteed debt grew by$3 billion up to $46 billion. Loans are mainly used for con-sumption and do not stimulate economic growth.

The investment climate in the country remains unfavor-able. The volume of foreign direct investments for 9 monthsamounted to $3.8 billion, two-thirds accounted for bybanks’ recapitalization. Approximately $1.5 billion was allo-cated into the real sector. For comparison, the volume ofFDI into the economy of Kazakhstan in the 1st half of 2016amounted to $9.3 billion.

Unfavourable external environment, increase in trade bal-ance deficit and insufficient volume of FDI create high cur-rency risks. Payments balance as of 10 months 2016remained positive, but low volumes of NBU FX reserves cre-ate a danger for exchange rate stability in the future.

2016 Results: Key Problems

IMF and EU funds are the main sources of replenishment of FX reserves and backing of the fiscal deficit

High dependence on the external environment

Trade deficit, low volume of FX reserves, external debt, debt owed to RF, public distrust in hryvnia

“Grey” economy 50% of envelope salaries, 40-60% of GDP is in the shadow economy

High currency risks

Weak recovery of the consumer demand

Significant connection between GDP growth and Commodity Price Index (87%)

High tax pressure

Growth of the external debt

Dependence on external donors

Direct and state guaranteed debt increased by $3 billion up to $46 billion

Negative investment climate Balance of FDI as of 9 months of 2016 is $3,0 billion, which is insufficient for reimbursement of the trade deficit

Raw materials exports Products of MMC and AIC account for up to 70% of total exports

The rate of budget revenues and PF to GDP is 38% (in Singapore, Korea it is 22%)

Real growth in household consumption in 2016Е is only 2-3%

Poor investment activity Share of investments in GDP 2016Е is 15% (while the target is 30-40%)

3

5,4 5,3

3,1

2,2

3,0

-1,0

0,0

1,0

2,0

3,0

4,0

5,0

6,0

9М 2011 9М 2012 9М 2013 9М 2014 9М 2015 9М 2016 -1%

0%

1%

2%

3%

4%

5%

6%64,459,1

50,6

35,4 31,9

62,4

0

10

20

30

40

50

60

70

2011

2012

2013

2014

2015

2016

Е

60

80

100

120

140

160

180

200

Com

mod

ity P

rice

Inde

x

2016 Results: Macroeconomic Indicators Economy of Ukraine shows a slow rise in 2016, which is mainly due to a low comparative base effect. The GDP growth at 1,1% is expected at the year end.

Level of FDI in the Ukrainian economy is increasing but its volume remains insufficient for the acceleration of the economy

Increase in nominal and real wage stimulates the growth of household consumption, but domestic demand still remains weak

Source: State Statistics Committee of Ukraine, the NBU (Data from 2014 without the Crimea, Sevastopol, and part of ATO area), the IMF; Institute for the Future calculations

Export is stagnating on the background of relatively low prices for raw materials

Formally, the Ukrainian economy is out of recession. GDPshowed a positive trend during 3 quarters. At the end of2016, GDP is expected to increase by 1.1%. The growth ismainly due to the low comparison base: during the previous2 years the Ukrainian economy was down by 16%, GDP in USDterms halved, and returned to the level of 2005 (maximumGDP was registered in 2008 - $188 billion).

Increase in nominal and real wage stimulates the growth ofhousehold consumption, but domestic demand still remainsweak. Consumer lending is recovering at a slow pace. De-spite reduction of the NBU refinancing rate, average rateson consumer loans increased significantly compared to lastyear. Without state support, household consumption will re-main under pressure. The main factor of a slowdown in do-mestic consumption is a growth in tariffs for the population.

Exports, which accounted for about 50% of GDP are stag-nating on the background of relatively low prices for met-als, iron ore and grains. Together, these products accountfor 40%-50% of total merchandise exports from Ukraine.

Investment activity is slowly recovering. As for the first 9months of 2016, the capital investment in Ukraine increasedby 163.4% up to UAH 204.5 billion ($8 billion). FDI in Ukrainefor 9 months of 2016 increased by 49% up to $3.8 billion;however, as was mentioned above, the real sector input isnot more than $1.5 billion. The share of total investment inGDP still remains low (12-15%), the peak values are 25% -28%(2006-2008).

4

Inflationary pressure eased. CPI at year-end 2016 is ex-pected to reach 12% - against 43.3% in 2015. The slowdown ofthe CPI growth was mainly due to the stabilisation of thehryvnia exchange rate, slowdown of imported inflation, slowincrease in prices for raw materials. Betterment of the in-flation expectation and predictability both create morecomfortable conditions for business and positively affectconsumers’ sentiments.

The rapid depreciation of currency stalled, but the devalu-ation risks remain due to low volume of international NBUFX reserves - $15.5 billion (as of Nov.11, 2016). For the main-tenance of macroeconomic stability as according to the IMFestimations NBU FX reserves need to increase up to $23.7billion before the end of 2017, which is unlikely to happenwithout an IMF tranche and/or a significant improvement ofthe external environment in the commodities markets.

Decline of the inflationary pressure allowed the NBU to con-duct a softer monetary policy. Since April, the regulatorgradually lowered the refinancing rate (from 22% to 14%in October).

Easing of monetary policy contributed to a moderate re-duction in the cost of credits for businesses. However,restoration of lending to the real sector of the economydid not happen, the surplus of bank liquidity was concen-trated in the financial markets, in particular the availablefunds moved into the deposit certificates of the NBU.

The next step should be a further softening of NBU mone-tary policy, decrease of the rates to 8-10%, stimulation ofthe internal demand for domestic production including realestate; increase in lending to small and medium businessup to $3.5-4 billion per year.

2016 Results: prices and value for money

The situation on forex market is stable, but the devaluation risks remain due to low volume of international NBU FX reserves

Inflationary pressure eased, CPI at year-end 2016 is expected to reach 12%.

Source: the NBU

0%

10%

20%

30%

40%

50%

60%

70%

Easing of monetary policy contributed to a moderate reduction in the cost of credits for businesses

0%

5%

10%

15%

20%

25%

30%

35%

14%

Decline of the inflationary pressure allowed the NBU to conduct a softer monetary policy, the refinancing rate as of October was reduced to 14%

10%11%12%13%14%15%16%17%18%19%

31,8

24,520,4

7,5

13,315,5

0

5

10

15

20

25

30

35

2011 2012 2013 2014 2015 окт.166

10

14

18

22

26

30

UA

H/U

SD

5

In 2016, Ukraine has taken a step forward regarding re-duction of energy consumption. Consumption and import ofnatural gas are decreasing. This is partly due to an increasein energy efficiency. Manufacturing plants are actively im-plementing energy effective technologies. For example,PJSC “Zaporizhstal” decreases monthly gas consumption by7 times due to production processes optimisation.

Growth in tariffs results in a decrease in gas consumptionby the population. In 10 months of 2016, this decreaseamounted to 4%.

At the same time comparatively weak consumption is ex-plained by slow pace of recovery of the Ukrainian economy.This tendency can change only if Ukraine enters a trajec-tory of sustainable economic progress.

Overall, the energy efficiency of the Ukrainian economy re-mains low compared to our western neighbours. Ukraine isstill critically dependent on energy imports. Its share intotal imports is 18%. We continue importing petroleumproducts, gas, and even coal while having our own huge re-serves. In 6 years the energy resources import bill washigher than $100 billion, which is higher than annual GDP.The volume of investment which is required to achievecomplete self-sufficiency in oil and gas in Ukraine is equiv-alent to 3-5 years of imports of those resources.

0

5

10

15

20

25

30

35

40

45

2016 Results: Energy Consumption

Import if natural gas is decreasing. Ukraine is not importing gas from the RF for more than a year

Consumption of gas in Ukraine continues decreasing. The decrease in 9 months of 2016 10% y-o-y

Source: Ministry of energy and coal industries, State Statistics Committee of Ukraine (energy resources import since 2014 without the Crimea, Sevastopol, and part of ATO area)

Imports of energy resources creates pressure on the trade balance and hryvnia exchange rate

Nevertheless, the total energy imports (gas, coal, petrochemicals) remain high. Its share in total goods import is 18%

44,8

32,9 28,0

19,5 16,5

6,3

� Volume of energy resources imports as of 9 months of 2016 is equal to $5 billion (trade balance deficit – $4,2 billion).

� Energy resources imports as of 6 years amounted to $100 billion.

� 80% of Ukraine’s demand for petrochemicals is provided by imports � Share of import in the liquid gas market is equal to 70%

� Share on import in total consumption of natural gas is 30%

35,3%31,5%

27,9% 27,8% 29,0%

18,3%

0%

10%

20%

30%

40%

2011 2012 2013 2014 2015 9 мес.2016

0

10

20

30

40

50

60

6

2016 is not over yet, but we can summarize the preliminaryresults.

The Ukrainian economy is recovering, but growth is ratherweak, given the drop during the previous years. Investmentactivity remains low.

Inflation has slowed. The increase of tariffs and expectedgrowth in commodities prices on the world markets createnew factors of risks. But the projected increase in harvestshould be a restrictive factor for inflation.

Decrease of merchandise exports slowed due to relativeimprovement of the price situation in comparison with 2015,as well as a good grain harvest.

Imports of goods continues to decline, energy importswere falling for 9 months in a row, at the same time the in-vestment imports (machinery, MMC products) showedgrowth. These are positive signals.

However, exports declined faster than imports; trade bal-ance remains negative, and the trade deficit is expectedto increase to $4.9 billion, or 5% of GDP.

Negative trade balance is partly offset by the inflow of FDI.Net income on financial account provides a positive bal-ance of payments. This is a fundamental factor of supportof the hryvnia exchange rate.

The surplus of balance of payments and IMF tranche al-lowed the NBU to increase FX reserves by $2.2 billion and to$15.5 billion (as of Nov.11, 2016). Overall, this corresponds tothe global benchmark of sufficient reserves (more than 3months of imports). However, the net reserves of the NBU(total reserves minus IMF tranches) amount to only $3.9 billion, which is critically low. NBU reserves are a mainrisk factor for exchange rate stability in the short-termperspective.

2015 2016Е

Nominal GDP, UAH billion 1 979 2 280

Share of investments in GDP, % 15% 15%

Real GDP dynamics, % -9,9% 1,1%

CPI (compared to December last year), % 43,3% 12,0%

Rate of growth of merchandise exports, % -29,9% -9,9%

Rate of growth of merchandise imports, % -32,6% -2,4%

Balance of visible trade, billion $ -1,7 -4,9

Balance of visible trade as % of GDP -1,9% -5,5%

Foreign direct investment (balance), billion $ 3,0 3,0 (9М 2016)

FDI as % of GDP 3,3% 4,8% (9М 2016)

Balance of payments, billion $ 0,8 1,0 (9М 2016)

FX reserves of the NBU, billion $ 13,3 15,5 (as of 01.11.2016)

Annual average UAH/USD exchange rate 21,8 25,5

Official UAH/USD exchange rate as of year-end 24,0 26,0

2015-2016 Results

Indicators

7

In 2017, we expect an acceleration of global economicgrowth; it is evidenced by forecasts of international or-ganizations and the majority of investment banks. Ac-cording to the IMF, next year global economic growth willaccelerate to 3.4% compared to 3.1% in 2016. The rate ofgrowth of world trade and world imports of goods, ac-cording to IMF forecasts, will rise from 2.4% to 4.0% withthe overall increase in demand and the weakening ofprotectionism.

Revival of demand, as it is expected, will stimulate a mod-erate increase in the cost of raw materials. However, thecycle of low prices for raw materials, apparently, is notover yet. The main negative factor for commodities is astrong dollar. The IMF forecasts growth of CommodityPrice Index only by a few points, the World Bank expectsthat prices for agricultural products, foodstuffs, and ironore will remain low during the next year, which preservesthe risks for Ukrainian exports and balance of payments.

80

100

120

140

160

180

200

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Е

2017

Е

Commodity Price Index (Fuel and Non-Fuel)

Commodity Industrial Inputs Price Index ( AgriculturalRaw Materials and Metals)

-12%-8%-4%0%4%8%

12%16%

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Е

2017

Е

Trade volume of goods and services

Volume of imports of goods

-4%-2%0%2%4%6%8%

10%

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Е

2017

Е

WorldAdvanced economiesEmerging market and developing economies

04080

120160200240280320

2013

2014

2015

2016

Е

2017

Е

2017: Global Economy In 2017, an acceleration of the global economic growth is expected up to 3,4% from 3,1% in 2016. The consequences of Brexit are the main risk factor

Source: The IMF, World Bank Commodities Price Forecast

Global rise of business activity and the weakening of protectionism will support the acceleration of growth of the global trade.

2016

Е

2017

Е

2016

Е

2017

Е

4,6% 3,4%

1,8%

3,8-4,0%

2,3-2,4%

The IMF forecasts a slight growth of Commodity Price Index in 2017 World Bank forecasts that prices for most commodities will remain low

2016

Е

2017

Е

2016

Е

2017

Е

8

The combination of the two factors (1 and 2) simultane-ously is unlikely to happen as slowed economic growth willhelp maintain low interest rates. However, this may be theworst scenario for the economy of Ukraine, which couldlead to a sharp decrease in external demand for Ukrainianproducts, reduction of exports, decrease in real GDP (-0.8%)and in nominal GDP calculated in USD.

3. Freeze of cooperation with the IMF. Probability ismedium. IMF funds are a main source of replenishment ofFX reserves of the NBU. Despite the fact that the Fund’s re-sources are mainly used for repayment of existing debts tothe IMF - and not on economic development, not even onthe foreign exchange market; these funds are one of keypsychological factors of stability of the hryvnia exchangerate. Without the IMF tranche in case of stability of a trendin commodity markets the risk of decrease in FX reservesdown to its critical minimum becomes extremely high. The

THREATS Effect on Ukrainian economy and

business

Increase in FRS interest rates (more than up to 1,00-1,25%), stronger dollar, lower commodities’ prices

The slowdown in global economic growth (World GDP growth less 3%, import - 2%)

Freeze of cooperation with the IMF

Other factors: Brexit, elections in France, the Turkish policy, the policy

of the new US administration

2017: External Threats

$47,9

Exports from Ukraine, billion $

30-35 UAH/USD $43,5

2015 2017Е

GDP 2017Е

(-0,8%)

$84 billion

FX reserves 2017Е

< $10 млрд. Target - $23,7 billion 30-35

UAH/USD

Currency restrictions

Commodity price shock, decrease of exports

Investments Macro help

Exchange rate

e

Exchange rate

What are the external threats to the economic growth of Ukraine in 2017?

1. Increase in FRS interest rates, stronger dollar, and lowercommodities prices. The decrease of quotations on com-modity markets can happen only if the growth rates in 2017are more significant than those which the analysts expect.A moderate increase in rates is already included in devel-opments of markets.

2. Slowdown in global economic growth in spite of the forecast:∙ cyclical slowdown in the growth of developing countriesbacked by a decline in domestic demand, lower commod-ity exports, and high debt burden;∙ growth rates being weaker than expected, and lowerrates of growth of the developed countries against thebackdrop of a slowdown in labor productivity growth.

9

negative consequences for the economy in case of the re-alization of this scenario would be such as devaluation ofhryvnia to 35 UAH/USD, tightening of foreign exchange re-strictions, growth of country risk, lack of access to exter-nal borrowing, lack macro-help to cover the budget deficit.

4. Other external factors. Consequences of Brexit, electionsin France, the Turkish policy, the policy of the new US ad-ministration may altogether have a negative impact on theeconomy of Ukraine through shocks in commodity mar-kets, a decline in international investors’ interest in thehigh-risk assets where Ukraine belongs, and rolling backthe programs of macroeconomic help from the traditionaldonor countries.

Effect on Ukrainian economy and

business

Slow reforms

Failure to comply with the revenue side of the Budget

Escalation of a military conflict in the East

A coup and a collapse of the country

2017: Internal Threats

Currency restrictions

Access on external markets

Global rankings Investments

Access on external markets

Investments

Outflow of human resources and capital

Economy collapse Redistribution of property, nationalization, self-proclaimed republics

Stagnation of the economy

Declining living standards

Inflation Exchange rate

Spending sequestrum

30-35 UAH/USD

15-20%

Increase in taxes

THREATS

What are the internal risks of economic growth in Ukrainein 2017?

1. Slow reforms. Until there is a lack of title guarantee, thecurrency restrictions, and until the tax system remainscomplicated and performs solely a fiscal function, therewill be no inflow of investments. The investment climate inthe country will remain unfavorable, and FDI will remaincritically low.

2. Failure to meet the revenue side of the Budget bears arisk of covering the deficit at the expense of emissions ofcurrency, and as a consequence an increase of inflation,and devaluation of hryvnia. An increase in tax rates and re-taining of high ad valorem charge for oil and gas produc-ers can become the most negative factor for the economy.This in its turn would put Ukraine far from achieving en-ergy independence.

10

3. Escalation of military conflict in the East of the country.The probability of this scenario is low, but its importance forthe Ukrainian economy is critical. In case of the militaryconflict spreading the further economic recovery is un-likely.

4. A coup and collapse of the country. We assume thepossibility of such a scenario in 2017, given the growingpolitical crisis, the increase of social tension and protestpublic sentiments. Events in November indicate the de-sire of certain political elites to destabilize the situationin the country which together with the initiatives of theexternal opponents of Ukraine can put the preservationof territorial integrity of the country under question.

OPPORTUNITIES Effect on Ukrainian economy and business

Realization of effective reforms

Government facilitation of FDI and expansion of market outlets

Completion of reform of the energy market

Stimulation of import substitution

2017: Opportunities

Currency and tax liberalization

Full guarantee of property rights

Investment

Investment

New markets, exports growth

Transfer of Hi-Tech production

17-18% of GDP

$2-3 billion

internal and external

Investment Import

$0,8 billion

Saving of $1-1,5 billion 26-27

UAH/USD

Import

Saving of $3-5 billion

Investment

$1,0 billion

Exchange rate

26-27 UAH/USD

Exchange rate

Opportunities for economic development in 2017 1. Completion of reforms: the concentration of political ef-forts on creating a full guarantee of property rights, in-cluding the completion of judicial reform; creation of anenvironment favorable for investment inflows; the removalof all currency restrictions; the reorientation of the func-tion of taxes to stimulating function. As a result of suc-cessful completion of key reforms the proportion of totalinvestment in GDP may rise to 17% -18% ($16-17 billion) al-ready in 2017. And in 2-3 years growth could likely achievethe targeted 30-40% ($35-45 billion).

2. Stimulation of import substitution. We import goodsworth more than $20 billion, which we could produce our-selves: primarily fuel (18% in total imports), consumergoods, engineering products, foodstuffs, medicine, house-hold appliances and electronics. Only in the following year,the savings generated by imports of these goods couldreach $3-5 billion, which could equalize the balance of tradeand reduce the risks of devaluation of the hryvnia.

11

3. Completion of reform of the energy market is a main toolof reduction of the dependence on imports and of a furtherturn to energy independence. Firstly, it is the potential in-vestment (around $0.8 billion in 2017, with a perspective ofgrowth up to $2-3 billion per year) which would give an im-petus for the development of the whole economy. And sec-ondly, this would mean an increase in oil and gasproduction, which would lead to a reduction of energy im-ports during the next year by $1.0- 1.5 billion.

4. Government facilitation of foreign investment inflows andexpansion of market outlets through diplomatic missions,trade missions, participation of top officials in advertisingUkraine. The growth of foreign investment and export ex-pansion can significantly neutralize the risks connected tothe unfavorable external environment in commodity mar-kets, the growth of imports, balance of payments imbal-ances.

Effect on Ukrainian economy and business

Development of transport infrastructure (Law on Concessions)

Increase of products competitiveness

Development of entrepreneurship

Pension Reform

2017: Opportunities

Concession of transportation facilities

New market outlets

Increase in number of new entrepreneurs

Establishment of middle class

10-30 thousand

Price of resources $2,3-2,9 billion Within next 5 years

Increase in private consumption

+12% y-o-y

Growth of export, GDP

Investment

$500 млн.

Export of goods with high added value

Investment Impetus for the economy

OPPORTUNITIES

5. Increase of competitiveness of Ukrainian products. In theconditions of a loss of a certain share of the world market(Russian market), Ukrainian exporters face the need to re-orient to new markets, to expand into new product seg-ments. This is possible due to qualitative transformationsof products, increase in the degree of its processing, cre-ation of fundamentally new and innovative products. If we

want to compete in global markets, we need to export endproducts rather than raw materials: e.g. flour and pasta in-stead of grain. And the role of the state is particularly im-portant in this matter, as it should be aimed at decreasingthe prices for resources in order to allow producers to mod-ernize their facilities.

12

6. Development of entrepreneurship. Amid transition to fullautomation of processes and growth of unemployment itis extremely important to create conditions for the devel-opment of private enterprise. It is necessary to realizetrainings on entrepreneurship and a creation of an Agencyfor entrepreneurship development. It will provide employ-ment, growth and alignment of incomes of the population,the formation of a middle class and the establishment ofstrong internal demand.

7. Development of transport infrastructure. Realization ofinvestment projects leads to an increase in consumption inrelated industries, creation of new jobs, increase in in-comes of the population and ultimately - to the growth ofthe entire economy. According to research, creation of 1job in the transportation sector results in creation of 6 newjobs in other sectors of the economy, and $1 invested in in-frastructure generates $2-3 of GDP growth.

Case of China. In 2009 in China as a measure to resolve thecrisis a program of transport sector development was re-alized. Investments in the sector increased by 76% com-pared to 2007 and amounted to 7.3% of GDP. There wereprojects aimed at improving roadways, 12 high-speed high-ways were built, 12 seaports were transformed into porthubs. As is known, the Chinese economy coped with theeconomic crisis, GDP growth in 2009 slowed to just 9.2%from 14% in 2007, and in 2010 exceeded 10%.

Thus, the development of the transportation sector is amain factor of domestic consumption stimulation inUkraine, which is critical given the high risks of downturnsin the external demand for Ukrainian products.

8. Pension Reform. A possible launch of the accumulatedpension system in 2017 would create a basis for further ac-cumulation of investment resources in non-governmentalpension funds (NPF). Its prospected volume is estimatedat $3 billion, in which not less than 40% would be allocatedin the real sector, within the next five years.

13

2017: Minimization of potential risks consequences

Сотрудничество с МВФ

� Increase in FRS interest rates, stronger dollar, lower commodities prices

� The slowdown of global economic growth

� Freeze of cooperation with the IMF

� Other factors: Brexit, elections in France, the Turkish policy, the policy of the new US administration

� Freeze of reforms

� Business shadowing, failure to comply with the revenue side of the Budget

� Escalation of a military conflict

in the East of the country

Steering of entrepreneurship, creation of jobs

State support of FDI inflow, widening of export, exploration of the new markets

Stimulation of import substitution

Acceleration of reforms: � juridical � tax � energy � currency

Uncontrollable RISKS OPPORTUNITIES

� Decrease of export

� Unfavorable external environment

� Trade balance deficit, decrease � of FX reserves

� Devaluation, inflation

� Outflow of investment

Controllable RISKS

� GDP and Budget revenue decrease

Energy market reform (decrease of energy consumption)

� Outflow of investment, stagnation of the economy

� Decrease of FX reserves, devaluation

� Emission, inflation

� Absence of macro help

� Outflow of investment � Poor internal demand

� Tax increase � Shrinking of social expenses

Ensuring the safety of citizens, involvement of IO

Attracting of investments into infrastructure projects

CONSEQUENCES

2017: Minimization of potential risks consequences on business

� Increase in FRS interest rates, stronger dollar, lower commodities prices

� The slowdown of global economic growth

� Freeze of cooperation with the IMF

� Freeze of reforms

� Budget 2017: increase of the minimum wage, failure to comply with the revenue side of the Budget

Reorientation on high value added products output

Exploration of the new markets

Creation of enterprises for import substitution

RISKS OPPORTUNITIES CONSEQUENCES

� Weaker external demand

� Unfavorable external environment

� Decreasing revenues of exporters

� Inflation, devaluation

� Currency restrictions Hedging currency risks using futures contracts with no physical delivery of assets

� Inflation, devaluation

� Weak internal demand

� Increased payroll costs

� Increased tax pressure

� Shrinking of foreign investments in real sector

� Shrinking of foreign investments in real sector

Export orientation

Staff optimization, transfer of non-core functions to outsource

Cooperation with international companies

14

Scenarios of Ukrainian economic development in 2017. A keyinfluence on the economy of Ukraine in the next year willbe provided by the growth rates of the global economy, thedynamics of prices in raw materials markets, the politicalsituation and investment climate in the country, the effec-tiveness of reforms.

1. The most negative scenario for Ukraine (pessimistic)foresees deterioration of the external environment, de-crease of internal demand and decrease in prices on rawmaterials markets. In addition, this scenario takes into ac-count the risk of slowing down or even stopping of reformsagainst the backdrop of the political crisis in the country,and therefore a freeze of cooperation with the IMF. As a re-sult of these factors, it is expected a reduction in business

activity, lower exports and production in export-orientedindustries, the outflow of investment, decrease in realwages and population incomes. The growth of the tradedeficit, which will not be covered by the inflow of foreigninvestment, along with the absence of the IMF funds is ex-pected to lead to a devaluation of the hryvnia to 35-40 perdollar by the end of 2017, and an increasing inflationprocesses.

Under the pessimistic scenario, real GDP in Ukraine in 2017will drop by 0.8% to $84 billion. The probability of this sce-nario is estimated as less than 20%.

We believe that even in the event of a sharp deteriorationin external conditions, GDP decline could be avoided by the

1180

1132

990 887 93 9684

00

20

40

60

80

100

120

140

160

180

200

22013 2014 2015 2016Е 2017Е 2017Е 2017Е

00,0%

--6,6%

--9,9%

11,1%

3,6%2,3%

-0,8%

--12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

22013 2014 2015 2016Е 2017Е 2017Е 2017Е

Forecast of the GDP of Ukraine for 2017

Nominal GDP, billion $

Source: State Statistics Committee of Ukraine, the NBU, forecasts of the Institute for the Future

Real GDP developments, %

93 9684

2017Е 2017Е 2017Е

3,6%2,3%

-0,8%

2017Е 2017Е 2017Е

Pessimistic scenario: � Further drop in commodity prices (CIIP Index - 113

2005 = 100)

� Reduction of exports (-1.2% y/y)

� Devaluation (UAH / USD = 30,5)

� Inflation - 13%

� Low investment activity, FDI outflow (decrease in

the share of total investment in GDP to 14.5%)

� Decline of real incomes

� Change of attitudes to Ukraine from Europe and

America

� Freeze of the IMF tranches

Realistic scenario: � Moderate price increases in commodity markets

(CIIP Index - 116 2005 = 100)

� Export growth (+ 8% y/y)

� Moderate depreciation (UAH/USD = 27,6)

� Inflation - 8.5%

� Continued reforms

� Increase of investment activity (increase in the

share of investment in GDP up to 16%)

� Support for Ukraine from Europe and the US,

cooperation with the IMF

Optimistic scenario: � Rising prices in commodity markets (CIIP Index -

120 2005 = 100)

� Export growth (+ 12% y/y)

� Stable exchange rate (UAH / USD = 27,2)

� Inflation - 9.5%

� Increase in investment activity (increase in the

share of investment in GDP to 17-18%)

� Growth of real wages and domestic demand

� Restoration of the banking sector and lending

15

maximum concentration of efforts on the implementationof measures to stimulate domestic demand and invest-ment. This is possible by stimulating domestic investmentthrough tax reform, the development of import substitu-tion by providing privileges and preferences for producersof import-substituting products, stimulating of the do-mestic demand by lowering interest rates and affordableloans for Ukrainian products, including real estate. Criti-cally important will be the attraction of investment in trans-port infrastructure, including public-private partnerships.The total range of these activities can provide about $ 8billion of additional GDP next year, even while reducing ex-ports.

2. The optimistic scenario assumes a significant improve-ment in external conditions, growth in commodity pricesagainst the backdrop of the more active than expectedglobal growth and world trade. In case of implementationof this scenario, the trade deficit, according to our estima-tions, will reduce, and the volume of foreign investment willincrease to $ 7 billion; the positive balance of payments willallow increasing the NBU reserves and will enable to main-tain stability in the foreign exchange market without IMFfunds.

Of course, the growth of exports in case of the implemen-tation of this scenario would stimulate production, invest-ment demand in the country, increase of real incomes andconsumer demand.

In the optimistic scenario, we expect real GDP growth of3.6%, nominal GDP at $96 billion, the exchange rate of UAH/ USD at 27.2 UAH / USD, which corresponds to the ex-change rate incorporated in the Budget 2017. The likelihoodof the realization of this scenario in our opinion is no morethan 20-30%.

3. The basic or the most realistic scenario, according to ouropinion, foresees a compilation of the above-mentionedfactors, an increase in economic growth by 2.3%, and nom-inal GDP growth up to $93 billion.

Most likely is that the situation on foreign markets nextyear does not change significantly. The world economy hasentered a long cycle of low commodity prices, although wewait for a moderate increase in the value of most com-modity groups. This will facilitate the recovery of Ukrainianexports (8% y/y), the inflow of foreign exchange earnings,increased business activity in general, and moderategrowth in real incomes.

The government, according to the basic scenario will con-tinue to conduct reforms, mostly following the require-ments of the IMF. Next year Ukraine will receive a part ofthe planned tranches, and the connected macro-economicassistance to cover the budget deficit. This would allowkeeping NBU reserves above the critical 3 months of im-ports and observing targets of inflation at 8-9%. We expecta moderate devaluation of the national currency, as ac-cording to the baseline scenario, to 27.6 USD/USD.

16

The GDP structure according to our estimates will not bearsignificant changes next year.

At a time when domestic demand is quite weak and in needof stimulation, only investment can become a driver of eco-nomic growth. Its share in GDP according to our estimateswill vary between 16-18% ($16-17 billion depending on real-ization of the scenario).

In order to reach sustainable economic development, ac-cording to our estimates, the share of investment in GDPneeds to increase in 2-3 years to 40%, and $20-25 billion offoreign investment not taking to calculations the internal

ones is needed to be attracted into the economy of Ukraineto reach the level of sustainable economic development.Without an inflow of investments the economic growth willbe in the range of 2.5-3.0% within the next 10-15 years. Givensuch growth rates, Ukraine will be able to reach the level ofpeak value of nominal GDP in USD (2008) only in 2025.

2017: GDP Structure

Source: forecasts of the Institute for the Future

Показатели GDP structure 2017Е (realistic scenario)

100%

69%

20%

16%

-5%

Private consumption

State expenses

Investments

Net export

� Domestic private demand in 2017 will recover slowly. �Contribution to real GDP growth at 0,8%-1,5% (depending on the scenario).

� The contribution of government spending to GDP growth in 2017 will be insignificant

� Only investment can become a driver of economic growth in 2017. Contribution of this indicator to GDP growth in 2017E is expected at 1,5% - 2,0% (depending on the scenario)

� FDI 2017Е – $4-$7 billion (depending on the scenario). �The 2017 budget provides for large-scale infrastructure investments - $460 million.

� A negative value of net exports in 2017 will make a negative contribution to GDP.

17

The total public debt of Ukraine is approaching 80% of GDP.Herewith, the foreign debt becomes critical, since it is nom-inated in foreign currency and creates the risk of default.The external debt of Ukraine also remains high, at 53% ofGDP. This is even higher than in the countries which havehigh debt pressure - Belarus (30%), Columbia (20%), Mexico(21%), Turkey (15%).

The total amount of payments on foreign currency debt in2017 will be approximately $3.6 billion.Generally, even if Ukraine is not able to receive external fi-nancing, the volume of FX reserves ($15.5 billion) allows forthe repayment of foreign currency debt in 2017. From thisperspective, the risk of default is minimal.

However, without the IMF tranche next year, the possibilityof reduction of the FX reserves escalates to a critical level

(less than 3 months of imports), and same risk refers tothe devaluation of hryvnia. The IMF tranche of $5.4 billionexpected in 2017 is questionable.

It is highly probable that in 2017 Ukraine will not be able tomeet the IMF requirements of volumes of the reserves tillthe end of 2017 up to $23.7 billion. Given the condition ofthe net reserves of the NBU (less than $4 billion), the riskof default in 2-3 years is rapidly increasing.

It is crucial to encourage the inflow of foreign investmentsin Ukraine, which will cover the current account deficit andat the same time will create the grounds for sustainablelong-term growth of the economy. This will enable mini-mization of the dependence on the IMF, formation of insti-tutional independence of Ukraine, and eventually takinggeopolitical decisions in the region.

0

5

10

15

20

25

As of 31.12.2016

$15,5

2017: External Public Debt and FX Reserves

Forecast of developments of FX reserves of the NBU in 2017, billion $

Currency debt repayments

2017Е

Deficiency payments of

current account of PB

in 2017Е

- $3,0

- $3,6

$8,9

2017Е

$14,8 IMF tranches ($5,4

billion) Investments

Foreign currency of

the population

IMF requirement-$23,7

?

External public debt* of Ukraine and FX reserves of the NBU, billion $

* Public and government-guaranteed foreign debt

** Reserves 2017Е –IMF forecast

Source: Ministry of Finance of Ukraine, the NBU, the IMF, calculation and forecasts of the Institute for the Future

Net reserves

38,7 37,6 38,8

43,446,4

48,3 51% ВВП

0

10

20

30

40

50

2012 2013 2014 2015 2016Е 2017Е**

18

Currently, Ukraine is more attractive than ever for invest-ment. The Ukrainian economy has more than halved, andhas significant growth potential within the next 3-5 years.The Ukrainian hryvnia in recent years devalued significantlycompared to many currencies; the cost of labor in Ukraineis several times lower than in neighboring countries. At thesame time reforms are implemented in Ukraine which upon

successful completion will create a foundation for a maximum effect of the traditional basic industries, willgive impetus to the development of the new sectors of the economy, and for the development of the internalpotential of Ukraine, which in a result will stimulate a sustainable development in a long term.

1 010

950

900

880

530

520

490

230

3,4%

3,3%

2,8%

2,8%

2,7%

2,5%

1,1%

3,6%

Why can Ukraine be attractive for investors in 2017?

Ukrainian economy growth rates given the realization of the optimistic scenario in 2017 will be higher than in the neighboring countries

� Ukrainian hryvnia has considerably devaluated during recent years comparing to the national currencies of other countries

� Country risks are decreasing. Fitch Ratings upgraded Ukraine to «В-» from «ССС»

� Implementation of the significantly important legislative

changes is expected next year: � Adoption of LAW ON CONCESSIONS

� Removal of MORATORIUM on cession of land

� Decrease in AD VALOREM RATES for gas producers

Cost of labor in Ukraine is significantly lower

Source: the IMF, https://en.wikipedia.org/wiki/List_of_European_countries_by_average_wage, forecasts of the Institute for the Future

Ukraine has a greater export growth potential in 2017 than the neighboring countries

UKRAINE

UKRAINE 2017Е Real GDP growth 2017Е Average salary 2016 – EUR

per month

8,8%

5,7%

5,4%

5,2%

4,9%

3,9%

1,6%

8,0% UKRAINE

Export growth rates 2017Е

19