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22 May 2020

Makar Paseniuk, ICU Founding partner


– 2020 crises often compared with the Great Depression of the 1930s. Can their scales be compared?


– I think it is possible. For example, in the United States, the unemployment rate at the peak of the Great Depression reached 23%, while GDP fell by 30%. In April of this year, the US unemployment rate soared to almost 30%, and in the 2nd quarter of 2020, the rate of decline in GDP is projected to be at 10%.


But at the same time, the cause of the crises, the speed of the spread and the response from the authorities is very different. The Great Depression began in 1929, peaked in 1933, the economy fully recovered only in the late 30s. The main reason for such a strong and protracted crisis was considered to be overproduction and a shortage of demand. Monetary incentives and employment programs were used to restore it.


The main reason for the current crisis is the administrative closure of a large part of the global economies. Accordingly, the opening of economies, which has already begun, should facilitate rapid recovery. According to our estimates, the return of demand to previous levels will be gradual, but not as drawn out as it was during the Great Depression. Because now authorities around the world have launched unprecedented monetary and fiscal incentives while taking into account the lessons of the Great Depression and the Global Financial Crisis (2008-09. – editor.).


– The crisis is often described by the letter V: recovery should be as fast as the fall. Do you share this outlook?


– In our forecasts, we focus on the recovery of the global economy which, so far, appears to resemble the letter U. I would consider further economic development from two angles – from the supply side and from the demand side.


The first shock for the global economy was on the supply side, part of which was administratively turned off. Now the opening of economies will contribute to the rapid restoration of “potential output”, but most likely not to initial levels – some businesses will simply not be able to re-open.


In the future, the growth rate of potential output may be lower than before the pandemic. For example, operating costs for business, including making provisions for social distancing and medical protection have increased and are unlikely to reduce. Increased protectionism on a global scale will continue to cause complications or ruptures in the usual value chain.


At the same time, the crisis can provide a positive impact on productivity – due to falling energy prices and actively switching to remote methods of work, sales, education, etc.


The key result for the economy now depends on effective demand. It will take longer to recover than the ”return of supply”, although it is possible that we will see first-hand the effect of the so-called deferred demand.


Most likely, the consumption rate will significantly decrease, as people will “sit” on savings, fearing layoffs and a second wave of the pandemic. This is especially true for the demand for long-term goods, travel, hotel services and restaurants. Also, companies will be more careful in their investment projects, due to the lack of solvent demand in the right volumes. At the same time, there will be an increase in investments in medicine and pharmaceuticals, IT, remote work, automation and robotics, but they will not be able to fully compensate for the reduction of investment in “traditional” areas.


The role of governments will be critical in the process of demand recovery. Today we see unprecedented volumes of fiscal and monetary incentives in both developed and developing countries. Although they were launched very quickly and on a massive scale, it takes time for these incentives to be reflected in the decisions of consumers and investors. Therefore, they will affect the recovery of demand later this year and during the next year. Naturally, without such incentives, the decline of demand this year would have been much greater.


– Alternative opinion: the crisis as such has not yet begun: the real consequences will appear later – in Q3 & Q4 of 2020, and the year 2021 will also be difficult. How close is this scenario to reality?


– Such a scenario cannot be ruled out. It can be triggered by new waves of the pandemic and, accordingly, new quarantine restrictions around the world. In our basic scenario, we are forecasting a gradual restoration of economic activity following the adaptation of people and business to new living conditions – masks, disinfectants, social distance, thermal screenings, tests, etc. In this case, taking into account the incentive measures taken, the demand should gradually recover. Although the structure of this demand will change – for example, instead of the traditional spending on restaurants, people will spend more on various online services.


– Will the dynamics of the Ukrainian economy be the same as in the world? Or is it worth describing our situation with a different letter? If so, why?


– The Ukrainian economy is heavily dependent on the global environment, so its recovery is likely to repeat global trends. Only the scale of the crisis and the speed of recovery will be determined by the specific characteristics of the economy and the actions of the authorities.


– The NBU predicts a V-shaped recovery with a full recovery (to the level of 2019) in 2022 and a – 5% drop in GDP in 2020. Many experts consider this forecast optimistic. What is your opinion more inclined to?


– In our forecast, published in early April, we expect the Ukrainian economy to fall by 6-8% this year and recovery to be U-shaped. Still, the decline in demand will be long, both due to lower incomes and lack of sufficient savings, as well as more cautious behaviour by consumers and business. This is indirectly confirmed by low inflation rates in April. In early June, we plan to update our forecasts based on April’s statistics, which should already indicate the first reaction of the economy to the quarantine.


– The degree of impact that the crisis has had on Ukraine is ambiguous. On the one hand, the service sector, which has suffered the most, does not affect Ukrainian GDP as much as in developed countries, on the other hand, a serious blow is expected to solvent demand, and private consumption has been the main driver of economic growth in recent years. Which of these features of our economy is more significant in the current circumstances?


– Due to its structure, the Ukrainian economy would suffer less from the consequences of the pandemic and lockdown compared to developed countries and even compared with the majority of developing countries, including countries in our region. In addition to the small share of the service sector, a large role is played by the agro-industrial complex and the IT sector. They suffered significantly less in comparison, for example, to the production of investment goods and durable goods – Ukraine as an economy does not produce much of those. Therefore, on the supply side, the lockdown effects are less notable.


But at the same time, the recovery of demand, unlike in many other countries, will be a long process due to, as I said, the lack of savings, as well as the limited measures taken by the state to stimulate the economy.


– Do you like the governmental anti-crisis plan?


– According to the Oxford Stringency Index of government measures taken, Ukraine, since mid-March, has shown some of the most stringent restrictions in the world. For example, the limited use of the metro and other public transport services. Thanks to this, it was possible to restrict the spread of coronavirus, and in recent days we have seen a gradual decrease in the number of new cases of those infected with the virus. But such a trend exists in other countries as well where the measures were not so stringent.


Regarding the anti-crisis plan – in general, it looks OК. Assistance was provided to those in need: to the medical professionals, to the unemployed through the Employment Service, and to small and medium-sized businesses that have lost the ability to work due to the lockdown.


But two key issues remain. The first is the slow implementation of this plan due to the weak institutional capacity of the authorities. For example, according to the Ministry of Finance, in March-April only 1.8 billion UAH of budget funds were spent on the fight against coronavirus – this is very small, given the scale of the problem. Other programs are just starting to launch, and right now maximum support is needed.


The second problem is the issue of financing. The authorities should stop the “ritual dances” with the IMF. It is necessary to secure a comfortable amount of cheap official financing and return to market borrowings from a position of strength. Relying exclusively on NBU is the path into the abyss.


– Do you understand what economic policy the Cabinet of Ministers of Denis Shmygal pursues?


– The government now primarily focuses on tackling the coronavirus pandemic, so it is obvious that the pace of structural reforms has seriously slowed since March. This is also indicated in the index that VoxUkraine calculates. At the same time, the lack of clear economic targets in the current government cannot but cause worry.


Goncharuks’ and Milovanov’s teams have reiterated their stance on the development of markets and attracting investments. Now the entire economic agenda is clogged with the fight against coronavirus, except perhaps the call for more active lending from the banks. But a cheap resource is not all that banks need to resume lending. I hope that after the pandemic situation improves and the government will have the opportunity to tackle the strategy.


– Has the nature of your business decisions changed since the government shift in early March? Did you follow the advice of Morgan Stanley to postpone investments in Ukrainian bonds?


– We take into account all the information that affects the sovereign risks. And it’s no secret – foreign markets reacted negatively to the government shift in early March.


Despite this, Ukrainian fixed income continues to be an essential part of our portfolio, primarily because of the fairly attractive profitability and still adequate macroeconomic policy. But the slow down of structural reforms is not conducive to improving the prospects of the Ukrainian economy. Accordingly, this has an impact on the interest of investors, including ours.


– What is your attitude to Ukrainian assets now? Will the situation radically change after an agreement with the IMF or is the crisis factor still stronger?


– The risks of Ukrainian assets are primarily associated with the budgetary need for resources and limited access to these resources on the financial markets. While earlier it was still possible to somehow postpone, now an agreement with the IMF is the only way for the crisis to be mitigated.


Naturally, any statements by the authorities, whether from representatives of the NBU Council or the previous Minister of Finance, about the possibility of default or debt restructuring as well as the uncritical nature of the program with the Fund, led to a deterioration in investors’ perception of Ukrainian assets and a corresponding market reaction. I think that also due to such statements, the Ministry of Finance is now partially overpaying for its borrowings.


On the contrary, the long-awaited signing of the program with the IMF, and the provision of official financing should help to normalize the Ministry of Finance’s access to financial resources.


– Businessmen often say that crisis is an opportunity. What can be bought at a good price in Ukraine right now?


– A good price is always relative. The crisis often creates attractive investment opportunities. Financial markets are a leading indicator of fundamental changes in the economy and respond to changes in future expectations faster than others. This movement creates investment opportunities due to the multidirectional actions of different players and a large number of other factors – from psychology to the structure of capital, sources of financing, liabilities, etc. This applies to all classes of market instruments. But the honesty of this process is that these assets can be bought or sold. And the answer to the question of whether the price was “good or not very” may be different at the time of the transaction and after.


As for private business acquisitions, the reaction of their sellers, as a rule, is associated with the sensation or awareness as well as acceptance, of new realities in the economy. And this is definitely a long process. A sustainable business rarely attracts capital or is sold during a crisis – there are simply no prerequisites. Deals during a crisis are usually bankruptcies and similar restructurings In our country, this happens rarely.


– The dollar has risen significantly in recent months, and the labour force in Ukraine due to the crisis is likely to become cheaper. Could this be an impetus for investment in the real economy, in your opinion?


Everything, probably, depends on where exactly someone is going to invest. The cost of labour for the lion’s share of modern production has not been a fundamental factor for a long time. Indeed, the level of automation is growing every year, and, as a result, the share of labour costs in the structure of production costs fell below 10%.

For a direct investor, the risks associated with macroeconomic stability, the general business climate, the judiciary, and sales markets are much more important.