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Summary

  • Low Gross Domestic Savings place a ceiling over future GDP growth in Ukraine.
  • Low birth rate will cause shortage of labor, and increase costs of opening businesses.
  • Inverted Yield Curve signals impending recession.

Although Ukraine has had its share of political struggle lately, its economy is what is more worrying. The country's economy has been struggling for the last few years. Although Ukraine boasts a highly educated workforce, it has falling labor force, and falling investment. Its savings rate has fallen to single digits (as a % of GDP), and its foreign exchange reserves continue to dwindle. Ukraine would certainly receive a boost from its new association with the west, however, the impact could be limited and may take a while to arrive.

New investment:

Ukraine has lagged behind other developing countries over the last few years. For instance, its Gross Fixed Capital Formation has not grown in several years. Gross Fixed Capital formation (GFCF) is a good indicator of new investment in fixed assets, and growth in the GDP. Since fixed assets are a major component of industry, growth in the same bears a strong correlation with an increase in national income.

Several factors may cause an increase in GFCF. The most decisive of those is an improvement in market sentiment (i.e. expectations of higher profitability in the future). Higher Savings rate is another major precursor to higher GFCF. However, as is explained below, savings in Ukraine have been falling consistently, leaving Ukraine dependent on foreign capital for new investment.

Gross Fixed Capital Formation:

Household consumption growth:

On the other hand, final consumption expenditure has grown steadily over the last decade. The growth in consumption has been higher than that in the GDP. Higher consumption is also a sign of lower savings, which reduce the potential of growth in GDP. Such high rates of consumption are common across Eastern Europe, and are a strong indicator of slow growth.

HOUSEHOLD FINAL CONSUMPTION EXPENDITURE - (% OF GDP) IN UKRAINE

Ukraine inflation:

The collapse in internal demand in countries like Spain, Portugal and Greece has led to higher imports in the rest of Europe, primarily Eastern Europe, and created deflationary pressures. Deflation discourages new investment since falling prices increase the probability of loss, to the company. If left unchecked, the country can succumb to a deflationary spiral, where prices and investment fall concurrently.

Ukraine Inflation Rate

Ukraine gross domestic savings:

The national accounts of Ukraine betray a lean towards increasing consumption, and falling savings. Ukraine's savings levels have been falling, as a % of GDP, for over 2 decades. Savings were at 9% in 2012. Macroeconomics dictates that economic growth is usually financed by the gross domestic savings of a country. Any portion of investment that exceeds savings leads to inflation, or a current account deficit. Resultantly, Ukraine's GDP has barely grown, and the country has instead run a high current account deficit. Its Current Account deficit is 5% of its GDP, and has been increasing for the last few years.

A high current account deficit is reason for concern, since chronic deficits lower the amount of foreign exchange reserves a country has. (A country must pay for its imports with Dollars or Euros). Such an event leads to lower capital inflows, since investors assume higher probability of a balance of payment mismatch. Thus, the country enters into a vicious circle of low investments, and high pessimism.

Gross Domestic Savings as a % to GDP

Current Account to GDP:

Foreign Exchange Reserves:

Yield curve:

The yield curve has been proven to be a good indicator of short term economic performance of a country. On a yield curve, we can trace the yields offered on government bonds, for different maturities. Generally, yields are lower for shorter maturities, and higher for longer maturities. However, due to pessimism about short term economic prospects, investors bid higher for the short term bonds, and lower for the longer term ones. This leads to an inverted yield curve. Inverted yield curves are generally considered forerunners of a recession. Thus, Ukraine's inverted yield curve points to a bad year or two.

Labor Force:

Ukraine boasts a highly skilled workforce. However, there's a shortage of labor in Ukraine, caused by two different reasons. First, due to its low per capital income, there's been mass migration to neighboring countries. Secondly, Ukraine suffers from a very low birth rate. So much so, at current rates, population shall shrink by 15% by 2035.

Overtime, the GDP growth of a country shows significant correlation with the labor supply within that country. This is so because newer businesses can't open unless there's adequate supply of labor, at somewhat reasonable wage rates. Such difficulty in opening a business may encourage the residents of that country to consume more, and save less.

Low birth rates are common across Europe and do place a ceiling on the potential growth achieved by these countries.

Conclusion:

Ukraine witnessed high rates of growth during the early 2000s, but has faltered since the 2008 recession. Its savings rate continues to fall, and leaves it fewer chances of growing its economy. In addition, the labor force falls each year, signaling limited GDP growth in the future. Despite possibilities of increasing trade with the EU in the future, there is high probability that growth in Ukraine will be confined to lower single digits.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Problem With Ukraine's Economy - Low Savings Rate