SStrategytrategy UUkrainekraine April 2012

Ukraine: A game worth playing?

Strong recovery vs. external vulnerabilities

Attractive valuations vs. macroeconomic risks

Pegged currency vs. eroding competitiveness

Untapped potential vs. weak institutions

www.raiffeisenresearch.at

© Vadym Dumanchuk Content

Highlights 3

Focus on: UEFA EURO 2012 and the 4

Politics 5

Real economy: GDP growth and fiscal policy 5

Monetary policy and inflation 7

Exchange rate, Balance of payments and external debt 8

Banking sector 10

Local currency government bonds 11

Sovereign Eurobonds 11

Corporate Eurobonds 12

Stock market (Top down) 13

Comparison tables and forecasts 14

Acknowledgements 15

Abbreviations CE Central European countries - Poland, Hungary, Economic abbreviations Stock Exchange Indices Czech Republic, Slovakia, Slovenia %-chg Percentage change BELEX15 Serbian stock index SEE South East European countries - Albania, Bosnia (not in percentage points) BET Romanian stock index and Herzegovina, Bulgaria, Croatia, Romania, avg average BUX Hungarian stock index Serbia CIS European CIS (Commonwealth of Independent bp basis points CROBEX10 Croatian stock index States) countries - Russia, Ukraine, Belarus BoP Balance of Payments PX Czech stock index CEE Central and Eastern Europe (CE + SEE + CIS) C/A Current Account MICEX Russian stock index CPI Consumer Price Index SASX-10 Bosnian stock index Currencies and Countries FDI Foreign Direct Investments WIG 20 Polish stock index ALL Albanian lek FX Foreign Exchange BAM Bosnian marka GDP Gross Domestic Product BGN Bulgarian lev LCY Local Currency BYR Belarusian roubel mmav month moving average Equity related CNY Chinese yuan mom month on month DY Dividend yield CZK Czech koruna pp percentage points EG Earnings growth EKK Estonian kroon PPI Producer Price Index LTG Long term (earnings) growth HUF Hungarian forint qoq quarter on quarter P/E Price earnings ratio HRK Croatian kuna T/B Trade Balance LTL Lithuanian litas ULC Unit Labour Costs LVL Latvian lats yoy year on year RS Recommendation suspended PLN Polish zloty UR Under Revision RON Romanian leu RSD Serbian dinar RUB Russian rouble SIT Slovenian tolar SKK Slovak koruna TRY Turkish lira UAH Ukrainian hryvnia

2 April 2012 Highlights

Ukraine – A risky game worth playing?

The Ukrainian economy remains on a strong recovery path. The country’s GDP Real GDP and inflation expanded at a rate of 5.2% yoy in 2011, propelled by a plentiful harvest, reviv- 30 25 Forecast ing domestic demand and favourable terms of trade. Inflation hit a nine-year low 20 15 in 2011, thanks to plunging food prices. Fiscal indicators have also improved no- 10 tably, with the general government deficit shrinking to 4.3% of GDP in 2011. The 5 0 public debt-to-GDP ratio dropped from 40% to 36%. Loan growth in the bank- -5 ing system returned in 2011, while the non-performing-loan ratio has finally sta- -10 -15 bilised at the very high level of 30-35%. -20 Despite these positive developments, the country is facing strong headwinds 2007 2008 2009 2010 2011 2013f 2012e given the troubles in the major advanced economies. The external position looks Real GDP (% yoy) extremely fragile, marked by a widening current account deficit, large external Consumer prices (avg, % yoy) Source: State Statistics Committee, Raiffeisen RESEARCH debt repayments and blocked access to global capital markets. With the less be- nign external environment and eroding domestic competitiveness, a deceleration Ukraine currency pegged to dollar of growth to 3-3.5% this year is in the cards. The challenging environment, pre- 8.15 12.00 election spending and the persistent loss-making of state-owned gas monopoly 8.10 11.50 limit the room for fiscal consolidation. Moreover, the country is still plagued by the same structural problems as back in 2008, with politics more occupied by 8.05 11.00 tactical manoeuvring than finding long-term solutions to these problems. 8.00 10.50 High macroeconomic risk dampens the performance of Ukrainian financial as- 7.95 10.00 sets. The local currency debt market remains shallow, with a high degree of dol- 7.90 9.50 larisation in the domestic economy, a dearth of long-term institutional investors 7.85 9.00 and a weak legal environment. The fragile external position and the IMF pro- May-10 Nov-10 May-11 Nov-11 gramme stalemate deter investors from taking Ukraine’s risk on the international USD/UAH EUR/UAH (r.h.s.) debt markets, despite attractive valuations. Finally, the performance of the local Source: Thomson Reuters stock market was disastrous in 2011, prompting an exodus of both institutional Ukraine sovereign ratings and private investors. S&P Moody's Fitch Foreign currency Ukraine definitely remains a risky game and the big question is whether it is Long-term B+ B2 B worth playing! No one disputes Ukraine’s bright long-term potential, but it is cur- Short-term B - - rently marred by the mounting economic vulnerabilities and tumultuous politics. Outlook neg neg stable Local currency We believe that without radical changes in the economic and institutional envi- Long-term B+ B2 B ronment, the country will be unable to exploit its long-term competitive advan- Short-term B - - tages. Instead, it may risk new cycles of high inflation and exchange rate depre- Outlook neg neg stable ciation, accompanied by subpar growth performance and deteriorating living Latest change Mar-12 Dec-11 Oct-11 Source: Bloomberg standards for many Ukrainians.

Analysts Key economic figures and forecasts Raiffeisen Bank Aval 2007 2008 2009 2010 2011 2012e 2013f Dimitry Sologoub Nominal GDP (EUR bn) 104.6 122.6 81.7 103.0 118.4 140.1 150.8 [email protected] Real GDP (% yoy) 7.9 2.3 -14.8 4.2 5.2 3.5 4.0 Olga Nikolaieva Industrial output (% yoy) 10.2 -3.1 -21.9 11.2 7.6 5.0 4.0 [email protected] Unemployment rate (avg, %) 6.4 6.4 9.0 8.5 7.2 6.5 6.5 Sergii Shvets Nominal industrial wages (% yoy) 28.2 29.8 5.0 15.0 17.5 12.0 15.0 [email protected] Producer prices (avg, % yoy) 19.5 35.5 6.6 20.9 19.0 10.0 10.0 Consumer prices (avg, % yoy) 12.8 25.2 15.9 9.4 8.0 4.2 8.5 RBI Vienna Consumer prices (eop, % yoy) 16.6 22.3 12.3 9.1 4.6 9.2 9.0 Andreas Schwabe, CFA General budget balance (% of GDP) -1.1 -1.5 -8.7 -7.5 -4.3 -3.0 -2.0 [email protected] Public debt (% of GDP) 12.3 20.0 34.6 40.0 36.0 37.5 37.0 Gintaras Shlizhyus Current account balance (% of GDP) -3.7 -7.2 -1.6 -2.2 -5.5 -4.1 -4.1 [email protected] Official FX reserves (EUR bn) 21.7 22.2 17.8 24.8 23.7 20.6 21.4 Gleb Shpilevoy Gross foreign debt (% of GDP) 55.8 56.4 90.7 85.9 76.6 71.4 72.8 [email protected] EUR/UAH (avg) 6.9 7.7 11.2 10.5 10.9 10.9 11.6 Alexander Sklemin, CFA USD/UAH (avg) 5.0 5.3 8.0 7.9 8.0 8.2 8.9 [email protected] Source: Thomson Reuters, wiiw, Raiffeisen RESEARCH

April 2012 3 Focus on

UEFA EURO 2012 and the Ukraine

 Positive economic impact is estimated at 2.8% of GDP with the major effect stemming from general infrastructure spending  Spending by foreign tourists should not have much of an effect on GDP or the balance of payments  Hosting of the event entails significant outlays, mostly borne by the public sector  Event organisation is not likely to generate a sizeable positive effect in the long run

Distribution of expenditures In 2007, Ukraine and Poland won the joint bid to host the UEFA EURO 2012, UAH 4,2bn which will take place between 8 June and 1 July this year. An event of such UAH 6,6bn 4% UAH 12,5bn 6% 12% massive scale attracts enormous public and media interest, thus putting the host

UAH 10,3bn country in the spotlight. On the other hand, organisation of the event requires 10% the presence of various necessary infrastructures: this goes beyond just stadi- UAH 32,5bn 31% ums and training facilities, and also encompasses a modern transportation net- UAH 21,0bn 20% work, security systems, communication services and accommodation facilities. UAH 18,3bn For Ukraine, it entails substantial preparation efforts. The country was lagging 17% Sport facilities Hotels far behind UEFA’s standard requirements, with the tumultuous economic develop- Airports Railway ments and persistent political quarrels of recent years deterring infrastructure in- Roads Urban transport Other vestments. Therefore, the hosting of the European football championship has pro- Source: State Programme on Preparation and Con- ducting of UEFA EURO 2012, Raiffeisen RESEARCH vided Ukraine with the opportunity to upgrade its poor infrastructure and attract a large amount of foreign tourists. According to our calculations, the total positive effect on the Ukrainian economy of hosting UEFA EURO 2012 amounts to 2.8% of GDP, spread over five years Value added impact (% of GDP) from 2008 to 2012. The major impact stems from general infrastructure spend- 1.2 ing, accounting for nearly 70% of the total effect, followed by the construction of stadiums and hotels. At the same time, the impact of spending by foreign tour- 1.0 ists on GDP is expected to be rather low and should not have much of an effect 0.8 on the balance of payments. The estimated impact on GDP for Ukraine is higher

0.6 than for other countries which have hosted major football events in recent years. This is not very surprising, given the smaller size of the Ukrainian economy, as 0.4 well as the much larger scale of the preparation activities. 0.2 At the same time, the visible economic impact seems to come at a substantial cost. The total spent on Ukraine’s preparations for the event amounts to 8% of 0.0 2008 2009 2010 2011 2012 GDP (USD 13 bn), significantly exceeding spending in other countries for sim- Source: State Programme on Preparation and Con- ilar events. Involvement by the private sector has been limited (financing less ducting of UEFA EURO 2012, Raiffeisen RESEARCH than 20% of total expenditures), due to the poor business climate, vague prop- erty rights and the absence of sufficient legal background for public-private part- nerships. As the public sector has absorbed most of the costs, this has resulted in surging public debt, thus damaging the country’s long-term fiscal sustainabil- ity. Furthermore, the weak rule of law in general and the non-transparency of the Distribution of value added impact preparation process have created vast opportunities for corruption and fraud,

8% 2%3% 5% raising suspicions of substantial overspending on UEFA EURO 2012 projects. Apart from direct financial costs, the preparations for hosting UEFA EURO 2012 15% also involve large opportunity costs. In particular, public money spent on the im- port of railcars and the construction of stadiums and airports could have alter- natively been used much more effectively to tackle structural weaknesses in the

67% Ukrainian economy. The influx of foreign visitors and a general infrastructure up- grade could potentially generate valuable post-event effects, such as an increase Event budget Tourism revenues in the country’s attractiveness to tourists and investors, as well as sizeable pro- Sport facilities construction General infrastructure upgrade ductivity gains. However, given the country’s poor international image and dis- Hotels construction Other astrous investment climate, we see a good chance that Ukraine will fail to utilise Source: State Programme on Preparation and Con- ducting of UEFA EURO 2012, Raiffeisen RESEARCH these opportunities. Hence, we would argue that the effect of infrastructure spend- ing might prove short-lived, unless the business climate improves considerably.

4 April 2012 Politics and real economy

Messy politics and crisis-prone economy

 Political situation still fragile, despite successful drive for greater political consolidation  Economy recovered strongly in 2010-2011, driven by resurging export prices and robust domestic demand  Growth deceleration likely in 2012, with a less benign external environment, and eroding domestic competitiveness  Otherwise improving fiscal picture is damaged by the persistent loss-making of state-owned gas monopoly

Politics Election schedule After years of persistent political quarrels (dating back to the Orange Revolu- October 2012 Parliamentary elections tion in late 2004), the strong drive for consolidation of power under the presi- (Verkhovna Rada) dency of sought to provide the country with long-awaited po- March 2015 Presidential elections litical stability and to improve external relations. After two years, however, these Main policy makers hopes have largely faded. The establishment is facing a severe decline in pop- ularity – the approval rating of the ruling Party of Regions plunged from 40% in President Viktor Yanukovych POR

April 2010 to just 14% at the moment – amid the abandonment of most pre-elec- PM POR tion promises, thriving corruption and increasing signs of political repression. First Vice PM - The imprisonment of former Prime Minister and presidential runner-up, Julia Ty- moshenko, and a few other opposition politicians on apparently dubious (politi- Vice PM (Health) Raisa Bogatyryova POR cally motivated) charges have gravely damaged Ukraine’s relations with the EU, Vice PM (Infra- POR essentially putting the country’s plans for European integration on hold. Ratifica- structure) tion of the EU free-trade zone and association agreements are not expected any Vice PM (Social Sergiy Tigipko POR time soon. Relations with Russia, the main trading partner, have been marred by Policy) regular political and economic conflicts (disputes over gas transit, trade wars, Economy - etc.). Defense POR Confronted with unfavourable electoral dynamics and souring external relations, the ruling party is facing the hard task of winning a majority in the parliamen- Internal Affairs - tary elections scheduled for October of this year. We do not rule out that the in- Justice POR cumbent administration may still retain control over parliament after the elections Kostiantyn Hrysh- Foreign Affairs - against the background of quarrels within opposition parties, the specifics of the chenko Ukrainian electoral system and a forthcoming pre-election spending binge. Nev- Finance Yuriy Kolobov - Energy and Coal ertheless, the declining popularity of the establishment coupled with growing re- POR Industry pression and falling living standards could significantly endanger political stabil- Emergencies Viktor Baloga UC ity in the country. Speaker Verkhov- Volodymyr Lytvyn LB na Rada Real economy Head of the NBU Sergiy Arbuzov - On one hand, the key characteristics of the Ukrainian economy suggest bright National Security potential for the long term. On the other hand, they also point to a number of and Defence Andriy Kluiev POR Council near-term structural weaknesses. In particular, favourable geographic location, POR = Party of Regions abundant natural resources and high-quality human capital make up the list of UC = United Centre LB = Lytvyn Bloc Ukraine’s key long-term economic advantages. At the same time, its unpleasant Source: Ukrainian Government features include extremely poor energy efficiency, a large shadow economy, un- favourable business climate and low diversification of foreign trade. The export Poll for parliamentary elections (%) structure is skewed towards low value-added commodities: steel exports com- April April April prised 33% of total exports in 2011, while chemical exports stood at 10%. Fur- 2010 2011 2012 Party of Regions 39.5 15.7 19.5 thermore, the investment share of output is disappointingly low and shrinking: Yulia Tymoshenko Bloc 15.9 12.6 13.5 16% at end-2011, far below the level necessary to modernise the capital stock Front for Change (A. 4.9 8.1 9.5 of the economy and improve the infrastructure of the country. Yatseniuk) The country recently survived a period of extreme economic turbulence. Backed Udar (V. Klychko) 3.2 7.4 by a thriving world economy and procyclical domestic policies, Ukraine’s GDP Communist Party 2.3 3.7 4.4 "Svoboda" 1.7 3.1 2.5 increased by an average of 7.5% yoy from 2000–2007. However, when steel Lytvyn Bloc 2.2 1.2 0.6 prices crashed in the late summer of 2008 and capital flows reversed after the Source: Razumkov Centre’s sociological service

April 2012 5 Politics and real economy

Output not back at 2008 level* Lehman shock in September, Ukraine immediately slipped into a deep recession,

120 becoming one of the main victims of the global economic downturn. The ad- 115 verse change in external conditions was exacerbated by domestic factors, such 110 as plunging confidence in the national currency, a run on deposits, frozen lend- 105 ing activity and persistent political quarrels. As a result, GDP slumped by 15% in 100 95 2009, while the local currency value to the US dollar plunged by 40%. Conse- 90 quently, the country had to be bailed out by the IMF, in the form of a USD 16.4 Forecast 85 bn stand-by loan, in November 2008. 80 2008 2009 2010 2011 2012f 2013f In late 2009, a mainly export-led recovery started, driven by resurging export

Poland Russia prices. Domestic demand embarked on the rebound path as well. As a result, the Ukraine Eurozone country’s GDP surged by 4.1% in 2010 and economic growth further acceler- *(GDP index 2008=100) Source: National Statistics, Raiffeisen RESEARCH ated to 5.2% in 2011, driven by robust agricultural output, revived bank lending and a boost in investment spending in the course of Ukraine’s preparations for GDP dynamics hosting UEFA EURO 2012. Ukraine’s growth in 2011 scores higher than neigh- 10 bouring Russia or Poland (both around 4% yoy) and feeble economies like Hun- 5 gary (1.5% yoy), but given a slump in output in 2009, GDP in 2011 was only 0 -5 at 93% of the 2008 level. We expect Ukraine to regain its pre-crisis output level -10 only by 2013, almost five years after the crisis broke out. -15 Unfortunately, over the last few years we have witnessed no progress with struc- -20 tural reforms aimed at tackling the main vulnerabilities listed above. Thus, the -25 country remains highly exposed to unfavourable global economic developments.

Q1 08 Q1 08 Q2 08 Q3 08 Q4 09 Q1 09 Q2 09 Q3 09 Q4 10 Q1 10 Q2 10 Q3 10 Q4 11 Q1 11 Q2 11 Q3 11 Q4 In fact, with the EU heading into a mild recession this year and less favourable GDP growth (% yoy) harvest prospects, growth deceleration is on the cards. Therefore, we argue that GDP growth (% qoq, s.a.) Source: State Statistics Committee, Raiffeisen without radical changes in the economic and institutional environment, the coun- RESEARCH try will be unable to tap its long-term competitive advantages and is at risk of falling into the vicious devaluation-inflation cycle, accompanied by sub-average GDP growth contributions (pp) growth performance and stagnating living standards. 20

10 Fiscal policy Ukraine’s fiscal position visibly deteriorated during the latest crisis. The collapse 0 in budget revenues, the near-bankruptcy of the state-owned gas monopoly Naf- -10 togaz, the unbalanced state Pension Fund and nationalisation of ailing systemic -20 banks sent the budget deficit figures deeply into the red. The general government

-30 deficit amounted to 8.7% and 7.4% of GDP in 2009 and 2010, respectively,

'05 '06 '07 '08 '09 '10 '11 while the public debt-to-GDP ratio surged from 12% at end-2007 to 40% at end- Household Government 2010. There has been some progress with fiscal consolidation measures in the Fixed investment Inventory changes Net exports GDP growht (% yoy) last two years, namely the implementation of pension reform (raising the retire- Source: State Statistics Committee, Raiffeisen ment age for women, extending the period for qualifying for full pension bene- RESEARCH fits, etc.) and adoption of the new tax code. Fiscal indicators* Headline fiscal indicators improved notably last year, with the total fiscal deficit shrinking to 4.3% of GDP (nevertheless missing the IMF target of 3.5%) and the 10 50 public debt-to-GDP ratio descending to 36%. The main reasons for improvement 8 40 were the impressive performance of budget revenues (thanks to economic stabili- 6 30 sation and improved tax administration) and expenditures’ rationing (due to the 4 20 lack of financing sources). The disastrous financial stance of Naftogaz remains

2 10 the major concern in the fiscal sphere: its financial deficit reached 1.6% of GDP in 2011, on the back of higher gas import prices and unchanged domestic tar- 0 0 iffs. Therefore, despite the improvement in headline debt and deficit figures, we

2003 2004 2005 2006 2007 2008 2009 2010 2011 still consider the fiscal situation rather challenging, taking into account blocked General budget deficit Public debt (r.h.s.) access to the global debt markets and the massive outstanding debt obligations * general government (% of GDP) of state-owned companies (Naftogas, the national railway operator Ukrzaliznyt- Source: Ministry of Finance, Raiffeisen RESEARCH sia, the road-building company Ukravtodor, and others).

6 April 2012 Monetary policy and inflation

The land of high and volatile inflation

 Monetary policy remains centred on maintaining the exchange rate peg  High and volatile inflation negatively affects the price competitiveness of the domestic economy  Notable disinflation in 2011-early 2012 is explained by temporary factors  Inflationary pressures are expected to re-emerge amid resurging food prices and increasing tariffs for utilities

National currency stability, the legally defined goal of the National Bank of Inflation (% yoy)

Ukraine, has mainly been viewed by the regulator in terms of exchange rate sta- 50 bility. Therefore, monetary policy is centred on maintaining the exchange rate 40 peg to USD, while the goal of price stability remains largely on the sidelines. In- 30 terest rates and reserve requirements are the main policy instruments of the cen- 20 tral bank, although their efficiency is apparently rather limited, taking into ac- 10 count the weak monetary transmission mechanism, the shallow money market 0 and the high degree of dollarisation. -10 Policy interest rates (discount rate, secured and unsecured refinancing rates) have Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 loosely tracked inflation in the past, while money market rates are traditionally Consumer prices Food prices Producer prices much more volatile. As the exchange rate stabilised after the initial bump and in- Source: State Statistics Committee, Raiffeisen flation started to abate in 2009, the central bank embarked on its monetary eas- RESEARCH ing path, cutting the discount rate from 12% to 7.5% in the period from January 2009 to March 2012. However, the easing process has not been smooth, as the resurgence of devaluation expectations last year led to radical changes in mone- tary conditions. To sustain the (politically motivated) exchange rate peg, the NBU had to tighten monetary policy accordingly, which provoked a severe liquidity High weight of food in CPI squeeze in the banking system. Consequently, money market rates shot up to 30- Other 35%, while most banks put severe limits on new lending in order to stabilise the li- Transport 13% 4% quidity situation. Since then, depreciation expectations have tapered off, improv- Health 4% ing domestic liquidity conditions. However, the risk of another bump in liquidity Household remains material against the background of the fragile currency peg. goods 3% Ukraine has one of the highest and most volatile inflation rates in the region. The Utility charges average CPI rate in 2000-2011 was 11.3%, fluctuating from -1% in June 2002 11% Clothing to 31% in May 2008. Ukraine’s poor inflation performance is rooted in struc- 7% Food & drinks tural weaknesses (i.e. lack of competition stemming from pervasive corruption, Alkohol & 53% tobacco poorly functioning antitrust regulations, etc.) and policy failures (procyclical mon- 5% etary and fiscal stance, monetary policy focus on exchange rate stability). More- Source: State Statistics Committee over, the high degree of price volatility should be attributed to unstable economic expectations and the skewed structure of the CPI basket (with the share of food products exceeding 50%). Last year’s bountiful harvest and tightened administrative controls over utilities tar- iffs gave rise to the impressive disinflation trend. The end-of-period CPI dropped to 4.6% yoy at end-2011 and fell further to 1.9% yoy as of end-March 2012. Local money market rates (%) However, this is primarily explained by plunging prices for just a few food prod- 70 ucts (namely sugar and vegetables), while other inflation measures exhibited 60 less positive dynamics. Producer prices (end-of-period) grew 14% yoy in 2011, 50 while the core inflation rate was 6.9% last year. Despite the notable disinflation 40 achievement in 2011, we expect the inflation rate to strike back this year, driven 30 by resurging food prices, PPI pass-through effect and increasing tariffs for utilities. 20 Thus, the price competitiveness of the domestic economy will be eroded further, 10 0 increasing the probability of nominal exchange rate realignment. We believe Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 that sustainable disinflation in Ukraine is conditional on tackling the structural KievPrime overnight rate KievPrime 1-month rate problems mentioned above and moving to a flexible exchange rate framework, Source: Thomson Reuters under which price stability becomes the main target of central bank policies.

April 2012 7 Exchange rate, BOP & external debt

After one devaluation is before another one?

 Informal peg of UAH to USD was re-established after the severe devaluation of 2008  Currency peg still vulnerable to falling steel prices and capital flow volatility  Current account deficit re-emerged surprisingly fast after the crisis, pointing to structural weaknesses  WTO accession may be followed by free trade with the EU, but Russian integration projects as an (inferior) alternative

Prices versus exchange rate Foreign Exchange Rate 12 Since the early 2000s, Ukraine follows a strategy of pegging the local currency 10 to the US dollar. Thus, its dynamic with other currencies (such as the exchange 8 rate to the euro or Russian rouble) usually reflects the swings of those currencies

6 to USD. The currency peg is backed by foreign exchange interventions, which

4 are performed by the central bank on a discretionary basis. In 2008, the stabil-

2 ity of the exchange rate proved deceptive: hit by slumping exports and capital flight, the central bank lost control and the hryvnia lost 40% of its value. After a 0 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 short phase of increased flexibility, the central bank reinstated its previous policy Consumer prices Producer prices of keeping the currency fixed to USD. Reasons for this were the restoral of appar- Official exchange rate to USD ent stability and the goal of preserving price competiveness, supporting domestic Relative purchasing power parity: Price indices in- clude inflation differential between Ukraine and the producers of tradable goods with an undervalued currency. USA Source: Thomson Reuters, Raiffeisen RESEARCH However, the inflexible currency regime has certain drawbacks, which makes it difficult to sustain in the long run. First, a peg has to be backed and – in this case CPI based real exchange rates – defended by selling hard-currency reserves, which are finite. Secondly, even with a peg, price competitiveness can be lost via high inflation rates driving up 150 140 domestic costs. Third, very low volatility in the exchange rate leads to an under- 130 estimation of FX risks and makes market participants highly sensitive to the slight- 120 est changes in the nominal FX rate (“panic reactions”). Fourth, as seen in 2008, 110 a necessary adjustment of the exchange rate tends to be abrupt, large in scale 100 and costly for the economy. For Ukraine, the high concentration of exports in one 90 volatile commodity (steel) adds to the fragility of the currency vis-á-vis a sudden 80 fall in export proceeds. 70 Jan-05 Jan-07 Jan-09 Jan-11 UAH to EUR UAH to USD UAH to RUB REER* (IMF) Not surprisingly, the hryvnia has demonstrated more vulnerability again. A fall *Real effective exchange rate in steel prices in the second half of 2011, in combination with high domestic de- Source: Thomson Reuters, Raiffeisen RESEARCH mand for hard currency, forced the central bank to sell 20% of its currency re- serves to defend the peg. Given substantial debt redemptions and a re-emerging current account deficit, 2012 looks challenging as well. However, the upcoming parliamentary elections in autumn 2012 make a shift in the exchange rate pol- Merchandise trade structure* icy politically difficult and thus, in the near term, unlikely. The key question is if the central bank will be able to successfully manage the transition to a less rigid Metals Agriculture currency regime in the next few years. Otherwise, a repeat of the 2008 devalu- Machinery ation is not unrealistic! On the other hand, we would not expect to see the hry- Energy Export Chemicals vnia currency regime change to a complete free float. Possible ways to manage Other a currency without letting it be completely free include the use of a currency bas- Energy ket, as in neighbouring Russia, or the introduction of adjustable trading bands. Machinery Chemicals

Import Agriculture Current account Metals Other Ukraine is an open economy: both exports and imports (including services) each 0 10203040account for 50-60 percent of GDP. This is both a strength and a weakness. On a * 2011 (% of total) positive note, large exports enable the country to import large quantities of con- Source: State Statistics Committee sumer and investment goods. But high trade volumes also make Ukraine highly

8 April 2012 Exchange rate, BOP & external debt

vulnerable to sudden changes in import or export prices – influencing the terms Current account balance (% GDP) of trade. Over the last decade, the country has profited from favourable export 15 prices. Goods exports more than quadrupled from USD 15 bn in 2000 to USD 10 5

70 bn in 2011. But imports expanded even more, leading to a structural shift in Forecast the current account. From 2000 to 2005, Ukraine was a country with a current 0 account surplus of around 5% of GDP (i.e. exports exceeded imports). But de- -5 spite the resurgence in steel prices from 2006 to 2008, the boom in consumption -10 pushed the current account into a deficit. When steel prices crashed in 2008, the -15 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 country plunged into a balance of payments crisis and required external IMF as- 2013f 2012e Trade balance Service balance sistance. The subsequent deep recession led to a shrinking of the current account Income balance Current transfers deficit. However, as opposed to other countries (for example, the Baltic States), C/A balance Source: a positive balance was not regained and the deficit widened sharply again in 2011. This time, an increase in Russian gas import prices contributed to the dete- Capital account balance (% GDP) rioration. Looking forward, the difficult challenge will be for Ukraine to diversify 20 its export structure (away from metals exports and manufacturing exports, which 15 are concentrated on Russia) and to adapt to higher energy import prices. The lat- 10 5 ter may again be delayed if Ukraine finds new arrangements with Gazprom on 0 price discounts. -5 -10 Forecast WTO accession in 2008 has not yielded any significant results so far. This is un- -15 -20 derstandable, given the economic disruption of the financial crisis. Ukraine and 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013f the EU successfully finished technical negotiations on an enhanced free trade 2012e FDI Portfolio inv. agreement in late 2011, the ratification of which is pending for political reasons Other capital Capital & fin. account by the EU, however. Meanwhile, Russia is trying to lure Ukraine into its recent All series are net flows Source: National Bank of Ukraine projects of closer cooperation with the territory of the former Soviet Union. While the long-term welfare gains from a free trade agreement with the European Un- Steel price slumps affect economy ion likely surpass those of taking part in a Russian-led Eurasian Economic Com- 125 25 munity, decision-makers in Ukraine may nevertheless find the latter more attrac- 100 20 tive, based on particular interests or tactical motives. 75 15 50 10 25 5 Financial account and external debt 0 0 -25 -5 In parallel with its booming economy (and the deterioration of the current ac- -50 -10 count), Ukraine witnessed a massive expansion of external debt over the past -75 -15 -100 -20 decade. In particular, the banking sector borrowed heavily abroad between -125 -25 2005 and 2008, leveraging external debt from 5% to 20% of GDP. Total private Q1 2002 Q1 2005 Q1 2008 Q1 2011 GDP growth (% yoy, r.h.scale) sector debt (i.e. banks and corporations) doubled from 2005 to 2011 (from 30% Steel price growth (% yoy) to 60% of GDP), and overall external debt peaked in 2009 after the devaluation Source: Bloomberg, Raiffeisen RESEARCH at 90% of GDP, recovering slightly to 80% (or USD 125 bn) in 2011. When the large-scale inflows of private capital suddenly stopped during the financial crisis, private sector debt had to be partly replaced by official inflows (mainly from the Gross external debt (% of GDP) IMF). Foreign direct investment, on the other hand, proved to be more resilient 150 during and after the financial crisis, amounting to 4-5% of GDP in recent years. 125 Special features of capital flow statistics for Ukraine are the importance of off- 100 75 shore registration of companies (e.g. on Cyprus) due to legal and tax reasons, 50 as well as the large role of (pre)financing of imports. Both result in an upward 25 bias in reported debt levels. 0 PL ID TR IN BR TH HR CZ RU AR ZA RO HU UA MX Over the next few years, we expect the current account deficit to be slightly MY higher than net foreign direct investment (FDI). Thus, debt inflows will be re- Emerging Europe Other Emerging Markets quired, leading to further growth in debt in USD terms. The debt level in terms of Government Central bank Banks GDP may, however, stagnate or grow only slightly, depending on the develop- Other sectors Intercompany ment of nominal GDP in USD terms. * as of end-Q3 2011 Source: World Bank, IMF, Raiffeisen RESEARCH

April 2012 9 Banking sector

Sailing in rough waters

 Lending activity largely recovered in 2011, after two years of stagnation  Domestic deposits increasingly become the main funding source, while external deleveraging continues  NPL ratios have finally stabilised, but at a very high level  Loan growth to remain subdued amid unstable economic environment, lack of long-term funding and weak legal framework

Total loans (% of GDP) The Ukrainian banking system remains fragmented with 175 banks operating, 90 and the top five banks controlling less than 40% of the market. The market share 80 of foreign-owned banks accounted for 37% of assets at end-2011, declining 70 from 47% three years ago. In the aftermath of the crisis, foreign-owned banks 60 50 switched to a more cautious approach, based on moderate loan growth and a 40 conservative pricing policy, while several private domestic banks emerged as 30 major winners in terms of market share amid aggressive growth strategies. 20 10 The banking sector has been hit hard by the latest crisis against the backdrop of 0 sharp depreciation of the hryvnia, massive deposit outflows and foreign funding 2005 2006 2007 2008 2009 2010 2011 drying up. The grave combination of liquidity and asset quality problems drove          more than two dozen banks underwater and required that survivors radically re- Source: National Bank of Ukraine, Raiffeisen RESEARCH vise their market strategies. Consequently, banks have stopped their lending ac- tivity, hiked deposit interest rates and stepped up cost-saving efforts. Crisis ten- sions in the banking system first started to ease on the funding side with a grad- ual return of deposits. In the light of certain economic stabilisation and attractive interest rates, the volume of private deposits has returned to the pre-crisis level of mid-2010. It has been followed by lending recovery – banks drastically cut Non-performing loans ratio (%) loan interest rates, while the demand for credit resources has also resurged on 15 50 the heels of reviving aggregate demand in the economy. The loan quality prob- 12 40 lem has been alleviated recently, as the NPL ratio apparently reached its peak in H1 2011 with the resumption of lending, economic recovery and the activation 9 30 of loan write-off and sales processes, following the relevant amendments to the 6 20 regulatory framework. Following the recovery in lending activity and loan qual- 3 10 ity stabilisation, banks’ financial indicators improved as well.

0 0 Despite these positive trends, however, the overall picture remains rather unfa- Dec-06 Dec-08 Dec-10 Dec-11 vourable due to a number of factors. First is the lack of long-term funding. The According to NBU According to IMF (r.h.s.) banks are undergoing a severe external deleveraging process (the total external

Source: National Bank of Ukraine, IMF debt of Ukrainian banks fell by 40% from October 2008 to December 2011), putting more focus on the domestic deposit base. However, local deposits are mostly short-term and highly volatile; furthermore, the Civil Code provision makes all deposits de facto callable. Secondly, given funding problems and continued feeble demand for loans, loan growth remains subdued. The total loan portfolio grew 9.6% yoy in 2011, which is much better than in the previous two years. Market structure by ownership However, the loan-to-GDP ratio continues to slide – from 77.4% at end-2008 to

9% 8% 11% 17% 17% 17% 62.5% at the moment – thus gradually realigning with Ukraine’s per capita in- come level. Third, NPL ratios remain dangerously high (30-35%, according to 50% 42% 37% 58% 40% 46% unofficial estimates based on IFRS figures), which poses a threat for the bank-

7% ing system in the case of a growth hiccup and/or an exchange rate dip. Finally, 5% 11% 12% 3% 12% banks are also plagued with exchange rate risk, stemming from their large open 37% 40% 35% 30% 31% 25% short FX position. Consequently, the outlook for the banking system is not particularly bright at this 2006 2007 2008 2009 2010 2011 State-owned Banks stage, given the unstable macroeconomic environment, a lack of long-term do- Private Ukrainian Banks Russian-owned Banks mestic funding and the weak legal framework. We expect loan growth to remain Foreign-owned (excl. Russian) Banks Source: National Bank of Ukraine subdued over the next few years (below 10%) and thus banks will face the diffi- cult task of sustaining profitability in an unfriendly growth environment.

10 April 2012 Bond markets

High macro risk dampens bond markets performance

 Government bonds are the only liquid instrument at the local debt market  Refinancing risk for domestic obligations is contained  Risks in the Ukraine Eurobond market are skewed to the downside  Cheap valuations of corporate Eurobonds are offset by high macro risk

Local currency government bonds LCY government bond yields (%)

Ukraine’s local debt market remains shallow, with a high degree of dollarisa- 20 tion of the domestic economy, a dearth of long-term institutional investors and a 18 weak legal environment. In fact, the only active market segment is government 16 bonds, as the large budget deficits in recent years have forced the authorities 14 to step up issuance of domestic bonds. The lion’s share of outstanding govern- 12 10 ment bonds (up to 70%) is held by the central bank and state-owned commer- 8 cial banks, while non-residents largely shun the Ukrainian debt market (despite 6 juicy yields), due to low liquidity, high sovereign risk and looming exchange rate 4 uncertainty. Given the frozen lending activity, over the last few years domestic 0.0 0.5 1.0 1.5 2.0 Duration banks have invested heavily in government securities. But with the revival of lend- Source: Raiffeisen RESEARCH ing, the banks have started to dispose of their bond portfolios, and we expect this process to continue. After the spike in bond yields to 25-30% in 2009 amidst rising default fears, the government managed to bring yields down in 2010-2011 to 8-11% (for one- to two-year bonds). However, the adverse change in investor sentiment and mone- Government bond holdings (UAH bn) tary tightening in the second half of 2011 put upward pressure on yields again. 180 This prompted the authorities to widen the range of available debt instruments, 160 140 including domestic government bonds in foreign currency (USD and EUR) and 120 exchange rate-linked bonds. We expect the government to smoothly meet its refi- 100 nancing needs in the local debt market in the near future, as repayment volumes 80 60 do not look particularly large; in addition, the authorities might be able to count 40 on NBU backing, if necessary. 20 The municipal and corporate segments of the bond market remain largely coma- 0

tose. Specifically, municipal bond issuance is constrained by inadequate regula- Jun-08 Jun-09 Jun-10 Jun-11 Dec-08 Dec-09 Dec-10 Dec-11 tions and the weaknesses of the Ukrainian fiscal system in general. The corporate NBU Banks Non-banks Non-residents bond segment was hit hard by the latest crisis, as nearly 90% of issues went into Source: National Bank of Ukraine technical default. Therefore, revival of this segment depends on the resolution of outstanding issues and appropriate legal changes.

Sovereign Eurobonds Ukraine’s sovereign credit rating came under pressure because of policy slip- Government debt redemptions* pages, widening external imbalances and the stalemate in the IMF programme. 12,000 Ukraine’s EMBIG spread in EUR peaked at 1220bp in October 2011, jumping 10,000 from as low as 340bp in early 2011 after S&P downgraded Ukraine’s rating 8,000 from BB minus to single B plus in September 2011. Concerns about fiscal slack- 6,000 ening and a failure to return to the IMF programme were multiplied by the Euro- 4,000 zone debt crisis. As a result, Ukraine’s Eurobond market performance remained 2,000 average at best, especially in the US dollar segment where Ukraine’s EMBIG in- 0 dex gained only 5.2%. This was notwithstanding a better external environment, yielding a subsequent rally in the Eurobond market and leading to spread com- 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Internal (total) External (total) pression in February and early March 2012. Ukraine’s sovereign spread re- All types (total) * USD mn, incl. IMF redemptions mains above the distressed level of 800bp, as measured by conventional mar- Source: Bloomberg ket yardsticks. The downgrade to single B rating and the negative rating outlook

April 2012 11 Bond markets

EMBIG return net of Composite * removed much of the upside which Ukraine could otherwise achieve. This situa- 120 tion has also forced the Ukrainian sovereign to indefinitely postpone a USD 1-1.5 115 bn issue planned for this year, as market conditions remain unsupportive for the 110 Ukraine government. 105 100 Although Ukraine’s total external debt is approaching 77% of GDP in 2011, the 95 government’s portion amounts to only 16% of GDP. In 2012, the government has 90 to finance USD 4.6 bn of short-term debt (including debt repayment to IMF); by 85 conventional yardsticks, this looks pretty manageable. However, total short-term 80 Apr-10 Nov-10 Jun-11 Jan-12 debt payable in 2012 (at about USD 57 bn versus only about USD 30 bn in FX

Ukraine EMBIG return net of Composite Index reserves) can impose severe liquidity pressure on the government and the na- Ukraine EMBIG price tional bank. Therefore, Ukraine’s non-payment risk remains high in the absence * Ukraine EMBIG price index offset for Composite EMBIG index return, price index points of sufficient external debt rollover and an IMF agreement anchor. As this situation Source: Thomson Financial Datastream, JP Morgan, will continue to weigh on Ukraine’s Eurobond market outlook throughout 2012, Raiffeisen RESEARCH we do not see much upside for Ukraine’s market in the absence of a strong ex- Sovereign spread development * ternal rally. Moreover, Ukraine’s risk outpaces potential rewards while its rating spread points to the downside. Accordingly, as we do not foresee a rating im- 1,200 450 provement in Ukraine in the next twelve months, we recommend underweighting 1,000 300 Ukrainian Eurobonds in EM portfolios. 800 150

600 0 Corporate Eurobonds 400 -150 Ukraine is the third-largest corporate Eurobond market in the CIS – after Kazakh- 200 -300 stan and the heavyweight Russia – with over USD 7.7 bn worth of high-yield Eu- 0 -450 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 robonds outstanding. The largest segment consists of private issuers (with 56%

Ukraine minus B-rating spread (bp, r.h.scale) of the outstanding amount), followed by quasi-sovereigns (44%). The former is Ukraine spread (bp) dominated by metals and mining names (41% of private issues), food produc- * Ukraine EMBIG price index offset for Composite ers (25%) and private banks (23%). Quasi-sovereigns are almost evenly split be- EMBIG index return Source: Thomson Financial Datastream, JP Morgan, tween banks and oil and gas (the only state-guaranteed paper being Naftogaz, Raiffeisen RESEARCH worth USD 1.6 bn). As opposed to Russia and Kazakhstan, Ukraine’s Eurobond market is dominated by the sovereign, whose bonds make up 53% of the total Performance of key indices stock. CEMBI BROAD B This year, Ukrainian corporates were out of the primary Eurobond market and CEMBI BROAD UA there are currently no issues in the pipeline. The only potential corporate issuer, CEMBI BROAD NONIG DTEK, preferred to borrow from Russian and Western banks. Last year, how- RUBI ever, Ukrainian credits printed over USD 2.5 bn, split among state-owned banks, CEMBI BROAD LATIN metals and mining, and food producers. In our view, the latter is the weakest EMBIG link among the country’s public borrowers. As opposed to other EM countries, CEMBI BROAD MIDEAST Ukraine lacks big blue-chip names (e.g. Gazprom, KazMunayGas, Petrobras, EMBIG UA etc.), which may act as regular borrowers on the Eurobond market. Although the -8% -4% 0% 4% 8% 12% Q1 2012 2011 SCM group accounts for about 26% of total corporate Eurobonds outstanding, it Source: JP Morgan, Raiffeisen RESEARCH is represented by three separate names, none of which – with the possible excep- tion of Metinvest – look like a visible Eurobond issuer in the future. We believe that corporate issuances from the country will largely be opportunistic in nature. Market structure With a total return of 9.9%, Ukraine was the third best performing EM corpo- Sector No of No of Weight* rate Eurobond market in Q1 2012. We attribute this to the general increase in issues issuers risk sentiment, as we cannot see any fundamental improvements in the country. Quasi-sov. banks 4 2 24% The spread between Ukrainian corporates and the sovereign had recently ap- Metals&mining 3 2 23% Oil&gas 1 1 21% proached the record lows again, and the lack of relative value hardly justified Food producers 4 4 14% positioning in the corporate segment. We advise caution on Ukrainian credits, Private banks 6 5 13% especially in the banking space. Despite cheap valuations, Ukrainian corporates Utilities 1 1 6% remain exposed to high macro risk, as we continue to see Ukraine as one of the *in the total amount of corporate EBs outstanding Source: Bloomberg, Raiffeisen RESEARCH most vulnerable sovereigns in CEE.

12 April 2012 Stock market (Top down)

Disappointing returns and diminishing liquidity

 Stock market plunged in 2011, erasing all the gains from the previous two years  Despite global market optimism, local market remains bearish this year  Market liquidity is diminishing, poorly developed market infrastructure, corporate scandals and price manipulation  At the current valuations, Ukraine’s stock market looks hugely underpriced

Ukraine’s stock market is never boring for investors. The worst global perfor- Stock market performance mance in 2008 was first replaced by the fastest recovery in 2009, followed MEXICO IPC DOW JONES by robust growth in 2010 thanks to the improved economic environment, po- S&P 500 litical stabilisation and return of (some) foreign investors. However, 2011 then BOVESPA DAX proved to be a disastrous year as the market was in free fall from April to Octo- HANG SENG MICEX ber, and the UX index was cut by half during this period, returning to the level WSE WIG Euro Stoxx 50 of late 2009. PX BUX Since then, the UX index has mainly oscillated in a range of 1300-1600 points Ukrainian UX as the news flow has mostly featured negative news (widening external imbal- PFTS Index -60 -40 -20 0 20 ances, failed gas negotiations with Russia, continued IMF programme stalemate), %, ytd %, 1year largely offsetting the positive developments (i.e. improvement in global economic Source: Bloomberg trends, Greece bailout, quantitative easing by ECB, fading domestic expecta- tions of depreciation). At the same time, contrary to common belief, the Ukrain- ian stock market in 2012 is not following other markets. For example, the Rus- sian RTS Index grew about 20% ytd, whilst the most liquid Ukrainian shares were down about 4% on average. Of course, the brilliant results of the Russian index Stock indices performance can primarily be attributed to the surging oil price, but we do not see correlation 400 to the leading global markets either (the S&P500 gained 10% ytd, for example). 350 Disappointing returns caused trading volumes to plunge (from an already low 300 level). Over the last year we have witnessed an exodus of investors (both do- 250 200 mestic and foreign) from the local stock market, provoked by unfavourable eco- 150 nomic developments, poorly developed market infrastructure, corporate scandals 100 and price manipulation. For example, over the last year there have been sev- 50 eral cases of market intervention by the regulator, such as the suspension of cer- 0 Apr-09 Dec-09 Aug-10 Apr-11 Dec-11 tain shares’ trading on apparently dubious legal grounds. This decision was can- UX (Ukraine) Micex (Russia) celled later, but hundreds of investors lost their money for good. Therefore, not MSCI EM (Emerging Markets) surprisingly, the market is losing not only institutional players but small private Source: Bloomberg investors as well, who appeared to be the most vulnerable to manipulation and corporate conflicts.

On a more positive note, we have witnessed the appearance of new equity mar- ket instruments in Ukraine. The Ukrainian Stock Exchange launched option con- tracts on its index last year. And even though the liquidity of the market and of UX daily trading volumes (UAH mn) this new product is low, this is a rather large step forward for the local market. Another idea that is currently lobbied by market players is double listing – i.e. to 200 allow to trade locally the shares of Ukrainian companies (Ferrexpo PLC (FXPO: London), MHP S.A. (MHPC:LSE), Kernel Holding Sa (KER: Warsaw)), which have 150 been listed abroad. So, despite all these negative developments, one probably should not abandon the Ukrainian equity market forever. With the current valua- 100 tions, Ukraine looks hugely underpriced as an artificially knocked-down market 50 with lots of potentially good issuers. However, the main question is when the mar- ket will step up onto a sustainable growth path. We believe that for this to hap- 0 pen many institutional changes need to be implemented, but this does not look Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 very likely in the immediate future. Source: Ukrainian Exchange

April 2012 13 Comparison tables and forecasts

Real GDP (% yoy) Private consumption (% yoy) Consumer prices (avg, % yoy) Countries 2010 2011 2012e 2013f Countries 2010 2011 2012e 2013f Countries 2010 2011 2012e 2013f Poland 3.9 4.3 2.8 3.7 Poland 3.2 3.4 2.3 3.0 Poland 2.6 4.3 3.9 2.5 Hungary 1.3 1.7 -0.5 1.5 Hungary -2.3 0.0 0.0 0.5 Hungary 4.9 3.9 5.5 3.5 Czech Rep. 2.7 1.7 -0.2 1.4 Czech Rep. 0.6 -0.5 -1.0 0.8 Czech Rep. 1.5 1.9 3.0 2.2 Slovakia 4.0 3.3 0.8 2.5 Slovakia -0.8 -0.4 0.0 1.2 Slovakia 1.0 3.9 3.0 2.5 Slovenia 1.4 -0.2 0.0 1.5 Slovenia -0.6 -0.2 0.0 1.0 Slovenia 1.8 1.8 2.2 2.0 CE 3.2 3.1 1.4 2.7 CE 1.3 1.6 1.0 1.9 CE 2.5 3.6 3.8 2.5 Croatia -1.2 0.0 -1.0 1.0 Croatia -0.9 0.2 -0.8 1.0 Croatia 1.1 2.3 2.5 3.0 Bulgaria 0.4 1.7 1.0 2.5 Bulgaria 0.6 -0.2 0.2 3.5 Bulgaria 2.4 4.2 2.7 3.1 Romania -1.6 2.5 0.5 2.5 Romania -0.4 1.4 0.6 2.0 Romania 6.1 5.8 3.0 3.6 Serbia 1.0 2.0 0.0 1.0 Serbia n.a. n.a. n.a. n.a. Serbia 6.5 11.0 6.5 6.0 Bosnia a. H. 0.7 1.9 0.0 2.0 Bosnia a. H. -1.3 2.5 -0.5 2.5 Bosnia a. H. 2.1 3.7 2.2 2.0 Albania 3.9 2.0 2.5 3.5 Albania n.a. n.a. n.a. n.a. Albania 4.0 3.5 3.0 3.5 SEE -0.7 1.8 0.3 2.1 SEE -0.3 0.8 0.2 1.8 SEE 4.5 5.4 3.2 3.6 Russia 4.3 4.3 3.7 4.0 Russia 5.1 6.4 5.5 6.0 Russia 6.9 8.5 6.0 6.9 Ukraine 4.2 5.2 3.5 4.0 Ukraine 6.7 15.0 7.1 5.6 Ukraine 9.4 8.0 4.2 8.5 Belarus 7.6 5.3 3.0 3.0 Belarus 10.2 n.a. n.a. n.a. Belarus 7.7 53.2 60.0 23.0 CIS 4.4 4.4 3.7 4.0 CIS 5.4 6.9 5.5 5.8 CIS 7.1 9.7 7.4 7.5 CEE 3.5 3.7 2.6 3.4 CEE 3.6 4.7 3.6 4.2 CEE 5.5 7.4 5.9 5.6 Turkey 9.0 8.5 3.0 4.0 Turkey 6.7 7.7 3.7 4.1 Turkey 8.6 6.5 9.5 6.5 Austria 2.3 3.1 0.3 1.3 Austria 2.2 0.6 0.9 1.3 Austria 1.7 3.6 2.3 2.0 Eurozone 1.8 1.5 -0.5 1.1 Eurozone 0.8 0.2 -0.3 0.8 Eurozone 1.6 2.7 2.2 1.8 USA 3.0 1.7 2.0 1.0 USA 2.0 2.2 1.8 1.2 USA 1.6 3.2 2.1 1.5 Source: National statistics, Raiffeisen RESEARCH Source: National statistics, Raiffeisen RESEARCH Source: National statistics, Raiffeisen RESEARCH

Current account balance (% of GDP) General budget balance (% of GDP) Public debt (% of GDP) Countries 2010 2011 2012e 2013f Countries 2010 2011 2012e 2013f Countries 2010 2011 2012e 2013f Poland -4.1 -3.9 -3.8 -3.1 Poland -7.9 -5.4 -4.9 -3.4 Poland 53.4 55.9 54.2 51.9 Hungary 1.1 1.6 1.8 1.0 Hungary -4.2 0.0 -3.4 -3.4 Hungary 81.3 82.7 80.7 79.9 Czech Rep. -3.9 -2.9 -2.2 -2.3 Czech Rep. -4.8 -4.4 -3.7 -3.4 Czech Rep. 37.6 41.1 43.6 45.2 Slovakia -2.5 0.2 1.4 2.0 Slovakia -7.9 -5.0 -4.6 -2.8 Slovakia 41.0 44.4 48.2 48.8 Slovenia -0.8 -0.5 -0.6 -1.1 Slovenia -5.8 -6.5 -4.5 -4.0 Slovenia 38.8 47.5 50.0 51.0 CE -3.0 -2.4 -2.1 -1.8 CE -6.6 -4.5 -4.4 -3.4 CE 52.0 55.0 54.8 54.0 Croatia -1.2 0.3 0.3 0.9 Croatia -4.9 -5.5 -4.3 -3.5 Croatia 41.2 45.1 52.2 53.7 Bulgaria -1.3 1.9 1.6 0.9 Bulgaria -4.0 -2.1 -2.2 -1.8 Bulgaria 16.7 17.0 19.9 19.1 Romania -4.4 -4.2 -4.0 -4.2 Romania -6.8 -4.6 -3.0 -3.0 Romania 30.5 33.4 34.3 35.0 Serbia -7.4 -8.9 -7.4 -7.3 Serbia -4.8 -4.5 -5.2 -4.6 Serbia 43.2 45.8 48.0 45.0 Bosnia a. H. -5.3 -8.1 -6.6 -8.1 Bosnia a. H. -2.2 -3.0 -3.0 -2.0 Bosnia a. H. 38.4 37.4 39.7 40.1 Albania -10.3 -11.5 -10.6 -9.6 Albania -5.7 -3.5 -4.0 -4.0 Albania 59.5 59.6 59.6 59.4 SEE -4.0 -3.6 -3.3 -3.4 SEE -5.6 -4.3 -3.4 -3.1 SEE 33.3 35.6 38.0 38.2 Russia 6.1 5.5 2.8 0.9 Russia -4.1 0.8 -1.3 -1.0 Russia 9.2 9.8 14.0 16.0 Ukraine -2.2 -5.5 -4.1 -4.1 Ukraine -7.5 -4.3 -3.0 -2.0 Ukraine 40.0 36.0 37.5 37.0 Belarus -15.1 -9.7 -12.9 -13.8 Belarus -2.6 2.4 -0.5 -1.0 Belarus 23.5 52.5 50.5 57.0 CIS 4.7 4.2 1.9 0.2 CIS -4.3 0.4 -1.4 -1.1 CIS 12.1 13.1 16.9 18.8 CEE 1.3 1.4 0.2 -0.7 CEE -5.1 -1.5 -2.5 -2.0 CEE 26.1 27.8 30.3 31.3 Turkey -6.6 -10.0 -8.3 -7.6 Turkey -3.7 -1.4 -1.5 -2.0 Turkey 42.2 39.1 36.2 35.0 Austria 3.0 1.9 2.6 2.6 Austria -4.5 -2.6 -3.1 -2.2 Austria 71.9 72.2 74.8 75.2 Eurozone -0.5 -0.3 -0.2 -0.4 Eurozone -6.2 -4.1 -3.4 -3.0 Eurozone 85.4 88.0 90.4 90.9 USA -3.2 -3.1 -2.9 -2.8 USA -8.9 -8.7 -7.6 -3.8 USA 93.1 98.7 103.7 106.2 Source: National statistics, Raiffeisen RESEARCH Source: National statistics, Raiffeisen RESEARCH Source: National statistics, Raiffeisen RESEARCH

Gross foreign debt (% of GDP) Exchange rate EUR/LCY (avg) Ratings* Countries 2010 2011 2012e 2013f Countries 2010 2011 2012e 2013f Countries S&P Moody's Fitch Poland 66.4 70.1 61.5 60.3 Poland 3.99 4.11 4.14 3.94 Poland A- A2 A- Hungary 139.4 132.9 133.9 125.1 Hungary 275.5 279.3 290.5 285.0 Hungary BB+ Ba1 BB+ Czech Rep. 47.9 48.9 47.4 47.9 Czech Rep. 25.3 24.6 24.5 23.5 Czech Rep. AA- A1 A+ Slovakia 74.5 79.0 81.3 86.0 Slovakia euro euro euro euro Slovakia A A2 A+ Slovenia 114.9 116.3 116.7 115.8 Slovenia euro euro euro euro Slovenia A+ A2 A CE 75.8 77.4 72.6 71.2 Croatia 101.2 99.1 103.6 100.7 Croatia 7.29 7.43 7.56 7.55 Croatia BBB- Baa3 BBB- Bulgaria 102.7 92.7 88.0 79.7 Bulgaria 1.96 1.96 1.96 1.96 Bulgaria BBB Baa2 BBB- Romania 74.5 72.2 72.5 71.0 Romania 4.21 4.24 4.34 4.24 Romania BB+ Baa3 BBB- Serbia 84.5 74.5 75.7 70.3 Serbia 103.0 102.0 109.0 106.9 Serbia BB not rated BB- Bosnia a. H. 58.3 58.9 61.0 60.6 Bosnia a. H. 1.96 1.96 1.96 1.96 Bosnia a. H. B B3 not rated Albania 23.5 24.0 25.4 25.1 Albania 137.8 140.3 140.2 138.5 Albania B+ B1 not rated SEE 81.7 77.5 77.9 74.8 Russia 32.9 29.4 28.0 27.9 Russia 40.3 40.9 39.7 41.2 Russia BBB Baa1 BBB Ukraine 85.9 76.6 71.4 72.8 Ukraine 10.54 10.92 10.89 11.57 Ukraine B+ B2 B Belarus 51.3 61.5 75.7 89.3 Belarus 3,950 6,300 11,700 15,200 Belarus B- B3 not rated CIS 37.2 34.3 32.6 32.9 CEE 54.5 51.7 48.3 47.8 Turkey 39.5 42.7 39.7 37.8 Turkey 2.00 2.30 2.36 2.28 Turkey BB Ba2 BB+ Austria n.a. n.a. n.a. n.a. Austria euro euro euro euro Austria AA+ Aaa AAA Eurozone n.a. n.a. n.a. n.a. USA n.a. n.a. n.a. n.a. USA 1.33 1.37 1.33 1.30 USA AA+ Aaa AAA Source: National statistics, Raiffeisen RESEARCH Source: Thomson Reuters, Raiffeisen RESEARCH * for FCY, long-term debt Source: Bloomberg, Raiffeisen RESEARCH

14 April 2012 Acknowledgements

Global Raiffeisen RESEARCH Team: Peter Brezinschek (Head) Vienna Leopold Salcher Croatia Romania Slovenia Aaron Alber Andreas Schiller Anton Starcevic Ionut Dumitru Primoz Kovacic Jörg Angelé Robert Schittler Zrinka Zivkovic Matijevic Nicolae Covrig Mario Annau Andreas Schwabe Ivana Juric Gabriel Bobeica Ukraine Eva Bauer Connie Schümann Nada Harambasic Romulus Mircea Dmytro Sologub Gunter Deuber Manuel Schuster Ana Franin Ion Gheorghe Guta Ludmila Zagoruyko Wolfgang Ernst Gintaras Shlizhyus Marijana Cigic Bogdan Campianu Olga Nikolaieva Christian Hinterwallner Gleb Shpilevoy Ionut Gutis Valentin Hofstätter Alexander Sklemin Czech Republic Alexandru Combei Company Research Stephan Imre Gottfried Steindl Pavel Mertlik Iuliana Mocanu Stefan Maxian (Head) Christoph Klaper Martin Stelzeneder Vaclav France Genghiz Curtali Igor Kovacic Magdalena Szczepanski Michal Brozka Daniel Damaska Lydia Kranner Jürgen Walter Ales Michl Russia Oleg Galbur Nina Kukic Jindrich Svatek Anastasia Baykova Natalia Frey Martin Kutny Albania Denis Poryvay Jakub Krawczyk Veronika Lammer Joan Canaj Hungary Anton Pletenev Bartlomiej Kubicki Jörn Lange Valbona Gjeka Zoltán Török Maria Pomelnikova Bernd Maurer Hannes Loacker Ádám Keszeg Pavel Papin Dominik Niszcz Richard Malzer Belarus Levente Blahó Irina Alizarovskaya Markus Remis Andreas Mannsparth Oleg Leontev Konstantin Yuminov Teresa Schinwald Johannes Mattner Vasily Pirogovsky Poland Sergey Libin Bernhard Selinger Stefan Memmer Natalya Chernogorova Jacek Wisniewski Jovan Sikimic Albert Moik Marta Petka-Zagajewska Serbia Arno Supper Julia Neudorfer Bosnia & Herzegovina Dorota Strauch Ljiljana Grubic Christoph Thurnberger Christine Nowak Ivona Kristic Tomasz Regulski Iryna Trygub-Kainz Peter Onofrej Srebrenko Fatusic Jacek Mielcarek Slovakia Helge Rechberger Pawe³ Radwañski Robert Prega Matthias Reith Bulgaria Micha³ Krajczewskik Juraj Valachy Kaloyan Ganev Boris Fojtik Hristiana Vidinova Cut-off for data: 18 April 2012 This report was completed on 19 April 2012

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April 2012 15 Raiffeisen Bank International AG

Investment Banking Units Raiffeisen Bank International AG, Vienna Capital Markets Minsk: Priorbank JSC Head: Nicolaus Hagleitner Tel: +43 1 71707 1467 Andrey Filazafovich Tel: +375 17 289 9 213 Head of Fixed Income Sales: Luca Scalzini Tel: +43 1 71707 3981 Head of FX-MM Sales: Wolfgang Kalinka Tel: +43 1 71707 3959 Moscow: ZAO Raiffeisenbank Austria Head of Solution Sales: Harald SchönauerTel: +43 1 71707 1148 Sergei Monin Tel: +7 495 721 9922

Belgrade: Raiffeisenbank a.d. Serbia Tirana: Raiffeisen Bank Sh.a. Zoran Petrovic Tel: +381 11 2207006 Christian Canacaris Tel: +355 4 253 646

Bratislava: Tatra banka, a.s. Prague: Raiffeisenbank a.s. Henrieta Hudecova Tel: +421 2 59191334 Jan Pudil Tel: +420 234 401 863

Bucharest: Raiffeisen Capital & Investment S.A. Sarajevo: Raiffeisen BANK d.d. Bosnia and Herzegovina James Stewart Tel: +40 21 302 0082 Sanja Korene Tel: +387 33 287 122

Budapest: Raiffeisen Bank Zrt. Sofia: Raiffeisenbank (Bulgaria) EAD Lázló Volosinovsky Tel: +36 1 484 4639 Evelina Miltenova Tel: +359 2 91985 451

Kiev: Raiffeisen Bank Aval Warsaw: Raiffeisen Bank Polska S.A. Oksana Volchko Tel: +38 044 230 0348 Krzysztof Lubkiewicz Tel: +48 691 335 510

Maribor: Raiffeisen Banka d.d. Zagreb: Raiffeisenbank Austria d.d. Gvido Jemensek Tel: +386 2 229 3111 Ivan Zizic Tel: +385 1 45 66 466

Raiffeisen CENTROBANK AG Institutional Equity Sales, Vienna Raiffeisen Investment AG, Vienna Head: Wilhelm Celeda Tel: +43 1 515 20 402 Gerhard Grund Tel: +43 1 51520-302 Sales: Klaus della Torre Tel: +43 1 515 20 472 Wolfgang Putschek Tel: +43 1 710 54 00-153

Commercial banks

Raiffeisen Bank International AG, Vienna RB International Finance USA, New York Austrian Corp. Customers: Joseph Eberle Tel: +43 1 71707 1487 Dieter Beintrexler Tel: +1 212 845 4100 Financial Institutions: Axel Summer Tel: +43 1 71707 1476 Stefan Gabriele Tel: +1 212 835 2328

RBI London Branch RBI Beijing Branch Wladimir Ledochowski Tel: +44 20 7933 8002 Andreas Werner Tel: +86 10 653 233 88 Mark Bowles Tel: +44 20 7933 8001 RBI Singapore Branch Raiffeisen Malta Bank plc., Sliema Stefan Mandl Tel: +65 6305 6100 Anthony Schembri Tel: +356 21 320 942

International Desk

Vienna: Raiffeisen Bank International AG Moscow: ZAO Raiffeisenbank Austria Rudolf Lercher Tel: +43 1 71707 3537 Maria Maevskaya Tel: +7 495 775 5230

Belgrade: Raiffeisen banka a.d. Prague: Raiffeisenbank a.s. Sofija Davidovic Tel: +381 11 220 7807 Roman Lagler Tel: +420 234 40 1728

Bratislava: Tatra banka, a.s. Pristina: Raiffeisen Bank Kosovo J.S.C. Henrieta Hudecova Tel: +421 2 5919 1849 Lirije LLazani-Hoxha Tel: +381 38 22 22 22 184

Bucharest: Raiffeisen Bank S.A. Sofia: Raiffeisenbank (Bulgaria) EAD Reinhard Zeitlberger Tel: +40 21 306 1564 Irena Krentcheva Tel: +3592 9198 5826

Budapest: Raiffeisen Bank Zrt. Sarajevo: Raiffeisen Bank d.d. Bosna i Hercegovina László Volosinovsky Tel: +36 1 484 4639 Vildana Sijamhodzic Tel: +387 33 287 283

Kiev: Raiffeisen Bank Aval Tirana: Raiffeisen Bank Sh.a. Oksana Volchko Tel: +38 044 230 0348 Jorida Zaimi Tel: +355 4 2381 445 2865

Maribor: Raiffeisen Banka d.d. Warsaw: Raiffeisen Bank Polska S.A. Simon Jug Tel: +386 2 2293 276 Zuzanna Szatkowska Tel: +48 22 585 2431

Minsk: Priorbank JSC Zagreb: Raiffeisenbank Austria d.d. Dmitry Naydenov Tel: + +375 17 289 92 09 Wolfgang Wöhry Tel: +385 1 4566 462

16 April 2012