Significance: Industry output rose by 11% in 2010 to be Ukraine's fastest-growing sector. Exports have been the key motivating force, but domestic demand has been recovering as well. However, investment spending and especially construction have remained weak.

Implications: Ukraine's economy has embarked on a cautious recovery in 2010 as the political and financial situation has stabilised. Industry has been the main driver, but many weaknesses prevail which haunt the current outlook.

Outlook: Output results signal that GDP grew by around 4.6-4.8% in 2010 altogether. The recovery pace will slowly accelerate in 2011 and 2012, with growth peaking at 6.4% in the latter year.

Ukraine's industrial production index has increased by 11.0% in 2010 on average, according to the State Statistical Committee, thus making good around half of the loss incurred during the crisis year 2009. Manufacturing alone grew 13.5% at the same time. While a significant amount of spare capacity still prevails in several sectors, industry—especially machinery and equipment, metallurgy and chemicals which are Ukraine's key exporting sectors—has been driving the recovery and pulling the economy out of recession. This was largely expected, but the latest good news is that growth momentum in Ukraine's industry has been maintained toward the end of the year.

Total industry output was up by 12.5% year-on-year (y/y) in December, with manufacturing rising by 15.6%. The key exporting industries have been responsible, which is remarkable given that Ukraine's heavy industry, especially steel production, is currently struggling with rising energy costs on the input side. However, the fact that Ukraine's export price index for steel rose 11% in the fourth quarter, according to Kommersant Ukraine, has surely helped steel producers to swallow higher energy prices so far.

The picture in other key sectors of Ukraine's economy is not quite as good as in industry, but improvements in recent months have been visible there as well. Retail sales, which had suffered in 2009 as unemployment bounced and households sharply curtailed spending, were up by 7.8% in real terms in 2010, and grew 14.7% y/y in December alone. This ties in with the steady recovery of household consumption over the course of 2010, which increased by 7.5% on the year in the third quarter, although this was from a low base level.

The financial situation of private households has been recovering steadily as the economy gathered traction. Despite suffering from food price spikes and higher energy costs, real purchasing power improved as unemployment sagged and nominal average monthly wages increased by 17.7% in January-November, which yields a real wage gain of more than 8% on the year. The unemployment rate went down to 7.1% in the third quarter, according to Labor Force Survey data, after 7.9% in the second and 7.8% in the third quarter of 2009.

Investment and construction have remained the major dampeners in 2010. In fact, construction output, which fell by 5.4% in 2010, declined for the third year in a row, having reached only 41% of the output level of 2007, the last year with an increase of construction output to date. On a positive note, though, was the 3.6% y/y rise of gross fixed capital formation in the third quarter, which signals a modest improvements in terms of investment conditions, namely as far as the political situation and the general macroeconomic environment is concerned. Indeed companies, particularly in Ukraine's industry, have been cautiously expanding capacity and ramped up capital spending as a result. However, credit-based financing of investments is still scarce, which puts a barrier to Ukraine's investment potential in general.

Outlook and Implications

The year 2010 has had both its disappointing and encouraging moments. The latter were due to the political and financial stabilisation after the chaos during the election campaign and economic crash since late 2008, while the former moments were associated mostly with the failure of the economy to embark on a full-fledged recovery at the same time, which we had hoped for after the election, anticipating that a sort of stabilisation would emerge and providing a relatively fertile ground for a sustained recovery. The protracted crisis in the banking sector played a role, but probably more important were the weaknesses which are deeply entrenched in Ukraine's economy and the public sector, such as the high level of corruption, the strong links between business and politics, which make market-based competition hard to pursue, and the complicated tax system.

Still, there are hopeful signs as foreign direct investment (FDI) inflows have remained fairly strong in 2010, though clearly below pre-crisis levels, the tax code has been amended and business surveys signal a more confident attitude in general among Ukraine's corporate sector. Moreover, the country may look forward to co-hosting the European football championship in 2012 together with Poland, which will still provide some support for the ailing construction during the next several months and lift consumption spending during the actual event. Even so, external demand will remain the key motive power for the recovery, although imports had outstripped exports by far in the second and third quarter.

The output results signal that GDP grew by around 4.6-4.8% in 2010 altogether, following the savage 15.1% decline in 2009. The recovery pace will slowly accelerate in 2011 and 2012, with growth peaking at 6.4% in the latter year.