The TOP 6 risks for Ukraine’s steel industry in 2020

16/ 01/ 2020

Stanislav Zinchenko. GMK Center Director What will await Ukraine’s steel industry next year? The answer to this question depends, to a large extent, on the quantity of products we will be able to sell in foreign markets, because 80% of Ukraine-made metal products are exported and the domestic market is too small and consumes just 4–5 million tons of steel. This makes Ukrainian steelmaking companies extremely vulnerable, as foreign markets are getting increasingly closed. We assessed the potential risks that await the Ukrainian steel industry in 2020. I would like to note right away that they are not much different from the challenges faced by other sectors of Ukrainian industry and the economy in general. 1. Slowdown in the global economic growth. Ukraine is highly dependent on exports of raw materials and, consequently, on raw materials prices. Meanwhile, commodity prices depend on trade wars, the dynamics of global GDP, and the situation in developing countries, primarily in China. Say, raw material prices fall amid a slumping demand in China. This means that we will have to sell products at a lower price. We cannot but sell products, as there is no growth in domestic demand. This is the biggest risk and, unfortunately, we cannot impact it. If steel consumption strongly declines in China, prices for steel products will fall, and the consequences for Ukrainian and global steel producers could be disastrous. 2. Protectionism. Amid global economic growth and declining demand, each country attempts to protect its market. Preservation of industrial jobs is a sacred cow of contemporary economic policies. The creation of a new, industrial, high-tech workplace is very expensive, $500 thousand to $1 million in a long-term perspective. Earlier, we talked about protectionism in large and rich markets, e.g. the U.S. and the EU, and now it is turn of small ones. And we must admit that we lose in these games. Much more investigations are being carried out against Ukraine compared to other countries, and we defend our market very poorly. To date, Ukraine is one of the most liberal and open countries in terms of steel production. Moreover, the Ukrainian market is open primarily to direct competitors of Ukrainian steelmakers in the markets of China, Turkey, and Russia. 3. Revaluation. Ukrainian exporters, agrarians and steelmakers who generate 40–45% of the country’s GDP currently suffer huge losses, because their products are becoming more expensive amid the strengthening of the hryvnia. The unpredictable exchange rate is a very bad factor, posing great risks for the business. It sometimes seems that the strengthening of the hryvnia was sponsored by Turkish, Chinese, and Russian steel companies, which overflow Ukraine’s market with their products. It reminds the 1990s when Ukraine fully depended on imports. Only imported goods — from Poland, Turkey, and China — were available in the domestic market. And this all could come back. With this exchange rate, our products could get more expensive than European ones. 4. The economic policy of the state. In the given situation of high market volatility, a correct, well-regulated state policy is very important, but, unfortunately, there is none in place. We were told about a 40% increase in GDP (although this seems to have already been forgotten), the withdrawal of the economy from the shadow (although all major value-added sectors have long been ‘white’), land reform (although foreign companies are banned from entering the market, which means that a ten-billion-dollar investment is unlikely to come to the country in the near term), and privatization, the economic effect of which is also doubtful or will become apparent on a long-term horizon. Frankly speaking, the business knows nothing about today’s priorities of the government: which sectors will develop, and in which infrastructure projects money will be invested. What counts are not words, but deeds. And today’s deeds mean an increase in the tax burden on all types of businesses. When it comes to the steel industry, they mean a higher rent for iron ore mining and a higher environmental tax. Higher tax pressure results in lower economic activity. As a result, we will not get a 40% growth, but a 40% drop in GDP. What will we do in two years when we lose other sectors of the industry, just as we lost the automotive industry and mechanical engineering? The government should not kill the goose that lays golden eggs. This applies to all sectors of the economy, ranging from steel and tobacco industries to agriculture and IT. 5. Infrastructure collapse. I would like to place a special emphasis on one of the main risks, i.e. infrastructure. Ukraine is an export-oriented economy, which means that it is very dependent on the efficient operation of the railway, roads, seaports, river transport, and other sectors for exporting our products. At the same time, a high depreciation of infrastructure is a potential for industrial growth, because the launch of infrastructure projects will significantly increase the domestic demand for industrial products. Amid a slowdown in the global economy and crises, all countries in the world stimulate and develop their economies due to two factors: large housing programs and large infrastructure projects. Everyone understands that infrastructure projects could lift the country’s economy out of recession. For Ukraine, this is important in terms of both export potential and domestic demand for industrial products. Yet unfortunately, there seem to be neither 2020 budget items nor respective target programs. On the contrary, there is a certain reduction in budget spending. 6. Administration. Effective communication with the government directly influences the business and its performance. A classic example of this communication is a VAT refund to exporters. Over the past two years, automatic VAT refunds have worked well enough, but now the government negates the accomplishment. What does it mean? This means that operating assets of large exporters — steelmakers, agrarians, car makers — i.e. those who make 60% of currency earnings of the country are being ‘washed out.’ They cannot settle accounts with suppliers, or timely pay salaries, etc. Unfortunately, the government cannot become either an effective owner or an effective manager-administrator. The issues of effective administration, VAT refunds, and communication between the government and the business affect the ability of the latter to pay taxes, create new jobs, bring currency earnings to the country, and the like. Conclusions. As is seen, Ukraine is in for completely different levels of risks in 2020. It is impossible to say that they are fundamentally different from the challenges of 2019. They have rather increased. Both internal and external problems were added. What needs to be done in this situation? I would recommend the following three things: Building, at all levels, of systemic protection of the domestic market and export support. We need to fight for our own economy. Inside and outside the country. Because in the same steel industry, Iran and Vietnam will soon surpass us. Cut in the tax pressure on the business, despite the need to service the foreign debt. Because the attempt to get money in 2020 will end in the absence of a tax base in 2021. Infrastructure, infrastructure and infrastructure again. Development of road, rail, sea, and river infrastructure. For the Ukrainian economy, this is both the issue of an effective export logistics and a chance to increase domestic demand for industrial products.

Stanislav Zinchenko

GMK Center Director

What will await Ukraine’s steel industry next year?

The answer to this question depends, to a large extent, on the quantity of products we will be able to sell in foreign markets, because 80% of Ukraine-made metal products are exported and the domestic market is too small and consumes just 4–5 million tons of steel. This makes Ukrainian steelmaking companies extremely vulnerable, as foreign markets are getting increasingly closed.

We assessed the potential risks that await the Ukrainian steel industry in 2020. I would like to note right away that they are not much different from the challenges faced by other sectors of Ukrainian industry and the economy in general.

1. Slowdown in the global economic growth

Ukraine is highly dependent on exports of raw materials and, consequently, on raw materials prices. Meanwhile, commodity prices depend on trade wars, the dynamics of global GDP, and the situation in developing countries, primarily in China. Say, raw material prices fall amid a slumping demand in China. This means that we will have to sell products at a lower price. We cannot but sell products, as there is no growth in domestic demand.

This is the biggest risk and, unfortunately, we cannot impact it. If steel consumption strongly declines in China, prices for steel products will fall, and the consequences for Ukrainian and global steel producers could be disastrous.

2. Protectionism

Amid global economic growth and declining demand, each country attempts to protect its market. Preservation of industrial jobs is a sacred cow of contemporary economic policies. The creation of a new, industrial, high-tech workplace is very expensive, $500 thousand to $1 million in a long-term perspective.

Earlier, we talked about protectionism in large and rich markets, e.g. the U.S. and the EU, and now it is turn of small ones. And we must admit that we lose in these games. Much more investigations are being carried out against Ukraine compared to other countries, and we defend our market very poorly. To date, Ukraine is one of the most liberal and open countries in terms of steel production. Moreover, the Ukrainian market is open primarily to direct competitors of Ukrainian steelmakers in the markets of China, Turkey, and Russia.

3. Revaluation

Ukrainian exporters, agrarians and steelmakers who generate 40–45% of the country’s GDP currently suffer huge losses, because their products are becoming more expensive amid the strengthening of the hryvnia.

The unpredictable exchange rate is a very bad factor, posing great risks for the business. It sometimes seems that the strengthening of the hryvnia was sponsored by Turkish, Chinese, and Russian steel companies, which overflow Ukraine’s market with their products. It reminds the 1990s when Ukraine fully depended on imports. Only imported goods — from Poland, Turkey, and China — were available in the domestic market. And this all could come back. With this exchange rate, our products could get more expensive than European ones.

4. The economic policy of the state

In the given situation of high market volatility, a correct, well-regulated state policy is very important, but, unfortunately, there is none in place.

We were told about a 40% increase in GDP (although this seems to have already been forgotten), the withdrawal of the economy from the shadow (although all major value-added sectors have long been ‘white’), land reform (although foreign companies are banned from entering the market, which means that a ten-billion-dollar investment is unlikely to come to the country in the near term), and privatization, the economic effect of which is also doubtful or will become apparent on a long-term horizon.

Frankly speaking, the business knows nothing about today’s priorities of the government: which sectors will develop, and in which infrastructure projects money will be invested. What counts are not words, but deeds. And today’s deeds mean an increase in the tax burden on all types of businesses. When it comes to the steel industry, they mean a higher rent for iron ore mining and a higher environmental tax.

Higher tax pressure results in lower economic activity. As a result, we will not get a 40% growth, but a 40% drop in GDP. What will we do in two years when we lose other sectors of the industry, just as we lost the automotive industry and mechanical engineering? The government should not kill the goose that lays golden eggs. This applies to all sectors of the economy, ranging from steel and tobacco industries to agriculture and IT.

5. Infrastructure collapse

I would like to place a special emphasis on one of the main risks, i.e. infrastructure. Ukraine is an export-oriented economy, which means that it is very dependent on the efficient operation of the railway, roads, seaports, river transport, and other sectors for exporting our products. At the same time, a high depreciation of infrastructure is a potential for industrial growth, because the launch of infrastructure projects will significantly increase the domestic demand for industrial products.

Amid a slowdown in the global economy and crises, all countries in the world stimulate and develop their economies due to two factors: large housing programs and large infrastructure projects. Everyone understands that infrastructure projects could lift the country’s economy out of recession. For Ukraine, this is important in terms of both export potential and domestic demand for industrial products. Yet unfortunately, there seem to be neither 2020 budget items nor respective target programs. On the contrary, there is a certain reduction in budget spending.

6. Administration

Effective communication with the government directly influences the business and its performance. A classic example of this communication is a VAT refund to exporters. Over the past two years, automatic VAT refunds have worked well enough, but now the government negates the accomplishment. What does it mean? This means that operating assets of large exporters — steelmakers, agrarians, car makers — i.e. those who make 60% of currency earnings of the country are being ‘washed out.’ They cannot settle accounts with suppliers, or timely pay salaries, etc. Unfortunately, the government cannot become either an effective owner or an effective manager-administrator.

The issues of effective administration, VAT refunds, and communication between the government and the business affect the ability of the latter to pay taxes, create new jobs, bring currency earnings to the country, and the like.

Conclusions

As is seen, Ukraine is in for completely different levels of risks in 2020. It is impossible to say that they are fundamentally different from the challenges of 2019. They have rather increased. Both internal and external problems were added.

What needs to be done in this situation? I would recommend the following three things:

Building, at all levels, of systemic protection of the domestic market and export support. We need to fight for our own economy. Inside and outside the country. Because in the same steel industry, Iran and Vietnam will soon surpass us.
Cut in the tax pressure on the business, despite the need to service the foreign debt. Because the attempt to get money in 2020 will end in the absence of a tax base in 2021.
Infrastructure, infrastructure and infrastructure again. Development of road, rail, sea, and river infrastructure. For the Ukrainian economy, this is both the issue of an effective export logistics and a chance to increase domestic demand for industrial products.