The coming of spring is always a cause for celebration in Ukraine but for the past two years the end of winter has done little to ease the country’s financial pain. This year, for the first time since before the Maidan revolution, the green shoots in Kiev’s famous parks are also visible in the economy.
GDP is finally moving in the right direction, albeit from a very low base. After two years of recession that saw the economy contract by more than 15%, the International Monetary Fund (IMF) is forecasting growth of 1.5% this year and 2.5% in 2017. Inflation is down to manageable levels, the hryvnia has stabilised and the once fragile banking sector has been bolstered and overhauled. The country is also running a primary budgetary surplus for the first time since the Maidan revolution.
Still more encouraging, says Olena Bilan, chief economist at local investment bank Dragon Capital, is the fact that investment in Ukraine’s corporate sector resumed in the fourth quarter of 2015. “That means that confidence is returning,” she says.
The political climate is also looking unexpectedly benign. Following a two month stand-off between president Petro Poroshenko and unpopular prime minister Arseniy Yatsenyuk, a new cabinet led by Volodymyr Groysman was finally installed on April 14. The preponderance of Ukrainian political insiders, as well as the absence of foreign technocrats such as former finance minister Natalie Jaresko, prompted fears that the administration would prove less reform-minded than its predecessor.
Within a fortnight, however, the new government demonstrated its reformist credentials with the announcement of plans to end gas subsidies. The move, which will involve a sharp rise in energy costs for local households, had been one of the key conditions set by the IMF for the release of the next round of financial support under Ukraine’s Extended Fund Facility programme.
THIRD TRANCHE HOPES
So far, only $6.7bn of the $17.5bn of funding promised to the country last March has been handed over, in two instalments. A third tranche, of $1.7bn, was due to arrive early this year but was delayed by the Fund due to concerns over the lack of progress on reform by the Yatsenyuk government.
Hopes are now high that the funding programme can be restarted. An IMF mission is due to visit Ukraine on May 10-18 and incoming finance minister Oleksandr Danylyuk has indicated that there is a “very, very high likelihood” of the next tranche of financing being released by July.
Liza Ermolenko, emerging markets economist at Capital Economics, agrees. “The new government has managed to push through the gas price hike, which means they should be able to do the same with other necessary reforms,” she says. “Everything is now in place for Ukraine to resume negotiations with the IMF and it seems likely that a deal will emerge fairly soon.”
Analysts say the new government’s enthusiasm for renewing the IMF programme is particularly encouraging given that Ukraine no longer stands in urgent need of hard currency support. Foreign exchange reserves have nearly doubled from the lows of $7.5bn seen in 2014 to more than $14bn, according to Dragon Capital.
This includes a record monthly inflow of $676m in April, when policymakers took advantage of upward pressure on the hryvnia caused by rising global steel prices to top up Ukraine’s hard currency coffers. The total is now equivalent to 3.6 months of import coverage.
CHANGING THE IMAGE
Marcus Svedberg, chief economist at East Capital, says the resumption of the IMF programme will therefore serve as “an important litmus test” for both local and external investors. “If the new government continues with the programme despite not having immediate financing needs, it will send a good signal to the international investment community that they are committed to reform,” he says.
Such a signal is urgently needed. While foreign direct investment reached an impressive-looking $3bn last year, it was almost all accounted for by Russian and Western banks recapitalising their Ukrainian subsidiaries. Inflows into Ukraine’s real economy from outside the country remain negligible.
Bilan suggests that, in addition to the resumption of the IMF programme, making a start on large-scale privatisations could also encourage the return of international investment. “The newsflow around Ukraine is still focused on the fighting in the east and high profile corruption cases rather than the improving economic outlook, so many investors have a negative view of the country,” she says.
To change this, she argues, the government needs to do “something really strong” that will attract the attention of the international community. “Privatising a couple of enterprises in a transparent way and with the involvement of European companies would go a long way towards changing the image of Ukraine,” she says.
Whether this would be possible, however, remains to be seen. Even if the new administration remains committed to reform, it may struggle to get parliamentary approval for progressive legislation. The governing coalition — which combines Poroshenko’s Solidarity party and the People’s Front Party led by Yatsenyuk, along with a handful of independent members of parliament — has a majority of just 10.
What is more, notes Bilan, the voting discipline of both main parties is notoriously bad. “This means that for legislation to be passed the government will need to solicit votes from MPs from other parties,” she says. “There are also a lot of vested interests in parliament in all political parties and they will not be willing to back legislation that would weaken the position of those who support them.”
These vested interests are widely blamed for the failure of the previous government to push through reforms. More optimistic analysts suggest that the new administration with its closer ties to the local power structure may be more successful in this respect than the outgoing technocrats.
“This government should be better placed to enact reforms than the previous one,” says Ermolenko. “These people know the system a bit better and are better connected, so it may be easier for them to get things done.”
Pessimists note that even the best-connected politicians may struggle to gain parliamentary acceptance for some of the more unpalatable reforms prescribed by the IMF, particularly those relating to pensions. They also point to Ukraine’s history of failed IMF programmes. In the past two decades, two funding rounds have been abandoned after reform targets were not met.
“The problem is that, for an economy like Ukraine, the ‘to do list’ is so frustratingly long,” says Svedberg. “At some point, there is a risk of reform fatigue.”
TACKLING CORRUPTION
There has also been little evidence as yet of any serious commitment on the part of Poroshenko and his allies, who include Volodymyr Groysman, to tackle Ukraine’s endemic corruption. Respected former economy minister Aivaras Abromavicius, whose resignation in February triggered the recent political upheavals, cited obstruction from the president’s inner circle to attempts to clean up state owned enterprises as the reason for his departure.
Similarly, Poroshenko’s apparent reluctance to withdraw his support from discredited prosecutor general Viktor Shokin after the resignation of his deputy, noted anti-corruption campaigner Vitaly Kasko, was widely seen as a sign that politicians are either unable or unwilling to get to grips with graft.
The latter affair prompted some of the strongest criticism yet from Ukraine’s international backers. In late April, US assistant secretary of state Victoria Nuland warned that financial support could be cut off if progress is not made on fighting corruption. “It’s time to start locking up people who’ve ripped off the Ukrainian population for too long and to eradicate the cancer of corruption,” she said.
Politicians will also need to convince voters that progress is being made on both corruption and other issues, say analysts. As Svedberg notes, ordinary Ukrainians have so far seen little benefit from the Orange and Maidan revolutions. “Ukraine is still a deeply corrupt country and, while the economy is improving, unemployment is still high and real wages are subdued,” he says. “There is also a feeling that little has changed among the ruling elite.”
Combined with the weakness of the governing coalition, this makes for an unstable political environment and raises the spectre of early parliamentary elections, says Bilan. “That would again hinder the reform process and delay the inflow of investment,” she adds.
She notes that Ukraine also remains vulnerable to external factors, notably changes in global prices for its key commodity exports and imports. “If the recent rise in steel prices is reversed or if oil prices start to climb, it would be negative for Ukraine,” she says.
Finally, there is the ever present risk of a renewed escalation of fighting in eastern Ukraine. Svedberg says that, while international investors may not need the conflict to be fully resolved before returning to Ukraine, they will want to see more signs of progress towards resolution.
Action on the Minsk Agreement — a package of measures agreed in February last year by Ukraine, Russia, France and Germany designed to bring peace to the war torn Donbas region — is seen as particularly important, adds Svedberg. “The implementation of the Minsk Agreement is crucial,” he says. “Obviously there are other parties involved, but there is plenty that Ukraine can do to move this forward.”
In this, as in other areas, the key to tempting international investors back to Ukraine will be actions rather than words, adds Svedberg. “Investors won’t give Ukraine the benefit of the doubt,” he says. “It is not enough to talk. They will also have to show that they are doing reforms and prove that they are serious about it.”
Ermolenko agrees. “Everything still depends on whether the IMF deal and the reform process are restarted,” she says. “The recession is over and the recovery has started, so as long as the government can muddle through and carry on with reforms, things should continue to improve. However, the situation is still fragile and things could change again very quickly.”