A matter of no choice
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A matter of no choice

Despite Ukraine’s political turmoil, politicians are likely to stick by agreements with the IMF – if only because there is nowhere else to borrow. Talk of a turnaround may be premature, but hopes are rising that the country will avoid all-out catastrophe

Ukraine, the largest of central and eastern Europe’s economic basket cases, could this year put in place the building blocks of recovery – or sink further into crisis. Much depends on external factors, but on balance, economists are optimistic.


The IMF, which last month steadied nerves in Kiev by disbursing a second $2.8 billion tranche of its rescue package, should be able to stabilize Ukraine’s shaky finances. International banks could be convinced to prop up their Ukrainian subsidiaries, while domestic banks are effectively nationalized. And cash could be brought out from under mattresses to fire up domestic demand.

On the other hand, recovery hopes could be skewered by another run on the hryvna, which lost 40% of its value against the dollar in last year’s fall. Ukraine’s politicians could also make things worse: the campaign for the presidential election, now expected in October, will probably be dirty. 

Fund boost

The IMF last week approved a second tranche of its stand-by loan of $2.8 billion – rather than the $1.8 billion envisaged in the initial schedule.

Ceyla Pazarbasioglu, IMF mission head, says the Fund’s officials had agreed “in the light of the sharper-than-expected-decline in economic activity” that the government run a budget deficit of 4% of GDP, rather than the zero deficit originally planned. The loan came after Ukraine agreed to reforms sought by the Fund.

The IMF mission implicitly acknowledged the limits of leverage on Ukraine’s political class, by recommending the disbursement despite parliament’s failure to approve key items of the rescue package. It voted against bridging financing gaps in the state pension fund and Naftogaz Ukrainy, the state oil and gas company.  

The three cornerstones of the IMF’s agreement with the Ukrainian authorities are fiscal tightening, a flexible exchange rate and the banking sector restructuring – which is now entering a second stage with the effective nationalization of seven of 26 “systemic” banks. 

Central Bank first deputy governor Anatoly Shapovalov said late last month that $2.5 billion will be pumped into the banks, in which the state will take shares of 75% or more.

A key issue is that some of Ukraine’s largest banks are subsidiaries of central and west European banks that have been partially or fully taken over by their home country governments during the financial crisis. 

There is concern in the international financial institutions (IFIs) that Austrian, Italian, Swedish and Hungarian financial groups could pull out of Ukraine as they try to reduce their balance sheets. It is understood that the IFIs are seeking informal agreements with governments and banks to prevent this happening, similar to those already made in Serbia and Romania.

Olga Pogarska, economist at SigmaBleyzer investment house in Kiev, says: “So far the only move out of Ukraine has been ING’s closure of its retail business, but it had always concentrated on corporate lending anyway and only entered the retail market recently.

“Ukraine still has a large population and a great deal of deposits to attract. I don’t believe foreign banks that paid premium prices for Ukrainian assets at the height of the boom will give up so easily.” 

Road to recovery 

Economists warn that Ukraine’s recovery depends on the external environment as well as on the rescue package – and are concerned about what happens after its short-term effects have worn off. There are no official GDP figures yet, but most economists expect a contraction of at least 8% this year.

Alexander Pivovarsky, principal economist at the EBRD, tells Emerging Markets that, in the medium to long term, “Ukraine will benefit if demand improves in the EU, in the Russian and Asian economies and to some extent in the Middle East.”

Such external factors are key to medium- and long-term recovery, Pivovarsky says. “But in the meantime there may need to be further packages, and I would expect the international community to consider them if Ukraine pursues responsible policies.”

Pivovarsky adds that stabilization of the financial sector and the exchange rate could help domestic demand. A stable hryvna would help enterprises and households to start reducing their dollar-denominated debt burdens, and could bring Ukrainian households’ cash savings back into the banking system, either directly or via consumption. 

The national bank estimated that even before last year’s financial meltdown, Ukrainian households possessed up to $40 billion in cash, inside the country but outside the banking system. It has swelled by at least $10 billion in the past six months, economists say – and could be crucial in helping fire a recovery. 

Irina Piontkyvska, economist at Troika Dialog investment house in Kiev, says that it is “still very difficult to tell” whether the Ukrainian economy has hit the bottom. But devaluation should help restart economic activity, both by supporting Ukrainian exports and boosting import substitution in the domestic market.

In the first quarter of 2009, exports were down 39% and imports by 47%. “In terms of export recovery, Ukraine is of course very vulnerable to global steel prices, for example,” Piontkyvska says. But people have already started switching to buying local rather than imported goods, which is a good sign for food processing and other consumer-oriented industries. 

Despite the unpredictability lent to Ukraine’s political intrigues by the prospect of an early presidential election, Piontkyvska is optimistic that politicians will stick by agreements with the IMF – if for no other reason than they know that there is probably nowhere else to borrow. 

With Ukraine priced out of private debt markets, ministers had talked to Russia, Japan and other countries about bilateral loans, but nothing came of the approaches, and Ukraine remains dependent on the IMF, Piontkyvska points out.

 “With GDP falling and public debt rising, once the IMF disbursements are completed, public debt will be about 30% of GDP, which is still a moderate level”, she says. “And while it is possible that there will be negative political developments before the elections, I think government spending will stay under control.” 

Fighting back

Ukraine’s real economy was hit especially hard by the financial crisis: first-quarter statistics show that, year-on-year, industrial output was down 30% and construction output down 57%. Wages were down 30% and unemployment has grown sharply. 

There are reasons for cautious optimism that the haul back from the disastrously low levels of the first quarter could start soon. Firstly, public investment will play a part – in construction and service sector projects connected with the Euro 2012 football tournament, for example.

Secondly, Ukrainian agriculture is expected to do well this year, on the back of a good harvest and strong export demand. The national bank is providing extra refinancing support to banks that lend to agricultural exporters.

Thirdly, some industrial sectors that have been hardest hit by the recession appear to be pulling off the bottom already. “There is indirect evidence, such as workers in the metallurgical sector, who had been on administrative leave [i.e. temporarily laid off] returning to the plants, even if on shorter working weeks”, Pogarska at SigmaBleyzer says.

Metallurgical processing production rose month-by-month in February and March, although it was still 43% lower year-by-year in March. Chemical sector output rose by 28% in February and 20% in March, although that meant it was still 30% behind where it had been last year.

It’s too early to talk about a turnaround. But hopes that Ukraine will avoid an even more catastrophic crash are rising.

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