Orange turns sour
Revolutions do not necessarily make economic reform easier – and by sacking his government this month, Ukrainian president Viktor Yushchenko has highlighted just how little it has achieved since taking office in January.
Market observers were hopeful that the new prime minister, Yuri Yekhanurov – a "safe pair of hands" who will likely stay in charge until the parliamentary elections in March next year – could regain momentum. But valuable time has been wasted in disputes between his predecessor, Yulia Timoshenko, and politicians close to Yushchenko.
On his first day in the job, Yekhanurov said he would not "micro manage" the economy – something of which Timoshenko, whose populist gestures quashed by Yushchenko included attempts to freeze petrol and meat prices, was accused.
Yekhanurov also said that, while the resale of Ukraine's largest steel producer, Kryvorizhstal, will go ahead on October 24, he is against any other reprivatizations.
That issue was another sticking point between Timoshenko and Yushchenko's allies.
The president accused Timoshenko publicly of siding with one business group (led by Igor Kolomoisky and clustered around the Dnepropetrovsk-based Privat Bank) against another (led by former president Kuchma's son-in-law Viktor Pinchuk) in the battle for control of the Nikopol ferro-alloy plant, the only other enterprise already in the reprivatization process.
Not that claims of partisanship are all on one side. It was accusations of large-scale corruption, made by a member of Timoshenko's political party against Yushchenko ally Petr Petroshenko, the Security Council chief, that tipped the government over the edge.
Inflation concerns
Now, however capable Yekhanurov (who served as first deputy prime minister when Yushchenko was Kuchma's prime minister in 2000-01) proves to be, he will have his hands full with macroeconomic policy issues that have received little attention in recent months.
Inflation is approaching 15%, and an IMF staff mission that visited Kiev in August warned that reducing it "remains the main macroeconomic challenge". It called for a "shift to greater flexibility in the exchange rate" by the National Bank of Ukraine (NBU), as measures taken so far had been "insufficient" to push inflation down.
While fiscal policy had tightened and tax loopholes had been closed, the government had also "stoked inflationary pressure" with large pensions and public-sector wage increases, the IMF team added.
But there was no indication from the Ukrainian authorities that they would heed the IMF's advice.
NBU governor Volodymyr Stelmakh, who joined President Yushchenko at talks with the IMF team headed by managing director Rodrigo de Rato, made no comment. In April the bank refixed the dollar rate at Hrn5.05, but has left parity unchanged since then. IMF officials consider that the Ukrainian currency is undervalued by about one-third.
After the IMF visit, first deputy prime minister Anatoly Kinakh announced that he was "categorically opposed" to "a substantial and sudden revaluation of the hryvna", arguing that inflation should be tackled by ensuring adequate money supply in the domestic market, reform of the "natural monopolies" and continuing changes to the tax regime.
Ralf Wiegert, senior economist (emerging Europe) at the Global Insight group, told Emerging Markets: "A gradual appreciation of the hryvna is vital. It would be foolish to scrap all restrictions, but Ukraine could, for example, peg the hryvna against a basket of currencies within a corridor, as China has done.
"Investment is far lower than was anticipated for this year. Exports are negatively impacted by external factors, such as steel prices. So the Ukrainian economy is driving on only one engine at the moment – consumer demand. The authorities perceive the exchange rate as a tool of industrial policy, and the NBU is sustaining it by buying large quantities of dollars. This is unsustainable in the long term."
Ukraine's rate of annual GDP growth was only 2.4% in July, and 3.7% for the first seven months of the year as a whole. Last year, Ukraine's economy grew by 12.1% and the government target for this year was 8.2% – which the economics ministry expects to miss.
Investment
Another key issue is investment. Here, too, the "Orange revolution" has not helped: the economics ministry recently estimated that foreign direct investment in the first half of 2005 was just $580 million, i.e. no higher than in the first half of 2004.
The quality of FDI is of concern, too. A research note from Alfa Bank Ukraine estimates that "about half" of this year's FDI has gone into real estate rather than industry, and adds that "chaos in Ukraine's regulatory environment" had discouraged FDI.
Regulation is also in urgent need of review in the embryonic capital market. Pavel Prosyankin at Renaissance Capital, the Russian finance house that has launched a Ukraine-based investment fund aimed at foreign investors, said: "In equities, the lack of liquidity is the biggest problem. To solve this a concerted effort is needed from the authorities, to create a sound local settlement process and create a framework for improved corporate governance and fair treatment of minority shareholders, and of course from investors and issuers too."
Electioneering starts here
Another problem, about which the compromise-inclined technocrat Yekhanurov can do nothing, is that the Yushchenko and Timoshenko camps, having united during the "Orange revolution", are now campaigning separately for the parliamentary elections next March.
On 1January, Ukraine becomes a parliamentary, rather than a presidential, republic, and whether Timoshenko's statist populism or Yushchenko's centre-right economic liberalism will triumph depends partly on the polls. No party is likely to score an outright victory so intense politicking with other parliamentarians is likely both before and after the vote.
"While it is very likely that the new government will prove more cohesive and less populist, short-term volatility still can not be ruled out", says Andriy Dmytrenko, head of research at local investment house Dragon Capital.