Ukraine is struggling. Its new president, Viktor Yanukovich,
has been able with surprising ease to appoint a government that
he can work with but has inherited a spending gap that
will take more than one IMF lending programme to bridge.
Yanukovich appears to have only a limited appetite for the
reforms the IMF is demanding. And despite his pro-Russian
credentials, Moscow is equally unlikely to offer financial help
without imposing conditions.
The economic outlook is only slightly less grim than the
fiscal one. Prices for steel, Ukraines main export, are
rising, and agriculture may also be a source of growth. But
trade, industrial output and the banking sector have been
ravaged by one of eastern Europes deepest recessions, and
will return to health only slowly.
Ukraine has emerged from the crisis with a gap in its
consolidated budget. Closing it will be a long, painful process
that will go far beyond the current IMF lending programme,
That programme, launched in October 2008, envisaged $14.6
billion of loans from the IMF, of which $10.6 billion had been
disbursed by the end of last year. The programme was put on ice
as the election approached and candidates offered voters ever
more generous forms of social support. Talks on disbursing the
final $4 billion are underway.
An IMF mission visited Kyiv to talk to the new government
just before Easter, and Max Alier, the funds resident
representative, said afterwards that significant
progress had been made on understanding 2010 budget
priorities but that a number of outstanding
issues remain, notably with regard to fiscal policy.
Talks resumed in late April, and both IMF chief Dominique
Strauss-Kahn and prime minister Nikolai Azarov have expressed
optimism about the outcome.
The IMF is unlikely to scrap the programme, and, even if it
did, Ukraine is unlikely to go bankrupt this year. The much
greater dilemma is how the budget deficit will be reduced over
the next three or four years, and how the government will
satisfy IMF demands for cuts without provoking social
The only public external liability this year is a ¥35.1
billion ($376 million) bond falling due in December; a dollar
bond matures in March 2011. The market for hryvna-denominated
Treasury bills ballooned in the second half of last year, with
interest rates hitting 2530% at one stage: in
mid-February about 12.9 billion hryvna ($1.6 billion) was
outstanding, more than 90% falling due in the first half of
this year. But local banks have an appetite for this debt and
it can be refinanced.
So markets no longer think in terms of imminent default:
one-year CDS (credit default swap) spreads on Ukrainian state
debt, which peaked at above 7,000 basis points early last year,
have come down below 1,000bp.
Koon Chow, analyst at Barclays Capital emerging markets
research, says: We are quite pessimistic, medium term,
about the sustainability of this government and the quality of
its decision making. But we do not think Ukraine requires
heroic or unrealistic efforts to avoid a debt-market
accident. Credit spreads have further room to compress,
Barclays Capital says in a research note.
While the government is likely to string together a
short-term package with the IMF, it seems just as far as its
predecessors were from a strategy to tackle the deficit.
The consolidated budget deficit which includes
outlays on bank recapitalization, and budget support for the
state oil and gas company Naftogaz Ukrainy (to pay higher gas
import prices) and the pension fund (which has been borrowing
from the treasury all last year) is estimated by
SigmaBleyzer, a US-based private equity firm that invests in
Ukraine, at 11% for 2009 [see table]. Other economists,
including the IMF, use similar figures.
The IMF says it wants the consolidated deficit to be cut to
6% in 2010, but no one can see how. The fund reportedly has
public-sector wages, and extensive subsidies for gas and
heating, in its sights. But Irina Akimova, deputy head of the
presidential administration and one of the leading economists
in Yanukovichs team, said during last months talks
that the authorities envisage a 10% gap this year.
Olga Pogarska, chief economist at SigmaBleyzer in
Kyiv, says: The government has promised a substantial
increase in public-sector wages and pensions, and although it
is trying to play some tricks that will reduce their scale,
this will be a big liability each year. Finance ministry
officials say that even the most limited version of the wage
increase will cost 24 billion hryvna this year.
The government is trying to please the population
its voters on the one hand, and the IMF on the
other, says Pogarska. No one sees how it can reduce
the deficit to meet IMF requirements this year. Painless
measures will not be sufficient. And local elections are due,
later this year or early next.
Iryna Piontkivska, senior economist at Troika Dialog
investment firm in Kyiv, says: The government says it
hopes to increase revenue, through new taxes, rather than
cutting spending. But there is limited room for this in the
In fact profit tax receipts will be lower this year, by up
to 17 billion hryvna, because some corporates pre-paid last
year to help out the previous government; a government promise
to business to slash its notorious VAT refund arrears could
cost another 2025 billion hryvna. And the economics
ministry says that the untaxed economy has grown to 3236%
of the total up from around 28% before the onset of
RUSSIA TO THE RESCUE?
It is hard to see international debt capital markets opening
to Ukraine in a hurry. But could Russia which is pleased
to see the back of Viktor Yushchenkos pro-Nato presidency
and eager to reset relations with Ukraine provide an
alternative source of funds?
On April 1, Russian finance minister Aleksei Kudrin, in the
latest of a series of conciliatory gestures, said that
all CIS countries... and that includes Ukraine are
invited to join the $10 billion Evrazes anti-crisis fund, set
up by Russia, Belarus, Kazakhstan, Kyrgyzstan, Tajikistan and
Uzbekistan. Mechanics of the funds disbursement have not
yet been made public. But presumably Russia, which funds
Evrazes, would want, at least, improved access to Ukrainian
assets in the aviation, atomic and telecoms sectors, for
example in exchange for any substantial financial
Ukraine will face similar problems when it comes to paying
its gas bill. For the first time this year, Naftogaz is paying
import prices linked to those in Europe, without discounts
meaning that the import bill for the year will total
around $910 billion.
The Yanukovich team expressed optimism that they would be
able to renegotiate contracts, put in place after the January
2009 gas war, to bring down import prices. But initial trips to
Moscow yielded no concessions only a promise to revisit
the possibility of establishing a Russo-Ukrainian-European
consortium to manage Ukraines gas transit network.
A deal is likely, but it will probably not depart from the
principle that Ukraine should pay European-linked prices, and
will probably mean part-ownership, or control, of the pipelines
by Gazprom of Russia.
Another factor that curbs Ukraine-watchers enthusiasm
is that, while the new government is likely to work better than
the previous one, its ability to push through reforms may be
constrained by its close links with powerful business
interests. The government is too large and has too many
political groupings in it to be as effective as it needs to
be, says Andrew Wilson, a senior policy fellow of the
European Council on Foreign Relations.
Azarov and Yanukovich have long worked together, and a rift
of the type that opened up in the last three years between
Yushchenko and prime minister Yulia Tymoshenko is highly
unlikely. But how the pair will deal with conflicting interest
groups in the Party of Regions that they head is another
Dmitry Firtash, the gas, chemicals and media billionaire who
lost out when RosUkrEnergo was pushed out of the
Russo-Ukrainian gas transit business at Tymoshenkos
behest, has surprised observers with the considerable influence
he wields in the new cabinet. Firtashs friend Yury Boiko
has returned as energy minister, and a management team full of
Firtash allies and former employees has been installed at
Deputy prime minister for energy Andrei Klyuev also has his
own business interests to defend (including power and nuclear
sector assets). And neither of these camps is always aligned
with that of steel-to-telecoms magnate Rinat Akhmetov,
Ukraines richest man, who will find a voice in government
via Boris Kolesnikov, the minister in charge of the state
property fund, the anti-monopoly commission and preparations
for the Euro 2012 football tournament.
It remains to be seen whether pro-European economic
reformers such as Serhiy Tihipko, who came third after
Yanukovich and Tymoshenko at the polls and is not affiliated to
the Party of Regions, will make their voices heard amid these
One saving grace from a European standpoint is that
Yanukovich is more pragmatic in his approach to the EU than his
reputation would suggest. Wilson says that Yanukovichs
strong pro-Russian credentials may make it easier for him to
sell rapprochement with Europe to Russian-speaking Ukrainians,
rather in the way that the anti-communist US president Richard
Nixon sold detente with China to Americans in the 1970s.
Yanukovich might even become something like
Ukraines Richard Nixon not because he is corrupt,
though that is also a danger, but because like Nixon he may be
able to reposition Ukraine in geopolitical terms, Wilson
But there are aspects of Ukraines economic recovery
and the living standards of its long-suffering citizens
who depend on it that will depend neither on the IMF,
nor Russia, nor the countrys politicians. One such area
is the agricultural sector, which last year kept growing
counter-cyclically. Another is the steel industry.
The real economy certainly has a long way to come back. In
2009, reductions of 21.9% in industrial output, 46.2% in
investment, 14% in private consumption, 40% in exports and 45%
in imports, were registered.
Output for the steel sector should grow by 15% year-on-year
Ivan Kharchuk, metals analyst at Troika in Kyiv, says, and will
regain pre-crisis levels only in 201213. Strong world
prices may boost steel companies revenues and
since the industry accounts for almost one-third of industrial
output and a higher proportion of export, this will be an
important driver of the economic recovery, he says.
The news from the banking sector and its ability to help
restart the wider economy is mostly bad, however.
Non-performing loans are estimated at 25%, and the
governments banking sector restructuring programme is
moving slowly. Slow credit growth will constrain economic
growth, for sure, says Pogarska at SigmaBleyzer. She
forecasts 3% GDP growth this year.
Chow at Barclays Capital says: There will be no return
to a credit-driven boom. No. By all accounts, the next
one will have to be based on something more substantial.