Monday, December 22, 2014


Ukraine

Crisis Piles Pressure On Ukraine's Fragile Economy

 If Kyiv is unable to obtain external financing, it could have difficulty maintaining the stability of its currency, the hryvnya.
If Kyiv is unable to obtain external financing, it could have difficulty maintaining the stability of its currency, the hryvnya.
By Charles Recknagel
As Ukraine tumbles into what could be protracted political unrest, investor confidence in the country is plunging, too.

And as a result, analysts say, Kyiv could be facing a series of economic woes including liquidity problems, a depreciated currency, and an inability of the government to meet basic financial obligations.

It is still less than a week since President Viktor Yanukoych snubbed an EU association and free-trade agreement in Vilnius. But Western financial markets are already showing visible nervousness about Ukraine's future stability.

One clear sign of jitters is the rise in the cost of insurance that traders must pay to protect themselves against the possibility that Kyiv might default on its debt obligations over the next five years.

Charles Robertson, global chief economist at Renaissance Capital in London, explains that "three days ago it [would have] cost you $9.5 million, today it will cost you $10.5 million to insure yourself against [a default on] $100 million. It has gone up about one percentage point."

At the same time, the return on investment that Kyiv must promise to attract potential buyers to its junk-rated sovereign dollar bonds due in June 2014 has jumped to 19.34 percent. That compares with an average of 8.52 percent since the bond was sold in August 2012.

Tim Ash, an expert on emerging European states at Standard Bank in London, calls both these developments measures of how much Kyiv's decision to not sign the pact with the EU and the subsequent street violence are now compounding Ukraine's already long-standing economic problems.

For years, Ukraine has been economically so fragile that the government has had to regularly go to Western markets for money to meet its cash flow needs, Ash notes. "Ukraine's problem is more an external financing and liquidity problem," he adds. "It faces a current account deficit of about 8 percent of GDP -- which indicates an underlying lack of competitiveness -- it has a lot of short-term debt that falls due, and its foreign-currency reserves have dropped by about one-third over the past year and now stand at below three months of import cover, at around 2.5 months of import cover."

The Pressure Mounts

But with investors now becoming worried, the cost for Kyiv to go to Western financial markets is rising. That means unless the crisis abates quickly, liquidity could become a still greater problem for Kyiv in the future, eventually endangering the government's ability not only to cover imports but also meet debt payments.

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There is another danger: If Kyiv is unable to obtain external financing, it could have difficulty maintaining the stability of its currency, the hryvnya.

Should that happen, ordinary Ukrainians might flee the hryvnya for hard currency, causing the domestic currency to depreciate significantly and throwing into question the government's ability to pay salaries, pensions, and other social benefits.

Russian President Vladimir Putin (left) will be in position to drive a hard bargain to keep Ukraine afloat.
Russian President Vladimir Putin (left) will be in position to drive a hard bargain to keep Ukraine afloat.


Such dangers place enormous pressure upon Yanukovych to urgently find new sources of external financing that can help Kyiv keep the situation from sliding out of control.

By snubbing the EU, Yanukovych shut off Ukraine's access to any country's most obvious recourse in time of economic trouble, the International Monetary Fund (IMF). Kyiv and the IMF had previously discussed a stand-by loan of as much as $15 billion but the global lender tied the new money to Ukraine making certain economic reforms that would have been included in the pact with the EU.

The IMF's demand for reforms comes as Kyiv must meet $15.3 billion in debt payments to creditors over the next two years. Among the most difficult of the reforms for Yanukovych was to reduce Kyiv's heavy subsidy of the price of natural gas to Ukrainian homes and industries. The president has feared that removing the popular subsidies -- which put a huge burden on the government budget -- would costs him reelection in 2015, so he has balked at doing so.

...And The Prices Rise

That leaves Kyiv now looking for other sources of external funding with less stringent conditions.

Yanukovych explored one possibility by traveling on December 4 to Beijing, which has previously provided Kyiv some $10 billion in loans. But China made no immediate commitment to provide new money.

Chinese Foreign Ministry spokesman Hong Lei did not directly link the turmoil in Kyiv to Beijing's willingness to provide financial aid but did suggest it might play a factor. Hong told reporters in Beijing on December 4, "We are paying close attention to Ukraine's domestic situation."

ALSO READ: At Kyiv Protest HQ, Hot Tea, Sandwiches, And Sympathy

Yanukovych's main hope remains Russia. But Moscow, which pressured Kyiv not to sign a pact with the EU, has its own conditions on providing help and these, too, are not easy for Ukraine to meet.

"Russia has been financing Ukraine for 20 years, has been hoping to get things like access to strategic assets like pipelines. Ukraine hasn't delivered very much of that, and [Russian President Vladimir] Putin is now saying, 'Enough of that, I am willing to lend you money, but I want something in return and that little bit of something is I want you to commit to joining my CIS Customs Union,'" Ash says.

"And unfortunately for Yanukovych, that is impossible to deliver because of the demonstrations on the streets of Kyiv. So Yanukovych is in a very, very difficult situation," he adds. "He needs some cash quick, but he doesn't want to meet any of the conditions that potential lenders are asking of him."

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