by Anders Aslund, Peterson Institute for International Economics
Op-ed in the Kyiv Post
October 14, 2011
© Kyiv Post
Ever since the financial crisis of 2008–09, Ukrainians have worried about a second wave of crisis. I have long considered it unnecessary and unlikely. Yet the current government has not alleviated the original causes of the crisis but added reasons for a new financial crisis. Therefore a new financial crisis is increasingly likely.
The first cause of the crisis was that the hryvnia exchange rate was pegged to the US dollar. Ukraine remains in such a situation, while economists overwhelmingly think that a relatively large country that is highly dependent on exports of a few commodities ought to have a floating exchange rate. Once again, the dollar peg undermines the credibility of the Ukrainian exchange rate.
Another concern in 2008 was Ukraine’s exposure to global financial markets, when the nation’s gross external debt amounted to $102 billion. Today it has risen to $130 billion, or from 57 percent of GDP to 79 percent of GDP. This includes both public and private debt. Ukraine is therefore much more sensitive to a sudden stop of international liquidity as occurred in September 2008.
Ukraine’s public debt was no great concern in 2008, when it amounted to merely 20 percent of GDP, but not least after the International Monetary Fund (IMF) has delivered a total of $14 billion of credits from 2008 to 2010, Ukraine’s state debt has risen to 39 percent of GDP, and repayment is due to start in August 2012.
The present key concern is that the state budget for 2012 calls for $11.3 billion of new borrowings and public debt repayments will amount to $7.3 billion, a total of $18.6 billion. That is a sizable amount, and Ukraine has difficulties in finding any source of financing.
The government had planned to raise $3.5 billion through Eurobonds in 2012, but the eurobond market has just closed for Ukraine and it is not likely to open soon again. Domestic treasury bills in hryvnia are just too costly with a yield of 17 to19 percent a year.
A mitigating factor in 2008 was that 17 Western banks accounted for 40 percent of total Ukrainian banking assets and they continued financing Ukraine during the crisis. Today, their share has shrunk to 27 percent, and some of them are giving up. The official budget deficit was never great in 2008 and it might be slightly larger this year.
The only clear improvements are inflation that is much lower today and the current account deficit, which has shrunk from 7 percent of GDP in 2008 to probably 4 percent of GDP this year. Arguably, these two factors were main causes of the crisis, but the aggravation of the public and foreign debts may more than compensate for these two positive observations. The current international reserves are marginally higher than in 2008 at $35 billion.
In 2008, the IMF rushed to assistance, and did so again in July 2010. Today, however, the Ukrainian government has alienated the IMF. The last IMF mission left on February 14, after having agreed four prior actions with the Ukrainian government for any new disbursement. Crucially, the Ukrainian government reneged on its promise to hike gas prices for consumers and utilities. As a result, the Ukrainian government’s subsidization of import of natural gas from Russia has risen to 4.5 percent of GDP. Ukraine should subsidize its poor rather than Russia’s Gazprom.
Therefore, the budget deficit—the most important IMF parameter—will be considerably larger than acceptable. The IMF is not likely to give up this demand, and nor is the Ukrainian government likely to hike gas prices in the middle of the winter. Therefore, no more IMF financing appears likely for the next half year. Without IMF approval, the World Bank cannot provide financing either.
The Ukrainian government has further undermined its credibility with the IMF by claiming repeatedly that an IMF mission is supposed to arrive or that the IMF is about to give one or even two tranches, when nothing of the kind has been considered.
For many reasons, Ukraine’s relations with Russia have turned really bad. In spite of frequent claims by Ukrainian officials, nothing indicates that Russia is about to lower its gas price for Ukraine, and Vladimir Putin is adamant that no Russian oil or gas will be transited through Ukraine in the future. During the last financial crisis, four Russian banks expanded in Ukraine so that their share of Ukrainian banking assets has risen to 11 percent, but now the Russian state bank VTB is demanding back a loan of $2 billion, whose rollover had been anticipated.
Over the summer, President Viktor Yanukovych has claimed success in relations with China, with an alleged Chinese loan of $4 billion, but all this is supposed to be in kind, and there are serious doubts that anything is forthcoming.
The European Union can provide Ukraine with an emergency loan, as it did to Iceland and Serbia. But after the severe European protests against the unjust sentencing of former Prime Minister Yulia Tymoshenko it is most doubtful that the European Union will sign the already completed European Association Agreement, and EU emergency financing is close to impossible.
One remaining possibility is privatization. Ukraine has a substantial privatization program prepared. But it is geared to benefit a handful of friends of the regime, who already own many big corporations in Ukraine. Currently, they are increasing their transfer-pricing, aggravating corporate governance, and depressing all stock values. The Ukrainian stock market has recorded the worst performance in the world this year with a plunge of 47 percent, and this market is virtually dead. These businessmen accumulate their large untaxed profits in Cyprus, which is the largest "foreign" investor in Ukraine. The current asset grab is reminiscent of Russia in the first half of 1996.
Few real foreign investors want to enter such a market. The European Business Association has just recorded an unprecedented decline in its investment attractiveness index from 3.39 in the second quarter of 2011 to 2.56 in the third quarter. The main deteriorations concern pressure and inspections from state administration, corruption and bureaucracy, and taxation. Specifically, the rules of the new Tax Code have been designed to stamp out small entrepreneurs, and at least one million small legal businesses have already closed shop.
Thus, the current government has managed to alienate all potential sources of financing. The decline of international reserves of $3.2 billion in September appears a natural consequence, as ordinary Ukrainians scramble to sell all hryvnia they can for any foreign currency. In the absence of any trust in government policy, depreciation of the hryvnia becomes inevitable. The more rigorous currency controls that have been introduced offer no solution.
A devaluation, however, would only aggravate the problems with both public and private debt service. A new round of bank failures and enterprise bankruptcies would follow. The government would face most unattractive choices. One alternative would be truly draconian cuts in public expenditures. Another option would be large gas price increases in the middle of the winter to gain IMF financing. A third possibility would be to sell the family jewels of the most attractive states assets, such as the gas pipeline and storages, to Russian investors, because nobody else is ready to accept the current Ukrainian country risk. Finally, Ukraine could default on its public debt. The substantial reserves offer a lifeline but no solution.
Unfortunately, after spectacular mismanagement of economic policy during the last year there seems to be no easy way out for Ukraine.
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Policy Brief 13-22: Ukraine's Choice: European Association Agreement or Eurasian Union? September 2013
Policy Brief 11-9: Lessons from the East European Financial Crisis, 2008-10 June 2011
Book: How Latvia Came through the Financial Crisis May 2011
Book: The Last Shall Be the First: The East European Financial Crisis October 2010
Paper: Proposals for Ukraine: 2010—Time For Reforms February 2010
Book: The Russia Balance Sheet April 2009
Book: How Ukraine Became a Market Economy and Democracy March 2009
Working Paper 06-5: The Eurasian Growth Paradox June 2006