COMMENT: Ukraine's options remain open

By bne IntelliNews February 24, 2010

Tomas Fiala of Dragon Capital -

Ukraine's presidential elections put the country back into the spotlight of the international media, probably for the first time since the Orange Revolution in 2004. Back then, on a tide of optimism and immense hope for change and reform, Ukraine received generally positive opinions from analysts all over the world. Now, having just passed the first severe economic crisis in its independent history, the country is uniformly condemned for being plagued with corruption, having no clear direction and economic policy, and lacking stability - in other words, for not living up to the high hopes of 2004.

In many ways this criticism is justified. The fact that the outgoing president, Viktor Yushchenko, received a humiliating 5.5% of total votes in the first round of presidential elections on January 17 and failed to advance to the runoff is a clear sign of the nation's disappointment with him and reflects a strong desire for change. The country's policymaking has suffered from a long-lasting deadlock between the main branches of power; its obscure legislation has spurred corruption; the judicial system can hardly be relied upon; and growing a successful business in such conditions is a real challenge.

What cannot be justified, however, are the audacious claims we hear that Ukraine has no option but to choose from either slipping into national default or sacrificing its independence for the sake of a Russian bailout. On the contrary, against the backdrop of difficult internal issues and challenges it faced during the global crisis, the country's economy has coped with the situation comparably well and is now putting itself back on a recovery path. The banking sector has stabilized due to the joint efforts of the International Monetary Fund (IMF), the National Bank of Ukraine (NBU) and the government, as well as the active support lent to local foreign-owned banks by their parent institutions. The revival of global commodity markets is supporting the recovery of Ukraine's steel giants, having kept exports and GDP on the rise for three successive quarters. Unemployment has stabilized at approximately 9%, which compares comfortably with other countries in the region. Foreign investor interest in the domestic market is clearly reviving, with the local stock market index up 273% from its bottom in March 2009 and 14% since the beginning of 2010.

Debt/GDP level is manageable

Ukraine's level of gross public and private debt had stood at a reasonable 57% of GDP just before the crisis erupted in the autumn of 2008. On this measure, Ukraine had a considerably more secure position compared to many of its peers in emerging Europe and beyond. Ukraine's debt ratio then surged due to the national currency's depreciation and the contraction of GDP, hitting 84% in the third quarter of 2009. This level is still considerably below the debt/GDP ratios of such regional peers as Hungary (177%), Bulgaria (116%) or Kazakhstan (100%).

Looking at the composition of gross debt brightens the picture further. Despite the influx of nearly $13bn of IMF financing - including a $2bn special drawing right allocation (SDR) - Ukraine's external public debt amounts to $24bn, or less than 21% of GDP and 23% of its total external liabilities. The government needs to repay a mere $1bn out of this amount in 2010 - a fraction of the country's current international reserves totalling $26.5bn. Domestic public debt amounts to $12bn or 10% of GDP.

The private sector debt should also be analyzed more accurately. External liabilities in the private sector amounted to nearly $80bn in the third quarter of 2009. According to NBU estimates, approximately $18bn-20bn of this amount matures in 2010 (net of trade credits). Refinancing the bulk of these liabilities does not seem a "miracle scenario" at all if one keeps in mind that out of $28bn that fell due in 2009, 75% was rolled over. The primary reason is related-party lending, which accounts for a majority of the above liabilities. This type of lending is a commonly used form of direct equity investing in Ukraine. The rollover rate may be even higher this year, as the anticipated post-election political stabilization should open access to new external financing.

Not surprisingly, the state budget suffered from the economic downturn, as did budgets all over the world. We estimate that last year's budget gap reached 8-9% of GDP (including the consolidated budget deficit and the deficits of the Pension Fund and the state-owned Naftogaz), or approximately $10bn. In the course of the year, the IMF provided $7bn for budget support (including $2bn of SDRs used for budget purposes), leaving little need for money printing. Unlike in many other economies, Ukraine's central bank has kept a firm grip on the money supply, which has created conditions necessary to stabilize the currency and reduce inflation to approximately 12.3% in 2009 from above 20% in 2008.

Foreign investors reconsider the market

IMF lending remains key to unlocking access to non-inflationary sources of budget deficit financing for Ukraine. IMF representatives have indicated that they are likely to restart lending following the presidential elections, and president-elect Viktor Yanukovych has confirmed his intention to continue cooperating with the Fund.

Despite the bitter aftertaste left by the recent crisis, foreign investors' appetite for Ukrainian risk is growing. Following the buyout of ISD, one of Ukraine's biggest industrial groups, at the beginning of January, the local stock market surged by 14% in 21 trading days, with some blue-chips gaining as much as 50%. Braving the looming elections, prices on Ukrainian sovereign bonds rose by 2-3%, while yields declined to 8.5-10.8%, moving closer to their pre-crisis levels. Average daily liquidity went up by more than 100% in January compared with December 2009, driven by both local and foreign money.

Ukraine is not straightforward, true, but it is a large, well-educated and aspiring European nation restarting its growth from a very low base. To say the least, this place merits an in-depth and careful analysis, and on any account is worth a short visit to form one's own judgment.

Tomas Fiala is Managing Director of Dragon Capital

COMMENT: Ukraine's options remain open

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