There was a mood of pragmatic optimism at the Ukraine investment road show held in London on March 20, but no one was pretending the country doesn’t face significant challenges – a fact highlighted by the dearth of fund managers and London-based investors in the audience.
In 2016, Ukraine’s economy returned to growth after collapsing in the wake of the Maidan protests two years earlier. However, the transformation can still be derailed as in 2018 the government has to start paying back billions of dollars in debt it delayed with a painful restructuring deal two years ago. Key parliamentary elections also follow the year after. Will Ukraine be strong enough to cope? The outcome hangs in the balance, depending on what happens this year, the panellists said.
Media reports have been focusing on the problems, the fighting, the corruption, and as an aside, the looming decision to ban Russia’s wheelchair-bound entrant to the Eurovision song contest that will be held in Ukraine this year. But the summit panellists were keen to highlight the “boring” reforms that have been put in place in the most difficult of circumstances over the last three years.
“For 25 years Ukraine was a state capture system and was never run as an economy,” said Artem Shevalev, Alternative Board Director of the European Bank for Reconstruction and Development (EBRD). “Ukraine was run on the basis of personal interests. Following the Maidan protests all the corrupt cash-generating schemes were stopped.”
Tax payments, land registry, e-declarations for civil servants and all the decisions of the Anti-Monopoly Committee are all online now, ushering in an unprecedented level of transparency for Ukraine. Gas tariffs have been hiked, the gas sector and distribution has been liberalised, and the deficit of the national gas company Naftogaz has been wiped out, to name just some of the more notable changes.
“The economy has stabilised now and is in a much better shape than three years ago,” said Timothy Ash, Senior Emerging Markets Sovereign Strategist, BlueBay Asset Management. “The worst of Ukraine’s economic collapse is clearly over. The economy will grow by 2-3% this year. Inflation is high single digits. The fiscal position is strong. And most amazing of all, the [state-owned gas monopolist] Naftogas deficit is gone.”
The government has also pushed through some key International Monetary Fund-sponsored reforms, and while there is still a lot left today, Ukraine’s supporters have plenty to point to when it comes to tallying up the progress.
“Now there is macro stability what is needed next is deep-seated reforms,” said Ash. “Ukraine exists in a competitive environment. It is in competition with the Poles, the Serbs, Vietnam and others. If these reforms can be done then I don’t see any reason why Ukraine should put in 5-6% of growth a year.”
Ash, who is probably the most widely cited analyst covering Ukraine, says the game has changed and is now is all about building sustainable long-term change and a business environment that is not corruptible. “There is no more room for excuses,” according to him.
Or surprises. The Ukrainian leadership’s decision on March 15 to support the economic blockade of the rebel-held territories in the east will hurt economic growth this year. Despite the fighting since 2014, the region remained economically active and its coal and power stations have until now still been working and supplying the rest of the country. Sergei Voloboev, chief economist of Norvik Banka, said that following the surge in growth in the last quarter of 2016 of over 4%, the growth in the first quarter of this year will probably be zero as a result of the shock from cutting off power plants in Donbas.
Ukraine’s recovery needs to stay on track this year as starting next year the country has to start paying back the debt that former minister of finance Natalie Jaresko negotiated in 2015. If growth is weak then the government will not generate the revenues needed to pay these obligations or raise refinancing on the international capital markets.
“Ukraine is at a tipping point. The International Financial Institutions (IFIs) and the people want to see deliverables. The elites and oligarchs don’t want that,” said Ash.
The arrest of oligarch Dmytro Firtash in Vienna and more recently Ukrainian tax service head Roman Nasirov in Kyiv has also unsettled the ruling elite, according to Ash, who are now afraid they will be in the crosshairs next and so are likely to actively stymie the anti-corruption drive.
“It is probably the greatest test the country faces now and it is struggling to overcome it,” he added. Still, despite the lack of progress in undoing corruption, the establishment of the independent National Anti-Corruption Bureau of Ukraine (NABU), which has indicted someone as well-connected as Nasirov, is already a big step forward. “Ukraine is on the cusp of something great, but the elites are stalling as the guys and girls don’t want to go to jail.”
Chris Weafer, managing director of Macro-Advisory and bne IntelliNews columnist, is critical of all these shenanigans. While on the one hand it is very encouraging that the government has set up an independent corruption agency that has arrested a high level politician for the first time, Ukraine is on the other still a long way from actually jailing people like Nasirov, he notes. The belief amongst the delegates at the conference is that it was a good thing that Nasirov has been indicted, but few expect that he will actually do time behind bars, “which means it is still probably too early to invest in Ukraine”, said Weafer.
“For the foreign investors what they really want to know is where the country will be in the next five to ten years. They are holding back as they want to get the timing right. The issues that concern them are not what is happening in Donbas or with the IMF payments, but is the country stable? Is another crisis coming? Plus a few specific items like a good land reform,” he added.
Another test year for Ukraine
Ukraine is in a delicate position now and every year is going to be a crucial year for several years to come. Its make or break time for the government that has little wiggle room to mess up. This one is important as the government needs to make the key reforms irreversible and reach critical economic growth mass, as from 2018 Ukraine will have start paying back its delayed debt, and it is the last full year before the next general election.
Ukraine has untapped privatisation and foreign direct investment (FDI) potential. “The failure of the privatisation process is obvious,” said Shevalev, but the government has grasped the bull by the horns so this year it will revisit the whole process and try and improve it.
“All these assets have potential buyers but the whole process will rest on an adequate investment climate. It’s all about having a level playing field. The resistance of the oligarchs and vested interests is the main obstacle,” he added.
Like most of the panellists, Shevalev doesn’t deny that Ukraine is still in a difficult place, but points to the progress made: “We are not out of the woods, but we can see the village through the trees.”
Two steps forward, one step back
The timing of the event was slightly unfortunate in that the IMF board of directors was due to meet on March 20 and sign off on the next $1bn tranche from Ukraine’s $17.5bn stand by programme. But after the government formally acknowledged an economic blockage of the rebel-held territories in the east of the country the IMF decided to put off the decision until it better understood the economic impact of the decision. According to preliminary estimates by experts the blockage is expected to cut 1.25-1.3% off the approximately 2% of GDP growth the country is expected to put in this year.
“The decision was a blow as it means the assumption that the remaining $5bn of IMF money due this year will be paid is unsafe,” said Weafer.
He also emphasised that 2017 would be a transition year given the return of growth, but he focused more on what needs to be done to attract foreign investors.
“Can Ukraine attract FDI and sustain it? There are two key prerequisites: political stability and economic predictability,” said Weafer. “Any government needs to get these two things right.”
Things are not going well on either of these scores. According to a recent polls, two-thirds of Ukrainians say they will tear up their ballots at the next elections, frustrated by the slow pace of reforms and the failure by the government to deliver on many of the promises made during the Maidan protests.
“These demands are something the politicians need to address and to ensure economic predictability the government has to make the changes,” said Weafer.
Tests of this commitment will come soon as the government is due to consider pension reforms and land reforms in April, both of which will have a large impact on the business climate.
Another item to watch is who will replace the current National Bank of Ukraine governor Valeriya Gontareva, who confirmed on March 20 she would soon step down and hopes a ‘technocrat’ will replace her.
Gontareva has carried out one of the most difficult reforms in the country over the last three years, cleaning up the sector, closing about 100 banks and avoiding a financial meltdown of the system.
She decided to quit as she has become increasingly frustrated in the reform drive by the lack of government support in dealing with the abusive oligarch banks, according to Weafer. Her departure will be another blow to Ukraine’s image and a disappointment for investors as Gontareva is the latest in a string of high profile and successful reformers that have quit their government jobs or been pushed out over the last years.
“Who replaces her and how the transition is managed will be another test of the government’s commitment to improving the business environment,” said Weafer.