KYIV BLOG: Kyiv - the new Minsk

By bne IntelliNews November 3, 2011

bne -

Kyiv used to look to cities like Warsaw, hoping to become a full-fledged member of the EU. Now it looks increasingly like Minsk as it turns in on itself. The ruling elite is calving up the country's wealth as the government careens from diplomatic gaffe to democratic debasement.

Ukrainian President Viktor Yanukovych's decision to jail former prime minister and opposition leader Yulia Tymoshenko in October killed the hopes of closer integration with the rest of Europe. Relations with the Brussels have become frosty and hopes of entering into a meaningful trade agreement with the bloc have been dashed.

Many recent column inches have been devoted to asking if the doors to Brussels close, will Kyiv be driven into Moscow's open arms? But that's to give Yanukovych too much credit: Ukraine doesn't have a strategy. "No-one knows where we are going," complains Brad Wells of Concorde Capital. "Are we going to align with the EU or move closer to Russia? There is no direction at the moment, only confusion."

In the face of an inability to influence government, a sense of apathy has descended over the citizenry that brought us the Orange Revolution. People are tired of politics of any shade. Deputy Prime Minister Sergiy Tigipko presented an ambitious programme of reforms at the start of this year, but all of his promises have fallen on stony ground. The extent of the government's reform programme seems to be entirely focused on meeting the International Monetary Fund's (IMF) demands in order to get the next tranche of cash on offer, which is essential to funding next year's deficit.

The uncertainty is also hitting the economy. The the hryvna has been under pressure in October after the population bought $3bn worth of hard currency. Analyst say the local currency is bound to devalue by about 5% in the new year and the government has already been forced to introduce administrative barriers on foreign exchange sales to slow the haemorrhaging. The banking sector remains sick and vulnerable to more shocks. "Perception is reality. The economy hasn't collapsed, but people are starting to take their money out of banks and are buying things like fridges," says Konstantin Golovynsky, head of communications at Renaissance Capital in Ukraine.

A new IMF team is in Kyiv to see whether next year's budget conforms to the Fund's demands. On November 2, Reuters was reporting sources close to the talks that the mission is likely to leave Ukraine without an agreement on reviving the $15bn programme suspended at the beginning of this year.

The IMF wants the government to hike domestic gas tariffs, but the government is living in la-la land by insisting in almost daily statements that hikes are unnecessary, because Kyiv is on the cusp of a deal with Russia to reduce gas prices. Following each of these statements, Gazprom replies that the existing and expensive deal is still in place. "Ukraine has met the major requirements, but the considerable deficit of Naftogaz highlights the household gas rate raise as being a consistent and justified IMF requirement. The government's... verbal assurances are unlikely to hit home with IMF representatives," reckons Oleg Ivanets of Art Capital in Kyiv, adding that the government will have to cave in eventually because recent pressure on the hryvna and wobbly banking sector makes IMF funding indispensable.

The government's strategy seems to be to try and link the gas issue to the one-sided negotiations with the Kremlin: if Russia refuses to revise Ukraine's supply contract and the Rada is forced to hike tariffs by the IMF, then it can usefully pass the blame onto the Kremlin, thus minimising damage ahead of next year's elections. "The government's problem is the people don't understand the need for the IMF loan and so won't accept a hike in domestic tariffs," says Wells.

Yanukovych has also turned on the oligarchs that put him in power, who he now holds at arm's length. Many of these businessmen would love to see the country join the EU, as much of their exports are headed in that direction, but they are keeping a low profile and unlikely to move against the government. What is left is a small circle close to the president that is attempting to grab what it can. As for Yanukovych: he is busy spending tens of millions of dollars on the luxurious Mezhyhirya palace, the new presidential residence, complete with a boating lake, gazebo, a helipad and a $17m Augusta Westland 139 helicopter to go with it, known as the "Ferrari of the skies."

"These guys at the top are the result of 15 years of violence and corruption. Some close to the president have survived multiple assassination attempts. It is the survival of the fittest and they will never leave on their own," says one banker, who prefers to remain anonymous.

Polarised politics

Still, Ukraine nominally remains the most democratic country in the former Soviet bloc and, in theory, Yanukovych could be voted out of office if he continues to do a bad job.

Yanukovych's rating has fallen to 16.7% against Tymoshenko's 13.3% as of October. The former PM should have received a sympathy bump since her jailing, but her low rating only highlights how disillusioned the voters are with everyone - orange or blue. And the government's rating is also tumbling. Yanukovych's Party of Regions has seen its popularity fall from 20.5% in January to 15.7% in October against 12.6% for Batkivshchyna, an opposition bloc that includes Tymoshenko's eponymous party. "The political situation has become more polarised. The attack on Tymoshenko looks like pure revenge. But because she has been jailed, the current team has to stay in power, as if the opposition takes over, then they will probably also take revenge," says one banker. "This will lead to trouble and the ruling elite need to make sure of the election result."

The trouble is that Ukraine is reverting to form and Yanukovych is following an old tradition of changing the election laws ahead of a general election, which is due next year. Ukraine's current election legislation is a proportional system: voters vote for one party and those that get more than 3% get seats. However, the names on the party lists are not made public until after the results. "Our president decided to change the election legislation to a mixed system: 225 deputies will be elected on party lists and the other 225 will be elected in single mandate districts," says Olesya Oleshko, an independent political analyst in Kyiv. "Those who will be running for election in single mandate districts only have a chance to win if they are on good terms with the corresponding regional governors - all of whom are appointed by the president."

What dissent there is has come from entrepreneurs who have borne the brunt of a tax reform that hikes taxes on small business and cuts it on big corporates, or are victims of "raiding": if an entrepreneur is unlucky enough to set up a successful business, then it doesn't take long for a representative of the local powers-that-be to show up and offer to buy the business at a massive discount. If the businessman refuses, tax police and secret service raids follow. "Earlier, the authorities built a coffin for entrepreneurs through their so-called 'reforms,' and now, through anti-national bill No. 8521 [on a simplified taxation system that hikes taxes on SMEs], they have already prepared a coffin lid and nails," says Andriy Panaetov, chief of staff of the Forward! Rally, which plans to demonstrate in Kyiv in early November.

The Rada is due to vote on the new election rules in the next few weeks and will almost certainly push them through. The expectation is that the Party of Regions will then sweep the single mandate seats in next year's election and will do what it needs to take much of the party list votes too.

The investment climate has become so poor that companies are already pulling out. On November 1, Czech utility CEZ said it was closing down its operation and the Bank of Georgia's investment wing BG Capital, which scored successes with two Ukrainian IPOs on the Warsaw Stock Exchange earlier this year, closed its office. "I'm writing to inform you that in line with Bank of Georgia's strategy to focus more on its home market, and given the changing business and political climate in Ukraine, the Bank has decided to close BG Capital's Ukrainian office," Nick Piazza, CEO of BG Capital, wrote to customers on November 1. "As of today, the Kiev office is officially closed," he concluded in a sentiment that echoes many investors' attitude to the whole country.

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