The government in Kyiv has achieved a remarkable result in turning around the economy. From a contraction of 9.9% in 2015, which followed a decline of 6.6% the previous year, the headline macro numbers have now stabilized or are showing modest growth. This year GDP will return to growth of 1.0-1.5% and for next year it is reasonable to assume growth at approximately 2.5%. The role of the National Bank of Ukraine (NBU) has been particularly important and it deserves huge praise for its work in stabilizing the banking system and the hryvnia. It also oversaw the big drop in inflation from an annualized 43.3% at the end of last year to 8% this summer, albeit that number will likely creep up to around 13% by end year. The success in cutting inflation has allowed the NBU to cut its benchmark rate from 22% to 15.5% since the start of the year.

Investors in Ukraine assets have been well rewarded on the back of the improved economic performance. The local currency UX equity index is up 22% year to date while the euro-denominated WIG-Ukraine Index is 33% higher. That compares with a 15% gain in the MSCI EM Index over the same period.

Debt instrument investors have also shared in the gains with, for example, the yield on Ukraine 2020 sovereign debt dropping from 9.8 percent at the start of the year to 8.2 percent in early October. The performance of some corporate issues has been even better with, for example, the yield in the MHP 2020 Eurobond dropping from 12.1 percent to 9.4 percent in the same period.

The question now is whether the solid progress achieved in the economy over the past 12 months can continue, and drive asset prices even higher, or whether Ukraine is about to enter a more difficult and dangerous phase which may disrupt the recovery and again boost the perception of investment risk?

Apart from the continuing risk of an escalation of fighting in eastern Ukraine and a less than favourable global economic backdrop, the government in Kyiv has a number of specific challenges to deal with through the winter months.

The biggest challenge comes from domestic politics and the growing public dissatisfaction with austerity measures, including the doubling of gas tariffs from early summer. The impact of that big price hike will be felt later this month and into November when households start to get the first of their revised heating and hot water bills. The opposition parties are already planning to stage major nationwide protests against these measures and the opinion polls show that they can expect considerable support.

The opinion polls also show a big swing away from President Petro Poroshenko and the ruling coalition in favour of the opposition parties. If elections were held this weekend, the surveys indicate that Yulia Tymoshenko would get the most votes in a presidential poll and her Fatherland party would be the biggest in the Rada. Of course it is normal than incumbent governments suffer a loss of support in mid-term polls and both Poroshenko and his coalition have plenty of time to recover before the next scheduled elections in 2019. It is, however, in the best interest of Tymoshenko and the other opposition leaders to try to force an early election in spring next year. That is their best chance of gaining control of the Rada and the public dissatisfaction with raised utility bills may prove the catalyst for the start of the process.

One way the government can head off the threat of such protests, and an effort by the opposition to force an early parliamentary election, is of course to start showing results in the campaign to deal with corruption in the state sector. Criticism of slow progress has also added to public frustration. Another is to show that the austerity measures are yielding results and a big part of that will be getting back on track with the International Monetary Fund (IMF) programme.

The IMF has just published a review of Ukraine and essentially set out the conditions for Kyiv to receive another tranche of the $17.5bn aid package agreed last year. The IMF recently paid out $1bn of the $3.3bn which was withheld by the IMF from last year because of slow progress in implementing key reforms. The $1bn payment was basically a reward for introducing the electronic anti-corruption system and encouragement to press ahead with other reforms.

To meet the IMF’s conditions for a resumption of the payment schedule much will depend on how the information collected in the new electronic reporting system, which requires all state officials and public servants to publicly declare their income and assets in an effort to stamp out corruption, is actually used. Vested interests have placed obstacles in its path previously and delayed the start-up date several times.

Another of the indicators that people are paying attention to is whether the EU signs off on the EU-Ukraine Association Agreement or continues to delay. The Dutch rejection of the deal in a referendum certainly complicates the issue, but the European Commission said it may press ahead regardless. If it does, then President Poroshenko will be able to show a major positive from the reforms and austerity measures, but an indefinite delay by Brussels will play into the hands of the opposition parties and weaken the government’s position.

Oligarch influence

Another issue is the continuing influential role of the oligarch groups. A major criticism of Poroshenko’s government is that it has not reduced the involvement of oligarchs in the economy and that many of them still are far too close to government and are influencing decisions. The IMF has been particularly critical of the role of oligarchs in blocking tax reforms and in reforming such key sectors as agriculture. The Rada has, for example, just voted to extend the moratorium on agriculture land sales to 2018 whereas the IMF requested the start of such sales from early in 2017.

If the headlines and TV images from Kyiv over the winter months are about mass protests and demands for an early parliamentary election against a backdrop of stalling by the EU and the IMF, then the risk premium applied to Ukraine assets will again rise. If the government can successfully negotiates what is now inevitably going to be a challenging period, and gets to the spring with better public support and a steadily recovering economy then investors may look forward to further and longer-term gains and the finance ministry in Kyiv may confidently plan its return to the international debt market in the autumn. 

Chris Weafer is a founding partner of Macro-Advisory, which helps investors cut though the noise & focus on underlying trends, real political risks, & opportunities in Russia/CIS, Eurasia Union, & Mongolia. Follow him on @ChrisWeafer