Political compromises come too late for Ukraine investors

By bne IntelliNews January 29, 2014

Graham Stack and Harriet Salem in Kyiv -

Ukraine's political crisis is edging towards a resolution, just as it might derail the economy.

The tumultuous special session at the Verkhovna Rada on January 28 was aimed at moving Ukraine's protracted political crisis - which recently descended into bloody street battles between police and anti-government protests - a step closer to a resolution.

The repeal of a controversial package of a repressive legislation, dubbed the "dictator's laws," alongside the resignation of the staunchly pro-Russian prime minister, Mykola Azakov, and his cabinet may have bought both sides some breathing space to continue negotiations, but the protestors on the street were less impressed and are insisting on nothing less than new elections. Much more needs to be done to alleviate investors' fears as the situation remains very fluid and unpredictable.

Certainly, rating agencies appear unconvinced that much progression has been made in improving the prospect of long-term political stability in the country. Almost immediately after the close of the Rada session - which continues January 29 with a vote on prisoner amnesty - Standard & Poor's downgraded Ukraine's credit rating to pre-default level 'CCC+' with a negative outlook, indicating the likelihood of a further downgrade.

According to S&P analysts, Ukraine is now "exhibiting characteristics of a distressed civil society with weakened political institutions, diminishing the government's capacity to maintain timely debt service." The move nixes the short-term rating boost gained by Yanukovych's controversial backroom deal with Russia in December, taking Ukraine back to where it started: with a pre-default rating.

The Ukrainian economy contracted by 1.1% in 2013, and as this year gets underway retail sales, the main economic driver, have started to collapse. The outlook for 2014 is poor and deteriorating.

Adding to the doom and gloom is a creeping devaluation of the hyrvnia, with the exchange rate dropping from a pre-crisis level of UAH8 per dollar to UAH 8.5. The fall will put further pressure on import-reliant businesses and consumers. "I ordered and paid for electronics three days ago and by the time I went to collect them the price had already increased by 5%," Nina Taraska complains to bne.

The rapid devaluation has also prompted tourist agencies to start demanding full payment in advance from Kyiv residents desperate to escape the current Arctic temperatures for warmer climes.

For foreign investors - who in general are keen on a more European-oriented government and business environment - there is a clear preference for talks over Molotov cocktails and rubber bullets. So the Rada session has "drawn the country back from the abyss," one Kyiv-based business insider tells bne. "But it is really too early for investors to say, there now needs to be a progression towards a solution that could convincingly work in the longer term and provide the country with stability and direction. As yet we haven't seen that."

Others, however, say the damage has already been done. George Georghiou, managing partner at Feod Group, a legal and financial consultancy, says the social unrest has damaged his business, which is located on Kyiv's main high street. "There are barricades right outside the door, clients are afraid at to come in," he tells bne. "I, myself, am considering ways out of the country. You'd have to be mad to want to invest in such an unstable place."

Certainly, the long-term trend, especially in the financial sector, has been for the withdrawal of foreign investors. The latest departure came on January 24 when Italy's Intesa San Paolo sold its Ukrainian unit, Praveks Bank, for €74m to gas and chemicals oligarch Dmitry Firtash. The Italians had purchased it in 2008 for €500m.

Status quo

On the other side of the fence, the departure of the PM and his cabinet, as well as the growing possibility that Yanukovych could also be ousted, is unnerving those with a stake in maintaining the political status quo - ie. supporters of the pro-government Party of the Regions.

On January 28, Russia's first deputy Prime Minister, Igor Shuvalov, warned that Russia could revise its December agreement to provide $15bn worth of funding and a reduced gas price, in the event that a new Ukrainian government announces a new agenda. In a display of good-cop bad-cop, Russian President Vladimir Putin then played down the threat. "We will stand by our partners in Ukraine, no matter who leads the Ukrainian government and holds a dialogue with us," he stated.

But others think that the president's honeyed words are just a show for the international audience that has an eye on the upcoming Winter Olympics in Sochi. "Let's wait until after Sochi to see whether we see a return to form in terms of Russian policy towards Ukraine," says Standard Bank's Tim Ash. "Lots of risks and uncertainties still lie ahead."

If the Kremlin were to withdraw its loan offer, or change the terms of its gas price deal (which is subject to quarterly review by Putin), the consequences would be disastrous for the precarious finances of Ukraine. The next red-letter day is an already announced $2bn Eurobond placement, which Russia should buy according to the terms of the December agreement.

Even Ukraine's usually untouchable oligarchs' businesses are feeling the pinch as result of recent events. Aside from the risk of sanctions being imposed against them - such as visa-bans from Western countries - concerns over an upset in the current power balance, which might lead to tighter adherence to due diligence processes in the future, is reportedly causing banks to back away from Ukraine's unelected power-elite; most of whom made their money in murky dealings during the 1990s and some of whom have alleged mafia ties. Journalist Serhiy Leshchenko, on a muckraking tour of the Alpine countries to investigate oligarchs' banking arrangements, reports back that: "Their firms cannot get credit lines, and are being asked [by Swiss banks] to return ahead of schedule credits they have already received."

There is, however, at least one niche of the market doing good business. Builders working on stately homes for Ukraine's super-wealthy have seen a surge in orders. "The MP-businessmen are all digging in at home and investing in their estates," a Ukraine-based Austrian house and garden construction businessman tells bne.

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