Graham Stack in Kyiv -

Ukraine's leading brokerage Dragon Capital has become the latest to slash Ukraine's GDP growth forecast for 2012 and warned the country will face considerable risks this year.

Ukraine had just started to recover from a gut-wrenching 15% plunge in 2009, with respectable growth of 4.2% in 2010 accelerating to an estimated 5% in 2011, primed by a record harvest and state-funded construction in preparation for the Euro 2012 football championships.

Third-quarter growth in 2011 even peaked at 6.6%, and consensus forecasts for 2012 were around the 4.5% mark. But in a nod to the Eurozone crisis and its potential double whammy on Ukraine's export revenues and the availability of external funding has caused analysts to pull back sharply.

First to go was the World Bank, which shortly before Christmas dropped their 2012 prognosis from 5% to 2.5%. Ukraine is entering a period of decreased external demand, more difficult access to financing and instability on global markets, warned World Bank economist Ruslan Piontkovsky. Even this much reduced forecast, said Piontkovsky, assumed an orderly solution to the Eurozone crisis and resumption of IMF funding: downside risks to this forecast are unusually high, he added.

Next up was Moody's Investors Service. Although not specifying a GDP forecast, the ratings agency was pessimistic on Ukraine's prospects for 2012 in its annual credit analysis January 6. In December, the agency had downgraded the outlook from stable to negative.

With an eye to Ukraine's 2008 meltdown under following the Lehman Brother's collapse, Moody's even warned that Ukraine could again go completely off the rails if the crisis deepened internationally. A single event could trigger a multi-notch downgrade, the report warned.

Now leading local brokerage Dragon Capital, traditionally one of the Ukrainian bulls, is getting cold feet, slashing its GDP growth forecast in 2012 to 2.2% from 4%. Chief economist Olena Bilan said at a press conference January 12 that revised assumptions about Ukraine's all-important steel production had prompted the decision. Steel accounts for two-thirds of Ukraine's export revenues, and steel prices had dropped by 10-15% from September through December, according to Dragon Capital, with output dropping at a monthly rate of 4% over the period and looking set to fall further in 2012.

Shades of 2008

The similarities to 2008 are not restricted to the fraught international financial situation. Just like then, Ukraine is also in down-to-the-wire talks with Russia over the price of gas, while lurching towards a domestic political crisis.

Ukraine is desperately trying to reduce the price of gas it pays to Russia, which, being indexed to the oil price, should soar 21% in January to a record-breaking $485 per 1,000 cubic meters. This price hammers Ukraine's gas-guzzling heavy industry, much of which is owned by key government backers such as oligarchs Rinat Akhmetov and Dmitro Firtash.

The soaring Russian gas price would force the government to raise domestic gas prices for the population at a high political price with crucial parliamentary elections slated for October. The gas price also exacerbates the deteriorating balance of payments, threatening the stability of the exchange rate.

Kyiv needs renewed International Monetary Fund lending to cope with the gas price, but the IMF insists on Kyiv hiking the domestic price of gas as a precondition. Kyiv has thus either to force Gazprom to concede a price reduction in court at the Stockholm international arbitrage court or to sell Gazprom a stake in the gas transit system, or some combination of the two.

Were Ukraine to get a deal from Gazprom over the gas price, it could then also renew IMF funding without a gas price hike and thus smooth things going into elections.

Ukraine has gone so far as to jail the politician responsible for signing the gas agreements back in 2009 on abuse of power charges, thus strengthening the legal case against Gazprom. And that politician also happens to be the undisputed leader of the opposition, firebrand Yulia Tymoshenko. She is now literally barred from participating in the 2012 elections, just as her popularity rating for the first time exceeded that of President Viktor Yanukovych, according to a Razumkov Center opinion poll published earlier in January. Relations with the West are in tatters as a result of Tymoshenko's imprisonment, and the move may have simply deepened the political standoff.

Also reminiscent of 2008 is the fixed exchange rate in the face of a growing balance of payments deficit and a dependency on vanishing external funding. Whereas neighbourhood currencies such as the Russian ruble have shifted away from a rigid exchange rate, the Ukrainian central bank seems to believe any weakening of the currency would prompt a run on Ukraine's shaky bank system. The National Bank of Ukraine has spent $5.8bn to defend the currency since August, 15% of reserves, and also reined in domestic liquidity, prompting a mini hryvnia credit crunch in late 2011.

Dragon's Bilan calculates that if the price of gas remains unchanged, Ukraine's current account deficit could reach $11.5bn, around 6.2% of GDP. Given reduced access to external funding due to the Eurozone crisis, and a heavy debt repayment schedule, this could create a funding gap of around $8bn.