Ukraine's short-term fix

By bne IntelliNews April 24, 2013

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Ukraine spent March and April trying to stitch together a patchwork of agreements on energy, finance, politics and reform that would allow the government to put off hard decisions and avoid having to address any of the festering problems it is facing.

The most obvious example was the failure in mid-April of a second round of talks with the International Monetary Fund (IMF) on restarting the country's stalled $15bn stand-by agreement. Increasingly strapped for cash, Kyiv could really do with borrowing a couple of billion cheaply at the moment. Hard currency reserves have fallen to 2.8 months' worth of import coverage, which puts the stability of the hryvna at risk, and a blowout in budget spending in February saw the federal budget deficit increase four-fold to UAH2.3bn (€216m). Another sharp devaluation of the hryvna is looming.

Kyiv is living off its luck at the moment. Happily for Ukraine, the markets are awash with money these days due to quantitative easing by central banks around the world and with interest rates close to zero in most countries, bond investors are willing to buy any old rubbish these days provided it comes with a decent yield. The same day that the IMF talks ended without agreement, the government tapped the international capital markets for a €1.25bn, 10-year Eurobond at an interest rate of 7.625% - a lot more than it would have paid the IMF. Raising another bond keeps the wheels turning - analysts say the government needs to raise about $500,000 a month to function - but this is not a long-term strategy.

Gas leaks

Kyiv has made a bit more progress undoing one of its knottiest problems - finding new sources of gas to replace the cripplingly expensive Russian imports. The amount it imports has been cut dramatically, falling by 17.4% between January and March from the year-earlier period. At the same time, Ukraine has started to import much cheaper gas from Germany and Poland. Hungary is expected to join the party later this year.

While the new imports are a tactical victory, Russia has accelerated its construction plans for the South Stream gas pipeline that will bypass Ukraine altogether. While Kyiv is keen to reduce the amount of gas its imports from Russia, it cannot do without Russian gas entirely so the South Stream pipeline leaves it in the nasty position of being cut out of the loop entirely - or being forced to pay through the nose for what it has to buy. Again, the new imports is a short-term victory, but at some point Ukraine is going to have to come to a fresh long-term agreement with Russia on gas.

While the administration of President Viktor Yanukovych wheels and deals, the basic reforms the country so badly needs are being ignored. The economy is in a mess and other than deal with the energy bill, nothing is being done to solve the problems. Reaching for a Eurobond issue to finance government spending is the national equivalent of a household putting its running costs on a credit card rather than economising and looking for a new job.

The economic indicators are all plummeting and the outlook is becoming bleaker. Growth stalled at the end of the first quarter and while the government insists Ukraine can put in 3-4% growth this year, the IMF cut its outlook from 3.5% to zero growth at the start of April. Hard currency reserves that support the value of the currency were flat in March at $24.7bn, or 2.8 months of import cover, which is not quite enough to support the currency. April's Eurobond issue has staved off devaluation fears for the moment, but the government was forced to spend $827m to prop the currency up in the first quarter of this year so has bought itself maybe another four months before it will need another big dollop of cash. Prices for goods are falling, down by 0.8% in March year on year - continuing the longest period of deflation in Ukraine's modern history - and will crush growth and investment. And tax collection is falling while spending increased four-fold in the first quarter on year.

In the face of all these problems, First Deputy Prime Minister and the former governor of the National Bank of Ukraine Serhiy Arbuzov have suggested that things will be okay because Ukrainians have an estimated $100bn in hard currency savings stashed under their beds. "We have a deep domestic market, the public has over $100bn in hand. The money is exposed to risks - from being eaten by mice to crime," Arbuzov said in an interview. This is an asinine economic argument and even if true, then while it might cushion the population from some of the pain in a crisis, it will do little to prevent an economic crash as by definition the government has no access to this money.

The state needs to be using this time to restructure the economy and put it back on the path to sustainable growth. However, since the opposition has blocked the Rada from carrying out its duties for most of the time since October's election, work has come to a standstill. In April, the ruling Party of Regions simply moved next door and threatened to pass laws on its own, in a move of questionable constitutionality, which has broken the impasse. However, as the two sides of the house are at each other's throats, the chances of getting anything done are next to nil.

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