James Marson in Kyiv -

Only two months ago, Ukraine was being read its last rites. With GDP in freefall, a currency that had lost 40% of its value since November, and a squabbling president and prime minister, doomsayers described Ukraine as "on the brink," despite most local analysts saying the country would get by somehow. Fast-forward a few weeks and the mood has changed dramatically - there is some positive news flow and a glimmer of hope that things are starting to turn.

Sentiment towards the country received a huge boost on April 17 when the International Monetary Fund (IMF) mission announced that it almost certainly pay out the next $2.8bn tranche of the $16.4bn agreement inked in November. The disbursement had previously been delayed after disagreement over the proposed budget deficit and concerns about political infighting. "There are a number of encouraging signs that the economy has started to adjust to the large shocks," said IMF mission head Ceyla Pazarbasioglu, citing the slowdown in inflation, the narrowing of the current account deficit and the significant exchange rate adjustment, which should help boost exports.

"It seems that major export-oriented sectors such as steel, chemicals and machinery have bottomed out," reckons Olena Bilan, an analyst at Kyiv-based investment bank Dragon Capital. Steel exports are up 15.3% in the first three months of 2009 compared with the last quarter of 2008, and industrial production saw small month-on-month increases in February and March after a 16% dive in January.

Analysts from Alfa Bank commented in a note on May 5 that Ukraine may not even need further IMF loan tranches, as their estimates "show that the first tranche of IMF funds allocated to address Ukraine's short-term balance-of-payments problems has worked." Inflows of foreign direct investment from privatisation, the Euro 2012 football championships and bank bailouts should help to bring equilibrium to Ukraine's balance of payments, it noted.

Confidence returns

The previously wobbly financial sector has also seen a return to stability. The hryvnia has settled at around UAH8 to the dollar as the population's stampede to change into dollars subsides. The National Bank of Ukraine has carried out the recapitalization of banks in a, "transparent, public and helpful way," says Nick Piazza, CEO of Galt & Taggart Securities. And consumer confidence has been on the rise since February, according to market research company GfK Ukraine. "People on the street are more relaxed," says Piazza.

Dragon Capital's Bilan also points to data that shows that salaries are going up, which indicates companies have started to adapt to the new conditions. "Companies had a huge shock when demand squeezed and credit became unavailable. At first they cut costs by firing lots of people, but now they realize they can increase salaries to motivate their remaining, often highly qualified, personnel. Companies have had to think of ways to increase productivity."

But while this news points to a welcome stabilization after a turbulent few months for the Ukrainian economy, it's hardly enough to start popping the champagne corks. President Viktor Yushchenko says that GDP dropped 25-30% in January and February, and the IMF in April revised its forecast for the year to a contraction of 8%.

Ukraine's export-dependent economy is heavily reliant on a global upturn. The key to a recovery will be a rise in global demand for commodities such as steel, which accounts for 40% of export revenues. "People are still not buying steel," says Piazza. "And no new sector is stepping forward to drive the economy."

Nor has the political squabbling abated. The greatest threat to stability on the horizon is the upcoming presidential election, set by parliament for October 25, although the president has challenged this date in the constitutional court (he is plumping for January 17). The election campaign is likely to see an escalation in the political infighting, particularly between Yushchenko and Prime Minister Yulia Tymoshenko, that has already paralyzed policymaking.

There will also be a temptation for the government to preserve or increase social payments in the run-up to the election, which could lead to inflationary pressures. Last time round in 2004, then-PM and now opposition leader Viktor Yanukovych doubled pensions just before the election. The IMF, however, could play the role of watchdog, Bilan says, with its strict conditions on budget deficit for disbursement of further loan tranches.

Any political instability could also frighten away FDI: the difference between Alfa Bank's worst-case and best-case scenario estimates is $1.3bn versus $13bn. The recent rise in the PFTS Stock Exchange is being driven by small local buyers, Piazza says, with foreign investors showing little appetite for the risk.

While the storm may have subsided for now, the reliance on external factors and the unpredictability of political life means the road ahead remains rocky. "Ukraine is stably dormant," says Piazza. "But we may not have reached the bottom yet."

Send comments to The Editor