KYIV BLOG: What price European values when economic collapse is imminent?

By bne IntelliNews December 15, 2014

Ben Aris in Moscow -


Ukraine needs about $15bn now or it will collapse, possibly in the next few weeks. Ukraine's prime minister, Arseniy Yatseniuk, called on Western donors to come up with a $15bn rescue package to stave off collapse on December 11 and was met by a deafening silence.

“The meltdown can still be prevented,” Anders Aslund wrote in a blog for the Peterson Institute for International Economics, but only if Ukraine’s new government and its international allies “act fast and hard.” And there is no sign of that.

The EU is not going to pay. It recently transferred €500mn that was already promised as part of an early aid package, but is unlikely to come up with more before a donors conference next year. The IMF is not going to pay. It has already paid $4.8bn of a $17bn two-year package, but said that it won’t transfer any more until at least the new year and that other donors would have to take up the slack. The US won't pay. Ukrainian President Petro Poroshenko was in Washington in September and asked for help during an impassioned speech to Congress, but he only got a $1bn loan guarantee (not even cash) and $53m in aid, including a paltry $7m of arms. And the bond markets won't buy Ukraine bonds, as the country is sliding into the abyss and its sovereign paper is starting to look seriously risky. Finance ministry officials from G7 countries are reported to be considering providing $4bn in funding for Ukraine, according to the Wall Street Journal on December 9, but even if this money comes through – which doesn’t look likely – it is less than half of what it needed.

So what happens next? The chances of a collapse are now extremely high. The yields on the country's bonds have been soaring in recent weeks and credit default swaps have widened in a way that is typical for a country about to default on its debt – indeed, even if Ukraine isn’t going to default, the spiking of CDS rates becomes at some point a self-fulfilling prophesy. As The Economist said in a recent article (about Russia), "sometimes international markets press the fast forward button and push countries into default faster and earlier than expected." If the markets have not already pressed that button, clearly their finger is hovering over it now.

The West needs to act now and kill the crisis-causing uncertainty before it gathers momentum. The sums involved are large, but precautionary bailouts are massively cheaper than repairing an economy that has already gone to the wall. Russia spent almost 10 years recovering from the 1991 crisis that destroyed its entire industry and banking sector; it spent about four years recovering from the 1998 crash that wiped out the entire top tier of its banking sector. Although it should be noted that it took only about nine months to recover from the 2008 crash, when only one bank went bust; the Russian economy it seems has been battle hardened by multiple crashes.

Ukraine's economy has not been hardened in the same way and its economy is extremely vulnerable. While Russia has burned through some $100bn of its hard currency reserves, it still has 1.7 years of import cover over the minimum 3 months considered necessary by economists. However, Ukraine's hard currency reserves dropped below $10bn in December, putting it at 1.3 months’ of import cover. Despite the more-than-adequate reserves, Russia's ruble has dropped about 40% this year, dragged down as its value is so closely tied to the tanking oil prices. The Ukrainian hryvna has fallen 86% over the same period.

At the same time, Ukraine's banking sector is on, or already over the edge. Russia's banks remain well capitalised and their non-performing loans are rising only slowly, the sector average being below the easy manageable 5% of total loans. Ukraine's banks, on the other hand, are in deep trouble. The central bank conducted stress tests on 35 domestic banks and Governor Valeriya Gontareva said in November they need UAH66bn (approximately $4.4bn) to bail them out – money the government simply doesn’t have. "These are the results of the stress tests conducted earlier this year on the largest banks, when the exchange rate was in the UAH11-12 range. At the current exchange rate of UAH15-16, I would expect bank re-capitalisation costs to be significantly higher," says Tim Ash, head of emerging markets research at Standard Bank.

Indeed, the only reason the economy has not formally collapsed is that investors are still expecting the international community to ride to the rescue at the last minute and bail the country out with more emergency funds. However, the rapidly sinking bond prices suggest investor confidence that the international community will do this is starting to crumble.

Value or values

The manifest reluctance of the West to come up with cash for Ukraine is starting to have wider effects. bne IntelliNews said on the eve of the EU summit in Vilnius in November 2013 – where former Ukrainian president Viktor Yanukovych refused to sign off on a long-negotiated free trade and association agreement, which kicked off this whole fight – that the EU deal wouldn’t work because there was simply too little money on the table.

The much-touted "values" that come with the EU deal have done nothing to support the hryvna, and other countries in the region are watching the "slow-motion car crash" in Ukraine with trepidation.

The upshot for the pragmatic strongmen of the Commonwealth of Independent States (CIS) is that the EU is undermining its moral authority, as its rhetoric about "values" is not backed by cash when  it's needed to stop a looming economic meltdown. Set this against the Russians, who immediately granted Ukraine a $15bn aid package – paid out over one year, not two – when Yanukovych sided with their Eurasian Economic Union, immediately loaning Ukraine in a $3bn bond issue in December 2013 with no reform strings attached (although a very nasty 60% of GDP cap on debt "poison pill" was included in the covenant). 

The upshot is that several countries, under increasing pressure to choose sides in the conflict, are plumping to side with Russia's EEU. Kyrgyzstan's prime minister was explicit in a speech at the European Bank for Reconstruction and Development (EBRD)'s annual general meeting in Poland this year that his country has "no choice" but to join the EEU. While Kyrgyzstan, as arguably the only real democracy in Central Asia, aspires to European values, it is simply "too far away from Europe" to expect any help from it, whereas Russia has already proven that its trade deal comes with tangible benefits and cash.

Russian President Vladimir Putin was in Uzbekistan on December 12 making the same point: Russia cancelled nearly $1bn of Uzbek debt and also signed off on deals to train six-times more Uzbek military offers and supply advanced attack helicopters and other high-tech Russian hardware.

Azerbaijan too, while it remains extremely keen on maintaining its neutrality, has been watching events to the north and is beginning to move closer to Russia, according to Aleksandra Jarosiewicz, an analyst with the Centre for Eastern Studies (OSW) in Poland. "Baku has been motivated to assume a Kremlin-like vision of the world by the rapprochement of its traditional ally Ankara to Moscow, as well as the Russian announcement of the construction of a pipeline through Turkish territory, which might strike a blow at Azerbaijani plans to extend the infrastructure to the EU," Jarosiewicz wrote in a recent paper. "Tangible results of Azerbaijan’s movement towards Russia over the last few months is the development of bilateral cooperation."

And Turkey too is flirting with Russia, one of its biggest trade partners and the destination for much of its foreign investment. Putin was also in Turkey in early December and announced that the Kremlin would cancel the South Stream pipeline that was to deliver gas to southern Europe, and instead build a gas pipeline to Turkey, from where the gas could be re-exported to Europe. The Turkish government has only said it is considering this proposal, as it’s wary of giving the Russians too powerful a lever over its energy security. But after two decades of waiting outside the EU club room for its membership card, Turkey must be getting a bit jaded with European promises as well.

In the long run, European values are worth pursuing because they will delivery more prosperity and a more balanced and just society. However, in the short run Europe's inability to act decisively to halt Ukraine’s slide to the brink of the precipice is undermining Europe's creditability in Central and Eastern Europe as a potential partner and political ally against an increasingly aggressive Russia. 

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