Ben Aris in Moscow -

The outlook for Ukraine is poor and boils down to two dismal scenarios of varying degrees: whether the economy will stagnate in 2013 or descend into crisis.

All of Europe was experiencing a slowdown towards the end of 2012, but Ukraine's problems have been exacerbated by its already weak situation. The administration of President Viktor Yanukovych has done little to address the country's structural weaknesses since it came to power in 2010 and any lingering will to implement reforms was killed by the general elections on October 28.

More saliently, the elections also made renewing a crucial deal with the International Monetary Fund (IMF) to restart Ukraine's $15.4bn stand-by agreement politically impossible, as the government needed to avoid taking any politically tricky reforms until the elections had passed.

If anything, a deal with the IMF will now be harder to cut after the elections, as they were widely regarded as unsatisfactory by the international community. Indeed, Andreas Gross, the chair of the Ukraine election-observing delegation from the Parliamentary Assembly of the Council of Europe (PACE), openly called Yanukovych and the Party of Regions of Ukraine an "authoritarian government," which brings Ukraine's relations with the EU to a new nadir.

Devalued

Since the election, pressure to devalue the local currency, the hryvna, has been rising. The government attempted to buy time by introducing a draconian mandatory surrender requirement on exporters, who will now have to sell half their hard currency earnings to the central bank for six months, and at the same time issuing an expensive $1.25bn Eurobond to shore up its reserves. But these are temporary measures at best to stave off a devaluation, which could spark a financial crisis. Ukraine must either negotiate a new deal with the IMF (probably by May if it is going to happen) and access its stand-by facility, or concede to Russian demands to join the Customs Union, which would come with a massive reduction in gas prices. High gas prices are currently bleeding the treasury dry.

Ukraine's economy has been slowing throughout 2012, from 2.5% in the first half of the year to 1.3% between January and September. Raiffeisen Bank International analysts forecast it will end the year at 0.5% or could even finish 2012 with a mild contraction - a dramatic turnaround from the 5.2% of growth posted in 2011.

The forecasts for 2013 are in a broad range from 1% to 3%, reflecting Ukraine's heavy reliance on external markets and the uncertainty that is plaguing the global economy. A devaluation of the hryvna looks very likely, from the UAH8.2 to the dollar in November to a 2013 range of UAH9.2-UAH9.6, predicts Renaissance Capital. Economists estimate the national currency is 10% to 20% overvalued and one of the IMF's key demands is the introduction of a more flexible exchange rate regime that would allow the currency to slide. The hryvna is under pressure due to dwindling hard currency reserves, which fell by $11bn over the year to about $26bn (before the last Eurobond issue), dropping 8% in the month of September alone. The currency is also suffering from the growing current account deficit, which widened to $9.3bn in the first nine months of the year from $5.9bn in the same period of 2011, due to slumping demand for the country's exports. Even a strong harvest and record grain exports were not enough to offset the contraction of the vital exports of steel.

Industrial production and construction were also both slowing by the end of the year, down 4.7% and 9.0% in August-September respectively, which signals falling investment, say analysts.

The Yanukovych administration has effectively killed the Ukrainian stock market, which was the very worst performer in the world as of November 13, 2012, down 41.51%. Portfolio investors have been burnt too often and on November 19 the emerging market index MSCI official downgraded Ukraine to "very low liquidity" as part of its biannual rebalancing. Telecommunications operator Ukrtelecom, which was privatized last year, was excluded from the MSCI Frontier Markets Indices in the rebalancing, joining another 11 companies that were already excluded in the previous rebalancing.

With daily trading totals never rising above a few million dollars a day, liquidity was never very great in the first place. While Ukrainian equities are extremely cheap, they are likely to stay that way until there is a new political trigger like a change of regime. The earliest that could happen is with the presidential elections in 2015. Having said that, there are still a handful of excellent companies that will continue to attract some interest, including: helicopter maker Motor Sich, utility Centrenergo, and agricultural concerns MHP and Kernel Holding.

In terms of reform, Ukraine has belated started to actively develop alternative energy sources such as shale gas and in November began to import cheaper gas from Germany. But neither of these measures are a substitute for the deep structural reforms necessary to put the country on a sustainable development path, and on this front there has been little or no action.