Ukraine investment case depends on peace, aid and unity, says Weafer

By bne IntelliNews January 21, 2015

Ben Aris in Moscow -


​"Ukraine 2015 investment case depends on peace, aid and unity," says Chris Weafer, CEO of Macro Advisory, but of the three at the moment aid is probably the most important. Ukraine has only five weeks left of hard currency reserves in terms of import cover and is teetering on the edge of a default on its debt at best and a full-blown financial crisis at worst.

The IMF team was in Kyiv in the week of January 12 and the resumption of the $17bn standby program agreed last April is expected to start soon, which will throw the government a lifeline. However, it is already clear that the IMF money will not be enough to get the country through this year. SP Advisors, a Kyiv-based investment consultant, estimates that in addition to the IMF tranches Ukraine's government needs $21bn and Weafer concurs, saying the $15bn is just money to keep the country afloat. The true to cost of restarting the economy will be a lot higher.

"It is accepted that Ukraine now needs at least an additional $15bn to cover its budget deficit and external obligations. The real figure is expected to be closer to $25bn when the cost of reconstruction and measures to try and pull the economy out of the existing slump are factored in," Weafer said in a note to clients.

The final estimates for the contraction of Ukraine’s economy in 2014 will probably come in at between 7.5% and 8.0%, "but the forecasts for 2015 vary depending on assumptions for external aid and the war disruption. We assume a 5.5% contraction, followed by a small recovery in 2016," says Weafer.

In the medium term, de-escalating the war in the eastern region will be critical to the success of recovery efforts.

Weafer goes on to spell out the considerations for longer-term investors and strategic corporate investors that will determine the pace of any economic recovery and the investment risks. These include:

- peace, or at least containment, in eastern Ukraine;

- resumption of the existing aid flow and, critically, the expansion of international aid by at least $20bn (can this be achieved with a default or a restructuring of existing debt?);

- bringing the budget deficit lower while accommodating the tax and payment changes demanded by the IMF;

- stabilising the economy and reducing the scale of the shadow economy;

- showing meaningful progress in tackling business and investment reforms;

- retaining majority public support for austerity measures;

- showing the country can prevent another political crisis.

There are problems on all these fronts. After a relatively quiet Christmas period, fighting escalated in the Donbass over the weekend and was particularly intense around Donetsk airport. EU leaders are due to meet in Berlin on January 21 to discuss Ukraine, but it seems the ceasefire is in danger of falling apart.

The EU has offered a short-term loan of an addition €1.8bn in January and the US promised another $2bn loan guarantee, but the West seems to be extremely reluctant to come up with the big money Ukraine (and international financier George Soros in a recent op-ed) is calling for. The reason for the West's reluctance is not clear, but is probably connected to the slow progress at implementing the reforms demanded by the IMF and the continuing problems with large scale corruption in the country, amongst other things.

Retaining public support is also proving hard. A recent poll conducted by the two leading sociological institutes in Kyiv, the Kyiv International Institute of Sociology (KIIS) and the Ilko Kucheriv Democratic Initiatives Foundation (DI), 

And finally there is talk of growing tension in the government between Ukrainian president Petro Poroshenko and Prime Minister Arseny Yatsenyuk over policy, and a power struggle could break out.

"The last few weeks of the new session of parliament, including in particular the work on the budget, show that the dividing lines within both the ruling coalition and inside the two biggest clubs, the Petro Poroshenko Bloc and the Popular Front, are being drawn ever more clearly. As expected, the inconsistency of the main ruling coalition parties – whose members come from a variety of groups, including social activists – is resulting in increasingly clear political and tactical differences between them. The main dividing line runs between those who want to continue the traditional, bureaucratic style of governance, and those who want to introduce solutions which are characteristic of mature democracies," Poland's Centre for Eastern Studies (OSW) said in a paper last week.

With aid money slow to arrive and the military situation in the east heating up while the political situation in the capital deteriorates, it seems Ukraine's chance of starting to climb out of the economic mire into which it has fallen seems further away than ever. And as the currency reserves continue to run out towards zero, the possibility of a default seems closer than ever.

"A consensus seems to be building that debt restructuring is increasingly likely - even set to be part of the solution," Tim Ash, head of emerging markets research at Standard Bank said in a note.

Weafer is more confident that a last minute fix will be found, arguing that no-one in Brussels is willing to see Ukraine implode.

"We do not believe Ukraine will land in a position where it defaults on debt obligations. While the IMF clearly has serious concerns about the implementation of the existing agreement, Western political support should ensure additional aid in a timely manner," says Weafer. "But, a restructuring of existing public debt appears unavoidable. Western donor countries are expected to insist on it as part of a new round of financial support."

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