West accused of 'sleepwalking' as Ukraine edges towards crisis

By bne IntelliNews November 26, 2014

bne IntelliNews -


Ukraine is teetering on the edge of collapse, but the West is "sleepwalking" in its response to the impending crisis, say observers.

The West has made a catalogue of errors since Ukraine's fateful decision to turn its back on Russia, to which Moscow responded by launching a proxy war that has made Kyiv's already dire economic situation worse. The  EU's Association Agreement with Kyiv, which commits Ukraine to moving closer to Europe, has not come with enough financial support to re-boot the economy.

"There is a currently a major hole in the Western financing package for Ukraine of somewhere in the order of $10bn for the next six months," says Tim Ash, head of emerging markets research at Standard Bank.

The Institute of International Finance (IFF), a global financial industry group, was also in Kyiv last week and came to pretty much the same conclusion. Despite a recent ceasefire with pro-Russian separatists in eastern Ukraine, Kyiv will suffer a "double-digit recession this year", the IFF said in a report.

Lubomir Mitov, the IFF's chief economist for Emerging Europe, added that Ukraine will have to restructure its external debt, something the government has desperately being trying to avoid, reports Reuters. in October, in order to maintain its credit reputation, it chose to redeem a $1.6bn Eurobond issued by national gas company Naftogaz that the country could ill afford because of the dearth of financial resources. 

"I'm almost certain that the IMF program has to be redone, has to be extended for three years at least," Mitov, who attended a conference in Kyiv last week, told reporters.

Ukraine's Eurobonds plunged on November 25 on the comments, as investors have started to price in the rising possibility of a taking losses on their Ukrainian bonds.

"We think that a debt restructuring in terms of a haircut doesn't help Ukraine because the gain is too small and the pain is too large," Mitov said. "But if they can agree on some sort of voluntary ...rollover of maturities, this could help in terms of cash flow," Reuters reported him saying.

Wildly optimistic

Ash argues that when the original IMF plan was put together in March-April it made some wildly optimistic assumptions about the health of the Ukrainian economy, which badly underestimated the scale of the challenge the country was facing. This included a forecast for only a 3% economic contraction this year, which now looks like it will come in at closer to a 9% fall in GDP. In addition to the miscalculations, Russia had not yet annexed Crimea, and there was not yet a military conflict in Donbass, so the plan obviously assumed lower financing needs, adds Ash.

"The West is sleepwalking in terms of the risks now of economic and financial collapse in Ukraine, but there are plenty of excuses that can be made not to provide more financing at this stage - the Ukrainians do themselves no favours by being so slow in putting together a new reform coalition. Why did it take a month to form a government?" says Ash.

Some commentators argue that the sinking economy is months away from defaulting on its external debt, while others say it could be only weeks away. Certainly the sense of impending doom is growing.

Budget delays

Oleksandr Shlapak, Ukraine's finance minister, said last week that the country was unlikely to get any more IMF money before the year-end because the delay in forming the government after elections on October 26 had pushed back passing a 2015 budget. An international donor conference that could be worth billions of dollars was likewise put off from November until sometime in the New Year. Ukraine has so far received $8.2bn in financing this year from a total of $27bn pledged by the IMF and other donors.

The country's gross international reserves were down to  $12.6bn in October, less than the necessary three months' of import cover economists recommend, and could be in single digits before the end of the year, according to Olena Bilan, chief economist at investment bank Dragon Capital in Kyiv.

Mitov called on the EU to stump up more cash in the short term to stop the rot in Ukraine, but with the leading European economies sliding into recession and already heavily indebted themselves, no one is expecting the EU to ante-up any time soon. Already used to the EU's habit of being long on rhetoric and short on action throughout the Maidan protests that ousted pro-Russian president Viktor Yanukovych , the mood of the new pro-EU government in Kyiv is one of grim determination, reports Ash. However, now the new government is in place, optimism that it will make the sweeping changes needed is in short supply.

The form of the new reform package is key. Ukraine's politicians need to push through a radical package of change that finally addresses the country's endemic and deeply rooted problems. Over the last two decades the oligarchic client system that passed for government has failed to make any reforms whatsoever, which is why the per-capita incomes in Ukraine are less than a third of those in Belarus, let alone a relatively well off country like Russia.

But here too the outlook is not good. The IIF argued in its report that a fatal flaw was perhaps not to change the electoral law in favour of a fully proportional representation system in October's parliamentary election. "The result being that the constituency-based system saw many vested business interests (some still linked to the old regime) still get into parliament. These are likely to be impediments to more wholesale but much needed structural reform," says Ash. 

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