Whither Ukraine?

By bne IntelliNews November 26, 2012

Ben Aris in Moscow -

Similarities between the US and Ukraine are not immediately obvious, but both countries have just completed presidential elections where the incumbent won, and both are headed toward an economic crisis which if ignored will have severe consequences for their economies. But Ukraine is in a much worse position; while pundits seems pretty confident that US politicians will thrash out some sort of deal to prevent the economy going over the "fiscal cliff" and back into recession, the chances of Ukraine suffering another destructive devaluation of the hryvna are much higher.

In a move that smacks of desperation, on November 19 the National Bank of Ukraine (NBU) announced it was going to use new powers handed to it by the Rada (parliament) at the end of October to force exporters to sell half of their hard currency revenues to the state. The state's foreign currency reserves have tanked in recent months, dropping below the crucial three-months of import cover economists say a country needs to maintain the stability of its currency.

The population is beginning to panic and bought 20% more foreign currency in October, according to the NBU, or $2.169bn in total. The central bank has forced to dip into its reserves repeatedly to defend the hryvnia, contributing to more than a $11bn drop in reserves to $26.8bn as of the end of October, falling 8.5% in October alone.

Economists estimate the hryvna is between 10% and 20% overvalued. The exchange rate was UAH5 to the dollar for several years, but slumped to about UAH8 to the dollar after the collapse of Lehman Brothers in 2008 and the government has been propping it up ever since. The currency lost 44.6% to the dollar between September 2008 and September 2009, but has stabilized at about UAH8. "All these problems are impacting the economy, which slumped to 1.2% in the third quarter, down from 2.5% in the first half of the year, and was in negative territory in October for the first time since the fourth quarter of 2009," says Dmitry Sologoub, an analyst with Raiffeisen Bank International. "The economy is likely to finish the year with little more than 0.5% growth for 2012 and a further worsening cannot be ruled out with growth falling to zero."

Stand-by me

The mandatory sale rule is a throwback to the chaos of the 1990s and Ukraine was amongst the last countries in Eastern Europe to abandoned the rule in 2005. NBU spokesman Oleksandr Kutereshchyn said in the middle of November that the mandatory sale rule would only be in place for six months and it seems the game plan is to buy some time while the government negotiates a bacon-saving deal with the International Monetary Fund (IMF) to re-start the stalled $15.4bn stand-by loan agreement. However, the IMF has dug its heels in and insists on hikes to domestic gas tariffs and more flexibility in the exchange rate, neither of which the government seems willing to contemplate. Indeed, the mandatory sales rule is clearly designed to maintain exchange rate stability and is diametrically opposed to the IMF's stand on the currency.

With Ukrainians in a foul mood following the irregularities in the election that saw President Viktor Yanukovych re-elected, the government appears more interested in maintaining social stability than dealing with the brewing crisis. But the government can't keep this up for long. The hryvna is also under pressure from the widening current account deficit, which also deteriorated sharply in September to $9.3bn in the first nine months of the year from $5.9bn in the same period of 2011, as demand for exports, especially steel, withered on world markets and imported energy costs rose.

Raiffeisen's Sologoub is even more pessimistic about next year and Ukraine's future will depend greatly on what happens in the rest of the world. With little tools available to the government, the only thing that will stave of a worsening crisis is a recovery in the demand for steel. Barring that, the situation will continue to deteriorate.

Still, despite the darkening picture the government has two get-out-of-jail-free cards to play. Either it can cave into the IMF's demands and tap its stand-by loan, or it can cave into Russia's demands to join its Customs Union that comes with a big sweetener: Russia has promised to slash Ukraine's cost of gas to $160 per thousand cubic metres from the current $424, which would go a long way to alleviating the pressure on the hryvna.

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