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Strategies & Market Trends : Countries

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From: Sam Citron1/27/2009 11:12:31 AM
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Ukraine Stares Into an Economic-Political ‘Abyss’ (Update2)
By James M. Gomez and Daryna Krasnolutska

Jan. 27 (Bloomberg) -- For Europeans, last week’s resumption of Russian natural gas shipments ended a two-week energy dispute. For Ukraine, it may have ended any hope of weathering the global financial crisis.

The accord with Russia will increase Ukraine’s spending on gas by almost 7 percent, to $9.16 billion, at a time when soaring bond yields are raising the specter of default. Already, Ukraine is living on the first installment of a $16.4 billion bailout from the International Monetary Fund. Further payouts will depend on whether the country balances its 2009 budget, cancels a tax on foreign exchange and strengthens banking laws.

Ukraine hasn’t been so fragile since the early 1990s, following the breakup of the Soviet Union. The economy may shrink as much as 10 percent this year, which would be the deepest recession in Europe except for Iceland’s. President Viktor Yushchenko’s support is close to zero and clashes with Prime Minister Yulia Timoshenko may bring down the government.

“The country is staring into the abyss, both politically and economically,” said Neil Shearing, an analyst at London-based Capital Economics Ltd. “I can’t think of another country that will be hit harder this year” in eastern Europe.

The 2004 Orange Revolution, which brought Yushchenko and Timoshenko to power when both favored joining the European Union and the North Atlantic Treaty Organization, seems far away.

Stalled Membership?

A promise of EU membership hasn’t been offered, and NATO ruled out near-term entry for Ukraine and Georgia last December, though support for Ukraine in the longer term would keep the region stable, said Czech Deputy Prime Minister Petr Necas, whose country holds the EU’s six-month rotating presidency.

“We are interested in having a stable and economically prosperous Ukraine,” Necas said in an e-mailed answer to a Bloomberg question yesterday. “Ukrainian workers undoubtedly contribute to the economic growth in the Czech Republic and we do not regard them as a threat.”

The outcome of the energy controversy has strengthened Russian Prime Minister Vladimir Putin, 56, who said on Jan. 8 that Ukraine’s leadership was “highly criminalized.” Over time, Ukraine’s income from transit fees for natural gas may be jeopardized as Europe seeks or builds more stable supply routes.

Sinking Steel

The dispute with Russia that left Ukraine and other eastern European countries without gas is only the latest in a series of events that brought the country to the brink of collapse.

Global steel prices have fallen 50 percent since a record in July, hurting the country’s largest export and cutting sales for VAT ArcelorMittal Kryvyi Rih and Metinvest BV. The higher gas costs will deepen this year’s expected contraction. Gross domestic product will shrink as much as 10 percent, according to Shearing, and 9 percent based on HSBC Holdings Ltd. forecasts.

Yields on Ukraine’s $105.4 billion of government and company debt, now at 25.67 percent, are the highest of any country with dollar-denominated debt except Ecuador, which defaulted in December.

The gross foreign debt includes direct state debt, including loans from the IMF, the European Bank for Reconstruction and Development; domestic Treasuries owned by foreigners; bank borrowing, including bonds and loans; and corporate debt, including bonds and loans.

The Ukrainian currency, the hryvnia, has lost 38 percent in the past year against the dollar and the benchmark stock index has plunged 75 percent.

Non-Diversification

Like fellow Russian gas customers Bulgaria and Slovakia, Ukraine failed to diversify its power sources or budget for a gas- price increase that Russia has been trying to impose since Yushchenko took office at the beginning of 2005. The agreement between Russian gas exporter OAO Gazprom and NAK Naftogaz Ukrainy will make Ukraine pay market prices starting next year.

The bickering between Yushchenko, 54, and Timoshenko, 48, has gone on since they began sharing power, crippling the government’s ability to pass legislation to strengthen the banking and economic systems and sell unprofitable state assets.

“You can start by putting the Ukrainian government on the stand,” said Fredrik Erixon, director of the Brussels-based European Centre for International Political Economy. “One can blame other factors, but the simple fact is you can avoid the situation you have seen in Ukraine with better policies.”

A Dec. 17-28 survey conducted by the Kiev-based Democratic Initiatives Foundation showed that 84 percent of respondents believed the country was moving in the wrong direction even before the gas crisis started. That compares with 48.6 percent in 2007. The poll of 2,012 people had a margin of error of 2.2 percent.

Poll Results

The poll also found that if presidential elections scheduled for January 2010 were held today, 22.3 percent would support former Prime Minister Viktor Yanukovych, the pro-Russian opposition leader. Another 13.9 percent would pick Timoshenko and 2.4 percent would choose Yushchenko. Almost half said no politician could deal with the financial and economic crises.

“The government was not ready to meet such obvious worldwide financial threats and currently is not able to protect Ukrainians,” said Oleksandr Slobodyanyk, 27, who lost his job more than two months ago as a broker at Concorde Capital in Kiev. “I see no other option but to look for a job abroad.”

The government broke down in October after Timoshenko joined the opposition in stripping the president of some powers. Plans for early elections on Dec. 14 were later dropped after the two leaders re-formed the Cabinet and promised to work together.

Pressure on Central Bank

Now, Yushchenko blames Timoshenko -- who went to Moscow and negotiated with Putin -- for giving in too far to Russian demands. She is trying to oust central bank Governor Volodymyr Stelmakh, an ally of Yushchenko’s.

Former Soviet republics Latvia and Lithuania to the north experienced rioting this month because of anger over government failure to limit the effect of the financial meltdown.

“Ukrainians, generally speaking, have had enough of the government,” said Tanya Costello, the London director for New York-based Eurasia Group. “I don’t think there is a political leader in whom the public has its trust at the moment. So it’s more likely you will see pockets of social unrest.”
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