Can Ukraine weather the summer (economic) storm?

Ukraine, not Greece, is the country in most danger of a default


AMSTERDAM, July 31, 2015 – Which country in the world now has the highest probability of default? If you said Greece, you’ve been watching the news too much. Even after narrowly avoiding a would-be catastrophic default on June 24 when it paid a $120 million Eurobond coupon to service its sovereign debt, Ukraine is still credited by Bloomberg with a 27 percent chance of default in the coming year. The country’s real test, however,  is just a month away when it is due to pay another $1 billion to bondholders in September, followed by a controversial $3 billion payment to its neighboring Russian aggressor in December.

With debt now ballooning to 158 percent of GDP and the economy set to shrink by 9 percent in 2015, Kiev has desperately been trying to strike a deal with its foreign creditors, who hold $8.9 billion of Ukraine’s $19 billion debts, to undertake a 40 percent haircut on its debt, worth $15.3 billion. But as the clock ticks on with Ukraine having until early fall to secure an agreement, international creditors led by the Ad-hoc Committee of Bondholders Ukraine have consistently rejected calls to provide Kiev with debt relief and insist that Ukraine’s financial woes can be resolved without a debt write-off. Despite the recent repayment and a new proposal submitted by Kiev’s officials signaling signs of progress, the most outspoken and largest holder of Ukraine’s debt, investment firm Franklin Templeton, has largely argued through representative Michael Hasenstab that a haircut sends “the wrong signal to global capital markets” and that the country merely needs time to stabilize and allow the economy to recover.

For its part, Ukraine has denounced such statements, fearing that without debt reduction the country could sink into an economic void unable to support an increasingly frustrated and angry population.  Even former Treasury Secretary Lawrence Summers argued that “the case for [Ukraine’s] debt reduction is as strong as any that I have encountered over the past quarter-century.” Without the deal, Ukraine will forfeit access to the rest of the $40 billion IMF package set aside to stabilize the country’s economy, and with cash running out fast, Ukraine could be right on track for an autumn default. Even worse, by losing its ability to access IMF bailout funds, the country will grind to a halt.

Investors on the run

Ukraine’s other immediate, and some would say more crucial, conundrum is the ability to attract foreign investors to prop up the country’s economy.  Despite the likes of Georges Soros toying with the idea of a $1 billion investment in Ukraine, claiming that the country offers immense opportunities at a low price, others have shied away from exposing themselves to the risky black hole of Ukraine’s business environment and endemic government corruption.

The question of reforms and the establishment of a new style of governance, moving away from the burdensome, corrupt and ineffective Soviet-era system, has been an important one. The government needs to tackle the bureaucracy, stamp out corruption and create a more business-friendly environment if it is to see enough foreign investment to provide more growth, insists Olena Bilan, chief economist for the Kiev-based Dragon Capital investment bank. Despite significant efforts from Ukrainian officials to bring in new reforms, evidenced by recently passed laws on utility prices, anti-corruption steps and deposit guarantees, these will not bear fruit in time for the country to attract the necessary investment it needs to stave off economic collapse.

For many investors, Ukraine remains an unstable environment, with many fearing that not much has changed in Kiev’s way of governance. Indeed, in the framework of President Poroshenko’s war against oligarchs, the campaign has come off to critics as a war against his opponents. So far, Poroshenko has attacked Ukraine’s biggest tycoons: Rinat Akhmetov, the counry’s richest man; Ihor Kolomoisky, disgraced governor of the Dnipropetrovsk region; and Dmitry Firtash, a gas a chemicals mogul who recently won a court case in Austria against his extradition to the U.S. After having 500 million cubic meters of gas confiscated from his company Ostchem and surviving attempts by the government to revoke the license of his TV channel Inter, Firtash has become a vocal voice in denouncing Poroshenko’s moves to use the oligarchs as “scapegoats.” Indeed, Poroshenko (himself an oligarch worth billions) has failed to keep his election promises and sell his chocolate empire Roshen and his TV channel 5, causing some to conclude “he has failed to introduce a new kind of politics” – the very ideal of the Euromaidan.

Mustafa Nayyem, a Ukrainian MP in Poroshenko’s bloc and a former journalist whose Facebook post spurred the original Maidan movement, questions the “will of politicians to reform” and predicted that at this rate it will take from five to seven years for a new order to emerge in Ukraine. Such a long time frame to instill the confidence of foreign investors in the country may be too little too late. With the economy having plummeted 23 percent since 2012 and with a potential default looming over the horizon, it’s high time for Ukraine to fully commit to its promises and for Poroshenko to lead by example.

For starters, by letting go of his own business interests, Poroshenko can signal to the international community that the country is serious about changing the way the government functions. Focusing on commitments to ease procedures for doing business, eliminating the bureaucracy that all to often leads to graft, and creating a more efficient and accountable system of law will go a much longer way both in terms of gaining the trust of foreign investors and in stabilizing the economy. In return, international creditors should give the country a break and agree to a restructuring of debt, not just for the sake of easing Ukraine’s debt burden, but also in order to send a strong message that Ukraine is on the right path. As the summer sizzles on, the next months are crucial in deciding Ukraine’s economic and political fate.

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