RaboResearch - Economic Research

Country Report Ukraine

Country Report


Ukraine flag

While the financing deal with Russia alleviates Ukraine’s external financing pressures in the short term, the deal is not without risk. The recent anti-government protests have increased pressure on President Yanukovych’s hold on power. Meanwhile, the domestic currency remains under pressure.

Strengths (+) and weaknesses (-)

(+) Strong agricultural and industrial sector

Ukraine is one of the top ten wheat exporters in the world and has a diversified heavy industry of which the steel sector is the most important.

(-) Weak fiscal balance

Government finances are in bad shape, as fiscal policy is weak and the budget balance continuously records deficits of around 4-6% of GDP.

(-) Weak external position  

The external position is structurally weak, as Ukraine continuously posts current account deficits (8.3% in 2013) , the level of FX-reserves is falling (only two months of import cover at end-2013)and downward pressure on the domestic currency remains.

(-) Authoritarian rule and embedded corruption

President Viktor Yanukovych rules Ukraine in an authoritarian manner while corruption within the government and business elite is widespread and pervasive.

Key developments

1. Financing deal with Russia is not without risk

Ukraine chose a financing deal with Russia in December 2013 after months of negotiations to seek the best terms for a loan with several other parties such as the EU, IMF and China. The deal with Russia provides the most immediate relief to Ukraine but is not entirely without risk. Russia promised to buy USD15bn in Ukrainian government debt over the next 12 months, including USD 3bn in 2013. Furthermore, Russia agreed to significantly lower its gas prices for Ukraine. The debt deal should avoid a default in mid-2014 and may give the president sufficient fiscal leeway to avoid unpopular hikes in household and public-sector gas tariffs, as demanded by the IMF as conditions for a loan. The lower gas price should also ease budgetary strains and pressure on foreign-exchange reserves and the hryvnya (HRN). Russia also promised an end to its trade protectionism and renewed industrial co-operation in the defense sector, which could boost the East Ukrainian economy. The total deal package sounds promising for Ukraine, but it is not without risks. Russia has already delayed the next tranche until it has studied the government’s policies. It remains a possibility that Russia could demand Ukraine’s accession to a Russia-led Customs Union 

Figure 1: Weak external position
Figure 1: Weak external positionSource: EIU
Figure 2: Social & governance indicators
Figure 2: Social & governance indicatorsSource: See factsheet

and/or joint ownership and control of the gas transit system down the line. Russia could demand this as it now has considerable leverage over President Yanukovych. He will be dependent on Russia fulfilling its pledges to buy Ukrainian debt, particularly if the 2014 budget is now set in a manner that excludes a new agreement with the IMF. That fiscal support can in theory be withdrawn at any time, leaving the Ukrainian president beholden to his Russian counterpart. Similarly, the restoration of "cheap" gas to Ukraine is a temporary phenomenon. The reviled 2009 gas contract, with its take-or-pay obligations and indexation to oil product prices, remains in place. All Mr. Putin has agreed to is the application of a further discount in order to bring down the price to USD 268.50 per 1,000 cubic meters; but this discount must be agreed quarterly, or it will be removed and Ukraine will again be obliged to pay over USD400 per 1,000 cubic meters, unless oil prices weaken.

2. Opposition pressure on President Yanukovych increases

The decision of President Yanukovich not to sign the long-planned Association Agreement with the EU in November 2013 sparked large protests. They have since developed a sharper anti-government sentiment but we expect that Mr. Yanukovych is likely to maintain power at least in the short term. Since the ranks of the ruling Party of Regions (PoR) did not break in a vote of no confidence in December, and none of the main business-political groups behind the president have abandoned him explicitly, Mr. Yanukovich initially did not budge to protesters’ demands but responded by suddenly signing new laws which target protesters and opposition lawmakers. However, this fuelled the protesters’s anger and Mr. Yanukovich was forced to repeal the new laws and sacked Prime Minister (PM)Mykola Azarov. Replacing PM Azarov poses a dilemma for Mr. Yanukovich: if he appoints a pro-western PM he will appease the opposition, but he risks aggravating Russia which could lead to a delay in disbursements in the USD 15bn loan and vice versa.  At the time of writing, the protests are being sustained and have become more violent. Increasing pressure from the opposition could force Mr. Yanukovich to call for early elections, which are currently planned for March 2015 and which he might then lose. However, only if defections by oligarchs and Mr. Yanukovych's supporting political and business elite begin, this would put his hold on power at great risk in the immediate term.

3.The domestic currency remains under pressure

Ukraine's currency, the hryvnya (HRN), has come under stronger downward pressure in recent months. The HRN’s fixed peg to the USD at the official rate of HRN 7.99:USD1 has been in place since 2011. The reasons behind the pressure on the HRN are numerous, but include a continuing recession, a very wide external deficit, a large government debt repayment schedule in 2014-15, and the very high borrowing costs on international markets that the government now faces. However, two particular factors have triggered the latest bout of depreciation pressure. The first is a fall in official reserves and the second is an upsurge in political unrest. FX-reserves have been on a downward trend since late 2011, from EUR 30.4bn in 2011 to an estimated EUR 19.4bn at end 2013. Successive governments have prioritised exchange-rate stability because of fears about the impact that devaluation could have on repayments of foreign-currency debt. Reserves began to fall sharply again from May 2013, as investor sentiment towards emerging markets soured, forcing the government to use reserves to meet its debt repayments. Political risk has increased since the anti-government protests continue and no short-term solution is in sight. This could feed exchange-rate volatility further, perhaps eroding Russia's loan more quickly than the government had hoped. 

Factsheet of Ukraine
Factsheet of UkraineSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Before its independence in 1991, Ukraine was the most important economic component of the former Soviet Union after Russia, producing about four times the output of the next-ranking republic. Its fertile black soil generated more than one-fourth of Soviet agricultural output, and its farms provided substantial quantities of meat, milk, grain, and vegetables to other republics. Currently, Ukraine remains one of the top ten wheat exporters in the world. The country has a diversified heavy industry, produces unique equipment such as large diameter pipes and vertical drilling apparatus used in other industrial sectors and mining sites. A very important sector is the highly cyclical steel industry, since steel and other non-precious metals are Ukraine’s largest export product. Fuel and energy are Ukraine’s largest import product, since the industrial sector is heavily dependent on imported gas to meet its energy needs. Structural reforms are needed to improve the economy including fighting embedded corruption, developing capital markets, and improving the legislative framework. While a new wave of privatizations could create market dynamism, from a long-term perspective, institution building is essential.

On the surface, Ukraine’s political scene is often said to be polarised between pro-Western and pro-Russian camps. Even though there is a stark contrast between market-oriented and state-oriented thinking, however, the political reality is more complex. Ukraine has various oligarchical political and business elites that are in fierce competition for the country’s leadership, which from time to time results in political turmoil. 

Economic indicators of Ukraine
Economic indicators of UkraineSource: EIU

naar boven