I recently received an e-mail from an organization, Business Monitor International, hoping that I would purchase their Ukraine Business Forecast Report for 2009. Rather ominously, they forecast “real gross domestic product to contract by an astounding 14.7 percent this year, which will make Ukraine’s economy the worst performing in the world.”
Why has Ukraine been particularly hammered by the global financial crisis? The International Monetary Fund indicated in November 2008, when approving the $16.4 billion standby loan to Ukraine, that the trigger was plunging prices for the country’s major export, steel, that led to a substantial deterioration in the current account.
Since steel accounted for roughly 40 percent of Ukraine’s exports last year, the significant reduction in the receipt of hard currency reserves from its sale exposed underlying vulnerabilities and caused great stresses domestically. The foreign currency loans taken out by banks suddenly became more expensive as the hryvnia sharply devalued when it became clear that there were relatively low foreign currency reserves to support it (or even to meet short-term external debt).
High inflation was sapping its strength and a weak fiscal position did not give potential purchasers of the currency much hope that significant resources would be yielded from tax collection. All this, against a backdrop of a crisis that was drying up liquidity globally, stifled capital inflows.
It is clear that Ukrainian banks and businesses have needed urgent surgery. Typically, for Ukrainian banks this has meant one of two options to prevent creditors from taking enforcement action against them: a standstill agreement, which is an agreement between creditors to give the bank time for information to be collected relating to its indebtedness and for a survival strategy to be put together; and second, temporary administration, a procedure controlled by the central bank, which has been introduced into several Ukrainian banks this year.
Both the standstill agreement and temporary administration procedure provide the necessary cover for a formal restructuring. Creditors can then agree between themselves and the bank, or a temporary administrator, on approving an appropriate formula so that creditors can extract the maximum return from their original investment while the bank management or temporary administrator attempts to ensure the bank can thrive in the future. Issues commonly considered include an appropriate extension to the duration of payment terms under the loans (particularly those that are short-term), an increased interest rate (with payment often left to the end of the term) and whether to convert the currency of the loan.
Only once their debt has been restructured can Ukrainian banks attract fresh capital. If Western money has stopped flowing into Ukraine for the time being, aside from foreign parent banks supporting their Ukrainian subsidiaries, and steel exports remain weak, what new sources are available to keep the economic engine ticking?
A significant chunk of the IMF standby loan arrangement, as well as funding from other supra-governmental international financial institutions. is specifically targeted at bank recapitalization. But the sums involved, although significant, are dependent upon Ukraine undertaking structural reforms. Three banks (Ukrgasbank, Bank Rodovid and Kyiv Bank) currently under temporary administration are to be nationalized and will be pumped with about $400 million each using money received by the central bank from international financial institutions. Nadra Bank may be set to join them in state ownership.
Such reliance cannot continue indefinitely and provides only a temporary fix. To continue recapitalization, the Ukrainian government will need to find money from the over-extended state budget. New investors, domestic or foreign, also need to be enticed. If there is no or little systemic reform, such investors are not likely to be foreign.
What about Ukrainian businesses? Since reforms have been slow in coming, with international capital markets still very hard to access and usual bank credit lines seizing up as banks have struggled to stay solvent by hoarding cash, domestic businesses have tried to survive by preserving cash and pursuing internal restructuring. Following the turmoil and volatility at the end of 2008, the first quarter of 2009 was eerily quiet, as businesses used their remaining cash to meet their fixed costs, reduce headcount, make financial forecasts and set budgets. Many considered which parts of their businesses were worth keeping.
Indeed, many large Ukrainian business groups have been busy refinancing their debts. But with limited international debt market capital available, they are also working hard behind the scenes to spin off non-core assets, liquidate unprofitable businesses and enter into new joint ventures with different partners using pooled capital. In these fraught times, it is the minority investors that are most vulnerable to being squeezed out.
Ukraine is now at a critical juncture. If the restructuring of banks and businesses is allowed to occur without systemic reforms being undertaken and little respect shown to minority investors, then it is plausible that Western investors would be less inclined to return. The chance to kick-start Ukraine into a more open market economy would recede. If Western money dries up, then domestic or perhaps Russian capital will be needed.
It is important to deal both with historic liabilities transparently and fairly, as well as undertake the painful reforms necessary. The manner and extent to which these two issues are tackled will likely determine the amount of appetite that Western investors will have in Ukraine.
Ukraine is a country of enormous potential with a skilled workforce and untapped natural resources. It should not be bottom of the economic table in 2009, or in any year.
John Dakin is an attorney in the Kyiv office of Chadbourne & Parke LLP. Chadbourne & Parke, headquartered in New York City, is an international law firm with 12 offices worldwide. He can be reached at [email protected].
