Dragon Capital’s Tomas Fiala cuts through negative hype on future of Ukraine’s economic plight.
Ukraine’s presidential elections have put the country back into the limelight of the international media, probably for the first time since the Orange Revolution of 2004.
However, apart from worthy praise earned from international observers on the democratic nature of the vote, Ukraine is hardly being seen in a positive light. The country is uniformly condemned for being plagued with corruption, having no clear direction and economic policy, lacking stability – in other words, for not living up to the high hopes of 2004.
In many ways, this criticism is justified. However, considering that Ukraine has just passed through its first severe financial crisis, the country’s economy has coped with the situation comparably well and is putting itself back on a recovery path. The banking sector has stabilized due to the joint effort of the International Monetary Fund, the central bank and the government, as well as the active support lent to local foreign-owned banks by their parent institutions.
The revival of global commodity markets is supporting the recovery of Ukraine’s steel giants, having kept exports and gross domestic product on the rise for three successive quarters. Unemployment has stabilized at approximately 9 percent, which compares comfortably with other countries in the region. Foreign investors’ interest toward the domestic market is clearly reviving, with the local stock index up 273 percent from its bottom in March 2009 and 14 percent since the beginning of 2010.
Yet media and credit rating agencies, such as Standard & Poor’s in a recent report, are painting a far gloomier picture, sounding alarm bells with suggestions that Ukraine could sink into default. If you ignore the messy domestic politics, instead of carefully and calmly focusing on the country’s macroeconomics, it is clear that situation is much better than many headlines and Western reports paint it to be.
Debt level manageable
Ukraine’s level of gross public and private debt had stood at a reasonable 57 percent of gross domestic product just before the crisis erupted in the third quarter of 2008. On this measure, Ukraine had a considerably more secure position compared to many of its peers in emerging Europe and beyond.
Ukraine’s debt ratio then surged due to the national currency’s depreciation and the contraction of GDP, having reached 91 percent in the third quarter of 2009. This level is still considerably below the debt/GDP ratios of such regional peers as Hungary (177 percent), Bulgaria (116 percent) or Kazakhstan (100 percent).Looking at the composition of gross debt brightens the picture further. Despite the influx of nearly $13 billion of IMF financing (including $2 billion in special drawing rights), Ukraine’s external public debt in the third quarter of 2009 amounted to $24 billion, or less than 21 percent of GDP and 23 percent of its total external liabilities. The government needs to repay a mere $1 billion out of this amount in 2010 – a fraction of the country’s current international reserves totaling $25.3 billion. Domestic public debt amounted to $12 billion, or 10 percent of GDP.
The private sector debt should also be analyzed more accurately. External liabilities in the private sector amounted to nearly $80 billion as of late last year. According to the National Bank of Ukraine’s estimates, approximately $18-$20 billion of this amount matures in 2010 (net of trade credits).
Refinancing the bulk of these liabilities does not seem a “miracle scenario” at all, if one keeps in mind that out of the estimated $28 billion that fell due in 2009, 82 percent was rolled over. The primary reason is related-party lending, which accounts for a majority of the above liabilities. This type of lending is a commonly used form of direct equity investing in Ukraine. The rollover rate may be even higher this year as the anticipated post-election political stabilization should open access to new external financing.
Not surprisingly, the state budget suffered from the economic downturn, as did budgets all over the world. We estimate that last year’s budget gap reached 8-9 percent of GDP (including the consolidated budget deficit and the deficits of the Pension Fund and the state-owned energy company Naftogaz), or approximately $10 billion. In the course of the year, the IMF provided $7 billion for budget support (including $2 billion of special drawing rights used for budget purposes), leaving little need for money printing.
Unlike in many other economies, Ukraine’s National Bank has kept a firm grip on the money supply which created conditions necessary to stabilize the currency and reduce inflation to approximately 12.3 percent in 2009 from above 20 percent in 2008.
IMF lending remains key to unlocking access to non-inflationary sources of budget deficit financing for Ukraine. Fund representatives have indicated that they are likely to restart lending following the presidential elections, and Victor Yanukovych, the likely next president, has confirmed his intention to continue cooperation with the IMF.
Despite the bitter aftertaste left by the recent crisis, foreign investors’ appetite for Ukrainian risk is growing. Encouraged by the buyout late last year by Russian groups of a leading Ukrainian steel group, Industrial Union of Donbass, the local stock market surged by 14 percent in 21 trading days or since the beginning of the year, with some blue chips gaining as much as 50 percent. Braving the looming elections, prices on Ukrainian sovereign bonds rose by 2-3 percent, while yields declined to 8.5-10.8 percent, moving closer to their pre-crisis level. Average daily liquidity went up by more than 100 percent in January compared to December 2009, driven by both local and foreign money.
Now that we put the elections phase behind us, both the foreign investment community and local businesses are looking forward to clear policy signs from the newly elected president. There is universal hope to see actions that would reduce the country’s perceived risk and let it benefit from its current undervalued position.
Tomas Fiala is managing director of Dragon Capital, Ukraine’s largest investment bank. He can be reached via email@example.com.