You're reading: Ukraine will start 2012 in precarious condition

Three years ago Ukraine’s economy was devastated by the global financial crisis.

Heading into a second, possibly more destructive phase, the country is better positioned to weather the storm, but still exhibits similar vulnerabilities to 2008.

The next year will not be easy for Ukraine. Central bank reserves are melting, capital is drying up, and a global slowdown is depressing prices as well as demand for Ukraine’s top export – steel.

The fundamental weaknesses which caused Ukraine’s gross domestic product to plunge an astonishing 15 percent in 2009 have not been addressed. While increased spending linked to the Euro 2012 soccer championship and autumn parliamentary elections should cushion the blow, 2012 promises to be tough for businesses and citizens alike.

The big unknown is the fate of the euro zone. The European Central Bank unleashed its biggest refinancing operation ever on Dec. 21, lending more than $630 billion to banks. Nonetheless, Europe’s leaders seem more focused scaring European Union states into federalizing than in solving the financial mess.

Failure to do so, warned International Monetary Fund head Christine Lagarde, would result in “retraction, rising protectionism, isolation,” in short, a new Great Depression.

Even in the optimistic scenarios, Western Europe is looking at several quarters of mild recession. This will surely affect Ukraine’s gross domestic product growth for 2012, which remains vulnerable to external shocks.

The World Bank recently cut its projection to 2.5 percent.

Yet it is not the slowdown that causes the most worry, but rather imbalances. Indeed, Ukraine’s current situation very much resembles that of end-2008 – falling exports, bloated energy imports fueled by rising gas prices and falling capital inflows.

Metal exports seem particularly fragile. Indeed, the international investment bank Troika Dialog recently cut 2012 earnings projections by 30-50 percent citing a “7 percent drop in steel prices and more prevalent transfer pricing than previously expected.” Meanwhile, state energy company Naftogaz is likely to drive the budget further into the red.

President Viktor Yanukovych said on Dec. 19 that the company currently has “$6 billion in losses on its balance” due to subsidies on household natural gas prices and high prices for Russian gas.

How big of an effect this will have depends largely on 2012’s second big unknown: Cooperation with the IMF. Ukraine is supposed to repay the lender $3.8 billion next year, in addition to close to $3.9 billion in sovereign debt due.

A renewal of cooperation, however, will almost certainly be conditioned on fulfilling the financial institution’s demands, such as moving away from a currency tightly pegged to the dollar and raising natural gas prices for households.

Both, however, constitute big political risks for Yanukovych’s dominant Party of Regions party ahead of the parliamentary elections set for Octoberr. Speaking at a press conference on Dec. 21, Yanukovych said raising gas prices for households – which consume domestically produced but heavily-subsidized gas – was off the table.

With devaluation pressure on the currency building, the past months have witnessed some of the most unorthodox central banking in history, suggesting the authorities badly want to avoid concessions.

The National Bank of Ukraine introduced currency exchange controls for citizens, government issued “devaluation-insured” dollar-denominated debt and central bankers even created “gold coins and certificates” for citizens.

According to Oleksandr Sugonyako, president of the Ukrainian Bank Association, these have no clear backing and are a sale of yet “unmined gold in Ukraine.” No worries, though, as the national bank is on top of this: A law passed on Dec. 22 allowed it to mine for precious metals.

Wacky as these measures may seem, their purpose has been rational. Ukraine’s citizens have $50-$70 billion in savings, explained Sugonyako, an amount the central bank would like to use to replenish reserves. Expect moves in this direction to continue.

Gas price negotiations with Russia will also play a major role. At present it seems the only concession Russia will offer is payment for gas in rubles. But Ukraine has a negative trade balance with Russia, meaning it will need to keep borrowing to pay its gas bills. “This would simply mean replacing the IMF with the RF [Russian Federation],” warned Sugonyako.

Yet even these measures will not be able to withhold the pressure of years of inflation and current account deficits on the hryvnia, experts say. According to a report by the international investment bank JP Morgan, the hryvnia will likely see a devaluation of around 15 percent in the first half of 2012.

While this should boost exports in the mid-term, short term panic would likely ensue. Ukraine’s citizens spent the past months preparing for this, avidly buying up foreign currencies.

Meanwhile, the government seems to be banking on Euro 2012-related investments and revenue filling the state coffers. The soccer championship, as well as the standard pre-election spending may boost domestic demand enough to hold Ukraine through the worst of the upcoming global turmoil. While prospects get much better starting 2013, this remains a risky strategy.

Kyiv Post staff writer Jakub Parusinski can be reached at [email protected].