After a tortuous couple of years when Ukraine hit the lows on both the economic and political fronts, the country desperately needs a period of stability in order to regroup and recover. Presidential elections in February have provided some hope in this regard.
Viktor Yanukovych’s victory in the second round presidential vote was decisive enough as to create momentum behind a Regions-led coalition which eventually secured majority-backing in parliament in early March. While the constitutionality of the parliamentary vote can be questioned and is being challenged in the courts, the fact that the coalition and government were quickly formed and early elections avoided is a definite plus from an investor perspective.
The fact that the presidency, parliament and the executive are now controlled by the same coalition holds out the hope of more effective policy making in what is still an acutely challenging domestic and global environment. The hope is that the new administration makes good use of its fresh and hopefully more stable mandate.
First signs from the new administration are encouraging. In Mykola Azarov the new president has appointed a capable and experienced prime minister. Azarov is well versed with the levers of power in Ukraine, and as an economist is also likely to be understanding of the problems.
Azarov is complemented with the appointment of Sergiy Tigipko as deputy prime minister, who brings to the table his experience of banking and the private sector. Yanukovych has also surrounded himself with a number of respected economists, including Iryna Akimova, as deputy head of the presidential administration.
Second, the administration appears to accept that it needs outside assistance, and has indicated a desire to move quickly to secure the resumption of funding from the International Monetary Fund. An IMF program is important both for the funding it would provide but also for the blueprint for reform and the positive signal that this will provide to investors.
Third, the economic backdrop for the new administration is reasonably supportive. The 15 percent real GDP drop in 2009 provides a very low base for the economy to bounce in 2010. Global demand and prices for metals, Ukraine’s key export, have begun to stabilize. Ukraine’s external financing gap has largely been closed. The real effective exchange rate is still around one-fifth below its levels before the crisis hit in September 2008, which should still provide support to the balance of payments and to the recovery more generally. Indeed, it is not inconceivable to think of a real GDP bounce in 2010 of 4-5 percent, which would also help the government’s fiscal position.
Finally, relations with Russia have significantly normalised over the past year, helped by the gas price agreement reached in January 2009, which makes the gas supply arrangement between the two countries much more transparent. The politics and economics of the gas supply/transit industry have also significantly changed with the advent of new sources of supply for Europe. This has made Russia much more eager to ensure supply stability, as was evident from its desire to avoid a repeat of previous gas price disputes over the past winter.
Nevertheless, significant challenges remain. Cutting a deal with the IMF will require the government to make difficult choices, particularly on the fiscal side. Domestic gas prices need increasing to market levels, not just to close the gaping deficit at Naftogaz, which the government covers, but also to provide an incentive to improve energy efficiency. What better time to undertake these reforms than as part of an IMF program, which will help fund programmes to target subsidies at the poor?
The government will also need to make choices as to how it plans to fund hikes in wages and pensions, legislated late in 2009. The Fund is likely to support these increases, if savings can be made elsewhere in the budget; albeit this is still likely to be difficult in practice. The government also seems eager to secure a lower gas price from Moscow, to secure lower energy import prices for Ukraine, although Moscow seems happy with the current agreement and the obvious question is what Kyiv can offer in return.
Ukraine needs to make painful reforms. But it has a new administration with a fresh mandate and reasonable prospects of support from the IMF and other bilateral creditors. Ukraine’s problems are manageable – its debt burden is not yet unsustainable, and the problems in its banking sector are at last being worked through. It would seem better to get key public finance and structural reforms out of the way early, and while something of a window of opportunity has opened on the macroeconomic front.
Timothy Ash is head of emerging markets research at the Royal Bank of Scotland in London. He is a regular visitor to Ukraine and regularly publishes research notes on the economy and the policy environment. [email protected]
