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EU Economic Collapse Exaggeration – Head of IB, Dragon Capital

Brian Best, head of investment banking of Dragon Capital, a leading Ukrainian investment bank, discussed the possible energy crises in the EU caused by Russia’s war in Ukraine; the effectiveness of sa

Sep. 28, 2022

Brian Best, head of investment banking of Dragon Capital, a leading Ukrainian investment bank, discussed the possible energy crises in the EU caused by Russia’s war in Ukraine; the effectiveness of sanctions against Russia; ways to reduce Russia’s revenue from energy trade; challenges of Ukraine’s economy and investment opportunities for the future, in an exclusive interview with Kyiv Post.

Can Russia’s war in Ukraine lead to an energy crisis and the economic collapse of the EU, as Russian propagandists say?

Economic collapse for the EU is probably an exaggeration. There will undoubtedly be economic hardship this winter as energy prices rise in European countries.

The countries that depend on heating gas will feel the pain of these economic changes. I don’t think it’s going to be something like a collapse of the EU. However, this will put some stress on Western-ally countries and strain the determination of Ukraine’s support. All decisions so far from the political leadership around Europe are that they will continue to stand behind Ukraine.

Analysts say the sanctions against Russia are ineffective due to a rise in energy prices: The Russian budget received more revenues than last year by selling less. Is this true?

Well, yes and no. The prices for the commodities have gone up considerably now, they are selling less regardless of the Russian budget earning more today than before the war, but I don’t think that means that sanctions aren’t working. We should look long-term: I think the sanctions are working quite well in this respect. No one can expect a country like Germany to immediately switch its gas from Russia’s supply to other countries overnight. It just can’t happen. They can do it by the end of 2023 or 2024 – it’s an incredible fit for such a country as Germany. I think the sanctions will work. It just needs some time. Where they are working in technology transfer, Russia, which has natural resources like oil and gas, can earn as much money as possible by selling gas but can’t spend this money on modern technology to replenish weaponry and their army. Then sanctions work in the technology field and will work in the economic field.

Will limiting the price for Russian oil and gas help reduce Russia’s revenue from energy trade?

Indeed, any price cap on the purchase of Russian oil and gas will positively impact Ukraine and its allies because it limits the amount of money Russia can make by selling its commodities. However, I don’t know how easy this is to implement. I leave this for Brussels and politicians to decide.

Is a complete embargo on Russian gas in Europe possible?

I think it is, but it will take time to build capacities for import from other sources. It is an excellent long-term thing for Europe to see that it was so dependent on one single supplier of the resources. Being able to diversify that risk and engage with other suppliers of energy resources will be, in the long term, very beneficial for the EU. How long that will take is another question. All the governments will work actively to implement this and to get it in place as quickly as possible.

What is the economic strength of Russia? How long will Russian authorities have the resources to finance the war?

Russia’s strength is in its resources. Russia has been selling resources since the Soviet Union collapse at huge rates. That’s been providing solid economic growth to Russian for the last 25 years. However, it would be good if Russia used its funds to diversify its economy and, unfortunately for the Russian people, that hasn’t happened. Russia has a highly dependent economy, and it doesn’t have any industry to rely on – IT, the agricultural sector, or an industry that can diversify funds from the other sectors of the economy.

As a result, Russia is highly dependent on natural resources. As the world starts to turn it’s back to Russia as the supplier because of Russia’s aggressive war in Ukraine, it will have fewer and smaller markets to sell its natural resources to. In the long term, it will have a substantial negative economic impact on Russia. I believe that after this war, it will take ten or even twelve years to cover what it’s losing due to its aggression.

In your opinion, the economy of Russia or Ukraine suffered more from the war?

Certainly, Ukraine is suffered more than Russia on relative bases. Ukraine is the one being attacked. A massive amount of critical infrastructure has been destroyed. Cities have been destroyed, and houses razed. Ukraine hasn’t attacked Russia, so the only thing is that Russia is losing is its demographic. Russian people are dying on the battlefield. That will have a long-term negative effect on Russia as well. It already has bad demographics as a country in the longer term. Indeed, Russia will suffer economically, but now it will speed up this suffering.

Ukraine hasn’t hit Russian infrastructure and hasn’t attacked Russian territory. That’s where Ukraine is suffering more than Russia.

What challenges do you think the government of Ukraine is currently facing? Will the national bank succeed in keeping the hryvnia exchange rate stable?

They are doing the best they can, but the state should have foreign currency to keep the hryvnia rate stable. That’s been challenging because of the war, mainly because of the blockage in the Black sea which kept Ukraine from being able to trade grains and other minerals on an international scale.

That limited the foreign currency in the country, so the government was forced to devalue the currency. Right now, the currency spread between the national bank’s official rate and the cash rate on the street is about 10 percent. It increased in the last two days by around 15-16 percent. I think it will go up to 20-25 percent. The government would have to do another devaluation to regain the balance.

However, with the increase in agricultural export, I believe there is a chance we can escape the devaluation of the currency as long as we continue getting agricultural products out of the country.

Are there any merger and acquisition (M&A) activities in Ukraine despite the war? Dragon Capital is actively working with the Ukrainian state – are there any projects in the state sector right now?

Certainly, investment activity has slowed. There are a few M&A transactions this year. One was right before and after the war began, both in the IT sector. This sector is not dependent on Ukrainian territory. People there are mobile or able to work anyway. So, this type of transaction can go anyway. Recently Kyivstar acquired a digital health technology service, an information collection business, and IT space. M&A is happening but on a much slower basis than we were used to. Usually, Ukrainian companies buy other Ukrainian companies. For foreign investors to enter the market, stability and predictability are essential. Right now, it is rather difficult to forecast. I think investors will probably wait until some form of cease fire.

At minimum they will wait until half phase of the war is over and they can put together some proper forecast, and then we might see some more investment activity.

As for Dragon Capital’s work with the state- and state-owned enterprises, we continue to help. Indeed, the Ukrainian government would like to continue raising essential funds for the country. Still, we have to understand that the rates are up, and is this economically feasible for Ukraine to do? We are helping develop structures for the government to allow them to reduce the cost of capital and attract institutional money to the country.

What about the investors who have already invested in Ukraine? Are they selling their Ukrainian assets or waiting for the war to stop?

Those that could sell sold when the war started. There was a lot of activity in the market. Interest rates jumped up, which meant that bond prices were collapsing during the first days of the war. Many of these investors have already exited Ukraine. Those that did not seem able to withdraw or hold their position and wait for the opportunity to buy more at these low prices, or to exit at the current market price. The volume of trade in the market is very low.

A successful development at the front gives us hope for Ukraine to obtain victory. Usually, after the war, there is a recovery. What are the investment opportunities in Ukraine?

I think investment opportunities will be pretty broad. There will be a lot of rebuilding – critical infrastructure first for most – allowing businesses to operate freely. Still, in addition to that, we need housing and to rebuild some business infrastructure destroyed during the war. We are talking about hundreds of billions of dollars of investment capital that would need to come to Ukraine to rebuild the country.

I think investors understand that and are ready to do what they can to invest in the country in the form of new bonds issued as direct investments to private equity or other kinds of investment structures. However, investors want predictability or stability before that happens. We don’t see a lot of investments in the country.

There will be a massive amount of opportunities in Ukraine and an amazing opportunity for Ukraine to clean up its past, and to build a better Ukraine than it was.