17/5/15: Forbes Opinion Piece on Ukrainian Crisis

An interesting, unorthodox - for Western media - perspective on the Ukrainian crisis and Russian longer term problem: http://www.forbes.com/sites/dougbandow/2015/05/11/ukraine-fight-flares-again-u-s-should-keep-arms-and-troops-at-home/


Note: as usual, my reposting of the material does not qualify as an endorsement of the views presented.

27/3/2014: Troika of Sorts for Ukraine: IMF's chip are on the table

IMF announced the agreement to provide USD14-18 billion in Stand-by Arrangement with Ukraine.

This is a 'troika'-like arrangement:

• 2 year stand-by line of credit
• Total package of USD27 billion
• IMF share of the package USD14-18 billion
• Main funding vis bi-lateral and multilateral agreements
• Presumably multi-lateral will envolve EU
• Bilateral packages are for US and possibly Russia

Macro analysis:

“Ukraine’s macroeconomic imbalances became unsustainable over the past year. The (until recently) pegged and overvalued exchange rate drove the current account deficit to over 9 percent of GDP, and a lack of competitiveness led to the stagnation of exports and GDP. With significant external payments and limited access to international debt markets, international reserves fell to a critically low level of two month of import in early 2014. The 2013 fiscal deficit was 4½ percent of GDP, and the government accumulated sizeable expenditure arrears. The 2013 deficit of the state-owned gas company Naftogaz reached nearly 2 percent of GDP, driven by the sharp increase in sales at below-cost prices. Without policy action, the combined budget/Naftogaz deficit would widen to over 10 percent of GDP in 2014."

So in other words, 2013 combined deficit was around 6.5% of GDP, but 2014 deficit - following 'some stabilisation' (see below) is to reach 10% of GDP. I wonder why?.. Is it down to expected price increases on gas and oil? Or is it down to the havoc wrecked by Maidan protesters? It is certainly not down to the Crimean crisis, since removal of Crimea off Kiev's books should save the Ukrainian Government money.


“Following the intense economic and political turbulence of recent months, Ukraine has achieved some stability, but faces difficult challenges. To safeguard reserves and address currency overvaluation, the National Bank of Ukraine (NBU) floated the exchange rate in February. Measures implemented in February and March helped stabilize financial markets and ensured that critical budget payments have been met. Nonetheless, the economic outlook remains difficult, with the economy falling back into recession. With no current market access, large foreign debt repayments loom in 2014-15."

Now, key question here is why is Government deficit rising if currency is being devalued? Especially as official debt levels in the Ukraine are relatively low? Is it because Ukraine running huge current account deficit (even with subsidised prices for Russian gas)?


"Monetary policy will target domestic price stability while maintaining a flexible exchange rate. This will help eliminate external imbalances, improve competitiveness, support exports and growth, and facilitate the gradual rebuilding of international reserves.  The NBU plans to introduce an inflation targeting framework over the next twelve months to firmly anchor inflation expectations."

This is pure nonsense. Devaluation is bound to drive inflation up. Rebuilding economy will require lower interest rates, which will further support high inflation. What on earth can NBU do to set price stability as its objective? Dollarise the economy? Tried and failed in the form of pegs, and given the role of Maidan (populist movement) how can vast amount of pain be inflicted on the economy to drive price inflation to reasonable bounds?


"Financial sector reforms will focus on: (i) ensuring that banks are sound, liquid, and well-capitalized; (ii)  upgrading the regulatory and supervisory framework of the NBU, including complying with international best practice and supervision on a consolidated basis,  and (iii) facilitating resolution of non-performing loans in the banking sector."

The above reads like a Cyprus-Greece scenario. Good luck finding Russian oligarchs to hit with a deposit tax.


"The initial stabilization in 2014 will be achieved through a mix of revenue and expenditure measures. For 2015-16, the program envisions a gradual expenditure-led fiscal adjustment—proceeding at a pace commensurate with the speed of economic recovery and protecting the vulnerable—aiming to reduce the fiscal deficit to around 2½ percent of GDP by 2016."

Yes, I know… it is… austerity. Higher taxes, lower spending, followed by lofty lower spending and lower spending. I think we shall recall that the current Government has been installed into place by the populist uprising.


"A key step is the commitment to step by step energy reform to move retail gas and heating tariffs to full cost recovery, along with early action towards that goal."

Read: 40% hike in domestic gas prices is only the beginning.


In conclusion, IMF release focuses on real issues - institutional deficits in terms of governance, corruption, procurement, transparency. All are laudable and much needed.

The key takeaways:

1. The entire package is still up in the air as to bilateral and multilateral funding - sources, costs, etc;
2. The package still needs engagement from Russia - majority of the above fiscal measures will require serious pain to be imposed and this pain can be ameliorated by Russia restructuring Ukraine's debts and providing some transitioning assistance on energy front, as well as continuing to give Ukrainian firms access to its markets;
3. The package is cheap from IMF's point of view (small outlays over short term) but is heavy on Ukrainian reforms side (needed, but how feasible in the current political environment?);
4. This is not a Marshall Plan I called for - it lacks clarity on the final cost of funding (which should be close to zero) and it lacks maturity span (which should be 20 years or so);
5. Overall, the reforms sketched out above are likely to lead to another Orange/Maidan Revolution in few years time and the funding that backs them is unlikely to provide support for political stabilisation.

Let's wait for more details on the above points.




Details here (click on individual image to enlarge):

10/3/2014: Crimean Crisis: NewstalkFM podcast

There was a very robust and interesting discussion of the Ukrainian crisis (including Crimea) last night on NewstalkFM Marc Coleman's show. Podcast http://russianireland.com/index.php/home/news-mainmenu/politics/7791-2014-03-10-08-52-48

Very good panel (excluding my small contribution). 

19/2/2014: Ukraine's Political Economy is… political first, economy last

This week's acceleration in the Ukrainian crisis is moving the country closer to the final denouement of sorts. Sadly, the one we are currently facing is of a less palatable variety: absent strong (majority, not plurality) mandate, any Government - be it new or old - will face continued chaos, political upheaval, internal in-fighting, external corruption and voter polarisation, with little hope for a constructive outcome (for the outline of a constructive resolution, see: http://trueeconomics.blogspot.com/2014/02/622014-what-does-future-hold-for.html).

With this, there is little hope for a sustained economic recovery on the horizon and investors are likely to remain in the state of high alert and volatility.

Tried measures to-date have failed:

• Removal of the Prime Minister and early negotiations between the incumbent regime and the opposition was not enough to clear a path to a shared power arrangement;
• Amnesty for protesters and reversal of the anti-protest law were not enough to clear the barricades; and
• A crackdown on protesters is unlikely to yield significant stabilisation, but will certainly amplify polarisation, making a shared power arrangement infeasible and further mobilising the internal splits amongst the already fragmented and fractious protest groups.

Thus, the only way forward will be for President Yanukovich to call early elections and resign prior to these - an outcome that is likely to solidify deep divisions within the electorate and shatter the opposition. In the long run, the outrun of snap elections will be the worst case scenario, since a poll today will be unlikely to generate a stable government. A presidential vote in current environment will simply force Ukraine into the perpetuation of a lingering conflict that the country entered following the Orange Revolution.

Crucially, Russian debt support for Ukraine is likely to be revised if the elections produce an anti-Russia Presidency, and absent this backstop, Ukraine will require full EU and/or IMF assistance. Securing this assistance will be very painful and is likely to throw a newly elected leadership into another crisis. Furthermore, Ukraine seeking EU funding is a can of worms that no one, least of all Brussels, would want to open.

Absent a very strong popular mandate for an established and well-known (aka predictable in her/his policies) Presidential candidate, the uncertainty will continue weighing heavily on bond yields, the battered currency and the economy. This is already reflected in the analysts' valuations, with S&P rating Ukraine as CCC+ for foreign currency debt, with outlook negative, while ECR rates the country in the highest risk tier 5, ranked 125 in the world (for comparison, Russia scores 54.62 in ECR and is ranked 51st in Tier 3 risk category).

Economy will continue stagnating or even contracting in either scenario (continued Yanukovich presidency or snap elections), with GDP heading for another drop in 2014, after a 1.1% contraction now estimated (preliminary data) for 2013.

There is a third alternative to the currently unpalatable ones of snap elections or continued violence: a referendum on splitting the Ukraine into two states. Given that the Ukraine is deeply divided between Western and Eastern parts, the referendum held today will likely lead to a nasty split (Ukraine is no Czechoslovakia when it comes to civil culture, as we can see now). While in the long run this can prove to be the only feasible arrangement, in the short run it will likely turn violent and will lead to massive dislocations in social and economic areas.

About the only possible positive scenario is to combine the two unpalatable ones with a stop-gap in between or a cooling-off period. First, snap elections with a strong Presidential candidate with a base support beyond party-politics of opposition. Second, such a candidate should campaign on a promise to hold - say within 3 years - a national referendum on the future of Ukraine (loose federation or split). Third, following the elections, the President will require tripartite support from the EU, Russia and the IMF to fund a major investment deployment into the economy (a Marshall Plan) so the population can be de facto incentivised into voting to continue with singular Ukraine. Fourth, fingers crossed, prayers said, wood knocked… wait and see if the referendum goes the right way. Wait and hold more cash to help whatever merges out of the referendum to weather massive shock that will follow its outcome.


Some facts on economy:

• GDP USD175.5bn or some 12 times lower than Russia's USD2.1 trillion and below Kazakhstan's USD224.9bn
• GDP per capita (PPP-adjusted) is only 7,4222 international dollars against Russia's 18,083 and Kazakhstan's 14,133.
• Total investment is only 16.2% of GDP against Russia's 25.4% while gross national savings are only 8.91% of GDP against Russia's 28.2%.
• Exports of goods and services down 2.582% in 2013 y/y for the second consecutive annual drop. This compares against 1.96% rise in Russia and 2.44% rise in Kazakhstan.
• Private sector investment is collapsing - down around 13% in 2013
• Unemployment is at 8.2% against Russia's 5.7% and Kazakhstan's 5.2%.
• Government finances are bleak: General Government Revenue is 45.22% of GDP (above Russia's 36.06% and Kazakhstan's 25.65%), Government total spending is at 49.51% of GDP (Russia's 36.71% and Kazakhstan's 20.81%). Total government deficit is 4.29% of GDP against Russia's deficit of 0.72% and Kazakhstan's surplus of 4.84%.
• Government debt: 14.1% of GDP for Russia, 13.24% for Kazakhstan and 42.8% for Ukraine. Ukraine's debt excludes some USD30 billion owed to Russian state lenders and local debts. Combined Government debt is estimated closer to 89% of GDP.
• Current account balance: +2.9% for Russia, +4.3% of GDP for Kazakhstan and -7.3% of GDP deficit for Ukraine.
• On trade side, 27% of goal value of Ukrainian exports flows to Russia, and 30% of imports come from Russia. Volumes of exports and imports to and from the EU are similar.
• On positive side, 2013 corporate tax rate was 19%, dropping to 16% in 2014 (assuming policies remain on track) and will be heading to 10% in 2015. VAT is set to fall from 20% in 2013 to 17% in 2014. Upper marginal income tax rate is 17%.
• Officially, roughly 6.6% of Ukrainian population currently works in Russia. These exclude undocumented workers, which probably bring the numbers closer to 4.5-5 million of 45 million total population.
• Russia-Ukraine deal of December 2013 included a loan of USD15bn to cover Eurobond issue. So far, Russia lent USD5bn back in December 2013-January 2014. Cut in gas prices for imported gas and relaxing the terms on late payments on USD2.7bn for Naftogaz Ukraine accrued under the previous contracts.

Simple, but sad conclusion: Ukraine is economically a failed state. And Ukraine is politically a failed state. Time for the West and Moscow to wake up and smell the roses.


Update: latest CDS moves from CMA:

Ukraine with double probability of default that of Greece... more than 4.5 times that of Russia... What was it that I said about the 'failed state' above?..

Update 2: some ECR scores for Ukraine:

Update: Via ZeroHedge, here is the final agreement between President Yanukovich and the opposition: http://www.zerohedge.com/news/2014-02-21/ukraine-crisis-settlement-agreement-reached-full-statement As argued in my posts, the only sustainable resolution of the crisis will require shared power arrangement backed by enforceable commitments to elections and deep political reforms.