4/8/15: IMF Downgrades Ukraine Growth Outlook

IMF just published its Article IV consultation paper on Ukraine. Here are some key points (I am staying out of extensive commenting on these, but emphasis is added in the quotes).

Before we start, it is important to highlight that IMF notes significant breadth and depth of reforms already undertaken by the Ukrainian authorities, albeit warns about potential slippage in future reforms. Given the overall environment (geopolitical and domestic) in which these reforms are taking place, Ukrainian Government deserves a positive assessment of their work in a number of important areas.

"The 2015 baseline growth projection has been marked down to -9 percent (relative to -5.5 percent at the EFF approval), driven by a delayed pick up in industrial production, construction, and retail trade, and expectations of a weaker agricultural season." Note: this is a massive contraction compared to Programme projections.

"Domestic demand will be somewhat more constrained than anticipated earlier by tighter credit conditions and larger-than-expected decline in real incomes amid higher inflation."

"Growth is expected to start recovering in the second half of the year, supported by growing consumer and investor confidence, gradual rehabilitation of the banking system, and restoration of broken supply chains in metals, mining, and energy production. Later on, manufacturing should also start benefitting from the restored competitiveness of Ukraine’s exports. However, the recovery is expected to take hold only gradually through 2016. Medium-term growth projections remain unchanged." Note: you can see projections for following years in the table at the end of this post.

"The 2015 inflation has been revised upwards to 46 percent at end-2015, compared to
27 percent at program approval, driven by the faster-than-expected pass-through effects of the large exchange rate overshooting in March."

Note: again, this is a massive revision on programme-assumed inflation. Take together with the GDP revision above, it is hard to see how the IMF can continue arguing sustainability case for the programme at this stage, without hoping for massive recovery.

"Inflation is projected to recede quickly in 2016 to around 12 percent as the one-off effects subside and economic stabilization takes hold. Monthly core inflation rates are already well below 1 percent and expected to remain in such territory, as the negative output gap, subdued demand, and the stabilization of the exchange rate will put downward pressure on inflation."

Here's an interesting bit: Inflation 'one off' drivers include IMF-required adjustment in energy prices:

"The rapid pass-through of the large exchange rate depreciation in February and increases in regulated energy prices pushed inflation to 61 percent y-o-y in April. As the hryvnia recovered and stabilized in April–June, prices of some imported goods declined while increases in prices of non-tradables remained moderate. As a result, inflation in June moderated to 0.4 percent m-o-m, or 57½ percent y-o-y. The high y-o-y number masks the sharp disinflation that has already occurred: the seasonally adjusted annualized inflation in May–June 2015 fell to 13 percent."

But energy prices are yet to be fully inflated to their targets, so more is to come: "Gas and heating prices increases. Gas prices for households were increased by 285 percent on average, effective April 1. Heating prices were also increased by 67 percent, effective May 8. Despite these increases, gas and heating prices remain among the lowest in the region. The program aims to reach 75 percent of cost recovery gas and heating prices based on international prices by April 2016 and 100 percent by April 2017."

Which, of course, means there will be much more pain for ordinary Ukrainians, comes winter.

"The overall balance of payments remains broadly unchanged. The current account deficit is expected to widen to 1.7 percent of GDP in 2015, compared to 1.4 percent of GDP at program approval. Both exports and imports are projected to decline considerably this year, driven by (i) falling export prices and larger-than-expected loss of export capacity stemming from the conflict; and (ii) the weaker economy and steeper fall of energy consumption."

"Risks to the outlook remain exceptionally high. Risks to economic growth are predominantly on the downside reflecting (i) uncertainty about the duration and depth of the conflict in Eastern Ukraine; (ii) prolongation of the discussions on the debt operation (which could disrupt capital flows); and (iii) slippages in policy implementation. In addition, confidence could fail to revive due to these factors, or due to a more protracted bank resolution process. Higher-than-expected inflation—due to inflation expectations becoming more entrenched—could reduce domestic demand further. On the upside, an early resolution of the conflict could boost confidence and growth faster than projected."

"…Regarding program implementation, policy reversals, including regarding the flexible exchange rate policy and fiscal/energy price adjustment could lead to continuing balance of payments problems and raise repayment risks."

"Against significant headwinds, the authorities showed again their determination to stay the course of the program. ...However, although domestic support for a new Ukraine is strong, pressures from populist forces and vested interests are growing. Moreover, the local elections in the fall pose a risk that the reform momentum could fade."

Bad news on debt levels are:

Note: Public debt levels assume meeting IMF target for restructuring current debt. There is another dreamy feature to both graphs - as with all IMF programmes, debt peaks out in year one. Given past histories, however, the forecasts don;t quite turn to reality.

Another set of bad news: Non-performing Loans (NPLs) as % of total assets was bad in 2013 and getting massively worse now:

And a summary of macro performance indicators and projections:

13/7/15: IMF's Russian Economy Forecasts 2015-2016

IMF WEO update covered, briefly, changes to the Fund outlook for the Russian economy. Here's a summary:

Overall, the only point here is the delayed upgrade to Russian forecast for 2015-2016. Lower rate of contraction forecast for 2015 (from -3.833% in April WEO to -3.4% this time around) and return to (basically zero) growth in 2016 (+0.2% forecast in july compared to -1.096% in April).

In its briefing on the WEO update, IMF said (emphasis mine): "The other country where the numbers are very bad is in Russia. We now forecast Russia’s growth to be negative at -3.4 percent. It’s a bit better than the forecast in April. That comes from a small improvement in commodity prices and a small increase in confidence, but that’s clearly a very large negative number that will lead to a very tough year in Russia."

Additional risk factor, noted by the IMF, is rates reversion in the U.S. and closing on the rate reversion cycle re-start in the euro area: "...this is going to be the year in which the interest rate in the U.S. is going to start increasing. The date by which the interest rate is expected to increase in Europe will also get closer, and so you are going to see tighter financial conditions, which means that capital will tend to go back to where the rates are attractive. So far, it hasn’t been happening on a very large scale. I think we can expect some capital outflows from a number of these countries, and these always create some problems but they can handle, but that is a challenge they are going to have to face."

Just how bad the effect of rates reversion will be is hard to tell. Overall, however, Russian economy has suffered quite significantly from both, the adverse changes in the global credit flows (away from emerging markets in general) and idiosyncratic drivers pushing credit supply lower. Here are two charts covering the latest BIS data we have:

Overall credit:

Credit to non-financial private sector:

And sources of funding:

Source for charts above: http://www.imf.org/external/np/pp/eng/2015/062915.pdf

20/6/15: Danske Outlook & Forecast for Ukraine

Danske Bank outlook and forecast for Ukraine:

17/5/15: Ukraine's GDP down 17.6% in 1Q

Some pretty bad numbers out of Ukraine this week. 

Remember that 1Q 2015 Russian GDP shrunk 1.9% y/y in real terms and the forecasts for 2015 full year decline range between 3% (official forecast) to north of 7% (some Western banks analysts), with the consensus at around 3.8-4.0%.

Now, Ukraine's economy is in the IMF programme and the Fund latest forecast for 2015 full year growth was -5.548%. That is the base on which the so-called debt sustainability analysis is based. Even the World Bank - which forecast -7.5% real GDP decline for 2015 - was contrarian to the IMF optimism.

However, this week official data shows real GDP decline of 17.6% in 1Q 2015 y/y and down 6.5% on 4Q 2014. Exports to the EU are down 1/3rd, exports to Russia down 61% and industrial output is down more than 20%. With inflation at around 60% y/y in April, retail sales are down 31% at the end of 1Q 2015 y/y. 

Good news is - it is likely that 2H 2015 will see some improvement in Ukrainian growth dynamics, just as the same is likely in Russia. But I fear that we are going to see a much sharper contraction for the full year overall, compared to the IMF forecasts. If that turns out to be the case, Ukraine can require restructuring of its IMF 'assistance' package, although much of that risk also hinges on the progress on haircuts negotiations with the private sector creditors. These negotiations have not been progressing too well, so far, but there may be a turnaround in the works. 

In short, Ukraine's 'debt sustainability' charade the IMF has put up is now firmly in crosshairs of two risks - the haircut slippage and economy collapse. And both risks are rising, not falling so far…

2/5/15: IMF to Ukraine: Pain, and More Pain, and Maybe Some Gain

A very interesting IMF working paper on sustainability and effectiveness of fiscal policy in Ukraine that cuts rather dramatically across the official IMF policy blather.

Fiscal Multipliers in Ukraine, by Pritha Mitra and Tigran Poghosyan, IMF Working Paper, March 2015, WP/15/71 looks at the role of fiscal policy (spending and investment) in the Ukrainian economy.

As authors assert, "since the 2008-09 global crisis, which hit Ukraine particularly hard, the government relied on fiscal stimulus to support recovery. In reality, it was the main lever for macroeconomic management… Today, even after the recent float of the Ukrainian hryvnia, fiscal policy remains key to economic stabilization." In particular, "Over the past five years, the government relied on real public wage and pension hikes to stimulate economic activity, sometimes at the expense of public infrastructure spending. Many argue that this choice of fiscal instruments undermined private sector growth and contributed to the economy falling back into recession in mid-2012."

Since the IMF bailout, however, fiscal adjustment is now aiming for a reversal of long term imbalances on spending and revenue sides. In simple terms, fiscal adjustment now became a critical basis for addressing the economic and financial crisis. As the result, the IMF study looked at the effectiveness of various fiscal policy instruments.

The reason for the need for rebalancing fiscal policy in Ukraine is that current environment is characterised by "…the severe crisis, its toll on tax revenues, and financing constraints, necessitate fiscal consolidation. But the challenge is to minimize its negative impact on growth."

In other words, the key questions are: "Will tax hikes or spending cuts harm growth more? Does capital or current spending have a stronger impact on economic activity?"

Quantitatively, the paper attempts to estimate "…the fiscal multiplier – the change in output, relative to baseline, following an exogenous change in the fiscal deficit that stems from a change in revenue or spending policies."

The findings are: "Applying a structural vector auto regression, the empirical results show that Ukraine’s near term fiscal multipliers are well below one. Specifically, the impact revenue and spending multipliers are -0.3 and 0.4, respectively. This suggests that if a combination of revenue and spending consolidation measures were pursued, the near-term marginal impact on growth would be modest", albeit negative for raising revenue and cutting spending.

"Over the medium-term, the revenue multiplier becomes insignificant, rendering it impossible to draw any conclusions on its strength. The spending multiplier strengthens to 1.4, with about the same impact from capital and current spending. However, the impact of the capital multiplier lasts longer. Against this backdrop, the adverse impact of fiscal consolidation on medium-term growth could be minimized by cutting current spending while raising that on capital."

The risks are unbalanced to the downside, however, so the IMF study concludes that "Given the severe challenges facing the Ukrainian economy, it is important that policymakers apply these results in conjunction with broader considerations – including public debt sustainability, investor confidence, credibility of government policies, public spending efficiency. These considerations combined with the large size of current spending in the budget, may necessitate larger near- and long-term current spending cuts than what multiplier estimates suggest."

In simple terms, this means that, per IMF research (note, this is not a policy directive), Ukrainian economy will need to sustain a heavy duty adjustment on the side of cutting public spending on current expenditure programmes (wages, pensions, purchasing of services, provision of services, social welfare, health, etc) and, possibly, provide small, only partially offsetting, increase in capital spending. This would have to run alongside other measures that will raise costs of basic services and utilities for all involved.

The problem, therefore, is a striking one: to deliver debt sustainability, current expenditure and price supports will have to be cut, causing massive amounts of pain for ordinary citizens. Meanwhile, infrastructure spending will have to rise (but much less than the cuts in current expenditure), which will, given Ukrainian corruption, line the pockets of the oligarchs, while providing income and jobs to a smaller subset of working population. Otherwise, the economy will tank sharply. Take your pick, the IMF research suggests: public unrest because of cut-backs to basic expenditures, or an even deeper contraction in the economy. A hard choice to make.

In the end, "More broadly, fiscal multipliers are one of many tools policymakers should use to guide their decisions. Given the severe challenges facing the Ukrainian economy – including public debt sustainability, low investor confidence, and subsequent limited availability of financing – it may be necessary for policymakers to undertake stark consolidation efforts across both revenues and expenditures, despite the adverse consequences for growth."

22/3/15: Ukraine: disastrous growth figures

Ten quarters of shrinking GDP, out of 11 last. Ukraine:

Source: FT

When's the next 'rethink' by the IMF of the debt projections?..

18/2/15: IMF Package for Ukraine: Some Pesky Macros

Ukraine package of funding from the IMF and other lenders remains still largely unspecified, but it is worth recapping what we do know and what we don't.

Total package is USD40 billion. Of which, USD17.5 billion will come from the IMF and USD22.5 billion will come from the EU. The US seemed to have avoided being drawn into the financial singularity they helped (directly or not) to create.

We have no idea as to the distribution of the USD22.5 billion across the individual EU states, but it is pretty safe to assume that countries like Greece won't be too keen contributing. Cyprus probably as well. Ireland, Portugal, Spain, Italy - all struggling with debts of their own also need this new 'commitment' like a hole in the head. Belgium might cheerfully pony up (with distinctly Belgian cheer that is genuinely overwhelming to those in Belgium). But what about the countries like the Baltics and those of the Southern EU? Does Bulgaria have spare hundreds of million floating around? Hungary clearly can't expect much of good will from Kiev, given its tango with Moscow, so it is not exactly likely to cheer on the funding plans… Who will? Austria and Germany and France, though France is never too keen on parting with cash, unless it gets more cash in return through some other doors. In Poland, farmers are protesting about EUR100 million that the country lent to Ukraine. Wait till they get the bill for their share of the USD22.5 billion coming due.

Recall that in April 2014, IMF has already provided USD17 billion to Ukraine and has paid up USD4.5 billion to-date. In addition, Ukraine received USD2 billion in credit guarantees (not even funds) from the US, EUR1.8 billion in funding from the EU and another EUR1.6 billion in pre-April loans from the same source. Germany sent bilateral EUR500 million and Poland sent EUR100 million, with Japan lending USD300 million.

Here's a kicker. With all this 'help' Ukrainian debt/GDP ratio is racing beyond sustainability bounds. Under pre-February 'deal' scenario, IMF expected Ukrainian debt to peak at USD109 billion in 2017. Now, with the new 'deal' we are looking at debt (assuming no write down in a major restructuring) reaching for USD149 billion through 2018 and continuing to head North from there.

An added problem is the exchange rate which determines both the debt/GDP ratio and the debt burden.

Charts below show the absolute level of external debt (in current USD billions) and the debt/GDP ratios under the new 'deal' as opposed to previous programme. The second chart also shows the effects of further devaluation in Hryvna against the USD on debt/GDP ratios. It is worth noting that the IMF current assumption on Hryvna/USD is for 2014 rate of 11.30 and for 2015 of 12.91. Both are utterly unrealistic, given where Hryvna is trading now - at close to 26 to USD. (Note, just for comparative purposes, if Ruble were to hit the rates of decline that Hryvna has experienced between January 2014 and now, it would be trading at RUB/USD87, not RUB/USD61.20. Yet, all of us heard in the mainstream media about Ruble crisis, but there is virtually no reporting of the Hryvna crisis).

Now, keep in mind the latest macro figures from Ukraine are horrific.

Q3 2014 final GDP print came in at a y/y drop of 5.3%, accelerating final GDP decline of 5.1% in Q2 2014. Now, we know that things went even worse in Q4 2014, with some analysts (e.g. Danske) forecasting a decline in GDP of 14% y/y in Q4 2014. 2015 is expected to be a 'walk in the park' compared to that with FY projected GDP drop of around 8.5% for a third straight year!

Country Forex ratings are down at CCC- with negative outlook (S&P). These are a couple of months old. Still, no one in the rantings agencies is rushing to deal with any new data to revise these. Russia, for comparison, is rated BB+ with negative outlook and has been hammered by downgrades by the agencies seemingly racing to join that coveted 'Get Vlad!' club. Is kicking the Russian economy just a plat du jour when the agencies are trying to prove objectivity in analysis after all those ABS/MBS misfires of the last 15 years?

Also, note, the above debt figures, bad as they might be, are assuming that Ukraine's USD3 billion debt to Russia is repaid when it matures in September 2015. So far, Russia showed no indication it is willing to restructure this debt. But this debt alone is now (coupon attached) ca 50% of the entire Forex reserves held by Ukraine that amount to USD6.5 billion. Which means it will possibly have to be extended - raising the above debt profiles even higher. Or IMF dosh will have to go to pay it down. Assuming there is IMF dosh… September is a far, far away.

Meanwhile, you never hear much about Ukrainian external debt redemptions (aside from Government ones), while Russian debt redemptions (backed by ca USD370 billion worth of reserves) are at the forefront of the 'default' rumour mill. Ukrainian official forex reserves shrunk by roughly 62% in 14 months from January 2014. Russian ones are down 28.3% over the same period. But, you read of a reserves crisis in Russia, whilst you never hear much about the reserves crisis in Ukraine.

Inflation is now hitting 28.5% in January - double the Russian rate. And that is before full increases in energy prices are factored in per IMF 'reforms'. Ukraine, so far has gone through roughly 1/5 to 1/4 of these in 2014. More to come.

The point of the above comparatives between Russian and Ukrainian economies is not to argue that Russia is in an easy spot (it is not - there are structural and crisis-linked problems all over the shop), nor to argue that Ukrainian situation is somehow altering the geopolitical crisis developments in favour of Russia (it does not: Ukraine needs peace and respect for its territorial integrity and democracy, with or without economic reforms). The point is that the situation in the Ukrainian economy is so grave, that lending Kiev money cannot be an answer to the problems of stabilising the economy and getting economic recovery on a sustainable footing.

With all of this, the IMF 'plan' begs two questions:

1. Least important: Where's the European money coming from?
2. More important: Why would anyone lend funds to a country with fundamentals that make Greece look like Norway?
3. Most important: How on earth can this be a sustainable package for the country that really needs at least 50% of the total funding in the form of grants, not loans? That needs real investment, not debt? That needs serious reconstruction and such deep reforms, it should reasonably be given a decade to put them in place, not 4 years that IMF is prepared to hold off on repayment of debts owed to it under the new programme?

Note: here is the debt/GDP chart adjusting for the latest current and forward (12 months) exchange rates under the same scenarios as above, as opposed to the IMF dreamt up 2014 and 2015 estimates from back October 2014:

Do note in the above - declines in debt/GDP ratio in 2016-2018 are simply a technical carry over from the IMF assumptions on growth and exchange rates. Not a 'hard' forecast.

12/2/15: IMF's Latest Ukraine 'Package'... It's Political

As expected, the IMF announced a revised package of loans for Ukraine today. Below is the statement with some comments.

Top line conclusions:

1. IMF Extended Fund Facility Arrangement gives Ukraine more breathing space (three years at a shorter end of debt repayments) and avoids significant repayments due this year under the old arrangement.
2. Nonetheless, the new package is still too short in its maturity - Ukraine will need closer to a decade to rebuild the East and own economy, and to implement reforms, while allowing reforms to take hold and start delivering on growth. 
3. IMF funding comes with expectations of European funding and will probably (at this time it is uncertain as no details have been released yet) imply Fund participation to 2/3 of the total package.
4. Ukraine needs not more loans, but a Marshall Plan with loans:grants ratio of 1:1 or close and total package volume of USD60 billion and duration of at least 10 years. In ignoring the grim realities of Ukrainian economy, the IMF has once again gone for a political compromise instead of a real solution.

IMF statement (select quotes):

"February 12, 2015: Nikolay Gueorguiev, Mission Chief for Ukraine, issued the following statement today in Kyiv: “The mission has reached a staff-level agreement with the authorities on an economic reform program, which can be supported by a four-year Extended Fund Facility, in the amount of SDR 12.35 billion (about $17.5 billion, €15.5 billion), as well as, by considerable additional resources from the international community. The staff level agreement is subject to approval by IMF Management and the Executive Board. Consideration by the Executive Board is expected in the next few weeks, following the authorities’ implementation of decisive front-loaded actions to achieve program goals."

So the total package extended to Ukraine is now in the region of USD40 billion. This might be enough, if the hostilities in the East end in the next month or so, and assuming post-hostilities ending, Ukraine regains the regions as a part of at least some Federal structure. Barring that, if the regions gain significant autonomy from Kiev, it is hard to see how the Ukrainian economy can sustain a loss of ca 15-20 percent of its GDP and still fund the debt it will be carrying.

“The policies under the new arrangement, developed by the Ukrainian authorities jointly with Fund staff, are designed to address the many challenges confronting the Ukrainian economy. Economic activity contracted by around 7-7½ percent in GDP in 2014, weighed down by the conflict in Eastern Ukraine, which  has taken a significant toll on the industrial base and exports, undermined confidence and ignited pressures on the financial system. The economic reform program focuses on immediate macroeconomic stabilization as well as broad and deep structural reforms to provide the basis for strong and sustainable economic growth over the medium term."

It is worth noting that in October 2014 WEO, IMF estimated 2014 GDP decline of 6.5% and forecast growth of 1% in 2015, followed by 4% in 2016 and 2017. At an upper reach of the latest estimate, the Ukrainian economy was shrinking at an annual rate of 1.5 percent in Q4 2014. Which is quite surprising as prior to that it was falling by 2.0-2.2 percent per quarter. Meanwhile, EBRD and others are forecasting for Ukrainian economy to shrink 5% in 2015 (a swing of difference of 6 percentage points compared to the IMF dreaming).

Ukraine's “…2015 budget initiates an expenditure-led adjustment to strengthen public finances within the availability of resources. This required bold, but necessary, measures, including keeping nominal wages and pensions fixed. The budget is supported by revenue reforms, including increasing the progressivity of the personal income tax and streamlining the tax system. The authorities are committed to medium term reforms of the civil service and the important health and education sectors, aiming to improve quality and efficiency, as well as widening the tax base and improving customs and tax administration. Fiscal consolidation would continue over the coming years which together with the debt operation envisaged by the authorities will strengthen debt sustainability."

All of this sounds benign, until you think about the impact of these reforms on Ukrainian power base (oligarchs), and foreign investment (sensitive to taxation regime). In addition, behind the 'widening of the tax base' rests a push to increase effective tax burden on general population. Now, consider this: inflation is running at close to 13% pa, hrivna is devaluing, taxes are rising (both in terms of enforcement and rates and breadth of applications), while nominal wages are fixed. And that in a country with GDP per capita (adjusting for PPP) at $8,240.4 in international dollar terms (for cross-referencing, comparable figure is $24,764.4 in Russia). So how soon will there be social unrest boiling up?

Again from the IMF release: “The authorities are firmly committed to deep and decisive measures to reform the critical energy sector. They have developed a comprehensive strategy aiming to foster energy efficiency and independence, increase domestic gas production, and restructure Naftogaz. As part of this strategy, and to rehabilitate Naftogaz while eliminating its drain on the budget, the authorities have decided to implement frontloaded gas and heating price adjustments aiming to reach full cost recovery by April 2017, while protecting the poor through revamping social protection schemes and allocating sufficient budgetary resources. At the same time, efforts are under way to improve Naftogaz’s corporate governance, as well as the framework for payment compliance and recovery of receivables."

What the above means is that cost of energy to middle classes and above will rise and it will rise dramatically. Note two things in the above: one part of this increase will come from eliminating energy subsidies these classes currently receive.  But another shock will come from "eliminating [Naftogaz] drain on the budget" which means that supports for low income earners and the poor in the form of subsidies will have to be loaded onto the rest of the population if Naftogaz were to be a cost-recovery vehicle.

“Monetary policy will be geared toward returning inflation to single digits in 2016 within a flexible exchange rate regime. To strengthen confidence in banks and improve their ability to intermediate credit and support economic activity, the authorities are moving ahead with a multi-pronged strategy to rehabilitate the banking system. The regulatory and supervisory framework will be upgraded, including through measures to address above the limit loans to related-parties; banks’ balance sheets will be strengthened, where needed, following a prudential review of banks; and measures will be undertaken to enhance banks’ asset recovery and resolution of bad loans."

Banking reforms are desperately needed in the Ukraine, as banks are running non-performing loans to the tune of 20 percent and that is before any losses taken on Eastern Ukrainian operations and before we take out foreign lenders who face lower NPLs due to more selective lending to larger enterprises and foreign companies. But driving inflation down to single digits by 2016? Any one can pass the IMF folks a reality pill? Driving inflation down to these levels will require a massive deflation of demand and money supply. Which will cut across bot the above reforms in taxation and wages moderation, and across the banks reforms too.

“Structural reforms will aim at improving business climate, attracting investment and enhancing Ukraine’s growth potential. To this end, the authorities are advancing efforts toward deregulation and judicial reform and implementation of the anti-corruption measures.  They will also proceed with state-owned enterprise reforms, to minimize fiscal risks and improve corporate governance structures and de-monopolization."

All is fine. Except we have no idea what any of it really means. Still, major risk to Ukraine on this front is what will it do replace lost Russian (and other CIS) investments and remittances?


In short, so far, we have very little to go on the IMF latest package fundamentals, but plenty indications that Ukraine is in for some serious, serious social and economic pain in years to come. This pain is necessary. But what is highly questionable is whether this pain is feasible over the 4 year horizon of the new programme. Should Ukraine get some real help: a Marshall Plan with, say at least 50:50 grants to loans ratio and a package worth around USD60 billion over 10 years instead of 4 year loans that only shore up redemptions of other debts?

4/1/2015: "Betting on Ukraine" - Project Syndicate

I have been trying to reduce my commentary on Ukraine to a minimum for a number of reasons, including the viciousness of the 'Maidan lobby' and the fact that Ukraine is not a part of my specialisation.

However, occasionally, I do come across good and interesting commentary on the subject. Here is one example: http://www.project-syndicate.org/commentary/european-union-ukraine-reform-by-andres-velasco-2014-12.

To add to the above: the USD15 billion additional funding required, as reported to be estimated by the IMF, will also not be sufficient. Ukraine will require double that to address investment gap. USD15 billion estimate only covers the short-term fiscal gap.

Note: I called from the very start of the crisis for a Marshall Plan for the Ukraine, and suggested that for it to be more effective it should include Russian participation in funding and economic engagement. Funding Ukraine via standard IMF loans (shorter maturity instruments designed to address immediate liquidity crises) is simply useless. The country needs decade-long reforms and these reforms will have to be accompanied by investment and growth for them to be acceptable politically and socially. Such funding can only be supplied by a structured long-term lending programme. One additional caveat to this is that funding sources must be distinguished from funding administration. Given extreme politicisation of Ukrainian situation, neither Russia, nor the EU or the US can be left to administer actual funding programme. Hence, the task should be given to an World Bank or IMF-run administration mechanism that includes direct presence at the Board level of funders.

13/9/2014: Ukraine's economy newsflow: from bad to worse

A small digest on Ukrainian economy - mostly news, less analysis.

Some grim stats on Ukrainian economy here: http://slavyangrad.org/2014/09/08/statistics-tell-the-tale-irreplaceable-losses-for-the-ukrainian-economy/
A very comprehensive survey, despite some politically loaded statements. Read it for the stats and ignore all political ravings.

Meanwhile, the prospect of Ukraine dipping into gas deliveries destined for Europe is looming as Naftogaz debt continues to rise: http://en.itar-tass.com/economy/747187 and as winter draws closer and closer. The fabled 'reversed flows' from Eastern Europe are not materialising (predictably) and reserves are bound to be running out faster as coal production is all but shut. Per Vice PM Volodymyr Hroisman, ukraine is facing a shortfall of some 5 million tonnes of coal by the end of 2014 and gas shortages are forecast at 5 billion cubic meters. As the result, Ukraine is now forced to buy coal abroad, with one recent agreement for shipments of 1 million tonnes of coal signed with South Africa.

Electricity exports from Ukraine are suffering too, primarily as domestic production falls and demand rises. In January-August 2014, electricity exports are down 6% y/y

National Bank of Ukraine governor, Valeria Hontareva, has been reduced to talking up the markets by delivering promises that the Government will not default on its bonds and Naftogaz bonds. She had to admit this week that hryvna devaluation has now hit 60% y/y (by other calculations, depending on the currency basket chosen it is just above 40%) and inflation is running at 90%. Recall that on September 2, the IMF assessment of the economy which reflected the updates to risks and latest forecasts. Revised programme forecasts now see real GDP shrinking 6.5% y/y in 2014, but growing by 1% in 2015 and 4% in 2016. Hontareva said this week the GDP can fall by 9% this year alone. End of year CPI is expected to come in at 19% in 2014 (which has now been exceeded by a massive 71 percentage points, based on Hontareva statement) and 9% in 2015 before declining to 6.9% in 2016. Hryvna devaluation vis-a-vis the USD was expected to run around 50.6% y/y which is already too conservative compared to the reality, and by another 6.4% in 2015 falling to a devaluation of just 0.8% in 2016. Needless to say, Hontareva's statement suggests that the IMF forecasts, published only 10 days before she spoke, are largely imaginary numbers.

And the streets are voting for this verdict too: in January-August 2014 net purchases of foreign currency were up 6.6 times than in the same period of 2013, while households' deposits in foreign currency fell 13.3%. This suggests that people are stockpiling foreign currency in the safety of their own homes, rather than in the banks. Consumer confidence latest reading, published last week showed a drop of 10.4 points to 54.7, while inflation expectations rose 2.8 points to 188.7 and devaluation expectations were up 22.1 points to 147.8.

Meanwhile, the Government is yet to catch up with the ugly realities. Last week, the Government approved macroeconomic forecasts for 2015-2017 which show expected real GDP growth of 0.3%-2% in 2015, rising to 2.5-4.5% in 2016. Good luck to them...

None of this is cheerful. The country is economically in a tailspin and the Government is currently unable to address multiple and still mounting problems. New elections for the Rada are due, with effectively a caretaker Government in place. The conflict, currently in a fragile ceasefire, is destroying the economy (not to mention lives and society).

Country political crisis is starting to push the anti-Russian and anti-Eastern Ukrainian rhetoric to new highs (e.g. http://www.bloomberg.com/news/2014-09-12/u-s-widens-sanctions-on-russian-banks-energy-defense-firms.html) which is not helping President Poroshenko, who is effectively held hostage by his pre-election promises to bring back Crimea and restore Kiev control in Donbas and the need for pragmatic de-escalation. The President seems to have embraced the latter, but the rest of Ukraine's Government, facing fresh elections, is going on the solo run of beating the anti-Russian drums.

PM Yatsenyuk's ravings are dangerous, although they are also amusing, precisely because they represent blatant political posturing. Last week he went so far as to suggest that Europe cannot exist without Ukraine as a member of the EU (despite the simple fact that no one in the EU ever offered Ukraine a prospect of membership) and that Moscow wants to restore the entire Soviet Union (despite the fact that parts of the Soviet Union today are firmly members of the Nato, while some other former republics are basket cases so poorly run, Russia would have to go bankrupt to accommodate any sort of union with them).

Ukrainian exports to Russia are now expected to fall 35% in 2014 and a further 40% in 2015. And it is not all down to agrifood and heavy machinery trade that is suffering. Take for example insurance sector. In H1 2013, Russian reinsurance companies provided cover for 32.9% on Ukrainian insurance companies (UAH270.2 million). In January-June this year this was down 42% to UAH157 million, with Russian reinsurance share of the Ukrainian market down to 22.1%. Substitute cover was sought instead in Germany and the UK - both markets trading in currencies not offering hryvna any hedging against devaluations, unlike falling ruble. Which means cover is now more expensive.

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.