Commentary

Oleksiy Sorokin,

Alexander Query

As COVID-19 shakes down stock markets around the globe, Ukraine is putting on a brave front.

Prime Minister Denys Shmygal claimed on March 11 that Ukraine was prepared for the world economic crisis “better than ever before.”

“We have great liquidity in banks, high gold reserves, we have a pretty positive dialogue with the International Monetary Fund,” said Shmygal.

However, with the world economy slowing down and lurching towards recession, Ukraine’s economy is about to take a hit, too. It will face additional pressure from expensive foreign lending and decreasing exports.

To make matters worse, Ukraine has a new government that has been on the job for just 10 days. There is low confidence that it is prepared to take on the crisis.

“Changing the economic policy team now was a big mistake from (President Volodymyr) Zelensky,” said Timothy Ash, emerging markets strategist for Bluebay Asset Management Company.

This has undermined the confidence of foreign investors, risking an outflow of portfolio investment, weakening the hryvnia, increasing borrowing costs, and hence reducing investment, growth and jobs.

The downturn in China’s production has caused the world’s petroleum prices to drop sharply, benefiting Ukraine in the short term. However, China’s economic halt will hurt Ukraine’s exports. China was Ukraine’s main export market in 2019.

Moreover, Ukraine is facing increasing borrowing rates and potential withdrawal of investors as panic mounts over the pandemic’s effect on the world’s economy.

Since March 1, the National Bank sold more than $1 billion of national reserves to keep the national currency from going into free fall.

The lack of an agreement with the International Monetary Fund on a new $5.5 billion loan program is also hurting investor confidence and will drive up interest rates, making borrowing more expensive – if possible at all – for Ukraine.

Cheap Oil Good for Ukraine

In early February, China began introducing drastic measures to halt the spread of the deadly coronavirus. It helped the people, but hurt the country’s economic output.

As a result, China’s production decreased over a quarter. So did its oil consumption, pushing the prices down. Days later, the oil price war between Russia and Saudi Arabia caused an additional price drop.

On March 9, futures of Brent crude oil dropped 30%, and were trading below $29. A month prior, the price was almost $70 a barrel.

The decrease in the world’s energy prices could have a positive effect on the Ukrainian trade balance.

Economist Anders Aslund, a senior fellow at the Atlantic Council, told the Kyiv Post that Ukraine could save up to $6-7 billion on cheap energy.

“Ukraine will greatly benefit from lower prices,” Aslund said.

Ash of Bluebay Asset Management Company said that cheap fuel can stimulate Ukraine’s economic growth.

“If we are talking about $40 a barrel, that should save a percentage point or so off the current budget deficit,” said Ash.

Ukraine’s 2020 budget plan, passed in November when oil prices were still high, expects a 2.1% budget deficit.

“A narrower current budget deficit, other things being equal, should mean a stronger hryvnia,” Ash said. “(This) should allow the National Bank to cut policy rates more aggressively.”

But there is a downside. The fall might also drag down prices for other commodities important for Ukrainian exports – metallurgy and agricultural products. This could hit the country’s already heavy industry, says Edward Chow, a senior fellow in the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.

“If oil prices are signaling a global recession and general commodity price weakness, this could hurt the Ukrainian economy,” Chow said.

The China Factor

In 2019, for the first time in Ukraine’s history, China became Ukraine’s top export and import partner. Ukraine exported $3.5 billion worth of goods to China, primarily metals, ore and agricultural goods. Additionally, Ukrainian imports from China hit an all-time record of over $9 billion.

But the numbers are expected to plummet. In February, Chinese factories were operating at 60% of their capacity, according to Bloomberg, while the overall exports fell by 17%.

“There should be a hit to exports, particularly likely in the semi-finished product category, such as metals,” said Ash. “This should weaken (economic) growth.”

Ukraine’s industrial output was suffering long before China’s economic downturn. Now it is expected to get worse. In 2019, Ukraine’s industrial output fell by 1.8% compared to the previous year. As of February, Ukrainian industrial output has been falling for seven months in a row, which hasn’t happened in 20 years.

Ukrainian exports suffered from the straightening of Ukraine’s national currency, which gained 19% compared to the U.S. dollar in 2019, and from low prices on metals and ore, Ukraine’s main export commodities.

“The low oil prices will further decrease the prices of Ukraine’s exports,” Sergey Chuikin, managing director at Concorde Capital investment bank, told the Kyiv Post. “The decrease in prices for grain and metals will be less drastic compared to oil prices. Ukraine’s budget might even win.”

National Bank vs. Panic

After becoming the world’s best performing currency in 2019, Ukraine’s hryvnia is in trouble.

The national currency has been falling, prompting the National Bank to sell $876 million on March 10-12, in an attempt to stabilize it.

Despite that, the hryvnia lost over 5% of value in less than a week, potentially helping Ukrainian exports, yet hurting Ukraine’s financial stability.

The National Bank said on March 11 that it was ready to further intervene to combat the panic disposal of the national currency. Ukrainian reserves are over $26 billion, record high since 2012, and the National Bank has short term leverage on stabilizing the currency.

Ukraine followed the global trend, where panic selling of stocks and bonds caused international markets to lose over $5 trillion over a span of three days.

Chuikin says that the National Bank is doing everything right. In the wake of the crisis, Ukrainians are buying dollars and euros, depreciating hryvnia.

“The bank is smoothening hryvnia’s fall to halt further panic,” says Chuikin.

On March 12, the National Bank lowered Ukraine’s interest rates from 11% to 10%, to stimulate business activity and prevent an economic downturn.

However, the panic continues and Ukraine has little leverage to intervene. Foreign investors are pulling out of developing markets.

The return rate on Ukraine’s short term Eurobonds jumped to 7.5% from the 3.75% to start the year, meaning that Ukraine is now borrowing money from foreign investors at a doubling rate.

“Ukraine has almost lost access to international financial markets,” says Aslund.

Yet, while coronavirus is the main cause of investor panic, Ukraine effectively poured fuel on the fire, by firing an investor-friendly government on March 4 and Prosecutor General Ruslan Riaboshapka on March 5.

“The president’s speech and his sacking of his government caused the crisis,” says Aslund. “The undermining of the prosecutor general’s office aggravated the crisis.”

New government, same IMF

Now the new government must reassure investors that it will keep the policies of the previous government intact. Yet economic experts have serious doubts.

“(Zelensky) had the winning ticket in his hand and seems to have allowed it to blow it away in the wind,” says Ash, commenting on the rapid and largely baseless government shakeup.

The economic policy team of the now-former government was able to keep inflation at 4% and ensure investors’ confidence that a new deal with the IMF would be reached no later than summer, providing an additional $5.5 billion loan and unlocking a $1 billion loan from European financial institutions.

Getting the IMF deal approved is important for Ukraine, which has to pay out $5 billion in foreign debt in 2020. Hlib Vyshlinsky, executive director of the Center for Economic Strategy, a Kyiv-based think tank, points out that without the IMF program, Ukraine won’t be able to refinance its foreign debt, leading to devaluation of the hryvnia and a budget deficit.

During the previous government, led by Oleksiy Honcharuk, interest rates were cut and long-delayed movement accelerated to lift a moratorium on farmland sales. Honcharuk set ambitious growth targets.

Now Ukraine’s economy faces uncertainty. The law to allow farmland sales has been paralyzing the parliament for the past month, while another law, crucial to Ukraine’s cooperation with the IMF, was withdrawn when the government that sponsored it was sacked.

The law proposed by the previous government would have banned nationalized banks from being returned to their previous owners. The law was demanded by the IMF to prevent PrivatBank, Ukraine’s largest bank, to be returned to billionaire oligarch Ihor Kolomoisky, who is accused of insider lending and bank fraud in the spectacular collapse of the bank, which he used to own before 2016. The $5.5 billion in losses were covered by taxpayers after the state took over ownership of the bank in December 2016.

Kolomoisky denies accusations and sues back, calling the nationalization of the bank illegal.

Additionally, the new government lacks an economy minister after Timofiy Mylovanov was sacked with Honcharuk’s Cabinet.

“It is critical now that the government signs on the dotted line for an IMF program, and provide assurance in terms of who is in the (new) economy team,” says Ash. “The people who buy Ukraine’s debt are the same people typically who buy eurobonds. If they get hurt on their portfolios because of policy mistakes, they are not going to buy Ukrainian eurobonds.”

This will result in an increase in borrowing costs, the budget deficit will be higher and Ukraine will have less money to spend on pensions, defense, teachers and healthcare provision, says Ash.

With the economic crisis is looming and Ukrainian economy isn’t sustainable without foreign help, the crucial question is will the new government be able to come to terms with the IMF.

“The government needs to restore sensible economic policies to regain access to international finance. The best seal of approval is to really conclude an IMF program,” says Aslund.

RONAVIRUS IN UKRAINE:

WHAT YOU NEED TO KNOW

• The first COVID-19 case was identified in Ukraine on March 3. It remains the only diagnosed case.

• Ukraine shut schools and canceled mass events starting March 12 to prevent the disease’s spread.

• Ukrainian airlines canceled a number of flights to 16 countries due to the novel coronavirus.

• 49 Ukrainians ended up in quarantine on a cruise ship near California. Previously, Ukrainians aboard the Diamond Princess ship refused to be evacuated.

• A Ukrainian lawmaker had to self-quarantine after meeting with a French counterpart who was later diagnosed with COVID-19.

• Ukrainians evacuated from the disease’s epicenter in Wuhan, China spent two weeks in quarantine in a sanatorium in Poltava Oblast and were released on March 5. Their arrival in Ukraine caused unrest.