As the world is grappling with a global pandemic crisis and we are now officially in the middle of a global financial crisis, the global economic outlook looks bleaker than ever.
The current crisis can somewhat be said to be worse than the global financial crisis of 2008 and 2009, with added uncertainties as entire economies begin to enter self-isolation/shutdown mode. We speak to Makar Paseniuk, Founding Partner of ICU on what the implications are for Ukraine?
Q: Is Ukraine particularly vulnerable?
Makar:
Emerging and developed-nation companies alike face disrupted supply chains and virtual or quarantined workforces amongst other uncertainties.
Ukraine has a debt-burdened frontier economy heavily reliant on external financing, commodity exports and remittances; and as such, it is particularly vulnerable to such events, especially since it’s grappling with several domestic issues.
Add to this the political instability of a recent government reshuffle. Prompting international investors to question the logic behind the recent reshuffle in the cabinet, undermining the reform momentum of the past six years.
Ukraine was until recently one of the best-performing emerging markets–Why do you think Ukraine is more exposed compared to other emerging market economies?
Makar:
Ukraine’s investment case looked good until the recent events unfolded. The yields to maturity on Ukraine’s longer dated Eurobonds had plummeted from 10 percent to under 6 percent, while the local currency denominated debt yields fell from 18 to 10 percent cutting the country’s borrowing costs and giving Ukraine ample access to capital markets.
However, in times of high macro shocks, investors typically liquidate more risky positions in more fragile economies like Ukraine and move their funds to less risky assets such as investment grade debt. Consequently, more fragile countries see the outflow of foreign capital from domestic government debt and as a result experience depreciation of their currencies against the US dollar.
By the end of March, Ukraine’s longer dated Eurobonds yields have increased to 10-12 percent. At the same time, yields of the government’s local hryvnia-denominated bonds have soared to 23-25 percent in the secondary market, making it increasingly difficult for the Ukrainian government to tap domestic and international capital markets for fresh capital.
What are the main issues facing Ukraine in this current market?
Makar:
The key concern now is that measures to prevent and contain the spread of coronavirus will have a devastating effect on the Ukrainian economy. These unprecedented measures have large ramifications and the losses of the economy may appear quite comparable to those incurred during the hardest period of Russia-Ukraine conflict in 2014-15, or even exceed them. Back then, Ukraine’s real GDP fell 7% in 2014 and 10% in 2015.
An equally serious problem is that Ukrainian authorities may fail to resume cooperation with the IMF and thus deprive the country of the much needed external financing. Thirdly, foreign demand for Ukrainian goods, particularly metal and mining products, may decline substantially as a result of the global recession.
What is the impact on the currency reserves and the Hryvnia?
Makar:
Ukraine’s international currency reserves are currently at their best shape since 2012. While the National Bank of Ukraine (NBU) had to inject USD 2.5bn of hard currency to contain the initial panic in the foreign exchange market in mid-March, ICU analysts estimate international reserves to be above USD 25bn in the first week of April, equal to slightly less than four months of pre-crisis imports.
The NBU’s interventions slowed down the depreciation but could not stop the 13 per cent fall in the hryvnia in March. Daily purchases of US dollars by Ukrainian businesses and population surged, while foreign investors selling hryvnias accounted for just about 3 percent of the overall demand for hard currencies.
As the foreign exchange market calmed down in end-March, the NBU had ceased to support the hryvnia by its USD-selling interventions. Moreover, in the beginning of April, the central bank started buying hard currency in the FX market. Still, concerns of coronavirus spread, economic hardship and uncertainties around the IMF deal may continue weighing on the national currency.
Would that be enough for Ukraine to weather the storm?
Makar:
Currently, the NBU has enough reserves to quell further possible selloffs of the hryvnia for some time. In fact, Ukraine’s imports are likely to fall due to lower consumption and lower oil and gas prices. This should make reserves as a multiple of monthly imports even higher than four.
However, debt repayments remain the key problem. From end-March until the end of the year, Ukraine needs to pay more than USD11.4 billion equivalent of debt and interest, including USD 8.3 billion of debt and interest in hard currency. Add to this around USD 1 billion of the current account deficit. This deficit has high risks of an additional hike due to a large dependence on remittances from labour migrants who may lose their jobs or see their incomes falling due to the pandemic and lockdowns in Europe. And on top of that, there is the need to finance the budget deficit which may soar to the equivalent of USD 7-10 billion this year and it will still be insufficient to cover economic losses from the coronavirus lockdown. With all these financing needs in mind, we can see now that the current reserves are far from sufficient and how urgent is the resumption of Ukraine’s cooperation with the IMF.
What are the key issues impeding the new IMF programme?
Makar:
Last December, Ukraine provisionally agreed to a USD 5.5 billion Extended Fund Facility Program with the IMF. In the last week of March, the IMF stated that Ukraine made a good progress in the discussions with the Fund on the arrangement. Ukrainian authorities hope to increase the facility’s amount to USD 8 billion in order to at least partially compensate economic losses caused by the coronavirus pandemic. The IMF confirmed Ukraine’s access to financing could be larger than previously envisaged.
However, the IMF’s management reiterated that the adoption of laws to improve the bank resolution framework and laws to open the farmland market are the key preconditions for the quick finalization of the new arrangement.
Adoption of the farmland market law faces disapproval from the majority of Ukraine’s population and as such, many members of the parliament’s ruling faction view it as harming their ratings amongst the voters.
However, the most debated issue is the bill on insolvent banks that would prevent them from being returned to former shareholders. This bill has been fiercely fought by former owners of Privatbank who seek to regain control over the bank to drop legal cases against themselves in London and other courts. The law if passed, will also counter other owners of failed banks who altogether may have illegally siphoned away around USD 16 billion of clients’ money. The draft law stipulates how the former shareholders should be compensated in case of unlawful actions by the regulator. According to the draft, an independent auditor will determine the amount of compensation. Which among other things means that Privatbank owners would be entitled to nothing. Recent changes in the government and the Prosecutor General’s office have fuelled concerns over these owners’ significant influence on Ukraine’s current authorities.
Without the IMF’s financial aid, Ukraine looks able to go through with its sovereign debt payments at least in 1H20. However, the lack of IMF’s funding cushion and guide over much-needed reforms would deter investors from pushing the yields significantly lower than now.
