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Hard Times Ahead for Ukraine

This year has been exceptionally difficult for Ukraine’s economy, and 2013 is unlikely to be any better. Popular discontent with the inability of the Yanukovych regime to provide the population with decent living standards contributed greatly to the Regionnaires’ poor showing in the October parliamentary elections in which, despite significant fraud, they managed to scrounge up only 30 percent of the popular vote. As the economy goes into tailspin, popular opposition to the president and his rapacious party of power will grow and Viktor Yanukovych will face an unenviably stark if richly deserved choice: either to ignore reform and attempt to shore up his crumbling rule with force or to promote economic reform by loosening his hold on political power.

According to the SigmaBleyzer Private Equity Investment Firm and The Bleyzer Foundation in Kyiv, here’s the bad news (pdf):

Ukraine’s industrial output fell by 4.7% yoy [year on year] in August and 7% yoy in September. Slipping global demand for steel and iron ore weighed on the steel and mining industries. In addition, production of machinery equipment and transport vehicles suffered from increased trade tensions with Russia, the largest consumer of Ukraine’s machinery products. In particular, output production in the machine-building industry fell by almost 17% yoy on average over August-September…. Domestic demand has also been cooling. A steep decline in the construction sector (by about 9% yoy over January-September 2012) signaled the subdued investment activity. Due to strained public finances, an ongoing credit squeeze and restricted access to foreign financing, the current level of investment spending cannot fill the gap left after the completion of large infrastructure projects related to the Euro 2012 football championship. Moreover, a deceleration in retail sales growth to 16% yoy over January-September indicates that private consumption has started to ease. While a deceleration in real wage growth to 11.7% yoy in September contributed to softening demand, consumer spending was likely affected by growing political and economic uncertainties. Due to weaker external and internal growth factors, the Ukrainian economy is forecast to increase by about 1% yoy in 2012.

The half-bad, half-good news is:

Ukraine’s inflation remains at a decade low level. ... Despite eased inflationary pressures, monetary policy remains tight. The National Bank of Ukraine continues to use a mix of its policy measures (banking sector liquidity regulation, forex interventions, and administrative restrictions) to suppress Hryvnia foreign exchange fluctuations. A relative stability of the exchange rate, however, was achieved at the cost of subdued bank lending activity. Indeed, the stock of bank loans rose by only 1.2% from January to September this year. A good agricultural harvest, large grain stockpiles ahead of a new marketing year and elevated world grain prices supported Ukraine’s exports of agricultural products, which expanded by about 50% yoy on average over August-September this year. This improvement, however, could not compensate for weaker exports of other key commodity groups (metallurgy, machinery, minerals). As a result, exports slowed to 1.1% yoy in August and fell be about 3% yoy in September. While imports also eased, Ukraine’s current account stood high at about $1.4 billion in August and September. The nine month gap amounted to $9.2 billion and is forecast to reach 6.5% of GDP this year. Growing external imbalances, high external debt financing needs amid turbulent international financial markets and strong population demand for foreign currency generate depreciation pressures.

One of the immediate upshots of all this is that, as Bloomberg puts it:

Ukraine’s government is running out of options to finance $4.3 billion of outstanding foreign-currency debt in the first half of next year. The government, which raised $1.25 billion in a bond sale on Nov. 20, wants to extend a $15.4 billion IMF loan suspended in March 2011 that expires this year. To regain access to funds, the government needs to give up resistance to raising gas prices and adopting a more flexible exchange rate. The economy, among the world’s worst-hit during the 2009 global recession, is slumping as the euro area’s crisis curbs demand for such export products as steel. President Viktor Yanukovych, who drew European Union criticism over the jailing of former Prime Minister Yulia Tymoshenko, has struggled to obtain alternative financing.... Ukraine’s default risk is the sixth-highest among 93 countries tracked by Bloomberg. The benchmark Ukrainian Equities Index has lost 41 percent this year, the world’s second-worst performance after the Cyprus General Market Index. International reserves have plunged to $26.8 billion, the lowest since May 2010, as the central bank dipped into the stockpile to prop up the hryvnia [Ukraine’s currency].

Clearly, Ukraine’s government will face some tough economic choices in 2013, at precisely the time that the legitimacy and stability of the Yanukovych regime will be at all-time lows. Popular regimes have difficulty enough persuading their constituents that belt-tightening is necessary. Unpopular, corrupt, and morally bankrupt regimes are intrinsically incapable of making any such appeals. Who would listen to a president who collects villas and whose family has practiced fabulous self-enrichment while the population has experienced impoverishment? Who would listen to a Parliament that has assiduously done nothing to promote the common weal and everything to divide the country against itself? Indeed, how many of Ukraine’s oligarchs will continue to support Yanukovych in the face of economic decline and political haplessness?

Unfortunately for the Yanukovych regime, inaction is no option. The economic situation is getting critical and the regime’s own survival may be on the line. What to do?

There are three options:

First, even though inaction is no option, Yanukovych may be sorely tempted to continue with the status quo. That would mean withdrawing into his palace, closing ranks with the most obtuse Regionnaires, and employing coercion with greater abandon. Past dictators have acted in this manner and managed to stay put for a while. Coercion will only provoke a counter-reaction from vested interests and radicals and the strategy of withdrawal is doomed in the long run, but Yanukovych may just decide that a few more years in power would give his sons enough time to transfer their funds abroad and prepare the transition to some warmer clime.

Second, Yanukovych could adopt bona fide reform that permits entrepreneurship to flourish and small and medium-sized business to generate the employment and economic growth Ukraine needs. This makes sense, of course, but would also mean introducing painful free-market measures and restructuring the political economy in favor of the little guy and not the tycoons. Neither measure is thinkable without expanding the regime’s political base and creating something in the nature of a grand coalition with the democratic opposition. The Regionnaires will howl in protest. The unenlightened oligarchs will, too. Will Yanukovych have the savvy and the will to use coercion against his own allies? Don’t bet on it.

Third, Yanukovych could seek outside support—either from the West or from Russia. Naturally, the West will insist on various political concessions and free-market reforms along the lines of the second option. Russia will insist on an Anschluss of Ukraine’s economy that will both require the measures outlined in the first option and, in all likelihood, infuriate the oligarchs who know that a Russian economic embrace will smother them.

In sum, Yanukovych and his regime are caught between a very big rock and a very hard place. As he scrambles to survive next year, expect that regime to start cracking, expect the oligarchs to push for greater economic and political rationality, and expect an opposition and population emboldened by regime weakness to up the ante and insist on genuine change. Don’t be too surprised if disgruntled Regionnaires and oligarchs, fearful of a second Orange Revolution, decide to pull a Khrushchev and give Yanukovych his walking papers. 

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