Ukraines economy-Worse to come

The swooning economy is in desperate need of investment

Nov 15th 2014 | KIEV AND SLOVIANSK

NINA KULIKOVA hid in her bathtub and cried when the war
neared her home this summer in Sloviansk, a city in eastern Ukraine. A shell hit a
neighbouring stairwell, shattering her windows and punching a crater in the middle of
her apartment block. No one has come to rebuild 4 Bulvarnaya Street. Ms Kulikova
has nowhere to go. Meanwhile, the prices of food, medicine and utilities have all
spiked. Her husband collects bottles and cartons for recycling to make ends meet.

A year of revolution and war has taken a grim toll on Ukraines economy. GDP could
fall by 10% this year. The currency, the hryvnia, has plunged nearly 50% against the
dollar in 2014. Inflation has hit 19%; at the beginning of the year, prices were stable.
The central bank raised rates this week, for the third time this year, to 14%. Consumer
spending rose by 5% in the second quarter compared to the year before, but that
probably reflects panic buying; it is likely to slump soon too.
In April the IMF co-ordinated a bail-out to which it pledged to contribute $17 billion over
two years. A coalition of Western countries provided smaller amounts. So far about $7
billion has been dispersed. But Ukraine needs more than temporary financing, and the
conditions attached may be exacerbating its woes.
Ukraines economic problems have been long in the making. Two decades of stalled
reforms and rapacious leadership have left the average Ukrainian about 20% poorer
than she was when the Soviet Union collapsed. Ill-planned privatisations in the 1990s
spawned an oligarchic class that sucked up most of the countrys wealth for itself.
Corruption is a way of life. University students bribe their professors to get a good
grade; taxmen reckon the majority of businesses pay their workers at least partly in
cash to evade tax. Transparency International, an advocacy group, puts Ukraine 144th
out of 177 countries in a global ranking of public perceptions of corruption.
The war in the provinces of Donetsk and Luhansk, the countrys industrial
powerhouse, has compounded these failings. The two normally account for 16% of
Ukraines GDP, supply 95% of its coal and produce a disproportionate share of
exports. In September industrial production in Luhansk fell by 85% year-on-year; in

Donetsk it fell by 60%. Other parts of the country are also suffering, as imports get
more expensive and credit impossible to find. Even agriculture, which many had
hoped would power growth, is struggling: Macquarie, a bank, expects wheat farmers
to produce 12% less next season.
On the surface, Ukraines public finances, at least, seem reasonably sound. Public
debt has risen in the past decade but it is no Greece. According to the IMF, the debtto-GDP ratio will be around 70% by the end of the year (though this calculation
includes the separatist regions). This year Ukraines interest payments will amount to
3% of GDP, which is low by international standards.
But Ukraine is running out of the money to service these debts. Few people, least of
all the IMFs technocrats, predicted that the
fighting would be so fierce. As investors pull
money out of Ukraine, the central bank has
spent billions of dollars in a desperate attempt
to prop up the tumbling hryvnia: foreignexchange reserves are now at their lowest
level in a decade. The central banks efforts
have done little: this week alone the hryvnia
fell 14% (see chart).
From now until the end of 2016 about $14
billion of debts denominated in foreign
currencies are due. Ukraine must also pay

$700m a month for gas imports from Russia. Its foreign-exchange reserves have
probably dwindled to about $12 billion. Worse, the debts falling due may rise. A year
ago Russia agreed to lend Ukraine 3 billion ($4.1 billion) via an international bond.
The money came with an important condition: if Ukraines debt-to-GDP ratio exceeds
60%, Russia can demand early repayment, which might, in turn, trigger an automatic
default on Ukraines other international bonds. Official figures due in March are
expected to show the governments debt well above the 60% threshold, enabling
Russia to precipitate a default.
Meanwhile, in return for its support, the IMF wants an overhaul of Ukraines economy.
Western officials believe that Petro Poroshenkos government is serious about reform.
Last months parliamentary elections removed obstructive deputies. There have been
other positive steps, such as forcing government ministers to declare their financial
interests. The government has scrapped the most bizarre loopholes in its procurement
rules, which are a massive source of corruption (including one that turned feed for
circus animals into a conduit for graft).
The government is also tightening its belt. The IMF expects that spending, as a
percentage of GDP, will fall by 4.8 percentage points over the next five yearsa
similar diet to Greeces in 2010-14. According to Macro-Advisory, a consultancy, the
jobs of 1m civil servants are under review. An update of the subsistence-minimum
amount that pensioners receive has been put on hold. Domestic gas prices were
raised by 56% this year in order to improve the finances of Naftogaz, the state-owned
gas monopolist.

Though higher energy prices and a smaller budget deficit are necessary, the scale of
todays spending cuts and price rises is likely to clobber demand in an economy that is
already slumping. Austerity programmes also tend to lead to political unrestjust look
at Greece. Ukraine is much poorer than the euro-zone periphery, and is filled with
traumatised men returning from the front.
Ukraine will only prosper when private investors venture back in. That will require big
investments in infrastructure, especially in the war-torn east of the country. The IMF
cannot provide that; it deals in short-term financing. Yet other potential benefactors,
including America and the EU, have been dragging their feet.
Ukraines energy sector is crying out for investment. If the country were as energyefficient as the EU average, it could probably avoid importing gas from Russia.
Alongside higher prices for consumers, projects to improve home insulation, to replace
old boilers and to fix leaky pipes would help. Investing in gas production also makes
sense: Ukraine has big reserves but output has fallen by two-thirds since the 1970s.
Mr Poroshenko has doubled taxes on domestic gas companiesa poor way to court
investment. Unless he and his Western allies start focusing on measures to boost the
economy, a slide into disarray and default seems inevitable.
From the print edition: Finance and economics
Posted by Thavam