Ash looks at Ukraine’s road ahead after collapse of Yanukovych regime - Ukraine Business Online #EuroMaidan

Ash looks at Ukraine’s road ahead after collapse of Yanukovych regime - Ukraine Business Online:

2014/2/24 0:41:08

What is clear is that Ukraine will need external support - perhaps a USD20bn+ external support programme from the West, but channelled through the World Bank and IMF. Given prior commitments, and the clear strategic significance of ensuring a stable Ukraine, we think such Western financing will be forthcoming. However, we think that any such assistance will still be made conditional on a coherent set of economic reform policies being put in place. We would include therein the already detailed set of conditions identified by the IMF, including exchange rate flexibility, energy sector reform (read gas price hikes), and fiscal consolidation.


LONDON, Feb 24, 2014 (UBO) – At the end of probably the most remarkable week in Ukraine’s history as an independent nation, Standard Bank chief emerging market economist Timothy Ash casts his eye on the road ahead:

A truly remarkable few days in Ukraine, with the country appearing on the brink of Civil War earlier in the week, then a last ditch attempt by the EU at a peace deal on Friday morning, which at first glance did not appear to go far enough in terms of concessions to the opposition, and then finally the total collapse of the Yanukovych regime through Friday evening and into Saturday.

In parliament support for the former Regions party collapsed, and this allowed the opposition to secure a constitutional majority of over 300. They took no chances and speedily pushed through legislation which brought back the 2004 constitution, shifting power from the presidency to parliament, then voted to oust key Yanukovych ministers, including the hated minister of interior, Vitaly Zakharchenko - seen as directly responsible for the deaths on Maidan over the past few months, and then voted to impeach now former President Yanukovych. Yanukovych had already fled the capital, to an unknown destination, but border guards are reported to have prevented him and some of his henchmen (including Zakharchenko) leaving the country. Parliament also voted to free former Prime Minister, Yulia Tymoshenko (jailed in 2011 on spurious charges) and appointed her Fatherland Party colleague, Oleksandr Turchynov, as speaker of parliament and then acting President, pending fresh presidential elections called for May 25, 2014. Tymoshenko subsequently appeared at a mass rally on Saturday evening having been sprung from her jail cell in Kharkiv earlier in the day - reported also to be the hiding police of former President Yanukovych.

The above represents a truly remarkable turnaround in events, if comments attributed to the Polish foreign minister, are to be believed, I.e. warning opposition leaders late Thursday evening that if they did not sign the deal with Yanukovych that they would all be dead. Instead, they are now in total control, and Yanukovych is on the run.

Parliament is slated to remain in session this week, and is expected to approve the appointment of a coalition government to take the country to early elections, and perhaps even agree the signing of the AA/DCFTA with the EU - Yanukovych's failure to sign this at the Vilnius summit back in November was the spark that led to mass protests and his subsequent ousting.

Why did the regime suddenly collapse, after months of resolute stonewalling?

My sense is that this was a combination of factors, but key was the extremity of violence used against demonstrators over the past week. The picture of police snipers picking off demonstrators was truly chilling - almost akin to death squads, committing premeditated murder. The sheer scale of the deaths - scores killed this week also appeared to be a turning point. This then set in motion the application of sanctions by the West which will have hurt allies of the regime, and there was further evidence of defections from the ruling Regions faction, and from the police/security services. The fact that Yanukovych showed his willingness to accept the EU3 brokered deal by which in effect he surrendered most of his powers, left him further exposed. The fact that Maidan failed to agree to the terms of this deal - signed by opposition leaders - and threatened to remove him then by force by 10am the following morning (Saturday) was the final blow for Yanukovych, who then fled Kyiv. And his fate was then sealed.

So what next for Ukraine?

The new administration faces numerous challenges. First cobbling together a coalition government to take the country to early elections, and remaining unified in the face of very significant domestic and external threats. Second, averting secessionist tendencies. Third, managing relations with Russia - assuming the decision is taken to sign the AA/DCFTA and hence opt for a European orientation. Fourth, grappling with an acutely challenging economic situation. If policy makers negotiate through this substantial list, then the country should have a good future.

On the issue of maintaining unity in the run up to elections, at face value this could be difficult, and especially after the past history of fractured Ukrainian Orange politics, e.g. the near self-destruct relationship between former President Viktor Yushchenko and Yulia Tymoshenko. However, what has been incredibly encouraging is the way that the unity of the three main opposition leaders - Klitschko, Yatsenyuk and Tiahnybok - held together through the crisis, and particularly in recent days. They also carried through on their pledge to free Yulia Tymoshenko at the first opportunity. They appear to have agreed that Turchynov will assume a temporary leadership role in the run up to elections - perhaps a reflection of his own experience heading the SBU under Yulia Tymoshenko. Of particular note perhaps, Yulia Tymoshenko, has rejected calls for her to become prime minister, albeit she is expected to run in the looming presidential elections. This does still raise the spectre of the opposition slugging it out in the presidential election, with multiple candidates, but we would expect the campaign between opposition leaders to be relatively tame, given what the country has already been through and given the challenges still faced, particularly on the external front. And, importantly, the reversion to the 2004 constitution denudes the role of president, with the government and parliament assuming a greater role. The position of prime minister, hence, becomes the dominant role - albeit we saw in the Yushchenko/Tymoshenko era that a good relationship between the two positions is still very important.

The threat of secession should be taken seriously, given the deep divides which opened up across the country through the past few months, with some opposition Western regions of Ukraine refusing to abide by the writ of Kyiv. There have even been threats by regions in Eastern Ukraine, traditionally a stronghold of the former ruling Regions party, to follow a similar tact with a new opposition administration in Kyiv. Moscow has warned that is will monitor the situation closely, and has even suggested that it might even have to intervene if the interests of ethnic Russians in the South and East of the country are not being adequately protected.

However, a number of actions in the past few days makes me less concerned over an immediate deepening in secessionist tendencies in Ukraine. First, the reaction of Eastern regions in Ukraine to the ousting of President Yanukovych has been calm/muted. This probably reflects the fact that the bulk of the Ukrainian population saw the former Yanukovych regime as corrupt, and little more than a "bandit" regime - this was evident in the collapse in poll ratings for Regions in the period since the 2010 presidential elections. Hence, and despite what Moscow and the Yanukovych regime had implied in self defence, Maidan was not a protest movement based on ethnicity, but it was a protest against unjust and corrupt rule. And the corrupt nature of the former Yanukovych regime was laid bare over the past few days after the capture of the former President's opulent country estate which could not have been afforded on his meagre public salary. Claims are that the "Family" stole billions of dollars through its position of patronage - and they now look set to be brought to account for this. Second, one of the first laws passed by parliament following the ousting of Yanukovych was a law against secessionist tendencies. This should rein all sides in. Third, it was particularly encouraging that the remnants of the Regions party issued a statement earlier today blaming Yanukovych for the violence, and mis-governance. The shear extent of graft, and violence used by the regime, seems to be encouraging remaining Regions members to show their loyalty to the new regime, and there seems little appetite to support any call for secession in Southern and Eastern regions of Ukraine. Fourth, I would contend that these secessionist tendencies in Eastern Ukraine were already weak, as the division of Ukraine would likely inevitably see their domination by Moscow, something which the vast majority of Ukrainian people and oligarchs alike simply do not want. Over the past twenty three years they have grown to appreciate independence - and many young Ukrainians have known nothing else.

The third major challenge for the new Ukrainian administration will be managing relations with Moscow. Moscow staked a huge amount in the end on the Yanukovych regime - backing the former president with a USD15bn+ bailout programme, calling the Maidan extremists coup plotters, and calling on Yanukovych to restore order. Many view Moscow behind Yanukovych's last ditch decision to stall on signing the AA/DCFTA with the EU at the Vilnius summit, as that would have his scuppered own vision for creating a CIS Customs Union that had any meaning or significance. As is, that vision now lies in tatters, and President Putin has now arguably suffered his most significant foreign policy defeat in a decade - since the first Orange revolution. If Russian TV commentary over the past few days is anything to go by, the Putin regime is now feeling extremely bitter. The question is could this bitterness produce any significant counter reaction? Herein, fears of a direct Russian military intervention in South and Eastern Ukraine, perhaps starting with the Crimea, seem to have faded with the lack of any significant popular reaction in these regions to the ousting of Yanukovych, and the disintegration of the Regions party itself. However, Moscow has a very significant ability to inflict damage on the Ukrainian economy, by disrupting trade ties (as in the lead up to the Vilnius summit), by perhaps causing problems in gas supply through Ukraine to Europe, and also via its ability to call in debts owed by Ukraine to Russian entities. On this latter issue, what seems now fairly clear is that there will be no further disbursements under the bail bond programme agreed in December 2013, but which has only disbursed USD3bn in credits thus far. Potentially though Russia could extract leverage via gas debts (estimated at around USD2-3bn) and there is now little hope that Ukraine will secure cheap Russian gas as per the December 2013 agreement. I tend to doubt though that Russia will seriously contemplate disrupting gas supplies through Ukraine to Europe, as arguably Russia ultimately loses herein as it shows itself as an unreliable partner for Europe in gas supply and encourages further diversification away from Russia by key European consumers. Perhaps also important is the fact that the annual heating season is drawing to a close and hence the ability to maximise the impact of gas supply disruption is reduced.

The economy is the fourth major challenge for the new rulers in Kyiv, and strains in the relationship with Moscow will likely just make a difficult situation even worse. To recap, the Ukrainian economy remains on the brink of recession - only posting flat real GDP growth in 2013, and recent political unrest may have pushed the economy back into recession. The budget has been running in large deficit, again likely made worse by recent demonstrations, as all sides probably stalled in paying taxes. We estimate the budget deficit to be in the order of 7-8% of GDP, while the Treasury has nearly no fiscal cash reserve, and has been living by "robbing Petro, to pay Viktor". The external accounts are also in a mess. Despite flat real GDP growth the current account ran in deficit of around 8-9% of GDP last year, suggesting the exchange rate is significantly overvalued, and reflected by the marked depletion of NBU FX reserves - halving over the past two years to just over two months of import cover. A weight of external liabilities fall due over the next year - USD68bn, and we estimate an external financing gap of USD15-20bn. This gap will likely need to be closed via a combination of exchange rate adjustment, and deflation, plus the provision of significant external financing.

We would also add herein that the above FX reserve data/financing equation makes no account for potential reserve depletion in the final few days of the Yanukovych regime - the fear surely is that the regime could have plundered the official accounts, perhaps with the intention of running a parallel administration out of Eastern Ukraine. We would perhaps also express some caution herein over the health of the banking sector, for similar reasons - many former regime friendly banks may now be shells, with significant holes in their balance sheets.

What is clear is that Ukraine will need external support - perhaps a USD20bn+ external support programme from the West, but channelled thought the World Bank and IMF. Given prior commitments, and the clear strategic significance of ensuring a stable Ukraine, we think such Western financing will be forthcoming. However, we think that any such assistance will still be made conditional on a coherent set of economic reform policies being put in place. We would include herein the already detailed set of conditions identified by the IMF, including exchange rate flexibility, energy sector reform (read gas price hikes), and fiscal consolidation. However, given the severity of the crisis which Ukraine has just been through we think that the nation will now be braced to undertake significant reforms and now should be a very opportune time to embark on landmark reforms which could well set the stage for a transformation in the Ukrainian economy. In some respects we might argue likely external pressure exerted on Ukraine by Russia will likely make it that much easier for the administration to sell the need for difficult but much needed reforms to the population - the economy is also in such a mess because of the mismanagement of the former administration.

We would add a couple of additional important points as to the reform agenda:

First, Ukraine does have a critical mass of reform minded politicians and officials. We would include herein, opposition leaders Yatsenyuk (a former central bank governor, and minister of economy) and Petro Poroshenko (former head of the NBU council). It is, however, very difficult to see Yanukovych place men, e.g. Incumbent NBU governor Sorkin, remaining in position. That said the NBU does have a number of credible technocrats who would be expected to stay, including the current deputy NBU governor, Mykola Udovichenko. It is not too difficult to imagine an economic reform team perhaps comprising Yatsenyuk as first deputy PM for finance and the economy, and Poroshenko as NBU governor - or indeed vice a versa.

Second, the energy sector remains important, indeed key. It might just be possible still to keep elements of Regions with coverage for this sector, and perhaps to try and ensure stable energy sector relations with Moscow. In this respect we assume that the Boyko/Firtash axis will still be working overtime to maintain an interest therein.

Third, it remains to be seen how a new Ukrainian administration, and official creditors, would deal with private sector creditors, particularly those which in effect have been bank rolling the former Yanukovych regime. The moral hazard issue herein was particularly relevant when it came to Ukraine, as the Yanukovych's administrations ability to borrow from the market over the past 2-3 years meant that it spurned entering into a formal relationship with the IMF and key reforms were delayed. Official creditors may also be loathed to be seen to so publicly bail out large private sector creditors who took high stakes bets in Ukraine, and on the assumption that it was "too big to be allowed to fail".

Hence, perhaps as part of any Western support package limits on borrowing from the market might be agreed, or this might even extend to some formal bailing in of creditors. The latter might be forced, depending on developments on the exchange rate front, the banking sector, realisation as to how bad the real accounts are when the new government takes office, and perhaps developments in terms of the relationship with Moscow, e.g. whether Moscow pushes for early repayment of liabilities. In the latter scenario a new administration might seek to re-profile its debt liabilities at the outset, so as to get ahead of the curve.

-------------------------------------------------------------------------------
The above commentary represents a personal view, is not investment advice or Standard Bank research, but may contain extracts from published research.

'via Blog this'