Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
WorldMay 1 2014

A glimmer of hope for Ukraine?

Between a floundering economy and volatile political situation, there is little room for optimism in Ukraine. But with new leaders hoping to tackle corruption and consolidate the fragmented banking sector, and with international funds earmarked to boost commercial lending, is the tide about to turn?
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Political upheavals and the widely criticised annexation of Crimea by Russia are taking their toll on the Ukrainian economy, with the country's banking sector facing a macroeconomic headwind that observers expect to remain throughout the rest of 2014.

Even before the loss of Crimea, Ukraine's gross domestic product (GDP) was expected to drop by 4% to 5% over the year. Now, practically every other macroeconomic indicator is also expected to decline. Stability is at a premium in the second quarter of 2014, as a senior advisor for the European Bank for Reconstruction and Development (EBRD), Anton Usov, notes. “The situation is so volatile that it is difficult to make even short-term forecasts. We do see this changing once the International Monetary Fund [IMF] package is signed, and Ukraine will need to follow some IMF guidelines,” he says.

Along with IMF backing, presidential elections in May and parliamentary elections in October will strengthen the position of the government, allowing it to make long overdue and fundamental policy and regulatory changes. It is also hoped that it will be able to tackle the problem of corruption – which was one of the reasons for the popular uprising against former president Viktor Yanukovych, who fled the country in February.

Former prime minister and presidential candidate Yulia Tymoshenko points to the current turbulence and previously moribund state of legislation as areas of concern. “Ukraine has too few domestic creditworthy borrowers that can generate significant demand for bank loans. This is caused by the country’s lack of macro stability, which prevents domestic corporations and individuals from having the confidence to use borrowed capital to undertake expansion projects, purchase homes, etc," she says.

Worst-case scenario

Just how bad can the macro environment become? A quarterly report by Kiev-based investment company Investment Capital Ukraine, published on April 18, 2014, suggests that while the loss of Crimea will shrink Ukraine’s GDP by only 3.7%, the annexation of other parts of the country would lead to more considerable economic losses. The loss of the eastern oblasts of Donetsk, Kharkiv and Luhansk together would bring down the national GDP by 23% and, in a less likely development, the extension of the current Russian border to the enclave of Transdnistria between Moldova and Ukraine, which would swallow the entire southern tier of Ukraine’s oblasts, would cut GDP by 47%.

Under these uncertain conditions, Stepan Kubiv, the new National Bank of Ukraine governor, must move quickly to wean central banking policy off a pegged foreign exchange [FX] fixation, say analysts, as well as change relations with commercial banks.

Mr Kubiv, an experienced former commercial banker and commandant of the headquarters of the Euromaidan national resistance movement, which was instrumental in the uprising against Mr Yanukovych, has had to quickly learn the ropes of central banking.

“Natural selection runs high in Ukraine’s financial industry,” says Dmytro Sologub, a research department head at Raiffeissen BankAval in Kiev. “The 2008-09 crisis flushed a lot of people out of the system – only the very strongest survived and they’ve gained considerable experience since then. There are a lot of good people to lure out of the private sector to help repopulate the NBU."

Mr Sologub adds: "Even though the past three to four years were dark ones for the NBU, the situation is more complex than that.” Legislation enacted by the NBU in 2000 was quite progressive for its time, and much of it has worn well. “Also, on an operational level, the NBU is quite good,” says Mr Sologub. “What’s needed are a few experienced hands to lead and people to implement a policy not based on FX stability.”

Mixed emotions

Is the NBU making the changes needed? The jury is still out.

“Not really,” says Elena Velikaya, CEO of Adamant Investments in Kiev. “The key problem with the current NBU policy is a lack of transparency and communication, both with the market and the population. Anyway, it has been very difficult to understand what the strategy and policies of the new government and NBU would be. Currently, they are using instruments that are typical of all the previous governments, instruments such as NBU refinancing of commercial banks, a capital increase for [state-owned oil and gas company] Naftogas and other similar state liabilities via internal government bonds bought by the NBU and state-owned banks.”

Mr Kubiv says that accountability is key to central banking in Ukraine. “It’s not enough that someone was, as the media puts it, ‘from maidan’ [Euromaiden]… I’m deeply convinced that the experience I have – 14 years of experience in banking – [together] with my desire [to implement reform], and above all, my accountability to citizens, I have enough to further all the planned reforms in the banking system,” he says.

Andrey Bespyatov, managing director of research at Dragon Capital in Kiev, says that Mr Kubiv is leading a change in how the NBU looks at the commercial banks in the country. “At our recent conference, Mr Kubiv told us that the NBU would be implementing stress-tests of all the banks in the system. Given the current FX instability, I think it’s a really good idea," he says.

Ms Tymoshenko says: “The NBU has already started a ‘cleansing’ campaign across the banking sector, which will likely impact approximately 50 banks considered to be linked to Mr Yanukovych and his close allies. NBU temporary administrators have been already introduced into several failing banks. The NBU is likely to continue its 2006 to 2009 policy of consolidating the banking sector by introducing further minimum regulatory capital requirements, making the banks more sustainable and less sensitive to oligarchs’ behaviour.”

Testing times

The slide into administration of several commercial banks raises the likelihood of a cull of the overbanked Ukrainian market. Mr Kubiv suggests another way to look at the situation. “If a bank operates within the legal framework and adheres to all of the requirements of the central bank, then there’s no reason to remove it from the market. Of course, banks that violate regulations threaten the interests of depositors and other creditors. That’s when the NBU has the right to take the appropriate measures,” he says.

Since the Russian annexation of Crimea, the reason for five Russian banks being in Ukraine has been called into question. “It’s a commercial issue,” says Mr Bespyatov. “It’s not their Russianness that is key, it is their business model that keeps them in Ukraine. Take Sberbank, for example, it would be a matter of reputation, and as such, being in Ukraine makes sense. For others, facilitating trade with Russia was the prime reason for being here.”

Mr Usov says that these banks will need to give more thought to Ukraine-Russia trade relations, adding that it is currently impossible to predict trade relations between the two countries. At the same time, Mr Kubiv affirms that Russian banks have traditionally had good relations with Ukraine, and that any withdrawal from the market is their own decision.

However, on April 16, Ukraine's acting prosecutor general, Oleh Makhnitskiy, announced in an interview on Ukrainian television network Fifth Channel TV that Sberbank had been identified as one of 14 banks linked with funnelling money from Russia to separatists in eastern Ukraine. Sberbank, for its part, has challenged Ukraine to provide evidence of wrongdoing, according to news agency Reuters, which says that the bank has hinted at legal action in response to an investigation into whether it facilitated the financing of pro-Russian separatists.

Extending credit lines

Commercial lending, especially to small and medium-sized enterprises (SMEs), languished under Mr Yanukovych's administration. This is set to change, as both commercial banks and international financial institutions (IFIs) such as the EBRD prepare for a new influx of business. The EBRD, in particular, is extending its infrastructure to meet the expected rise in demand.

“The EBRD is launching a small business support liaison office in Lviv,” says Mr Usov. “We see that by supporting small business in Ukraine, we support an important part of the economy looking forward. SMEs are often more willing to make changes [to the way they do business] and are more transparent, and that fits well with our business.”

Placing the new office in Lviv also takes into consideration the fact that western Ukraine has a large percentage of SMEs to begin with and that many of the large corporations based there already have experience in accessing the capital markets. Companies such as petroleum company Halnaftogas have been placing Eurobonds, American depositary receipts and equity in EU markets. However, these markets have become generally inaccessible as investors grow wary of the country’s future.

This does not mean that there is a lack of interest. Ms Velikaya sees the situation turning around quite quickly. “There were a lot of companies – mostly in agriculture and food processing – which made pre-initial public offering arrangements but for timing reasons couldn’t go public on the capital markets. They’ll probably be the first to turn to Europe again," she says.

"We also expect a large number of debt launches beginning in the third quarter of 2014, mostly for the big mining and energy companies already known by the market. These launches could be used for refinancing previous debt at cheaper rates. However, any suggestions regarding possible new launches can only take place after the new presidential elections take place, the new IMF loan is finally approved and the tranches are clearly communicated to the market. Moreover, the government needs to show that it has enough political will to implement unpopular reforms and crucially reduce the ‘shadow’ part of the economy, which, at Hrv280bn [$24bn] per year, is at least $4bn more than the whole IMF loan package.”

Right track

Tackling corruption, which was one of the pillars of the Euromaidan movement in the first place, may finally be on the agenda for both Ukraine’s government and its business circles. Mr Usov points to the revived Ukraine Business Ombudsman project that the EBRD and six other parties including IFIs and the Ukrainian government, have recently signed.

“Fighting corruption is difficult anywhere in the world; [but] this has worked elsewhere. Ukrainians seems to know that it is time to tackle it. The business ombudsman that is taking shape is an independent institution to support businesses and safeguard their interests. We expect significant movement on this by the end of the second quarter of 2014, as the concept papers have already been drafted,” he says.

Taking advantage of the focus in domestic politics and civic consciousness on corruption in the near term can bring about some results. Realistic expectations seem to run through the investor community, with Dragon Capital's Mr Bespyatov citing an informal poll showing most investors and industry professionals expecting the new government to accomplish 30% to 70% of what it needs to do. “And the majority view was weighted toward 50%. Considering the low base, that in itself would be very useful,” he says.

While extreme optimism is rare in Kiev, countering naysayers is in demand when considering the pervasive cult of corruption. “Fighting corruption isn’t akin to tilting at windmills here,” says Mr Kubiv. “It takes concrete steps. Those include not having a vendetta against former leaders, but at the same time, not allowing an environment where corrupt practices can flourish.”

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe , Ukraine