Ukraine's economy falters as government collapses (again)

Published: October 15, 2008

Ukraine’s most recent political crisis couldn’t have come at a worse time, as banks go bankrupt and investors lose faith in Ukrainian debt.

In two hectic days in the second week of October, two Ukrainian banks had to be bailed out by the central bank, and the credit default spread on Ukrainian debt rose 523 basis points, to 1,750bp, as the market showed it thinks Ukraine could default on its debt.
The market turmoil came just as Ukraine’s chronically-dysfunctional government collapsed yet again, as President Yushchenko dissolved the government in September and called for fresh parliamentary elections in December.

Yushchenko has fallen out yet again with his prime minister and one-time Orange Revolution ally, Yulia Timoshenko.
International markets appear to have lost faith in the Ukrainian political elite’s ability to agree on anything, let alone on economic measures to tackle the country’s financial crisis. The Ukrainian stock market is the worst performing stock market in the world this year, and has fallen over 70% since January. In October, trading on the Kiev stock exchange was frequently suspended, as the market fell by an average of 10% a day. The hryvna has also fallen around 20% on the dollar in September and early October.
On October 8, the central bank took over management of Prominvestbank, the sixth largest bank in Ukraine, which has total assets of US$5bn, after a run on the bank forced it into bankruptcy. The deputy central bank governor, Volodymyr Krotyuk, declared a six-month moratorium on the bank’s liabilities.

Some analysts say the run on the bank was the result of a dispute between shareholders over ownership of the bank, rather than a genuine run on deposits. But other banks have also had to seek emergency funds from the central bank. Nadra Bank, the country’s seventh largest bank, received a US$300mn emergency loan from the central bank. Several other banks, including Rodovid Bank, have also sought emergency liquidity from the central bank.
It is notable that it is the locally-owned banks that have so far had liquidity problems. Ukraine’s banking sector is unusual in the former Soviet Union in that foreign banks own a majority of the banking system. Several of the top 10 banks have foreign owners, including Aval Bank (owned by Raiffeisenbank), Ukrsibbank (owned by BNP Paribas), Ukrsotsbank (owned by UniCredit) and OTP Bank.
Theoretically, these foreign-owned banks are in a good position now to increase their market share. However, the foreign owners of these banks are facing their own financial issues in their domestic markets. UniCredit, for example, saw its share price fall by 30% in September, although it has since raised around US$7bn in fresh capital, to cover losses incurred on its German subsidiary, HVB.

Political crisis
While the country’s financial crisis has been in large part caused by the global financial volatility, it has been exacerbated by yet another political crisis. In September, President Yushchenko dissolved the government, led by Prime Minister Timoshenko, and called for fresh parliamentary elections, which look set to be held in December. They will be the third general election the country has held in three years.
Andriy Bespyatov, head of research at Dragon Capital, says: “The political crisis comes at a very bad time. Foreign investors don’t seem to have much faith in the ability of our government to steer us through this dangerous situation.”
The latest political argument was sparked by the Russo-Georgian war in August. Yushchenko has accused Timoshenko of failing to support Ukraine’s ally, Georgia, during the war, and of being an “agent of the Kremlin”. The normally-outspoken Timoshenko was unusually quiet during the Russo-Georgian war, leading some to think she has made a deal with both Russia and the Russophile Party of Regions, led by Viktor Yanukovich, in order to win their support for her campaign in the 2010 presidential election.
Timoshenko has reportedly struck up a political alliance with former President Kuchma’s chief-of-staff, Viktor Medvedchuk, a power broker who was behind Yanukovich and Kuchma’s attempts to steal the 2004 presidential election. The attempt failed, because of the democratic protests led by Yushchenko and Timoshenko during the Orange Revolution. Now, Yushchenko claims: “Timoshenko and Medvedchuk are the first couple in Ukrainian politics today.”

Timoshenko visited Moscow and held talks with Prime Minister Putin in early October. A pact or truce between Timoshenko and the Kremlin would make Nato membership for Ukraine a less likely prospect.
However, Nato membership for Ukraine is in any case not immediately likely. A majority of the population is against Nato accession, and the country is far from ready to meet Nato criteria for membership.
Behind the latest dispute is a more deep-seated problem in Ukrainian politics. First, the constitutional reform agreed by Yushchenko and Kuchma during the Orange Revolution inadequately defined the powers of the president and prime minister, leading to a constant battle over which office has more authority.
Second, the three leading politicians in Ukraine –Timoshenko, Yushchenko and Yanukovich – appear incapable of working together or forming a lasting alliance.

Yushchenko himself increasingly looks like a spent force in Ukrainian politics. A recent poll by the Kiev International Institute of Sociology showed that just 14% of Ukrainians wanted him as president, compared to 40% for Timoshenko.
But if Timoshenko is going to create a genuinely functional government in Ukraine, she will need either to win a majority in both the parliamentary and presidential elections, or to forge an enduring alliance with either Yushchenko’s Our Ukraine party, or with Yanukovich’s Party of Regions. So far, she has proved incapable of achieving this.