Ukraine: The Star of the East

Two years ago, as the world was bracing for the onset of the Lehman Crisis, there were great concerns about Ukraine and Kazakhstan. Corporates from both countries had gorged themselves on a binge of debt issuance. With the capital markets shutting down and amortizations looming on the horizon, it was clear that both countries were going to be in trouble. However, we thought Kazakhstan would fare better. It had a reputation for sound regulation, with its financial regulatory body modelled on the FSA. There was more political stability, with an autocratic, but business-oriented leader. Kazakhstan’s economy was based on foreign investment and the development of huge energy resources. Last of all, its proximity to China put it in a geographically enviable position. At the same time, Ukraine had a reputation for high levels of corruption and poor corporate governance. In 2009, it ranked 146 out of 180 in Transparency International’s annual Corruption Perceptions Index (CPI). Ukraine’s political environment was chaotic, especially in the run-up to the 2010 presidential elections. Its areas of comparative advantage, specifically agriculture, coal and steel production, did not seem to be too appealing. Last of all, its proximity to Russia was seen as more of a liability than an asset, particularly as its former master tried to micromanage the leadership in Kiev. Yet, something odd happened along the way. Kazakhstan’s shiny veneer came crushing down brewing during the restructuring of its financial sector, revealing a tangle of mismanagement, fraud and nepotism. Astana’s attitude towards investors was pure contempt. Meanwhile, Ukraine coalesced into a coherent crisis management plan that allowed it to put its economic house in order, while finding ways of dealing with corporate debt servicing needs in an amiable and orderly fashion. Today, investors are flocking back into Ukraine, while Kazakhstan has been relegated to pariah status—and it will probably take a generation before it regains the confidence of foreign investors.

The roots of Ukraine’s economic crisis came from the emerging markets boom of 2007, as well as the country’s energy spat with Russia. The heady GDP growth rates of 7.3% y/y and 7.6% y/y in 2006 and 2007, respectively, resulted in a rapid deterioration of the external accounts as imports poured into the country. Ukraine’s current account deficit peaked at 8.1% of GDP in 2008. Up to this point, the situation was manageable. International reserves were high and debt levels were low. However, a brewing energy dispute with Russia finally came to a head early in 2009, when Moscow turned off the tap. The problems were much more deep-seated than a pricing dispute between Gazprom and Naftohaz. It was a reprisal against President Viktor Yushchenko’s attempt to move Ukraine into Europe’s orbit by applying for EU ascension and admittance into NATO. Ukraine was always considered an integral part of Greater Russia. Furthermore, Russia’s immense Black Fleet facilities in the Crimea made it vulnerable if Kiev shifted allegiances. With the presidential elections looming on the horizon, Moscow decided to put immense economic and political pressure on Ukraine to influence a pro-Russian outcome. At the same time, the West provided Kiev with economic support through a $16.5 billion IMF Standby Facility. In the end, the electorate decided to remain within the Russian orbit by electing Viktor Yanukovych. This allowed Moscow to soften its stance with Kiev, and provide better terms for gas exports. Likewise, the new Ukrainian leadership negotiated and extended the lease for the Black Fleet’s facilities in the Crimea for another 25 years.

Of course, it was not just a series of external events that helped shape the changes in Ukraine. The country was forced to undergo a severe fiscal adjustment in order to secure the IMF Standby Facility. The IMF threatened to cut off its assistance when the government’s program went off track in 2009. Specifically, an attempt by President Yushchenko to raise wages and pension benefits on the eve of the elections was met by a stiff rebuttal by IMF Managing Director Dominique Strauss-Kahn. Moreover, a 38% devaluation of the Hryvnia helped the country to rebalance its external accounts. The confluence of these factors, along with a commitment by the corporate sector to treat external creditors amiably is what led to the country’s reversal of fortune. Today, Ukraine is on the road to recovery, with a more balanced economy and international investors aboard.