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Tuesday, December 23, 2008

As The Politicians Battle It Out Ukraine's Economy Tunnels South In Search Of Australia

“In Ukraine, the evidence is still that policymakers do not quite understand the seriousness of the challenges they face,”. Timothy Ash, analyst at the Royal Bank of Scotland.

“There is a burgeoning economic crisis in the European periphery,” Krugman said on the ABC network Dec. 14. “The money has dried up. That’s the new center, the center of this crisis has moved from the U.S. housing market to the European periphery.”

Make no mistake about it. What is taking place right now in Ukraine is extraordinarily serious. The IMF have recently agreed a support loan to the country, but the politicians themselves still can't agree on whether or not they are actually going to abide by the conditions attached to it. Meantime, as we can all see on our TV screens, tensions with Russia continue to escalate, fuelled by the conflict-ridden negotiations over Ukraine's gas debt.

And just to add to the nighmare, Ukrain's economy made a dramatic entry into recession in Q4 2008. In fact, so severe has been the slowdown that nobody at this point can even muster enthusiasm for opening up one of those interminable discussions about whether or not what the country is going through really counts as a "technical recession" (in terms of two successive quarters of GDP contraction) or not, since the drop in national output has been enormous, and it it fairly obvious that isn't about to come bouncing back up again. At least not for the next several quarters it isn't, and - to give us an early glimpse of the terrain onto which we are now entering - the World Bank have just forecast a 4% contraction in GDP for 2009.

In a year when you would think little would surprise us the sharp change in real Ukraine GDP dynamics has been astonsihingly swift, with the growth rate moving from the 11% year on year expansion registered in August to the 14% year on year contraction reported in November (according to data put together by the World Bank). GDP for the whole January-November period is now down to 3.6% when compared with the equivalent months in 2007, and this is reall a sharp drop, since the average over the first nine months of the year was a growth rate of 6.9%. For his part the office of Ukraine President Viktor Yushchenko is suggesting that gross domestic product may contract at an annual rate of between 7 percent and 10 percent in the first quarter of next year, and by 5 percent over the whole year, according to Oleksandr Shlapak, deputy chief of staff to the president.

The contraction has been led by sharp falls in manufacturing and construction, while the financial system has been in serious trouble since late September, and the loss of UAH deposits from the banking system has amounted to 14% during October and November. But the real problems Ukraine is facing in confronting this most serious economic crisis, lieas in the political sphere, and the complete lack of the kind of political consensus which is so necessary to see through the measures which can it to an end.

Political Chaos Adds To The Problems

Ukraine’s government - which is laways a chaotic process at the best of times - is once more having a serious identity crisis about who it is and what it wants to do, with one of the exectutive's two visible hydra's heads (Prime Minister Yulia Timoshenko) seeking to respond by manipulating the currency downwards, by boosting social expenditure to an extent which will push next year’s budget deficit up to 2.96 percent of gross domestic product (from an agreed 1.4%) and well beyond the IMF pact level, and by attempting to resolve the trade deficit problem by imposing an administrative tax on imports. The other head of the hydra (President Viktor Yushchenko) is busy opposing all these moves on the grounds that they may jeopardize the second tranche of a $16.4 billion loan from the International Monetary Fund, and obviously, were this to be the case, the country would basically find itself bankrupt, and at the mercy of whatever sentiments the global financial markets wish to express when it comes to Ukraine.

Of course regular readers of this blog will not be surprised to find that this politically split personality crisis goes right into the heart of the central bank (see my Monetary Chaos Breaks Out At the Ukraine Central Bank post) and no one will be really that surprised to find that the two key characters in this round of the saga are (yet one more time, read the linked post, its all explained there) National Bank of Ukraine Governor (and board chairman) Volodymyr Stelmakh’s and Petro Poroshenko head of the central bank council.

Well things are really hotting up at the moment, with Viktor Yushchenko this week threatening to fire some central bank employees (presumeably those who were not implementing the decision to allow the Hryvnia to float), while Yulia Timoshenko was busy demanding the dismissal of National Bank Volodymyr Stelmakh himself - presumeably because he was trying to stop further currency intervention. In an official statement the central bank council responded by accusing Timoshenko of stirring up “chaos” and undermining the nation’s banking system, while Timoshenko, for her part has now taken the matter to the Ukrainian parliament (the Verkhovna Rada - where she may well carry a majority) which will now hold a full debate the role of the central bank next week. It seems not to matter too much here that the bank council is simply trying trying to implement a set of policies which were agreed to (or everyone thought they were agreed to) as part of the IMF loan agreement.

“A hryvnia level above 9 per dollar is unacceptable, it threatens the economy and banking system,” Petro Poroshenko, the head of the central bank council said. “The situation with the hryvnia rate demands urgent measures.”

Volodymyr Stelmakh, Central Bank Governor, the Yulia Tymoshenko Bloc is proposing his immediate arrest.

(Interfax-Ukraine) - Yulia Tymoshenko Bloc has proposed that, based on results of a report by an ad hoc parliamentary commission scrutinizing the National Bank of Ukraine's activities, an address should be sent to the Prosecutor General's Office and that National Bank Chairman Volodymyr Stelmakh should be arrested. "I think that, based on the report's findings, there will surely be an address to the Prosecutor General's Office of Ukraine and other law enforcement agencies, which, by the way, are already conducting inquiries," Volodymyr Pylypenko of the Yulia Tymoshenko Bloc said in an interview with Interfax on Wednesday. "The best gift in this situation can only be an order on taking [National Bank of Ukraine Chairman Stelmakh] into custody for all wrongdoings the National Bank has committed in the past months," Pylypenko said.

President Yushchenko did express the hope last Tuesday that Ukraine's currency market might be moving rightside up, with the hryvnia trading at about 7.8-8.0 to the dollar and level of "stabilising" dollar purchases by the central bankdeclining, but Prime Minister Tymoshenko remained unconvinced that this was a desireable level, and demanded more concerted intervention to move the currency up to a much higher level - around the 6-6.5 to the $ mark. She gave Yushchenko a week-and-a-half apparently, since otherwise she stated the country would face increasing problems with inflation, and in the banking and other sectors. It is not clear (at least to me) why these problems (which are, and will continue to be, serious) should suddenly deteriorate within the time scale of ten days, but presumeably there was another, more political, message behind this choice of words.

Adding to the confusion, Ukraine's parliament, has decided to impose an additional 13% temporary duty on all imported goods - and this despite the fact that Ukraine only recently entered the WTO. A total of 269 MPs from the ruling coalition and the Communist Party voted for the relevant law which amended existing Ukranian lefislation - with, it was said, the aim of improving the state of Ukraine's balance of payments. "Duties have been increased on all imported goods, apart from a [so-called] 'critical' [list of goods]," the head of the parliament's committee for tax and customs policies, Serhiy Teriokhin, is quoted as saying.
"I'm alarmed by the report of my legal department on parliament's decision to impose an additional temporary duty on all imported goods. Parliament's decision puts Ukraine's presence in international programs in jeopardy," President Yushchenko said at a press conference yesterday. "Similar decisions by Russia and Europe might be made against us in three days,".

IMF Taking Large Political Risk

Last month, a point in time which now seems so distant it feels like eternity, Ukraine received approval for a two-year IMF loan intended to help support its banking system and cover the country’s widening current-account gap during what was always seen as being a difficult adjustment process. Under the terms of its agreement with the IMF, Ukraine is expected to have a balanced budget next year. If the Cabinet fails to meet the target, then the Fund may withhold the second tranche of the loan, according to press statements by Balazs Horvath, IMF representative in Kiev. Ukraine received the first installment of $4.5 billion last month, and is due to get the second tranche in February. Obviously the IMF is by now well accustomed to playing the part of the "bad boy" in this type of situation, but what if the country they are trying to deal with should simply "implode", right in its face, I'm not sure even the hardened hand of the IMF are ready for this. So let's just hope I'm exaggerating, and that it won't happen (fingers tightly crossed everyone, please).

Discrepant GDP Forecasts

So Ukraine faces a crisis on three fronts, financial, economic and political. On the real economy side, the Ukraine cabinet currently expects growth in the country’s economy to slow to 0.4 percent next year, compared with a final rate which turn out to be somewhere between 1.8 percent and 2.5 percent this year. As I say the World Bank now expects a 4% contraction in GDP next year, and thus a 0.4% expansion in the budget is potentially a very serious problem indeed for the deficit, if the economy underperforms, as it surely will.

“The draft budget, prepared by the Cabinet, is not realistic,” Yushchenko said today in a statement on his Web site. “The 2009 budget is a tragedy; it is the most irresponsible document worked out by the government. Professionals should plan a realistic budget, not optimistic.”
The government plans to cover the budget deficit by selling bonds in domestic and foreign markets, and is to receive a $500 million loan from the World Bank to cover the budget deficit. Under the terms of the IMF agreement with the Inernational Monetary Fund Ukraine has pledged to keep its 2009 budget deficit under 1 percent of gross domestic product, below the 2 percent initially planned by the government. In October, the government reduced its planned 2008 budget revenue from the sale of state assets to 401 million hryvnia ($59.4 million) from 8.6 billion hryvnia, citing the unfavourability of the moment for selling.

Pressure On The Hryvnia

The Hyrvnia has been falling for a number of weeks, but the rate of decline has really accelerated in the last ten days, and we are really now talking about one of those famous currency crises. The national currency has fallen 50 percent against the dollar since June, and according to Michael Ganske, head of emerging markets in London for Commerzbank, it may well drop another 24 percent in the next few weeks given market sentiment and that the International Monetary Fund package effectively limits central bank intervention to halt the slide. The terms of the IMF $16.4 billion bailout package, agreed to last month, require Ukraine to move toward a flexible exchange rate and place a maximum limit of 4 percent for any reserves reduction during the remainder of 2008 (from the base of around $32.8 billion). Thus while the agreement does allow intervention to stem “disorderly” swings, it places a tight limit on what this means. And this now is just the problem, although before we jump to our guns, we should bear in mind that what is provoking the fall is not the IMF and the bailout, but confidence in the ability of the political system to implement a workable recovery plan. Trying to run a currency corridor, and accepting the inflation that went with it, is how we got here in the first place.

The only real remedy Ukraine’s central bank has at its disposal at this point is to raise its base refinancing rate, and this it duly did last week, taking it up from 18 percent to 22 percent in an attempt to arrest the hryvnia’s decline To give us some idea where we are at this point, at the start of 2008 the dollar bought 5.04 hryvnia, while right now it can purchase around 8.25 hryvnia.

The central bank is currently offering to sell dollars at 8.0 hryvnias and to buy them at 7.8788 on the interbank market. Yushchenko told a news conference last week that the central bank had bought $270 million on Monday and Tuesday, but had been required to sell only $30 million on Tuesday. He informed the assembled journalists, however, that complete stabilisation would need to wait until after the debts for Russian gas and other expenditures had been paid (you should be able to start to smell just how complicated all this is by this point, just who exactly is batting for who here?). "Until debts are paid for gas, and settling the debts of (the national road network) Ukravtodor, it would be madness to talk about steps aimed at a fundamental, professional stabilisation". "Everything is earmarked", he claimed, "$3 billion (for intervention from reserves), more than $2 billion set aside for gas arrears, $1 billion for repayment of a loan to Ukravtodorom, $200 million to (rocket maker) Yuzhmazh, leaves only an additional $400 million to defend the hryvnia."

As a result of the $7.5 billion the Ukraine central bank spent supporting the hryvnia in October and November foreign reserves fell to $32.7 billion as of Nov. 30. At the same time the hryvnia has declined 21 percent against the dollar over the last month alone . Under the terms of the agreement with the IMF, the reserves should not fall below $31.4 billion by the end of this year, so we are talking about a very close call on this front too.

Equities Down And Credit Default Swaps Up

Ukraine’s stocks have also been falling, and the benchmark PFTS stock index is down 74 percent this year, the third-steepest decline among the 22 so-called frontier markets tracked by MSCI Barra. Mariupolsky Metallurgical Plant, Ukraine’s largest steel company by revenue, has fallen 92 percent on the Kiev stock market. On the other hand the extra yield investors demand to own Ukrainian government bonds instead of U.S. Treasuries has increased more than nine times this year to 25.86 percentage points, according to JPMorgan Chase’s EMBI+ indexes, which compares with an average three-fold increase in the main emerging-market index to 7.09 percentage points.

Loan Defaults Coming

And as the currency slides, so too does the ability of the average Ukrainian to pay his or her debts. Another Yushchenko aide, Roman Zhukovskyi, recently estimated that up to 60 percent of foreign-currency loans and mortgages could default given the extent of the decline. Ukraine, which has around $105 billion in corporate and state debt, has the fourth-highest credit risk worldwide, according to credit-default swap data. The cost of insuring Ukraine bonds against default is up more than thirteenfold this year, to an astonishing 31 percent of the amount of debt protected. This puts the country behind only Ecuador, which defaulted last week (59 percent), Argentina, which defaulted on $95 billion in bonds in 2001 (46 percent), and Venezuala ( 33) percent, according to the data from CMA Datavision.

Ukrainian companies need to repay as much as $4.1 billion this month while lenders refuse to refinance debt, according to Dmitry Gourov, an economist at UniCredit in Vienna (oh, no, not Unicredit again, see this post). Dollar denominated loans made up 53 percent of credit issued by Ukrainian banks as of 30 September, according to central bank data.

Thus, with just over half of all bank loans denominated in US dollars, they obviously become vastly more expensive for borrowers who are paid in the national currency.

Aggressive lending by banks that borrowed heavily from abroad has obviously contributed to Ukraine’s ballooning private sector external debt (currently estimated at $85 billion). Official figures indicate that only some 2.5 percent of loans are currently problematic, but this situation is obviously about to worsen considerably next year as the currency is down and the economy contracting.

Earlier this month, Finance Minister Victor Pynzenyk called on banks to refinance loans amid a weakening hryvnia and rising interest rates. Some banks in recent days said they would seek compromises with clients, rather than hike interest rates further. Pynzenyk’s proposal called on the NBU to amend its rules to allow borrowers either partially or in whole to pay back loans in the national currency at the exchange rate which was operative when the loan agreement was signed. The banks, in turn, would be allowed to lower their capital/asset ratios and write off their losses, thus paying lower taxes, which would also require amendments to the tax legislation. Obviously some such solution will need to be found for this problem. (There has already been some move in this direction in Hungary, another of the countries which is strongly affected by the forex loans problem).

Other measures under consideration at the present time include extending loan periods, and the temporary reductions in loan payment installments. If the hryvnia-dollar exchange rate further widens, mass loan defaults are inevitable, according to Yuriy Belinsky, head analyst at Astrum Investment Management. At the current Hr 8 to the $1 rate, “40 percent won’t be able to pay their loans,” Belinsky told Korrespondent, a Russian-language Ukraine newspaper.

And the situation is deteriorating fast, a quick visit to the foreclosure sections on the websites of banks like Finance and Credit Bank or Alfa will turn up plenty of property and cars already listed for sale or soon to be auctioned. But given the slump in the real estate market and falling house prices it isn't clear that banks will find it any too easy unloading any property they do repossess. We are back to the "you owe them a little money and you have a problem, and you owe them a lot of money and they have a problem" situation. Last weekend, the NBU also recommended that banks lower interest rates on foreign-currency denominated loans, but the problem is going to be, as ever, who is actually going to fund these measures?

Industrial Output Plummets

Meantime in the world of the real economy things simply get worse and worse. Industrial production shrank by a record 28.6 percent in November as steel, machine building and oil refining slumped, after a 19.8 percent decline in October.

And as output falls, prices come tumbling behind. Steel production dropped 48.8 percent in November, while the price of the benckmark European hot rolled coil has fallen 47 percent since August and is now at around $425 a metric ton, according to data from U.K. industry publication Metal Bulletin.

World Bank Forecast

The World Bank have predicted a sharp recession for Ukraine in 2009, with GDP being expected to fall by some 4.0 percent. This compares with their July forecast of 4.5 percent growth. The Bank also cut back its forecast for 2008 growth to 2.3 percent from a previously forecast 6.0 percent. It raised its inflation forecast for this year to 22.8 percent from 21.5 percent previously predicted, up from 16.6 percent in 2007. It cut its forecast for inflation next year to 13.6 percent from 15.3 percent.

(please click on image for better viewing)

The Bank take the view that the Ukraine government - in agreeing to the terms of the IMF loan package - have initiated an important programme of macroeconomic adjustment measures, but (with a wary eye on what is actually going on in the Parliament) stress that consistent implementation is essential to avoid a further erosion of market confidence. In their latest report the Bank highlight the shift towards a flexible exchange rate policy, financial sector stabilisation measures , and a more conservative fiscal policy, but as we have seen, these are just the measures which seem to be being challenged by some of the political participants .

So What Does The Future Look Like?

Obviously Ukraine is heading into a major recession in 2009 fuelled by the nasty cocktail of a credit crunch, a terms of trade deterioration, and a consequent massive slowdown in both internal and export demand. Given the damage to competitiveness caused by two years of double digit inflation, macroeconomic stabilization will require a very large and significant correction, and this will mean a significant tightening of aggregate demand and a shift in its composition away from domestic consumption and towards net exports. The government debt stock is currently low at 10 percent of GDP, and will undoubtedly remain sustainable throughout and after the adjustment, even allowing for the potential costs of bank recapitalization. But the ability of the Ukraine administration to carry out the necessary adjustment hinges critically on the willingness of external creditors to refinance the banking and corporate sector debts, and this willingness in its turn depends on the perception those creditors have of the level of political coherence and stability the country has. And as we are seeing such perceptions must be reasonably near an all time low at the present time.

But even with the best political system in the world, the economic correction facing Ukraine is going to be large and the stresses enormous. The World Bank more or less spell this out in the paragraph I extract below. A 200% contraction in real imports (ie not due to cheaper energy prices or something) is massive, and we are talking about a basically balanced budget (ie very little fiscal stimulus) and monetary policy where interest rates are at the current giddy heights of 22%.

The basic macroeconomic parameters in our forecast are broadly consistent with those of the IMF program. Balance of payments pressures will lead the economy to adjust the composition of growth through 2009. As a result, the current account deficit is expected to improve from over 6 percent of GDP in 2008 to 1-2 percent of GDP in 2009-11. To achieve this adjustment, an over 20 percent real import contraction will be needed in 2009 in order to counter the 7 percent forecast terms of trade deterioration. Real wages and employment are forecast to decline in 2009 to restore price competitiveness of Ukrainian exports in the wake of declining export prices and to support the adjustment in aggregate demand. With this current account adjustment and with the support of the IMF Stand-By, the external financing gap would be closed under our baseline assumptions. Declining commodity prices, tightening liquidity and the forecast decline in domestic demand will contribute to disinflation. However, offsetting this, the exchange rate correction and the adjustment of energy and utilities tariffs will make disinflation a more prolonged process. We assume that the government will maintain a balanced budget in 2009 (not accounting for bank recapitalization costs) and have a small deficit thereafter.

So I think we need to be very clear at this point. The Ukraine position is very difficult, and everything is very delicate. The danger of total financial meltdown (which would be in this case in the private banking sector, not sovereign debt) is real and significant. The economic downturn has only just started and further downside risks are large and depend critically on the size of external shocks and the limitations imposed by inadequate policy responses.

Any further deterioration in the terms of trade (unlikely at this point given how far steel prices have already fallen, but these prices may stay lower for longer than many in the sector can sustain) or further decline in export demand would certainly put almost unsustainable pressure on the real sector. Banking sector vulnerabilities may be further exacerbated by further overshooting of the exchange rate and external debt refinancing difficulties as corporate balance sheets weaken further and household incomes come under strain from rising debt service costs.

Prudent fiscal, monetary, and financial policies (many of them anchored in the program supported by the IMF), accompanied with renewed efforts to deepen structural reforms, can help Ukraine to stabilize its situation and move the economy towards recovery. Conversely, a continuation of the current disorderly response and poor implementation of the agrred policies may easily trigger further financial chaos leading to an even shaper downturn and a postponement of any recovery off into the distant sunset.

But Beyond The Recovery, What About The Demography?

One of the reasons why I think the IMF and the World Bank are taking such a big risk with their credibility in Eastern Europe at the moment, is that I don't think they are getting through to the heart of the problem. One way of thinking about this is to take Paul Krugman's favourite Keynes quote - "we've got magneto trouble" - and ask ourselves whether all we have before us in the CEE countires right now are magneto problems, or whether, to continue with the metaphor, we may not have issues with the cylinder head gasket. And it gets worse, because the cylinder head gasket does seem to have blown (and it will keep blowing) because we have leakage problems in the sump, and the main oil pump isn't working - and who knows, maybe the crankshaft even needs replacing. As they always tell you when you take the car into a garage for "fixing", we won't know till we take the thing apart. What do I mean?

Well take a look at the chart showing the relative size of annual births and deaths in Ukraine over the last twenty years.

I mean to the normal and untrained eye stands the problem stands out a mile, population dynamics went underwater in the Ukraine in the early 1990s, and they aren't coming back to the surface again (not now, not in thirty years, not...... well maybe never is too much of a long time, but certainly not over a time horizon which is going to make any essential difference to anyone who is already alive today.)

And this is without taking any outward labour migration into account, so just think about the negative labour market dynamics that this implies, and already has implied. Can anyone really be surprised that Ukraine has been suffering from acute inflation as its number one problem?

To some extent it is worth stressing here that what really matters is the actual numbers of annual live births, rather than any more complex measure of fertility. In 1989 for example there were nearly 700,000 children born in Ukraine. By 1998 this number was near to 400,000 (ie there was a drop of 40% or so in a decade). In practical terms (and if we take 18 as an average age for labour market entry in a country like Ukraine) next year there are potentially 650,000 people to enter the labour force, but by 2016 this number will be only 400,000. So it isn't simply a question of pushing the fertility rate up towards the replacement rate (a difficult, but not impossible task), we also need to think about what economists term the "base effect" here, that is that with each passing year and cohort you have less and less women in the childbearing ages, so even if those women replace themselves, the base of the pyramid is still much narrower than the top, and it is the people at the top who need caring for and financing.

And even if some of this loss can be offset at the workforce level by increasing labour force participation at the older ages, we would still be talking about a very sharp rise in the average age of the workforce. And productivity improvement alone cannot possibly hope to compensate for the kind of labour force contraction we should reasonably expect, at least not over such a short period of time it can't. So this is just one more reason why, against all expectation, fertility really does matter.

While many continue to believe that falling populations don't actually have any tangible impact on economic performance, it is very striking to notice that when it comes to ageing and declining populations we really lack ANY evidence to substantiate that claim in the affirmative. On the other hand we do have plenty of evidence from countries where the population is either falling or gathering negative momentum to suggest that these countries face some very special kinds of economic problems. The example of Eastern Europe is clear enough I would have thought, but people really do need to take a closer look at what has been happening in recent years in countries like Japan, Germany, Italy and Portugal. And if falling population does produce its own kind of economic problems, well then we should be expecting to see plenty of them in Ukraine, since as we can see in the chart below Ukraine's population peaked in 1993, and has been in some sort of free-fall ever since.

Evidently there are a number of factors which lie behind this dramatic decline in the Ukrainian population, fertility is just one of these (with poor health and net emigration being the others). Ukraine fertility is currently in the 1.1 to 1.2 Tfr range, and, as we can see in the chart below, it actually dropped below the 2.1 replacement level back in the 1980s.

Another major influence on demographic dynamics is health, and one good measure of this is the level of life expectancy, which in the Ukraine case has shown a most preoccupying evolution, since it has been falling rather than rising. The chart below shows life expectancy at birth for both men and women, the male life expectancy is evidently significantly below the combined figure.

This life expectancy situation is, as well as being preoccupying, highly unusual (it is however paralleled to some extent in Russia itself, and some other CIS countries). Apart from the obvious, the deteriorating health outlook which this data reflect places considerable constraints on the ability of a society like Ukraine to increase labour force participation rates in the older age groups, and this is a big problem since this is normally though to be one of the princple ways of compensating for a shortage of people in the younger age groups.

So what about the future? Well, two issues are really starting to worry me at present, the first of these is the short term fertility shock Ukraine will undoubtedly receive on the back of the current crisis. If young people were already rather reluctant to have children, then then will now almost certainly be much more so, given the downward pressure on living standards we are about to see.

The second worry concerns the future of the country itself. A recent study carried out jointly by the Kiev based Democratic Initiatives Foundation and Nova Doba History and Social Sciences Teachers Association found that while more than 93 percent of the Ukrainian seventeen year olds they inteviewed considered themselves Ukraine citizens, only 45 percent said they planned to live and work only in Ukraine, citing Western Europe, Russia and the United States as possible future destinations. When 55% of your potential future labour force are thinking of working elsewhere you have a problem, and one which needs a solution. Simply putting a strip of band-aid over a festering wound won't work, I'm afraid, however much the Ukrainian people may struggle and sacrifice. With or without Keynes, we've got more than magneto problems on our hands here.


A much fuller analysis of the problems presented by Ukraine's long term population implosion (including the issue of out-migration patterns and trends) can be found in this post here.

Sunday, December 14, 2008

Ukraine's Industrial Output Drops An Annual 28.6% In November

Ukrainian industrial production fell at the fastest pace registered anywhere in Europe in November, falling for a fourth consecutive month, led by steel, machine building and oil refining. Output shot dopwn an annual 28.6 percent, following a 19.8 decline in October, according to the Ukrainian Statistics Office last Friday. Steel production slumped 48.8 percent, oil refining and chemical output fell 35.2 percent and machine building by 38.8 percent.

The Ukrainian economy, which has been expanding at an average annual pace of 7 percent since 2000, is now “in recession,” according to Finance Minister Viktor Pynzenyk speaking on December 10. Econoic growth will probably slow to between 3.5 percent and 4 percent this year from 7.6 percent in 2007, First Deputy Economy Minister Serhiy Romanyuk said on December 3, while the economy may contract by 5 percent next year, according to Oleksandr Shlapak, the president’s deputy chief of staff, at the end of November.

Ukraine’s national currency, the hryvnia, is heading to its worse year since 1999. It lost 34 percent in October and November and has been sliding further this month. The government of the nation of a 46 million people relies on a weakening hryvnia to boost exports, said Finance Minister Viktor Pynzenyk yesterday.

Industrial output grew 10.2 percent in 2007, boosting economic growth to 7.3 percent. Piontkivska expects industrial production to contract by 3 percent in 2008, while economic growth slows to “around 4 percent.” Production increased 2.2 percent in the first 11 months of the year, compared with 10.7 in the same period a year ago, according to the statistics data.

Friday, November 7, 2008

Ukraine Inflation Continues To Drop Back In October

Ukraine's inflation rate, which is still the highest in Europe, fell back again in October - for the fifth month, following falls in food and commodity prices. The annual rate was at 23.2 percent, down from 24.6 percent in September, and considerably down from the May peak of 31.2, according to data released this morning (Friday) by the state statistics committee. Month on month, prices were up 1.7 percent.

The Ukranian government is struggling desperately to bring inflation back under control and to stabilize the economy as part of a pledge to the International Monetary Fund who agreed this week to lend Ukraine $16.5 billion.

It is hard to say how quickly disinflation operates in Uklraine, since in part this depends on what happens to the hyrvnia, although the Ukraine president's office do not expect it to fall below 18 percent this year, compared with 16.6 percent in 2007.

I am sorry I have not found the time to make much comment on the Ukraine situation in recent days. I will try and find time to say something "useful" over the weekend.

Monday, October 27, 2008

Hryvnia Falls To Record Low On Monday

Ukraine's hryvnia fell to near a record low against the dollar this morning as the $16.5 billion International Monetary Fund loan failed to restore confidence in the country's ability to weather the global financial crisis. The hryvnia slid 1.3 percent to 5.9500 per dollar by 9:48 a.m. in Kiev, from 5.8750 on Oct. 24. It traded as low as 6.0812 last week, according to Bloomberg this is the hryvnia's weakest level since at least 1994, when they began tracking Ukraine's currency.

The IMF said yesterday the loan is conditional on Ukraine balancing its budget, reining in social spending and narrowing its current-account deficit, which was $7.7 billion in the first seven months of the year. The hryvnia lost 12 percent versus the dollar last week, its biggest weekly drop on record, as investors sold emerging- market assets from Brazil to Korea on concern emerging-market countries will have difficulty servicing their foreign debt.

Sunday, October 26, 2008

$16.5 Billion IMF Loan Agreed For Ulkraine

The International Monetary Fund has reached an agreement with Ukraine on a $16.5 billion loan to help the country confront the ongoing financial and economic crisis. IMF managing director Dominique Strauss-Kahn said on Sunday that agreement had been reached between the IMF staff mission to Ukraine and the government, although it still needed to be formally ratified by the IMF board.

The 24-month stand-by loan will be conditional on parliamentary approval of legislation to support the country's banks. Ukraine will also need to balance its budget and address the current-account deficit problem, according to a separate statement from the Kiev-based central bank.

It is hoped that the loan will provide a framework within which it will be possible to try to increase financial stability and rebuild confidence among investors, although there does seem to be a long hard road to go down here.

The Ukraine central bank has pledged to support the country's banks and has injected more than 16.25 billion hryvnia ($3.13 billion) into the banking system over the last month. It also took control of Prominvestbank (one of the country's larger lenders) and promised an injection of 5 billion hryvnia into the bank to help the lender "renew its financial stability'' after a run by depositors.

Really there does seem to be a very severe credit crisis raging in Ukraine (and across Eastern Europe) at the present time, and the macroeconomic consequences are hard to forsee, although recession does seem imminent.

Friday, October 24, 2008

Ukraine's Credit Rating Cut Again By S&P

Ukraine's credit ratings were lowered for the second time since June by Standard & Poor's on concern about the country's banks, its weakening currency and slowing economic growth. The foreign-currency debt is now rated B, five steps below investment grade, down from B+, according to a statement from the Ratings Agency earlier today (Friday). Ukraine local currency debt was lowered to B+ from BB-. S&P have thus joined Fitch and Moody's, which downgraded Ukraine's ratings earlier this month.

``The downgrade reflects the rising cost to the Ukrainian government of a necessary recapitalization of the banking sector against a backdrop of declining growth and heightened exchange rate risk,'' said S&P in the statement. ``Low confidence in Ukraine's financial and monetary institutions increases the associated risks to the real economy and inflation.''

The outlook for Ukraine is negative, S&P said, indicating the agency may cut the rating further.

``Conversely, the outlook on the ratings could change to stable if the government is successful in implementing effective financial stabilization measures that lay the foundation for economic recovery over the next two years,'' said S&P.

Meanwhile Ukraine parliament chairman Arseniy Yatsenyuk told a packed chamber that Ukraine's talks to secure credit from the International Monetary Fund could collapse unless the parliament acts to pass the measures needed to ease the effects of the global financial crisis.

"It is very important for us to achieve results in a vote on the financial crisis," Arseniy Yatsenyuk told the chamber, which was deadlocked for the fourth day, after adjourning debate on the issue until next week.

"Bang, Boing, Crash" I think must be the sort of background noises they can detect rudely inter-rupting them from the street outside as one peice of financial scaffolding after another falls away from the building it had been momentarily holding up while they trundle on with their interminable debate about their endangered country's short term future.

An International Monetary Fund mission has been holding talks for more than a week in Kiev on extending credit that Ukrainian officials say could amount to up to $14 billion. Yatsenyuk said no consensus could be reached on six draft laws to tackle the crisis, including a package proposed by Prime Minister Yulia Tymoshenko's government.

A working group was set up to draft a document able to command a majority. Debate would resume next Tuesday. Tymoshenko, speaking later outside the chamber, said: "If we pass this package of bills to combat the crisis, we could secure the vitally necessary substantial help Ukraine needs and we could get it next week."

The government's package calls for amendments to the 2008 budget, borrowing of $2 billion from unnamed international financial institutions, sovereign guarantees to firms seeking foreign credit and creation of a stabilisation fund.

Parliament has been thrown into disarray over proposals to combine debate on the crisis with measures to finance an early election called by President Viktor Yushchenko.Tymoshenko, at odds for months with the president, opposes the election and members of her bloc have milled about the chairman's rostrum to curtail debate.

The president dissolved parliament this month and called a Dec. 7 election to the assembly after the collapse of a government team linked to the 2004 "Orange Revolution".He lifted the dissolution order this week and said he was putting the election back for a week to Dec. 14. It remains unclear when the poll will take place.

Tuesday, October 21, 2008

Deal Near On $15 Billion IMF Loan For Ulraine

Ukraine seems to be on the point of signing a loan worth as much as $15 billion with the International Monetary Fund. Agreement could be reached as early as next week as the government urgently seeks to inject cash into domestic banks and avoid an economic meltdown, Prime Minister Yulia Timoshenko said.

Talks about the loan are "90 percent" completed, Timoshenko said at a press conference in the Ukrainian capital Kiev today. Talks with the IMF may be completed tomorrow. Once signed, the pact will need to be approved by lawmakers, who are expected to vote on it by the end of the week, the premier said. "The talks are almost finished with the IMF and we've almost agreed on what necessary changes to laws we have to make to get the loan,'' Timoshenko said.

Tymoshenko said the loan would be used to bolster central bank reserves of $35-38 billion and prop up the banking system. "The financial resources, which will be received from the IMF, will be directed first of all towards making central bank reserves stronger and, secondly, to supporting the national banking system," she told a briefing.

Hyrvnia Falls Again

Ukraine's hryvnia weakened for a fifth straight day against the dollar today as the government continued to negotiate with the IMF and Fitch Ratings extended its cut of Ukraine's credit rating to 10 of the former Soviet republic's banks. The currency dropped 0.4 percent to 5.5200 per dollar by 11:18 a.m. in Kiev, from 5.4975 late yesterday, after earlier falling to 5.5500, the lowest level against the dollar since Oct. 9.

Fitch Downgrades Banks

Fitch Ratings today downgraded the Long-term Issuer Default ratings (IDRs) of 10 Ukrainian banks and their Support ratings, and revised downwards the Support Rating Floors of four of these banks. The Outlooks on the Long-term IDRs remain Negative. This follows the downgrade of Ukraine`s Long-term foreign and local currency IDRs to `B+` from `BB-` (BB minus) with Negative Outlook (see the announcement on `www.fitchratings.com`).

According To Th Statement

The downgrade of the IDRs and Support ratings of Swedbank, Forum, ProCredit Ukraine, VTBU, UkrSib, Ukrsots and Pravex reflects the downgrade on Ukraine`s Country Ceiling to `B+` from `BB-` (BB minus). The Country Ceiling of Ukraine limits the extent to which support from the shareholders of these banks can be factored into their Long-term foreign currency IDRs, and their Long-term local currency IDRs also take into account Ukrainian country risks.

Swedbank is 100%-owned by Swedbank AB (`A+`/Negative), Forum is majority (60%+one share)-owned by German Commerzbank AG (`A`/Rating Watch Negative), ProCredit Ukraine is 60%-owned by Germany`s ProCredit Holding AG (`BBB-` (BBB minus)/Stable), VTBU is more than 99%-owned by Russia`s JSC Bank VTB (`BBB+`/Stable), UkrSib is 51%-owned by France`s BNP Paribas (`AA`/Stable), Ukrsots is 94%-owned by Italy-based UniCredit (`A+`/Negative) and Pravex is 100%-owned by Italy`s Intesa Sanpaolo (`AA-` (AA minus)/Stable). The Long- and Short-term IDRs and Support ratings of these banks reflect the limited probability of support being forthcoming from their majority shareholders, in case of need.

The downgrade of the Long-term IDRs and Support ratings of Oschadny and Ukreximbank reflect the reduced ability of the government to provide support in case of need as reflected in the downgrade of Ukraine`s Long-term IDRs. Oschadny`s and Ukreximbank`s Long- and Short-term IDRs and Support ratings reflect Fitch`s view of the strong propensity of the Ukrainian authorities to provide support for these banks in case of need, although the ability to provide that support is less certain now. Both Oschadny and Ukreximbank are 100%-owned by the state (represented by the Cabinet of Ministers of Ukraine). Non-binding letters of support from the government have been provided in the offering circulars of Ukreximbank`s international debt issues (the most recent dated March 2007).

The downgrade of the Privat bank`s Support rating and revision of its Support Rating Floor reflects Fitch`s view that the Ukrainian authorities now have limited ability to provide support if required, as reflected in the `B+` sovereign Long-term IDRs, although there is a propensity to support the bank in case of need, based on Privat`s size and importance to the Ukrainian banking sector: it is the country`s largest bank (privately owned) with a share of approximately 10% in sector assets and 15% in retail deposits.

The downgrade of the Long-term and Short-term IDRs and revision of the Support Rating Floor of Nadra Bank reflect the reduced ability of the government to provide support in case of need, despite the propensity of the latter to provide such support to a bank of Nadra`s size. Nadra is the seventh-largest Ukrainian bank by asset size, with a presence in the retail segment and about 3.4% of system assets at end-H108.

Unfortunately, even the weather isn't brightening things up at the moment:

Ukraine to see cold weather and fogs this week

No precipitation expected in Ukraine tomorrow. The country will see fogs at night and in the morning. According to the National Weather Center, the night temperature will make 0-5 C degrees above zero. The temperature during the day will make 11-16 C degrees above zero.

Monday, October 20, 2008

Moody's Cuts Ukraine Outlook

Moody's Investors Service lowered Ukraine's outlook as the global liquidity crunch adds pressure to an economy already beset by racing inflation and political instability. The outlook for the former Soviet republic's foreign- and local-currency debt ratings was cut from positive to stable. Moody's downgrade follows similar moves by Fitch Ratings and Standard & Poor's.

The worldwide financial turmoil is prompting investors to shun riskier assets in emerging markets. Ukraine has the worst creditworthiness of Europe's emerging markets, based on the cost of credit-default swaps, which protect bondholders against default. The country is also heading for early elections on Dec. 7 after the second collapse of a ruling alliance between President Viktor Yushchenko and Prime Minister Yulia Timoshenko.

``Although Ukraine's government balance sheet remains strong at the moment, the current global market turmoil heightens the existing vulnerabilities,'' said Moody's Vice President Jonathan Schiffer said in the statement.

The hryvnia fell 3.7 percent 5.4400 to the dollar, its weakest level in more than a week, as of 2:25 p.m. in Kiev. The hryvnia has slumped 16 percent against the dollar since early September.

Fitch cut Ukraine's credit rating to B+ on Oct. 17 and Standard & Poor's put it on review for downgrades on Oct. 15.

Ukraine's foreign-currency denominated bonds are currently rated Ba3 by Moody's, a high-yield, or ``junk,'' level three steps below investment grade. The local-currency debt is rated a step lower at B1.

Sunday, October 19, 2008

Fitch Cuts Ukraine Debt Rating

Fitch Ratings cut Ukraine's credit ratings as risks about the hryvnia, the bank system and the economy increased. Fitch lowered the credit rating to B+ from BB- and left the outlook negative, indicating it may cut the rating further.

``The downgrade reflects Fitch's concern that the risk of a financial crisis in Ukraine involving a large depreciation of the currency, further stress in the banking system and significant damage to Ukraine's real economy is significant and rising,'' according to Andrew Colquhoun, the director of Fitch's Sovereigns Group.

The global financial crisis is hitting more vulnerable emerging markets as investors shun riskier assets in countries with big current-account deficits in a flight to safety. Ukraine has the worst creditworthiness of Europe's emerging markets, based on the cost of credit-default swaps, which protect bondholders against default.

Contracts on Ukraine's debt are traded at 2000 basis points, compared with 458 for Hungary, according to CMA Datavision in London.

``Fitch is unconvinced that the raft of emergency support measures announced by the central bank will be adequate to shore up depositor confidence and forestall further banking-system stress,'' said Colquhoun. ``New central bank rules restricting loan growth threaten to exacerbate a slowdown in the economy, which could hit banks' asset quality relatively soon.''

Friday, October 17, 2008

Ukraine Set To Receive IMF Help: Details Only Await Agreement Between Yushchenko and Tymoshenko

The global credit crisis continued to extend its reach on Thursday as Hungary and Ukraine both approached international institutions for support in an effort to avoid following Iceland into financial turmoil.

The European Central Bank also announced yesterday that it will support the Hungarian central bank's money market operations with as much as 5 billion euros ($6.7 billion) to help it ease the present financial tensions. The agreement will provide the central bank with a facility to borrow up to 5 billion euros in order to provide additional support to the central bank's operations, the ECB said in a statement this morning. The move will support the Hungarian central bank's "instruments of euro liquidity provision.'' This move is an important "first", since Hungary isn't a member of the 15-nation euro region, a may well set a precedent which will need to be followed as more and more of the walking wounded limp over and present themselves at the Kaiserstrasse front door, before being politely shown round the back to the overnight lending window.

And today we learn that Ukraine may borrow between $10 billion and $15 billion from the International Monetary Fund to "strengthen its position'' during the global financial crisis, according to Deputy Central Bank Governor Oleksandr Savchenko. The cost of insuring Ukrainian debt in the credit default swaps market also increased today (Friday) by 200 basis points to reach an all-time high of 2000 bps (or 20%), meaning it will now cost $2 million a year to insure $10 million of five-year debt.

Emerging Markets Take a Bashing

Emerging equity markets sank for a third consecutive day on Friday, setting new three-year lows as more positive sentiment in developed markets was unable to lift deepening gloom.Iceland's highly indebted banking system has already driven the country and currency to collapse, while worries over banking stability in Ukraine, Serbia and Hungary have forced these three countries to seek outside help and in so doing sparked investor nerves.

Standard & Poor's has announced that it placed its 'BBB+/A-2' sovereign credit rating on Hungary on CreditWatch with negative implications. S&P has also placed the following ratings on Ukraine on CreditWatch with negative implications: its 'B+/B' foreign currency and 'BB-/B' local currency sovereign credit ratings on its global scale; and its 'uaAA' ratings on its national scale.

“The CreditWatch placement reflects our concerns over mounting financial-sector
funding pressures and their potential to raise general government debt
materially from its current level of 67% of GDP," explained Standard &
Poor's credit analyst Kai Stukenbrock. S&P said the weakened funding profile
of these institutions stems not only from the current turmoil in credit markets
throughout the industrialized world but also from domestic issues.

“Much of this credit growth has been denominated in foreign currencies and was - to a large extent - financed by rising external debt, which for the financial sector alone reached a high 34% of GDP in 2007. Some domestic banks have ownership concentrations that make raising equity capital more difficult."

The International Monetary Fund is prepared to give Ukraine credit of $14 billion in a bid to help stabilise the country's financial system, a spokeswoman for President Viktor Yushchenko stated on Friday. An IMF mission is currently in Ukraine to see how it can help cushion the effects of the global financial crisis. It began its day meeting Prime Minister Yulia Tymoshenko and was holding talks later with Yushchenko. The process is not helped by the fact that the two former allies from Ukraine's pro-Western "Orange Revolution" of 2004 are now openly at loggerheads.

Tymoshenko, for example, stated on Thursday said the Fund was considering granting a credit ranging from $3-14 billion, contingent on the postponement of an early election called by President Yushchenko. The Fund subsequently denied it had made any such link.

On Friday morning, a UKraine government spokeswoman said the IMF mission's head, Ceyla Pazarbasioglu, had told the prime minister the Fund was "ready to provide help to IMF member-states."We are working very hard and are prepared to do everything within our power to help you in working out economic policy," Pazarbasioglu was quoted as saying.

Ukraine's hryvnia fell for a third day against the dollar on Friday. The hryvnia, which Ukraine's central bank currently aims to keep within a trading band 8 percent either side of 4.95 per dollar, slid as much as 1.4 percent to 5.3100 per dollar, and was at 5.2800 by 10:36 a.m. in Kiev. It has now lost 2.3 percent this week. The currency also fell against the euro, slipping 1.1 percent to 7.0892, leaving it 2.5 percent lower since Oct. 10. Ukraine's currency has slumped 13 percent versus the dollar since early September as the collapse of its governing coalition and the financial concerns reignited by Lehman Brothers Holdings Inc.'s failure deterred investors from emerging markets and nations reliant on external funding.

"The CreditWatch placements reflect our concerns over the impact of a
deteriorating economic situation and associated exchange-rate depreciation on
the country's financial sector asset quality, especially in light of its high
level of private sector foreign currency borrowing, equivalent to 35% of GDP,"
said Standard & Poor's credit analyst Frank Gill.
Ukraine's current account gap soared sixfold in US dollar terms during the first half of 2008 to USD 6.8 billion (an estimated 7% of GDP), but S&P believes this figure is likely to shrink markedly during the remainder of 2008 and into 2009 “as Ukraine faces a sudden stop in external financing." These last words should send a shiver down the spine of anyone who has any idea of what a "sudden stop" implies.

S&P consider that high short-term financing needs will remain, noting that Ukraine's gross external financing requirements (current account balance, amortization of long-term external debt, and stock of short-term external debt) will be 147% of international reserves over the next 12 months.

Carefully Made Property Investments?

When Lev Partskhaladze, a Ukrainian property developer, was preparing to float his company on the London stock market three years ago, he saw no end to his country’s home and office construction boom. Today, with cranes standing idle over Kiev building sites and property sales evaporating, he admits the global credit crunch is bringing the boom to a halt. “We are seeing a financial crisis transforming into an economic crisis in the world. It has not fully hit Ukraine yet but it’s close,” says the chairman of XXI Century Investments. With its shares down 97 per cent from their peak, the company is trying to raise cash by offloading projects to other developers.

In Ukraine, banks have also borrowed heavily overseas to finance credit growth and are struggling to refinance themselves. At the same time, the current account deficit is widening as prices for steel, Ukraine’s main export, plummet. So Kiev’s external financing needs are growing just as credit is short and foreign direct investment, a big source of finance in recent years, is slowing.

The Bankruptcies Start

Industrial Carriers, based in the Marshall Islands and operating from Odessa in Ukraine, has today sought protection from creditors. The company's debts reported to be related to trading of ships and derivatives.

The Baltic Dry Index, a gauge of shipping costs, has fallen 87 percent since May 20 on a slowing world economy. Steelmakers are curbing production as prices decline, cutting demand for iron ore, the biggest single source of demand for commodity carriers. Usage has also fallen because traders can't obtain credit to purchase consignments.

Daily rental income for coal and iron-ore transporters, called capesizes, tumbled to $11,580 a day yesterday, taking the decline in the past four months to 95 percent, according to the London-based Baltic Exchange. Companies that lease ships out in the single-voyage, or spot, market would lose money on ships that they have hired at higher, fixed daily rates.

Industrial Carriers hires vessels on so-called time charters, meaning it commits to paying a fixed daily rental fee for them for a period of several months or years. According to information provided on Industrial Carriers website the company generated sales of about $1 billion last year from leasing out vessels.


The contents of this post are largely narrative of ongoing events, a full economic analysis of the present crisis can be found in my Ukraine Wobbles As The Financial Ground Beneath It Trembles post.

Tuesday, October 14, 2008

Ukraine Joins The Swooning Bout And Heads For The IMF

Ukraine has joined the growing list of Eastern European countries who have now entered some form of "consultation" process with the IMF and today formally requested "systemic support'' and "active cooperation'' from the fund. The government will meet with IMF representatives in the ``coming days,'' according to a statement from First Deputy Prime Minister Oleksandr Turchynov. He declined to give further details about Ukraine's request.

``Now, the IMF is coming and the Finance Ministry is starting to work with them actively,'' Turchynov said. The IMF will meet the Prime Minister Yulia Timoshenko ``to discuss the financial system's stability.''

Contracts on Ukraine's debt were today being traded at 1,500 basis points,as compared with 440 on Russia and 337.5 on Hungary, according to CMA Datavision in London.

Even as late as yesterday central bank Governor Volodymyr Stelmakh had been saying IMF help wasn't needed. The banking system is "normal and reliable,'' he said in an interview.

The Icelandic authorities were really the first to bite the dreaded bullet, and after some coming and going agreed to accept assistance from the IMF. An IMF mission is now on the island preparing a plan which will then be put to the Icelandic government (protocols here are important). Under negotiation are the terms of any possible loan. According to Einar Karl Haraldsson (a political adviser to the Icelandic government) the plan is expected to be finalized in the next few days, after which the government will have to decide whether to accept the aid and the terms under which it is being offered.

Then it was Hungary who announced on Monday they had enetered into consultations with the fund.

And now the list is growing by the day as more and more Eastern European countries seem to be at risk of following Iceland and Hungary into the arms of the IMF, with the Baltic republics of Estonia, Latvia and Lithuania looking particularly vulnerable at this point, according to a warning from the International Monetary Fund itself yesterday.

Dominique Strauss-Kahn, managing director of the IMF, which was formally approached yesterday for assistance by Hungary as well as Iceland, said: "The fallout for most banking systems in emerging and developing economies has been limited so far but signs of stress are growing, " Strauss-Kahn said some banks in eastern Europe have become increasingly exposed to struggling property markets, having raised funds on international money markets in the same way as the ill-fated Icelandic banks.

For the time being the various national governments are denying the possibility, with Edgars Vaikulis, spokesman for Prime Minister Ivars Godmanis, being quoted in Bloomberg as saying "There is no reason to speak of threats to the Latvian financial system......Latvia's situation is different from some of the eurozone members.''

I'm sure that the latter statement is true, even if not in the sense that Vaikulis meant. Nonetheless the Latvian government has taken the step of raising guarantees on all bank deposits to 50,000 euros ($68,225), in line with an earlier decision by European Union finance ministers.

In my view the threat to the Baltic financial systems is real, as is the threat to the Bulgarian and Romanian ones. Action, of some form or another needs to be taken, and soon. Latvia and Estonia are now in deep recessions, and Lithuania, while still clinging on to growth, can't be far behind. Basically it is hard to see any revival in domestic demand in the immediate future, which means these countries now need to live from exports. But with the very high inflation they have had it is hard to see how they can restore competitiveness while retaining their currency pegs to the euro. The IMF will almost certainly insist on a currency float as a condition of rescue, and if you look at the speeches of Lorenzo Bini Smaghi and Jürgen Stark over the last year, it is clear that thinking at the ECB runs along pretty much the same lines. So better get it over and done with now I would say, and take advantage of the shelter offered in the arms of the IMF. Indeed the more I look at what is happening, the more it would appear that a division of labour was agreed to in Paris last weekend, with the EU institutional structure sorting out the mess in Ireland and the South of Europe, and the IMF taking care of all that broken crockery out there in the EU10.

In what is likely to become a sign of the times Hungary's MKB Bank announced that yesterday that it is going to stop providing euro- and Swiss franc-denominated loans until further notice. In defence of its decision MKB said the huge volatility registered in the value of forint in recent weeks, and especially the strong depreciation at the end of last week, make the outlook on the currency extermely uncertain. Most other Hungarian banks are expected to follow MKB's lead. This practice of bringing an end to the extremely dangerous practice of offering foreign exchange denominated loans in countries running large external deficits is now likely to come to a screeching halt all across the CEE and CIS economies, and bit by bit the IMF will have to be brought in to offer support during the transition back to reality.

For a full and thorough analysis of the current threat to the Baltic economies, see this whopping post this morning from Claus Vistesen.

All the relevant background and analysis to the economic situation in the Ukraine can be found in this post which I put up on on this blog on Sunday.


According to the Ukrainian news source Delo the Ukrainian central bank injected almost 11 billion hryvnia ($2.2 billion) into the banking system in the first 13 days of October because of the credit crisis. The Natsionalnyi Bank Ukrainy were reported to have approved more than 6 billion hryvnia of one-year loans and another 4.7 billion hryvnia of overnight loans. In September, the Kiev-based central bank gave 2.5 billion hryvnia to banks as overnight loans.

Tuesday, October 7, 2008

Ukraine Wobbles As The Financial Ground Beneath It Trembles

The medium-term outlook is sensitive to external developments and policy responses. A benign external environment, featuring even higher steel prices and FDI, could produce growth in excess of 7 percent, but inflation could prove hard to control under a peg. Under an adverse external outlook, by contrast, the peg could lead to external sustainability problems.
IMF 2006 Article IV Consultation Staff Report (February 2007)

Ukraine's economy is in trouble, there is no doubt about it. The cost of protecting debt against a sovereign default by Ukraine's government soared to a record on Friday, following the arrival of a twin storm of both political and financial uncertaintly. The Ukraine president Viktor Yushchenko announced earlier in the week (only to be challenged on Saturday by his perpetual rival Julia Tymoshenko) that he was going to call what would be the country's third parliamentary elections in as many years just as the central bank found itslef forced to step in and take control of the country's sixth-largest bank while the country's currency - the hyrvnia - went for a nose-dive. With the benefit of hindsight the IMF forecast cited in the paragraph above has been extremely prescient. During the "benign external environment stage" Ukraine's economic growth has been substantial, steel prices have been high, and FDI flows (especially into the banking sector) strong. As a result inflation went through the roof. Now we have entered the "adverse external environment" stage, and steel prices are falling while bank and other external finance flows reverse direction. The sustainability issues are evident, and the coming days are going to be critical.

Ukraine is not alone in having problems at this point (but here there is no strength or consolation to be found in company), and stock markets around the globe fell dramatically last week. Ukraine's PFTS bourse was, thus, only one among several that found themselves complelled to suspend rading. Ukraine's stockmarket was closed for the second time in the week on Wednesday (trading had previously been suspended on Monday) following an 11 per cent drop in shares on Tuesday (with banks plummeting between 22 and 26 per cent, and metal producers slumping from 13 to 16 per cent). Trading did recommence again on Thursday, only to see an additional 14 percent in value wiped out, and the doors firmly barred again on Friday. Markets will now remain closed until Monday, when, at the time of writing, they are scheduled to open once more. The PFTS index has now lost 41 percent since the start of September, when the large scale investor pull-out from Russia really got underway, and is down 73 percent since the start of the year, a rollercoaster performance following the 130 percent rise last year.

Credit Default Swaps Soar

Credit-default swaps on Ukraine's $14.9 billion state debt jumped by 473 basis points to 1,700, the biggest one-day advance, according to CMA Datavision prices in London. Ukraine now is priced as having the highest risk of default among Europe's emerging markets.

Ukraine is highly dependent on foreign investment at a time when credit markets around the world are frozen. Ukraine's current account deficit has surged strongly this year to a projected $7.7 billion (up from about $2 billion). At the same time annual inflation soared to a record 31 percent in May and was still stuck at 25 percent in September.

The central bank has already spent an estimated $1 billion supporting the hyrvnia after it fell as much as 12 percent against the dollar during September and early October. The intervention reduced foreign reserves to $36.5 billion yesterday and pared the decline in the hryvnia, which strengthened by 6.6 percent on Friday to reach 4.9987 per dollar. This followed a drop to 5.9 to the dollar on Wednesday (or a cummulative 20% devaluation since early the start of September). All these numbers are large, whichever way you look at them. And this kind of intervention is expensive, and while Ukraine is not on the brink of bankruptcy (yet) it cannot continue for that long. Reserves already fell in terms of months of next period imports from 4 months to 3.7 between Q1 and Q2 2008 according to central bank data. At the same time Ukraine's external financing requirements have risen sharply in recent years (see chart below).

Banks Take A Beating

The National Bank of Ukraine also took over the management of Prominvestbank during the week, and imposed a moratorium on payments to creditors for six months, triggering generalised credit rating downgrades.

The move came after nearly a week of local media reports, which were followed by queues outside banks and in front of ATMs, that Prominvestbank was in difficulties due to heavy involvement in Ukraine metal and real estate industries - both good earners until as late as last month, but now sectors which face massive losses due to falling international commodity prices and more costly credit.

Moody's investor services expressed concern about the ability of Kiev-based Prominvestbank - which had a reported 27.6 billion hryvnia ($5.1 billion) of assets as of Sept. 30 " to continue its operations as a viable stand-alone entity". In a report written by analyst Yaroslav Sovgyra, and was published Thursday, the ratings agency said "Prominvestbank's franchise and the overall credit profile have been significantly impaired in light of the recently experienced run on deposits by the bank.'' Moody's cut its foreign-currency deposit grade for Prominvestbank to Caa2, the fourth-lowest ranking, and down from B2.

Fitch Ratings cut Ukraine's credit outlook to ``negative'' from ``stable'' on Sept. 25.

Ukraine's banks owed a total of $38.4 billion as of July 2008, according to central bank data. To put things in perspective, this could be compared with the estimated $61 billion owed by Iceland's three collapsed banks. But the foreign indebtedness of Ukrainian banks has grown rapidly in recent years, doubling in 2006 to $13.87 billion, from $6.75 million in 2005. Much of the lending (around 50%) is forex denominated, and although the total private debt to GDP ratio (65%) is comparatively low, lending has been rising at a very fast rate (75% per annum).

Around 30% of Ukraine's total foreign debt ($128 billion or around 65 percent of GDP in 2008 according to IMF estimates) is owed by commercial banks.

In an attempt to address the crisis, the Ukraine central bank has injected 7.795 billion hryvnia into the banking system since the beginning of October, following 5.96 billion lent to banks during September. The problem is much more extensive than Prominvestbank itself, with shares in Raiffeisen Bank Aval, Ukraine's second-biggest bank by assets, also down 74 percent this year. Shares in AKB Ukrsotsbank, the country's fourth-biggest bank, have slumped 79 percent.

Ukraine's banking sector appeared even more shaky following the Prominvest decision than they did before it, with multiple banks applying formally for government assistance. Acoording to intefax a total of 25 loan institutions have filed requests for low- interest credits or other state financing.

Local newspaper Kommersant-Ukraina named Narda bank (another in the top ten) as one of the banks seeking government financing. Narda are set to receive a 290 million dollar bail-out package to cover approximately 230 million dollars of external debt, according to the report.

Other Ukrainian banks reported to be asking for help on Thursday were Rodovidbank, Alfa-Bank, Kreditprombank, and Finansi i Kredit bank, according to an article in Economicheskie Izvestia. The article said that the central bank had already approved 23 of 25 assistance package requests - and that they were worth in total around 620 million dollars,. Banks applying for cash injections account for something like 25 per cent Ukraine's banking sector.

Apart from Kazakhstan, Ukraine is currently the only government among Europe's emerging markets with credit-default swaps currently trading above the 1,000 basis points level. But even Kazakhstan debt is way below the UKraine equivalent, with contracts on Kazakhstan jumping to 1,050 basis points from 759 basis points on Friday as the government increased sevenfold the limit on retail bank deposits guaranteed.

The problem is most certainly becoming a regional one, and extending across Eastern Europe, with contracts on Russian government debt up 179 basis points (to 559), their highest level since at least 2004. Credit-default swaps on Turkey rose 138 points to 552 points, while those on Hungary increased 116 points to 458.

As I have argued in a number of previous posts (here, here, here and here) Ukraine is evidently suffering from a wide variety of problems, including institutional chaos and ongoing population decline, and it is not really surprising that it should be singled out as the country destined to lie at the heart of the forthcoming CEE "correction".

Strong GDP Growth

“The growth forecast for 2008 reflects strong performance during the first half of the year, terms-of-trade gains, and indications of a bumper harvest,” the October 2008 IMF World Economic Outlook report stated. “Going forward, growth is projected to decelerate markedly, reflecting weaker export market growth, slowing real wage increases, moderating terms-of-trade gains, and higher financing costs.”

The current events in Ukraine may well take some observers by surprise, since the general impression has been that the economic performance has been solid and GDP growth has been strong in recent years, and this has given the impression that the underlying reality was sound, which it basically hasn't been. The country has been bedevilled by constant infighting, while at the same time a combination of strong migration of Ukraine workers to external destinations and very long term low fertility has meant that the country endemically suffers from acute labour shortages as the population both ages and declines comparatively rapidly. Hence, in my view, the absurdly high levels of inflation we have been seeing.

Nevertheless, real GDP has grown by 7.5 percent a year on average since 2000, in line with other CIS countries, and indeed that rate has been higher than in most other transition economies: whether or not this growth was built on sand is what we are now all about to find out.

GDP was up at a 7.1% y-o-y rate in the January to August period, and in fact the expansion has even been accelerating in recent months largely, due to the good harvest and the increase in agricultural output - up 24.4% January to August. Manufacturing output has also been doing well, driven by a seemingly unquenchable thirst for steel in Russia, and was up 7.3% y-o-y in the January-August period. Construction, on the other hand, has now been in recession for some time, with output down 5.3% y-o-y in the first eight months of the year. The decline in construction is a reflection of the growing credit difficulties the economy has been having, and the slowdown has been making its presence felt in domestic consumption generally, with the rate of retail sales increase (while remaining strong) starting to taper off, falling from 10.4% y-o-y in Q1 to 8.2% in Q2. And as we know, the recent Russian tank excursion through the Roki tunnnel has meant that Russia is now nothing like so thirsty for steel (see below), and as a result, we should expect to see headline Ukraine GDP growth dropping fairly rapidly (we could be down to a 3 or 3.5% annual rate by the end of Q4, with more downward movement to follow as we move into 2009), as the country gets caught in the twin pincer of an internal credit crunch (sudden stop) and a sharp drop in external demand for its key product.

Overheating and The Inflation Problem

Evidently the Ukraine economy was pushed well beyond its short term capacity limits by a combination of expansionary fiscal and incomes policies (real, inflation adjusted, income was up 13.4% y-o-y in January-August) and high steel prices (both of which fuelled very strong domestic demand growth), and these were simply reinforced by very rapid money and credit growth. These factors, together with rising food and energy prices, lifted CPI inflation to a peak of 31% percent in May (see chart below), since which time the rate has fallen back, but only as far as the 24.6% rate registered in September.

Core inflation has also risen - with producer prices still rising at an annual rate of 42.7% in September (having peaked at 46.3% in July, see chart below), while real wage growth continues to be substantial, and inflation expectations remain at a very high level.

Current Account Deterioration

The Ukraine current account deficit has deteriorated sharply because of the very strong domestic demand growth and, more recently, the eroding competitiveness of Ukraine manufacturing industry. This has loss of competitiveness has occurred despite significant improvements in the terms of trade. This favourable situation is now coming to an end and in all probability even reversing as steel prices drop substantially. Capital inflows, and especially FDI, which have been strong, may now well reverse. Private external debt and debt rollover have risen sharply, leaving the economy more sensitive to balance-sheet risks and deteriorating global liquidity conditions, according to the most recent staff report by IMF economists.

The IMF estimate (October 2008, WEO) that this years current account deficit will rise from 3.7% of GDP in 2007 to 7.2%.

Fiscal policy has been dangerously expansionary in the face of the rising inflationary pressures and the deteriorating current account position. Nominal spending has risen by an average over 30 percent a year since 2003, stimulating domestic demand and increasing the size of the government sector. This growth reflected rapidly rising public-sector wages and social transfers and, in 2008, partial restitution of Soviet-era bank deposits that had been wiped out by hyperinflation.

Deficits have been moderate, as spending growth has been paid for by inflationary revenue windfalls that fiscal policy itself has helped bring about. Nevertheless, the fiscal stance has been procyclical and Ukraine is one of the few countries in Eastern Europe to have increased its fiscal deficit as capital inflows have surged.

Steel Dependent Economy

In what is now a sign of the times Ukraine's biggest steel mill, owned by the ArcelorMittal group, reduced steel output by 10.5 percent to 5.471 million tonnes in January-September 2008, according to Ukraine news agency reports last week. The reports suggested the ArcelorMittal mill had decreased rolled steel output by 12.4 percent to 4.663 million tonnes so far this year, while pig iron output fell by 9.3 percent to 4.935 million. The company had previously increased steel output to 8.103 million tonnes in 2007 from 7.6 million in 2006.

Just over the border, OAO Severstal, Russia's largest steelmaker, also announced last week plans to slash output in Russia, the U.S. and Europe by as much as 30 percent in October and review full-year forecasts. Production is to be cut 30 percent in the U.S. and Italy, and 25 percent in Severstal's home town of Cherepovets in Russia.

Steelmakers from China and South Korea to Austria and Russia are curbing output as demand for cars and buildings weakens, and as banks withdraw funding for new plants. OAO Magnitogorsk Iron & Steel, Russia's third-largest producer, Posco, Asia's biggest stainless steel maker, and Voestalpine AG, Austria's top steel company, all signaled cuts in production plans this week.

The production and export of steel is an important pillar of the Ukrainian
economy, and steel production accounts for more than a third of total goods exports (equivalent to some 12 percent of GDP). Thus real GDP growth in Ukraine is closely linked to steel prices. During the global economic upswing of the past few years, along with a wider surge in metals valuations, steel prices have risen dramatically, thus underpinning Ukraine’s mostly favorable export performance and impressive GDP growth ever. Although steel prices had been holding up till very recently, the current global financial turmoil is having a dramatic impact on car, construction and investment activity, all of which impact steel prices and we may therefore expect significant adverse effects on Ukraine growth and export receipts. A key issue for the future is, of course, how Ukraine’s economy can be made less dependent on such global price volatility in one key product.

Sharp Steel Downturn

As recently as Sept. 4 OAO Severstal had been suggesting that output would rise 31 percent to 23 million metric tons this year, so the slowdown has been very rapid indeed. Goldman Sachs Group Inc. yesterday cut its 2009 steel price forecast by 29 percent. Global export prices for hot-rolled coil steel, a benchmark, have declined 19 percent since July, according to Bloomberg Metal Bulletin data.

And the slump doesn't only affect current output, investment is also affected. Thus Austrian steelmaker Voestalpine announced during last week that it is considering delaying a decision on building a new steel plant on the Black Sea due in part to the financial crisis. Voestalpine had been planning to build a plant with a 5.5 million tonne capacity in either Bulgaria, Romania, Turkey or Ukraine, with a cost which investment analysts estimate to be in the 5 to 6 billion euros ($6.7-8.2 billion) region.

Hyrvnia Under Pressure

While the official exchange rate is set as Hr 4.95 – plus or minus eight percent – to the U.S. dollar, some exchange booths were offering Hr. 5.5 to Hr 6 for $1.
Kiev Post Report

The hyrvnia - Ukraine's national currency fell to an eight-year low last Wednesday, following the decision of the National Bank of Ukraine to widen the currency's trading band.

The National Bank, which has $38 billion in foreign exchange reserves, is now engaged in a delicate balancing act since while on the one hand officials are promising “strong interventions” to keep the hryvnia at roughly five to the dollar, international financing sources are drying up and Ukraine is running a growing current account deficit, which hit nearly $8 billion in July.

The strategy appears to be not to waste foreign exchange reserves, defending an arguably un-defendable exchange rate, but to conserve reserves to support banks and corporates to meet external debt service payments falling due and, also, to more generally prop up the banking sector. The problem is that the NBU can either support the currency, or support the banks and corporates but it does not really have enough foreign exchange reserves to do both at once.

Ukraine's central bank has weakened the currency's official rate against the dollar and widened its trading limits on October 7. The currency's new official rate until the end of the year was weakened to 4.95 per dollar from 4.85 and it will be allowed to rise or fall 8 percent from that level, compared with the previous 4 percent.

The hryvnia has slumped 18 percent against the dollar since Sept. 2, when President Viktor Yushchenko's party broke from its coalition with Prime Minister Yulia Timoshenko. Yushchenko dissolved the parliament yesterday, calling for new elections.

The managed currency is also being pushed down by demand for dollars from local banks and companies who need to pay down debt which they can't refinance so they have to buy dollars and pay back now. Exporters seeing this situation are also postponing selling dollars hoping for more local weakness down the road.

Nationalnyi Bank Ukrainy, which kept the hryvnia little changed against the dollar throughout 2007 and 2006, allowed it to trade more freely this year to help combat inflation, now at 26 percent. The bank strengthened the hryvnia's official rate by 4 percent to 4.854 per dollar in June, after leaving it at 5.05 per dollar since April 2005.

Declining Population The Root Of All Evil?

One of the things we should all now be learning as we look out across what is currently happening right across Eastern Europe (and I do mean right across) is that what we have is an environment where a number of long term underlying problems persist. These range from a lingering and heavy state presence in the economy, high and enduring inflation which steadily eats into the export competitiveness of manufactured goods and services, wage pressures which stem from labour supply shortages produced by out-migration and long term low fertility, and heavy balance sheet exposure due to an extensive euro- or dollarization of the banking sector (the later being the Ukraine case). The large current account deficits which follow from the above, and the consequent ongoing dependence on the arrival of substantial capital inflows can create a vulnerability to short term shocks which puts the entire macroeconomic framework at risk. The current credit crunch is, of course, almost a text book example of just such a short term shock.

This danger of a strong correction in adverse times becomes even greater (as we are now seeing) if measures are not taken (which they weren't in Ukraine's case, see this post) to drain excess liquidity from the system (by running a fiscal surplus for example), to loosen labour supply constraints by facilitating inward migration of unskilled workers, and to accelerate the pace structural reforms - and particularly those which facilitate the development of "greenfield" investment sites which help channel capital flows towards productivity-enhancing uses and in so doing raise exports. Unfortunately, at least this time round, it would seem it is a little late in the day for this kind of advice.

So to answer the question I somewhat provocatively inserted at the head of this section, Ukraine's declining population is not 100% of the problem, not by a long stretch it isn't, but it is an important component, and does form a context in which the other parameters need to be situated, and this dimension of the current crisis in Ukraine is all the more important since it is one which is normally ignored, and even more to the point, has been left unattended for so long that it has become an issue which it is very hard to address.

A Declining and Ageing Population

According to data from the State Statistics Committee , Ukraine's population fell by 290,220 in 2007. That is a rate of only just short of a million people less every 3 years. Simply there are more people dying every year than are being born, with 472,657 births being registered (up 12,000 from 460,368 for 2006) and 762,877 deaths (down slightly from 758,093 in 2006). What this means is that Ukraine's population is now falling very fast, at an annual rate of 0.675%. And remember this is the natural decline, not counting out migration. As we can see in the chart below the Ukraine population peaked in 1993, and has been in some sort of free-fall ever since.

There are a number of factors which lie behind this dramatic decline in the Ukrainian population. One of these is fertility, which is currently in the 1.1 to 1.2 Tfr range. In fact Ukraine's fertility actually dropped below the 2.1 replacement level all the way back in the 1980s, but somehow people haven't seen fixing this "bust" as being in any way particularly important.

A second factor which is also important is life expectancy, and in the Ukraine case the trend in male life expectancy has been most preoccupying, since it has been falling rather than rising in recent years. In particular male life expectancy which is currently running at around 64. Apart from stating the obvious here, we should note that the deteriorating health outlook which this low level of life expectancy reflects places considerable constraints on the ability of a society like Ukraine to increase labour force participation rates in the older age groups, and this presents a big problem since increasing later life employment participation is normally though to be one of the princple ways in which a society can compensate for a shortage of people in the younger age groups.

The third factor influencing population dynamics is obviously migration. Ukranian out-migration since the turn of the century is distinguished by two key tends: a) a reduction in intensity when compared with the very dramatic population movements which were so characteristic of the 1990s, and b) a significant change in destinations. From migrating East the Ukranians are now moving West. There is little in the way of systematic data here, but there is national level data on the numbers of Ukranians who now live and work in Portugal, Spain and Italy, together with plenty of anecdotal information about Ukranian migrant workers in Latvia, the Czech Republic, Poland and elsewhere in the EU 10.

According to information provided by Ukrainian diplomatic missions, 300,000 Ukrainian migrants may be working in Poland, 200,000 each in Italy and the Czech Republic, 150,000 in Portugal, 100,000 in Spain, 35,000 in Turkey, and another 20,000 in the US. According to official information based on the number of permits issued by the Russian Federal Migration Service, some 100,000 Ukrainian citizens currently work in Russia, although the real number of Ukrainians working there is often estimated to be more in the region of 1million.

With Fewer and Fewer People Available For Work

This out migration is very significant from the economic point of view, since the majority of those working abroad send money back on a regular basis (see chart below which shows World Bank estimates for Ukraine remittance flows) while at the same time are not present in the country to offer themselves for the work which this extra money creates. So out migration and the accompanying remittances are one thing in a high fertility, growing population like that which is to be found in Ecuador or the Philipinnes, and quite another in the long term low fertility, declining population environment of Central and Eastern Europe. Hence all that demand driven wage inflation. As we can see from the data in the chart below (which the World Bank Economists themselves recognise if surely a substantial underestimation) the flow of remittances into Ukraine has increased steadily in recent years. According to the World Bank remittances amounted to approximately 1% of Ukraine GDP in 2007, a number which seems rather small given the number of migrants involved, and one may suspect here that the data is rather underestimating the scale of the flows, but even as it is this amounts to a fiscal stimulus of 1% of GDP as a minimum.

As a result unemployment has been falling steadily over the last two years:

According to data from the Ukraine statistics office the official rate of unemplyment stood at 1.8% of the economically active population in August 2008 (down from 2.4% in January). Now these numbers are undoubtedly an underestimate of the true levels of unemplyment (the ILO compatible rate is the much higher 6.2%, but given the very special health situation in Ukraine we need to ask ourselves just how many of those who are formally included in the ILO classification are actually fit for work in a modern economy) but they do give an indication of the trend, and it is clear that some parts of the Ukraine labour market have been suffering from acute labour shortages, and hence the wage-push inflation the country has been experiencing. Wages have been rising (see chart below) at a rate which has been way above the combined inflation and productivity increase levels for many years now, and although wages did start from a very low level, and some degree of "catch up" was not only inevitable but also desireable, the complacency of the relevant authorities (both nationallly and interbationally, IMF, World Bank etc) in the face of such levels AFTER inflation really started to take off really does strike the external observer as quite extraordinary.

In many ways Ukraine could be considered to be a rather important strategic component in the whole Eastern labour supply and demographic puzzle, as we are no about to see, since many have been hoping against hope that as the recent expansion steadily drained labour supply resources across the whole region, then Ukraine would simply be able to step up to the plate and offer countries as diverse as the Baltics, Poland, Hungary, the Czech Republic and Russia the labour they needed to keep their own inflation in check. This view implied, in my opinion, that Ukraine was to become some kind of "fish farm" for the rest of Eastern Europe, and that view as we are seeing was always based on a huge misunderstanding, since a low fertility society simply cannot export labour indefinitely, and if it does try to do so, then internal wages simply explode.

In Conclusion

Of course, such demographic considerations may well seem to be rather distant from the very real and pressing drama which is breaking out in Ukraine. Obviously there are a great many lessons to be learned from the current "undoing" of the Ukraine economy. One of these is undoubtedly the desireability of moving away from dependence on one or two key commodities (steel, agriculture) whose prices are known to be very volatile and tied-in intimately with the global business cycle. Another would be the belated recognition that while FDI inflows are vital, such flows into the banking and financial sectors are not the same as inflows to fund greenfield industrial site development, and that an economy which is dependent on one or two primary commodities on the one hand, and construction associated business and financial services on the other simply is not a balanced or a stable one.

It is also clear that, whatever the well-wishing we would all like to make towards a rise in living standards for the Ukranian people, it is now abundantly clear that this cannot be achieved via a lack of vigilance towards the dangerous impact of spiraling wage-cost inflationary pressure, not can policy be adequately conducted under such circumstances by a central bank whose main priority is steering the value of a currency. Laxity and tolerance towards the inflation menace ultimately comes at a very high price, especially when it is allowed to get out of control in the way it has been in the Ukraine.

Finally, even if in fighting the short-term battle for survival which is now going to confront the Ukraine economy and its banking sector longer term demographic concerns are inevitably going to take a back seat, I think we need constantly to keep in mind that a failure to come to grips with this key ingredient in Ukraine's problem set will surely only lead to more of the same at some point in the future. So if you don't especially like suffering - and who does - then act, and act now.