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Tuesday, May 7, 2013

The Suitcase Mood

Suitcase mood is a Russian website with travel and tourism content. The term is also a popular expression widely used within Russian culture to describe the state of mind which grips a voyager on the brink of a journey. The mood is often associated with a ritual which involves the departing person sitting, sometimes accompanied by family or friends, in the vicinity (when not actually on top of) the packed suitcase, ostensibly to try to remember if there is anything they have forgotten to take and bid loved ones farewell. Sometimes, however,  the phrase can take on a different, and rather darker, meaning. It can be used to describe someone who is fed up with the status quo, has become footloose and decided they simply want out. "This will never change," might be the thought, "I'm leaving". In my mind's eye I even see the person having the thought seated on their suitcase adopting the posture of Rodin's thinker, turning over and over again whether they are doing the right thing, even while those around them vent their sadness in a bath of tears and alcohol. Or maybe I have just been watching too many Russian movies.

Naturally such a custom does not exist along Europe's Southern fringe, which doesn't mean it couldn't be invented since the young and educated are increasingly leaving much to the chagrin of those they leave behind.

But the "packing up and leaving" variant has now become the predominant one in another country suffering brain flight, one which has does have significant historical associations with traditional Russian culture: Ukraine. The suitcase mood is alive and well among a growing number of young Ukrainians, as journalist Vitaly Haidukevych discovered when he conducted an online survey on the subject via his facebook page,
"The suitcase mood is there. [...] Young, promising people have it. [...] Since they are young, they are leaving not for the sake of immediate earnings [...], but to grow roots for the future. [...] I assume that these people asked themselves whether it was possible to change the state of things in the country – and the answer was ‘no'. [...] Some are leaving for exactly the same reason others are reluctant to join [the anti-regime] protests – they care about themselves, their families and their future. [...] “what are those rapid movements for, you've got kids, think about them” – this is what those who've stayed think. And those who are leaving [...] do not want to wait for the tax authorities to come and take away their last pair of underpants. [...]"

Is Ukraine Headed For Imminent Population Meltdown?

Now, as I say, this "want out" phenomenon can now be found in many countries on Europe's periphery (here, here, here and here), but the Ukrainian case is an extreme one. So much so that the Ukrainians themselves have a word for those who have left the country in search of work and fortune elsewhere - zarobitchany. According to a 2011 report issued by the International Organization for Migration six and a half million Ukrainians, or 14.4 percent of the population, are now emigrants who have left their country (or rather they were at that point, since the 2013 number is certainly larger). Countries like Russia, the Czech Republic, Hungary, Poland, Italy, Portugal and Spain are among the most popular destination countries identified in the report.

In all cases of low fertility societies young population exodus is a problem, but in Ukraine's case it is well nigh lethal. The country has a little over 45.5 inhabitants and the population is shrinking by 330,000 per year. Besides the birth/death deficit emigration obviously contributes significantly to this sharp downward demographic trend (hat tip to Ukrainian blogger Veronica Khokhlova for most of the above).

Even without emigration the population would be falling, since the birth rate is around 1.3 (well short of the 2.1 replacement level) and far more die each year than are born, but the fact that so many also chose the exit route raises deep and preoccupying questions about the future of such countries.

The latest UN population forecasts put Ukraine's population at around 30 million by the end of this century, but this number is surely a highly optimistic one, in part because it assumes some sort of fertility rebound, but more importantly because it assumes that emigration won't melt the country down much more quickly and much sooner than that. In addition to the smaller population the shifting age structures mean that the proportions of Ukrainians over 65 and over 80 will rise continuously. According to latest estimates Ukraine's population in 2050 will look something like this.

Obviously people aren't leaving because the population is declining, but rather because the economy is not able to incapable of generating sufficient economic growth and sufficient jobs to encourage people to stay. There is a loss of confidence in the future of the country because the economic decadence becomes associated with degeneration in the political system.

Decadence certainly seems to have set in at the economic level. The economy fell by nearly 15% in 2009, recovered growth of 4-5% a year in 2010/11 and then fell back into recession in the second half of 2012 (in which year overall growth was effectively zero. The IMF forecast a further year of zero growth in 2013 followed by a return to 3% growth thereafter. This subsequent out come may be very optimistic, and the country will possibly suffer from weak growth from hereon in, before eventually turning negative.

In this context the feeling inevitably grows that there is no way to turn the situation round. This feeling feeds on itself, and the big question is whether it produces a kind of circularity whereby the loss of confidence and the loss of people also feeds back into the economic process making the lack of growth and employment even worse.

Low Fertility Trap?

Such seems to be the situation Ukraine finds itself in, and naturally the frustration can be seen everywhere. As one comment on Vitaly Haidukevych's Facebook thread put it, "It's futile to expect economic growth in Ukraine. Everyone is trying to escape from it as quickly as possible." Another said, more ironically, "One has to leave quietly, or else they'll soon introduce a tax on leaving." Others are more passionate and apparently even more determined:
"People ran, are running and will run. So many have left [Western Ukraine] for Italy, Portugal and the Czech Republic, and have not returned, and more will leave. It's just that [mostly people from] the provinces used to be leaving before, and now Kyiv is moving as well. People are taking their kids to study to Poland and some even further! It's a difficult situation in the EU now, but it's still livable, while in Yanukovych's Ukraine it's 100 times harder! Me, I came to the Czech Republic five days ago, sit here without a job, but I'm not going back home".
All of this puts me in mind of a fertility model developed by the Austrian demographer Wolfgang Lutz which he called the low fertility trap hypothesis. In developing this hypothesis his starting point was the assessment that "there is no good theory in the social sciences that would tell us whether fertility in low-fertility countries is likely to recover in the future, stay around its current level or continue to fall". He then goes on to advance "a clearly defined hypothesis which describes plausible self-reinforcing mechanisms that would result, if unchecked, in a continued decrease of the number of births in the countries affected". Claus Vistesen wrote up a description of the hypothesis on the Demography Matters blog (back in 2007) and I have some notes here.

Obviously the number of live births fluctuates according to the number of women in a given population who are of childbearing age, which can be more or less depending on the size of the cohorts involved. But in general terms a country with 1.3 or 1.4 fertility will have steadily less and less children as cohort size drops. This is basically population melt-down, and this critical state can be triggered by a number of processes, including social and economic ones. Some country's, as well as possibly being caught in fertility traps are also caught in liquidity ones, a connection which has not escaped the notice of Nobel economist Paul Krugman. While Krugman is surely not familiar with the fertility trap literature, he sees clearly that the low fertility Japan has experienced over decades has played an important part in the country getting stuck in a liquidity trap.

As he puts it: "Why is Japan in this [liquidity trap - EH) situation? A debt overhang from the 1980s bubble surely started the process; but surely it’s reasonable to suggest that the demography also contributes, since a declining working-age population depresses the demand for investment".

Lutz already suspected that their might well be an economic feedback mechanism that would work to drive the number of children born in a country ever further downwards towards lower and lower levels, but I think the experience of the crisis has made this pathway a little clearer, in that those low fertility countries whose economic trajectories fall off a stable growth path may find it ever more difficult to get back on one again. In street jargon they could fall into a "lose-lose" dynamic driven by low-living-standards low-growth expectations and high unemployment. Not only do such negative economic conditions discourage young people from forming families and having children (obvious I think), they can also have the effect that young people leave in search of a better future thus reducing the potential number of children who can be born in the future.

The ensuing acceleration in the rate of population ageing and the proportions of older people only makes the problem of sustaining public spending on pensions and health systems worse and worse, causing the fiscal burden on those who stay to grow and grow, a development which makes it more and more attractive  to leave and start up again elsewhere. And with each additional person who leaves there is another turn of the screw, and the costs of staying get higher, as do the advantages of not doing so. This is how melt down can happen.

Naturally there can be a political dimension to the disintegration, as the need to implement ever less popular policies (especially policies unpopular with older people, those who do vote) leads politicians to become more and more demagogic while delivering less and less. Naturally the democratic quality of a country's institutions starts to deteriorate under these circumstances, which only makes the young feel even more helpless and under-represented.

This outcome is now becoming plain in much of Southern Europe, but it is obviously even more evident in Ukraine, where the former Prime Minister Julia Tymoshenko is currently imprisoned, a decision which has just been roundly criticised by the European Court of Human Rights.

Can Countries Actually "Die"?

So where does all this lead. Well it leads me personally to ask the question whether it is not possible that some countries will actually die, in the sense of becoming totally unsustainable, and whether or not the international community doesn't need to start thinking about a country resolution mechanism somewhat along the lines of the one which has been so recently debated in Europe for dealing with failed banks.

That something like this is going to be needed I regard as being what John Locke would have termed a "self evident truth". As we know, in country after country each generation is getting smaller. While we can argue about exact timing, what this falling population means means is that GDP will eventually start to contract. This should make those ecologists who have long been arguing that the planet was over populated and that zero of even negative economic growth was desirable extremely happy. But what about the debt left behind by earlier generations, will that also contract? The Japan experience so far tends to suggest it won't, and herein lies the rub.

But this is only part of the problem, since the process of country decline, like most processes in the macro economic world, is non linear. That is to say critical moments or turning points will exist when suddenly things move a lot faster than expected. Hemmingway grasped the essence of this in his much quoted "bankruptcy comes slowly at first but then all of a sudden". As the economy falls back, and the burden of debt grows on the ever smaller numbers of young people expected to pay, the pressure on those young people to pack their bags and leave simply mounts and mounts, accelerating the process even further.

In fact populations dying out is nothing new in human history if we move beyond the most recent world delineated by nation states. In hunter gatherer times populations occupied increased or reduced proportions of the earth's surface as climate dictated. In more modern times, islands have been populated or become depopulated according to economic dynamics (think the Scottish coastline). More recently, it is clear the old East Germany would have become a country in need of "resolution" had it not sneaked in under the umbrella of the Federal Republic. Why people should find the idea of country failure so contentious I am not sure, perhaps we have just become accustomed not to have "hard" thoughts.

Applying the argument many apply to banks, unsustainable countries "deserve" to fail, don't they? Why should the US or German taxpayer have pay to keep them afloat? Naturally, including Spain in this group of countries that can only now salute Cesar as they prepare to die my seem extreme, but just give it time. 

I expect (should I say "predict" in the Popperian sense, since this argument IS empirical, and is surely falsifiable) the first countries to die to be in Eastern Europe, with the most likely candidates to get the ball rolling being Belarus, Ukraine and Serbia. But then gradually this phenomenon will spread along the EU periphery, from East to South. Latvia's own president said recently that if the net outflow of population was not stopped, within a decade the country's independence would not be sustainable. I don't think he was exaggerating.

So, as these countries "die", we (the rest of the international community) will have to decide what to do about them. A country "resolution" programme should be considered. The scale of the humanitarian tragedy will not be small.

Now, from time to time conventional economists do start to have a glimpse of what is really going on. This happened to Paul Krugman a month or so ago when he came up with the memorable phrase that part of Japan's economic problem was the result of a growing "shortage of Japanese". Now, as I am trying to suggest, this shortage is not simply a local, Japan specific, phenomenon, but forms part of a global pattern. Again, exact timing isn't clear, but sometime in the second half of this century global population will peak, and the shortage will steadily spread to take in all countries. To quote Krugman (in an earlier piece) again, at that point "to which planet will we all export"? Answers on a single piece of paper, in a plain white envelope, please.

But not all countries will experience the shortage (which is already being talked about in China in labour force terms) in the same way. Some countries, with competitive economies, healthier banking systems, younger populations, and better-quality institutions will gain the population which is being lost by the others. That is another of the reasons I say the process will not be linear. This is naked capitalism in the raw, sovereign against sovereign, with a winner take all structure.

So the modern economic system becomes something like the game musical chairs. When the music is playing everyone gets up to dance, but each time it stops there is one less chair (country) to fall back on. And so it goes on and on, through numerous iterations. Now where's my suitcase.


I have established a dedicated Facebook page to campaign for the EU to take the issue of  emigration from countries on Europe's periphery more seriously, in particular by insisting member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometime great things from little seeds to grow.

Saturday, February 25, 2012

Staring Into The Ukrainian Economic And Political Abyss

It's been a long time now since Paul Krugman spoke of the Ukraine economy epitomising the arrival of what he then termed the "second great depression", and its been an even longer long time since we lay awake at night dreaming about the coming conquests of the Orange Revolution. It's also been a good time since I looked at and wrote about the country, so now may be as good moment  as any to do so.

"Ukraine’s efforts to seek cheaper natural gas from Russia rather than comply with the terms of a bailout have alarmed investors, propelling the former Soviet republic’s credit risk above Argentina’s for the first time in two years. The government is shunning the International Monetary Fund as it struggles to agree on discounted fuel imports from Russia, with whom clashes halted European gas transit twice since 2006. That’s fanned concern over its ability to meet $11.9 billion in debt costs this year, with default risk rising more than any country Bloomberg tracks except Greece in the last six months."

Ukraine is once more getting into a mess. Part of the problem is political, part of it is economic, and part is a combination of the two. On top of which Ukraine has one of the most severe demographic problems in the CEE, which is itself a region of severe demographic problems. So what we have are a cluster of problems just waiting for the perfect storm to gather.

As is well known, Ukraine was one of the worst affected countries following the onset of the global financial crisis. Industrial output slid - great depression style - by more than 30% in a matter of months (the chart Krugman used was of course mine), largely due to a massive overdependence on steel, the price of and demand  for which had fallen off a cliff.

The onset of the crisis also brought to light the way the country had been living on an unsustainable credit boom fueled by short term forex borrowing in the years prior to its arrival, and as the fund flows which had been financing this rapidly reversed Ukraine was sent running into the arms of the IMF, and rapidly accepted a  $16.5 billion standy  loan in November 2008.

As the IMF put it in their programme documentation:
Ukraine’s current account and growth performance relied strongly on favorable terms of trade. From 2003 to mid-2008, the price for steel, which  accounted for 40 percent of Ukraine’s export and 15 percent of GDP at the time of the crisis,  had increased fourfold and prices for gas imports were still far below world market prices,  providing little incentive to improve Ukraine’s dismal inefficiency in energy use.  Nevertheless, by 2007 the current account had already deteriorated strongly as imports had  surged on the back of a credit and real estate boom and an overheating economy. Private  sector balance sheet imbalances widened sharply with foreign currency loans accounting for  nearly 60 percent of total loans, often extended to borrowers without foreign exchange income, and bank funding increasingly relying on short-term borrowing from abroad.

A Love Hate Relationship With The IMF?

Well, for those familiar with the region there is nothing particularly strange about the imbalances and the credit bust. But as the Fund itself makes clear in its ex-post evaluation of the first crisis programme, relations between the multilateral institution and the Ukraine administration have been far from easy over the years:

Ukraine has had long but complicated program relations with the Fund. From 1994  to 2005, the Fund supported Ukraine through six arrangements. Completion of reviews  tended to be difficult, as only 13 of the envisaged 24 reviews were completed, of which  10 with delay or involving waivers. The Ex Post Assessment of Longer-Term Program  Engagement in 2005 (IMF Country Report No. 05/415) found that “Fund-supported  programs had a mixed record in achieving their objectives. While the programs were quite  effective in supporting macroeconomic stability, they did not succeed in accelerating the  buildup of more market-friendly institutions.”
Unfortunately things did not go that much better this time, and the initial programme was terminated after the second review and a disbursment of $10.4 billion:
"Program implementation was difficult against the backdrop of sharp political divisions. Only two of the envisaged eight reviews were completed, with the first review already delayed by three months due to failure to reach understanding on fiscal and bankingrelated policies in the midst of political wrangling between the president and the prime minister.....After the second review was completed on time in June 2009—reflecting some progress with the bank resolution strategy, announcement of future plans to increase gas prices, the adoption of a restructuring strategy for Naftogaz, and a slowdown in foreign exchange interventions—the Fund remained closely engaged with the authorities. But the program went off track as ownership vanished and fiscal policy diverged further from the program".
In fact here we see three of the key Ukraine issues all lined up together - energy prices and the fiscal deficit, problems in the banking system and constant foreign exchange interventions to maintain a currency peg with the US dollar, a peg which encourages unnecessary forex borrowing while fueling inflation at continually high levels.

Running such consistently high inflation simply leads to rigid monetary policy, high interest rates, and inadvertently enhances the attractiveness of foreign exchange borrowing (which is the ultimate undoing of these pegged economies) since interest rates are much lower elsewhere, the currency is fixed (so where's the risk) and wages keep going up and up along with the inflation. You seem to be getting better off than your peers in the country you peg to, but in fact you are simply sliding steadily towards the precipice. In many ways things on the Euro Areas Southern fringe are only different in terms of degree. I can still remember Spain's now ex-Prime Minister José Luis Rodriguez Zapatero telling his compatriots that they were steadily moving towards the top of the EU per capita wealth league, overtaking Italy, and then France, just before the bubble burst, and the house valuations which lay behind those impressive appearances started tumbling.

Frustrated and fed-up, the IMF cannot simply ignore the country. Ukraine is simply too large and too strategically situated to be allowed to go awol. So when the new Ukraine government requested a further standy arrangement in the early summer of 2010 there was little alternative but to agree (shades of Greece and the EU) and make an additional $15.1 available to the country, bringing the outstanding borrowing to $25.5 billion. And here comes the rub: according to the IMF, Ukraine is due to repay $2.4 billion this year; $3.5 billion in 2013 and $1.3 billion in 2014. This is quite an onerous schedule for a country which is now  struggling to finance itself in the financial markets. Many of the current IMF programmes in Europe have the look of succes, until the time comes to pay back.

Predictably the second programme didn't proceed any more smmothly than the first one, and the first review was only approved after a lengthy tussle about pensions, with the Ukrainian government eventually ceding to pressure and in July 2011 passing a pension reform wherby the female retirement age was raised from 55 to 60, and the duration of pension contributions needed for entitlement increased by 10 years.We will return briefly to this topic, but it is instructive to note that while most economic analyses of the current crisis (everywhere, not just Ukraine) fail to mention the underlying demographic issues, the problem of how to pay for pensions keeps cropping up time and time again. The need for the reform was obvious, with a rapidly ageing population the country, despite being poor, had one of the most generous systems on the planet. In 2010, the last year before the reform, Ukraine spent 18% of its GDP on pensions and had a pension fund deficit of UAH 34.4 billion or 3.2% of GDP.

Despite this relations between the fund and the Ukraine administration failed to improve substantially (they have now been bitten too often) and at the end of August 201 an IMF staff team was sent to Kiev to carry out the second review of the new programme. The review was never formally completed, and the IMF announced on November 4 that negiotiations had been broken off.

It's All About Gas

Gas prices are an issue everywhere, and especially in election years, but in Ukraine, due to the geopolitical situation, they take on a special significance. Negotiations between Ukraine and Russia over the supply and payment of gas and terms of transit for Russian  gas to Europe have been a recurrent theme since the end of  the Soviet Union. During 2011, as gas prices rose by an annual 60%,  Ukraine repeatedly sought to renegotiate the 10-year contract signed in January  2009. The Ukraine administration considers the gas price  formula unfair and the gas price – currently US$416/mcm in  1Q12 – too high. The two sides have now been working for some months in an attempt to reach an agreement, but it is still not clear one will be reached.

Gas is a core issue for both the Ukraine and the IMF due to its impact on both the current account deficit and on the level of domestic consumption. It is evident that Ukraine growth is now slowing and coming under threat from rising energy prices. Morgan Stanley estimate that the country had a nonenergy current account surplus of 8.2% of GDP in 2011, but since it ran an energy deficit of 14.1% of GDP, the outcome was a  current account deficit of 5.5% of GDP.

To slow the rate at which this current account deficit is eroding reserves and undermining the stability of the currency, the Ukraine central bank has tightened monetary policy sharply, which in turn has contributed to the rapid deceleration in growth, which consensus forecasts put at  around 3.0% in 2012, but which may eventually turn out to be significantly lower. To put this slowdown in perspective, despite the fact that Ukraine's economy has been growing steadily since the 2009 annus horribilis, output levels are still below the pre crisis peak. As Capital Economics' Neil Shearing puts it:
"Ukraine grew by 5.2% last year, which, on the face of it at least, seems a decent outturn. But context is crucial. In 2009, output contracted by a whopping 15% – a recession from which the economy is still recovering. What’s more, the pace of recovery has actually been somewhat disappointing. Output is still well below its pre-crisis peak [see my chart below - EH] yet growth already appears to be slowing. In Q4 GDP expanded by 4.6% y/y, down from 6.6% y/y in Q3. At current rates of growth, it will take another two years for output to return to pre-crisis levels. But even this could be a tall order given how vulnerable the  economy is to a fresh escalation in Europe’s debt crisis".

In addition to the energy price constraint domestic consumption in Ukraine is still weighted down by the indedbtedness problems created by the earlier boom. Non-performing loans are still running at a very high level, although no one really seems to know quite how high, since there are major question marks hovering over the official figures. The IMF's permanent representative in Ukraine Max Alier estimated in the spring of 2011 the figure might be as high as 30% of total loans. And with every 1% drop in the value of the hryvnia the proportion rises, due to the extent of forex borrowing.

In addition, with many Ukraine banks being owned by parents in other EU countries, the credit crunch in the west is rapidly transmitted to the east. Corporate lending growth is slow, and the steady contraction of household borrowing is following a path which looks very similar to that seen in Southern Europe, or the Baltics.

Ukraine - like Hungary - badly needs an agreement with the IMF to facilitate the financing of debt which needs to be rolled-over this year. These rollovers will put significant strain on the system, Neil Shearing estimates something of the order of 34% of GDP.
"Meanwhile, Ukraine faces external debt servicing costs of $52.5bn (around 30% of GDP) this year. A large chunk of this debt is in the banking system, but roughly $5.4bn is owed by the government ($3.5bn of which is due to the IMF). Put together, we estimate that Ukraine’s external financing needs are close to $58bn this year – equivalent to 34% of GDP."

Obviously, with so much debt needing to be rolled over, the country is very exposed to any sudden reversal in risk sentiment, just as it was in 2008. It needs to be under the sheltering wing of the IMF, but this time round the dynamics are rather different. In particular, countries which once got a large net benefit from IMF lending are now facing the moment of truth - when they need to start paying back. Unfortunately, and for whatever reason, the programmes sponsored by the IMF - in Ukraine, in Latvia, in Hungary, in Romania, in Greece, in Ireland, in Portugal - are not yielding the benefits which were initially claimed for them by the advocates of the "structural reform path", in particular in the growth area.

In addition, years of fiscal austerity are now starting to take their toll on the populations concerned. Expectations are not being fulfilled, and a backlash is underway. Regular readers will be aware that my baseline case in Europe is that these misguided/insufficient programmes will steadily destabilise the political systems on Europe's periphery, leading to unstable and unpredictable outcomes. Not the kind of stuff would-be investors like.

Evidently it would be unfair to blame the Fund itself for the kind of problem which exists in Ukraine. Clearly it is a very complex and difficult-to-handle situation. But if you haven't gotten hold of the full extent of the problem in the first place, then it is hard to offer recipes which open a sustainable path forward. Read as much as I can, I still fail to be able to find any single mention of the isssue Ukraine's dire demographics presents for future growth prospects in the IMF literature.

The country's population is falling steadily, due to a long run excess of deaths over births and a steady outflow of working age population, leaving to seek a better life elsewhere. This is not only causing the population to shrink, it is also leading to a dramatic change in the age composition of the population, increasing the average age of the workforce, and lowering the number of those employed per person retired. This is the strategic importance of health and pension system reforms in a country like Ukraine.

Naturally structural reforms are important, but they need to be part of a mix of policies, and among these doing something to address the country's demographic death-spiral should be given a great deal more importance than it is presently - where in fact the issue is almost absent from economic debate.

At this point it is hard to say how the present stand off between the IMF and the adminstration will work out, but as in the Hungarian case I have the feeling that most mainstream bank analysts are underestimating the capacity of the political system to produce "bad outcomes".

The macabre "culebron" associated with the apparent medical condition of the country's former Prime Minister - in prison for having signed the last gas deal - only adds to  the sense of surreal drama associated with the country's potential default.

Ukraine’s ex-premier Yulia Tymoshenko is ill and in constant pain, Canadian doctors who examined her in prison said, adding that authorities denied her key blood and toxicology tests. A team of Western doctors went last week to the prison where Ms Tymoshenko is held to examine the opposition leader amid complaints about her treatment and health.The three Canadian and two German medics included a cardiologist and a nervous system expert, the former Soviet republic’s penitentiary system said in a statement.“

After meeting and examining Ms Tymoshenko, it was the Canadian opinion that she required confidential blood and toxicology testing,” doctor Peter Kujtan said in a letter to Ukraine’s ambassador in Ottawa, Troy Lulashnyk.The medical team had been invited by Ukraine to carry out the examination and even brought along diagnostic equipment which could produce on-the-spot test results, Dr Kujtan said.“But Ukrainian authorities refused to allow its use, stating that we would be breaking several laws of the land and could face prosecution,” he said. 
Now here's the "official version" via interfax:
Ukraine's jailed former Prime Minister Yulia Tymoshenko needs no surgery, the State Penitentiary Service cited a seven-member medical panel as saying on Friday after Tymoshenko had extra checkups on Thursday.The findings of an X-ray test confirmed the previous diagnosis and meant there was no need to revise "the recommendations for her preliminary treatment, while changes that have been detected do not warrant surgical treatment," a statement from the Penitentiary Service cited the seven doctors as saying in their assessment. Tymoshenko, who had herself requested the additional checkups, was examined at a clinic in Kharkiv, the city where her prison is situated. She had an X-ray test, a computed tomography scan and a magnetic resonance imaging scan. However, she again refused to have a blood test, the Penitentiary Service said, adding that foreign doctors would need the results of a blood test for the final diagnosis and treatment recommendations.
Naturally this sort of thing is not new in the country, and anyone with an interest in reading about a similarly surreal situation some years ago might like to read my "Will The Real Ukraine Central Bank Please Stand Up! " post.

And if you have the kind of sense of humour I have about technical issues, you might appreciate this short list of concerns about the way the bank problem resolution issue was handled by the central bank, as voiced by the IMF in their ex-post  first standby agreement review:
a) Liquidity provided to insolvent banks: As it was difficult to distinguish between solvent and nonviable banks, liquidity support was likely extended to the latter. Moreover, the maturities of NBU loans, which originally ranged from 14 to 365 days, were later converted up to seven years providing de facto solvency support.

b) Relaxation of collateral requirements: Banks’ own shares were accepted as eligible collateral despite the significant risk for the NBU.

c) Mandatory purchases of bank recapitalization bonds: The NBU was required to purchase at face value recapitalization bonds issued by the government, a practice that the Fund staff advised against.
The first point is an important one in any traditional approach to bank resolution, distinguishing between the rescuable and the un-rescuable,  but, of course, none other institution than the ECB itself has now crossed the line, and with the 3 year LTROs (which will, naturally, be extended) the central bank is offering, as the IMF suggest in the Ukraine case, solvency support to a number of otherwise insolvent banks. On the collateral side, the ECB isn't accepting bank shares as collateral, yet, although it is accepting nearly everything else, and this idea of the central bank buying recapitalization bonds, wasn't it first tried and tested in Ireland, and hasn't it be applied to some extent in Greece? Nuff said, I think.

What Can't Go On Forever Will Only Go On As Long As It Can

So where do we go from here? The IMF have dug their heels in about gas, but this is only a symptom of a much deeper sense of frustration. The fund has been financing the Ukraine deficit and cheap gas, but will the money disbursed ever get returned, or will the can be continually kicked down the road. It is worth remembering that the initial financing of 11 billion SDRs was equivalent to 802% of the country's quota, a very large quantity in terms of the standards of 2008. As the fund puts it in the review:
"No major shift in policy making  occurred and political economy considerations continue to drive policy making in Ukraine.  Efforts to tackle the underlying structural and institutional weaknesses stalled. Bank  resolution remained incomplete, the exchange rate regime returned to pre-crisis practices, the  energy sector remained largely unreformed with quasi-fiscal deficits widening, and legal and governance reform fell short of objectives".
Put crudely, the fund was being used to finance cheap energy to win votes for populist governments. The frustration to be seen in the above summary suggests to me at least that coming to a new agreement won't be as easy as many think. Especially with a number of other countries looking on. It all used to be called moral hazard I think.

Only industrial users in Ukraine currently pay the full cost of gas. Residential users pay something like 30% of the cost of the gas they consume. This subsidy is a key cause of the loss suffered by the state-owned oil and gas company, Naftogaz, which was UAH 21 billion orUS$2.6 billion, equivalent to 1.6% of GDP in 2011. A planned 50% hike in gas tariffs in April 2011 was negotiated down to 30% hike in two tranches in return for unspecific "offsetting measures" to keep the wider fiscal deficit at 3.5% of GDP. However, eventually, the tariffs were not hiked at all in 2011, widening the actual deficit to 4.3% of GDP. The result of all this is that the IMF have their foot firmly put down, and it will be hard to get it lifted again.

So one possibility is that the Ukraine government, seeing their approval ratings dropping, will consider the political costs of household gas tariff hikes to be too high, and not seriously pursue a renewed IMF deal, hoping that the cut in the current account deficit due to the lower gas import price plus any other investment commitments or payments which would arise from of a Russian gas deal will be enough to reduce pressure on reserves to a sustainable level. The Bank has spent nearly $7bn – or 20% – of its reserves since last August, and with reserves now approaching $30 billion this strategy is clearly becoming unsutanable.

There is, of course, another possibility, and that is that there is no Russia deal and no IMF deal. This could occur  if the government baulks at both of the possibilities on the table: either selling a stake in the gas transit corridor to the Russians or raising household gas tariffs. Under this scenario the Ukraine government could follow in the footsteps of Hungary's Prime Minister Viktor Orban which involves seeming to cooperate (in this case with both parties) but doing nothing, and in the meantime hope to muddle through - at least in this case till the elections in October. However, against the backdrop of falling reserves, a rising current account deficit and external funding markets which are closed to Ukraine, a sharp devaluation could become virtually unavoidable if there is neither a gas deal and nor a resumption of the IMF programme.

Following the decision of the ECB to introduce 3 year LTROs and the agreement on the terms of a second Greek bailout global risk sentiment has improved significantly in recent weeks, but it would be foolhardy to imagine that this situation will become permanent. Too many risk elements are still in play, and there are still far too many loose cannon floating around on the EU upper deck for vigilance to relax. But that is exactly what may happen, in which case, if disaster does strike in Ukraine, it will surely be disaster.

This post first appeared on my Roubini Global Economonitor Blog "Don't Shoot The Messenger".

Wednesday, February 17, 2010

Ukraine's 2010 presidential election: another power struggle to follow?

by Manuel Alvarez-Rivera,

It's official now: Ukraine's former Prime Minister Viktor Yanukovych, the leader of the pro-Russian Party of Regions, was declared elected President by the former Soviet republic's Central Election Commission on Sunday. Yanukovych prevailed over Prime Minister Yulia Tymoshenko by a relatively narrow but nonetheless clear margin of just under three-and-a-half percentage points in a runoff election held last February 7; detailed results are available in Ukrainian at the Commission's website and in English at Presidential and Parliamentary Elections in Ukraine.

As previously noted on Ukraine holds an early parliamentary election, Yanukovych ran for the presidency in 2004, and was initially declared the winner over pro-Western candidate Viktor Yushchenko in a highly irregular runoff election. However, the attempted election fraud triggered massive protests in Kiev, which came to be known as the "Orange Revolution" (after Yushchenko's campaign color); in due course, the runoff election results were invalidated, and in a repeat runoff vote Yushchenko prevailed over Yanukovych.

Nevertheless, the past five years have been characterized by a seemingly endless power struggle between President Yushchenko and his successive prime ministers, most notably among them erstwhile Orange Revolution ally Yulia Tymoshenko (who served as Ukraine's head of government in 2005 and again since 2007) and Yanukovych himself (who held office from 2006 to 2007). Beyond free and fair elections and a free press, little else has been accomplished, and Ukrainian voters have become disenchanted with the Orange Revolution politicians - especially President Yushchenko, who ran for re-election but was eliminated in the first round of voting last January 17, coming in an ignominious fifth place with only 5.5% of the vote. To be certain, Mrs. Tymoshenko did much better than expected in both rounds of voting, but in the end the economic legacy of her government - which presided over a severe 15% contraction of the Ukrainian economy last year, in the wake of the global economic crisis - proved too much to overcome.

Although international election observers have praised the conduct of this year's presidential election, Yulia Tymoshenko stubbornly refuses to recognize Viktor Yanukovych as the legitimately elected president: to the dismay of the Western powers, she insists the election was rigged to the tune of million votes - a figure large enough to overturn the official result - and has challenged the election results in court. In fact, Mrs. Tymoshenko's eponymous political bloc has demanded recounts in several eastern regions, even though an analysis of the runoff vote results shows the election was decided not in the east, but in the west.

Since the attainment of independence in 1991, Ukrainian politics have been characterized by a sharp East-West divide: eastern and southern Ukraine are strongly pro-Russian, while the country's western and central regions are just as staunchly nationalist and pro-West. This was the case as well in the 2010 presidential election, as illustrated by the first round and runoff election maps, courtesy of Serhij Vasylchenko:

In the east and the south, Yanukovych swept with 76.9%, while in western and central Ukraine he polled just 23.8%. However, relative to the 2004 repeat runoff election, Yanukovych's share of the vote in the East rose by only 0.5%, whereas in the West he registered a sizable 8.2% increase. Likewise, Yulia Tymoshenko's 17.8% share of the vote in the eastern and southern regions was just slightly smaller than the 19.2% scored by Viktor Yushchenko five years earlier; in some regions where she is demanding a recount, such as Crimea, she actually had a better result than Yushchenko in the repeat runoff. However, the 70.4% of the vote she polled in western and central Ukraine stood well below the 81.1% won by Yushchenko in 2004.

Moreover, regional differences in voter turnout decline may have also helped Yanukovych, if only slightly. In eastern and southern Ukraine, turnout in the 2010 runoff election fell by 7.2%, to 69.4%, while in the western and central regions turnout declined by nine percentage points, to 69.6% (the overall turnout rate stood at 68.8% because only 10.3% of the expatriate voters - whose votes are tallied separately from those cast in Ukraine proper - bothered to take part in the runoff election).

In addition, a record 4.4% of voters cast ballots against all candidates in the runoff election - twice as many as in the first round, and nearly double the figure in the 2004 repeat runoff; as a result, Viktor Yanukovych will become the first president of Ukraine to win office without an absolute majority. Interestingly, the 2.2% increase between rounds in the number of votes against all candidates correlates strongly with the share of the vote for independent businessman Serhiy Tihipko, who came in third place in the first round; there is no significant correlation with the first round vote for President Yushchenko, who called for a vote against all in the recently-held runoff.

Beyond refusing to concede defeat, Yulia Tymoshenko has made it clear that she has no intention to comply with President-elect Yanukovych's request to submit her resignation as prime minister. While her refusal to step down will trigger a vote of no-confidence in Parliament - which she is expected to lose - Mrs. Tymoshenko will nonetheless remain as caretaker head of government until a parliamentary majority coalition nominates a replacement. No single party commands a majority in Ukraine's unicameral Parliament, the Supreme Council, and negotiations leading to the formation of a new government could take weeks, if not months - assuming a new government can be formed at all without having to call an early parliamentary election. As such, Ukraine - which is in desperate need of political stability to deal with its struggling economy - may be in for yet another protracted power struggle.

Wednesday, October 21, 2009

Ukraine's Problems Show No Sign Of Abating

Despite the fact the Ukraine administration is resplendent with confidence that the International Monetary Fund is going to release the next $3.4 billion payment under the country's $16.4 billion lending program with the Fund, things are not so clear. In fact the International Monetary Fund only this week warned Ukraine (25 October) that they might freeze assistance ahead of the forthcoming presidential election if proposals to make populist wage and pension increases move forward.

In a statement issued after talks with Kiev’s officials, the IMF said its decision to go ahead with the next $3.8bn in aid would hang on “assurances that the wage and pension law approved by Ukraine’s parliament, which is at odds with the objectives of the authorities’ programme, will be vetoed”. The statement was a clear and explicit warning to President Viktor Yushchenko, who has not yet clarified whether he will sign or veto the law.

Still the Ukraine authorities are giving the impression that everything in the garden is rosy, or at least this is the impression Economy Minister Bohdan Danylyshyn is attempting to send out to the world.

“The payment will help sustain the economy and, to a certain extent, help cover the budget deficit,” Danylyshyn said last week in an interview at Ukraine’s New York Consulate. “It’s a pretty complicated situation in Ukraine, that’s why we expect a budget deficit this year and next.”
In fact he couldn't have put it better, the situation in Ukraine is pretty complicated, it really is. But behind the scences things don't seem to be anything like as clear as Danylyshyn is suggesting, and there is plenty of evidence of fund frustration with the administration and of a growing determination to tighten the screw somewhat. So is Ukraine assuming that, not being Latvia, they are too big too fail? And if they are doing so, are they right in their assessment, and if they are not, what might be the final outcome here.

Certainly Ukraine, for its part is now completely dependent on the IMF loan program - from which it has so far received $10.6 billion - to keep itself afloat following the impact of the credit crunch on the internal lending and construction boom and the fall in external demand for the raw material exports, and especially steel, on which it has allowed itself to become so dependent.

One thing which strikes the external observer immediately is the differential treatment Ukraine has been receiving when compared with other East European borrowers like Hungary and Latvia, since unlike the latter two the pressure on the administration to make swinging budget cuts has been fairly muted up to now. In fact the country did meet its end of May fiscal target, but since that time the underlying fiscal situation has worsened considerably. The general government deficit was 1.8 percent of GDP during the first five months of 2009, against an agreed program ceiling of 2.4 percent of GDP. However, according to the IMF this positive outcome largely reflects an increase in VAT refund arrears and advanced tax payments by large enterprises (0.5 percent of GDP).

At end-June, the government deficit stood at 3 percent of GDP, while expansionary fiscal measures are increasingly coming under consideration ahead of next years elections. The government has adopted a moratorium on tax audits and considered a tax amnesty, while parliament adopted modifications to the budget code implying additional transfers to local governments (which could exceed 1 percent of GDP in 2010). A draft law including large increases in public wages and pensions (2 percent of GDP in 2009, and 4 percent of GDP in 2010) has even been suggested by the opposition.

Not unsurprisingly an IMF team is now hard at work in Kiev, trying to assess whether Ukraine still meets the agreed terms of the loan prior to a final decision on the next payment.

And again, not everyone is in agreement that things are going as planned. Ukraine is at “serious risk” of veering off track ahead of the coming country review in November, according to a Fitch Ratings statement of October 14.

Fitch argue that Prime Minister Yulia Timoshenko's government has “abandoned” commitments made under the IMF's second review of the loan program, and the clearest evidence of this abandonment is the evident failure to increase prices for natural gas paid by households and utilities despite the massive subsidies the government is finding itself forced to pay.

In fact JuliaTimoshenko reiterated only last week there will be no increase in natural gas rates this year. Yet low gas prices simply add to the country’s budget deficit, which the IMF estimate will finally total 8.6 percent of gross domestic product this year, and that is excluding bank restructuring costs. Fitch themselves forecast a deficit of 8.5 percent of GDP, rising to 11.1 percent once the deficit of Nak Naftogaz Ukrainy is added in.

Danylyshyn for his part is much more optimistic, suggesting the deficit this year may fall to 6 percent, and then shrink to around 3.8 percent in 2010.

Naturally the IMF remain unconvinced by Danylyshyn's forecast, and argue that the outlook for public finances has worsened significantly, and that revised 2009 GDP growth projection implies that, without offsetting measures, the general government deficit is set to increase from 4 to 6.5 percent of GDP in 2009, to which needs to be added an anticipated extra 2.7 percent of GDP for Naftogaz which would send the total public sector deficit (inclusive of Naftogaz’ deficit but still excluding bank restructuring costs) up to 9.2 percent of GDP.

Ukraine’s economy is currently struggling to recover from an extremely severe recession which lead GDP fall by an annual 17.8 percent in the second quarter of this year, following a 20.3 percent decline in Q1. GDP may decline as much as 14 percent over the year as a whole (and grow 2.7 percent next year) according to the October IMF forecast, with everything really depending on the average prices of, and demand for, ferrous metals, which are Ukraine’s major export.

In line with the general outlook for the entire CEE region, anything in the way of vigorous recovery is not expected before the second half of 2010, and even then in many cases the vigour may be quite muted. If Ukraine's economy is to return to growth improvements in competitiveness (following the recent real exchange rate depreciation), a recovery of global steel prices, and increased public and private sector investment in infrastructure and energy projects with a clear external orientation will be the main drivers of the recovery.

Obviously all are agreed that a return of foreign investment to stimulate export activity is the key to recovery, and Danylyshyn expects Ukraine to receive $20 billion in foreign direct investment between next year and 2012 to help it diversify the economy away from exports of raw materials, such as steel and grains, and modernize existing facilities.

But again, at least in the short term, things are not so easy, given that while the current account has adjusted, net capital outflows continue to present an important source of balance of payment pressures.

In the first 8 months of 2009, the current account deficit amounted to USD 1.1 billion, USD 7 billion lower than a year ago. At the same time, external debt roll-over for banks and corporates was 76%, resulting in USD 7.1 billion net outflow over the same period. Additionally, ‘domestic capital outflows’ – flight to foreign cash by residents – drained out USD 5.7 billion. The recent IMF’s SDR quota allocation and the Special Borrowing Arrangement have helped to ease what otherwise would have been a major drop of forex reserves. The marginal weakening of the external accounts over the summer, higher demand for forex from corporates and households, on the back of heightened depreciation expectations have placed pressure on the currency since end-July. The depreciation trend also resulted in the leakage of Hryvnia deposits from the banking sector of around 7% during Q3. And indeed multiple exchange rates have once more reappeared following the return to selective National Bank of Ukraine forex interventions.

A Large Output Gap Remains

The economic contraction may have slowed, but a large output gap continues to exist. Industrial output was in fact up 1.9 percent month-on-month in September, with production resuming its upward trend following a 0.9 percent monthly fall in August. Steel output however continued to decline, raising more doubts about where the recovery is headed.

Industrial output fell 18.4 percent in September year-on-year and was down 28.4 percent between January and September when compared with the same period in 2008. Output in the steel sector fell 7.1 percent month-on-month after falling 0.3 percent in August. Year-on-year, it fell 14.9 percent in September. Steel production between January and September fell 36.9 percent against 39.0 percent in the January-August period and 41.2 percent in January-July.

The Industry Ministry forecast that raw steel production will fall to about 30 million tonnes this year from 37 million in 2008 and 42.8 million in 2007.

Economic activity plunged in the last months of 2008 and has continued to fall since. Real GDP fell 20.3 percent year-on-year in the first quarter of 2009, reflecting the deterioration of the global environment and further exacerbated by Ukraine’s pre-existing vulnerabilities. As in many other countries in the region, the recession was led by a drop in export volumes, followed by a very sharp contraction of domestic demand.

The pace of decline in private consumption was broadly unchanged in the second quarter at 11.6 percent year on year, while fixed investments sank by 57.8 percent. The contribution of net exports to growth became larger as real imports declined even faster (-53.5% y/y) than exports (-32.3% y/y). Output indicators point to stronger performance in Q3. In particular, as we have seen industrial production has started to recover gradually in recent months.

Ukraine's economy is following a typical boom/bust scenario, and following several years of evident overheating characterised by ever more rampant inflation the global crisis final brought the inevitable to pass. The IMF now expect real GDP to decline by 14 percent in 2009, against the 8 percent they expected at the time of their first programme review earlier this year. The downward revision reflects the larger than expected contraction in the first quarter of 2009. Given the pronounced recession in Ukraine’s main trading partners and the likely frail global demand for steel in the coming quarters, the forecast assumes only a very timid recovery in the second half of 2009, followed by a return to GDP growth in 2010, and there are, of course, evident downside risks to this scenario.

Beyond the export and industrial shock output has also been contracting fast in both the construction sector and in retail trade, reflecting the sharp impact of the credit crunch. Price adjusted retail sales were down 22% year on year in September, while construction activity has fallen by over 50% from 2008 levels.

Inflation The Large Fly In The Ointment

One of Ukraine's greatest headaches in recent years - as can be seen in the chart below - has been the high level of domestically produced inflation, and the total incapacity of fiscal and monetary policy to get to grips with this. Price pressures are, however, now easing fast in Ukraine as the output gap has its impact, and headline CPI inflation has now fallen to around 15 percent year-on-year, down from 22.3 percent in January. Inflation is expected to continue to decline, reflecting the massive excess capacity. However, base effects from the second half of 2008 will slow the decline in headline inflation, which the IMF expect to be still at 14 percent by end-2009.

Ukraine’s inflation rate is, however, still the highest in Europe, and even rose 0.8% month on month in September. This latest rise followed a 0.2% mom decrease in August. Annual inflation did however decelerate from 15.3% in August to 15.0% in September. The most significant contributor to this slowdown has been the slow rate of utility price increases, and this is a clear bone of contention with the IMF as the government refuses to change gas prices significantly given the scale of the recession and the looming elections. For the rest of the year, most observers expect inflationary pressures to remain muted, with annual inflation remaining around its current level of 15%.

The producer price index was however up by a monthly 3.6% in September, notably more than the 1.8% monthly increase registered in August, giving the highest monthly increase since July 2008. As a result the annual PPI turned positive again (up 1.6%) following a 3.7% year on year fall in August. So despite all the pressures inflation is proving extraordinarily resilient and continues to present a major problem for economic management.

Monetary Policy Caught in a Trap

All of which causes significant problems for the operation of monetary policy. The central bank realises the issue - and central bank Governor Volodymyr Stelmakh this summer described double figure interest rates as "far too high" (especially for an economy with a 14% annual contraction) - and has now cut its key discount rate twice since June to the current level of 10.25 percent. The bank justified the cuts by stating that price pressures have “eased” since inflation peaked at 31.1 percent last May, but on the other hand it is evident that inflation is still way to high. But the central bank is under continuous pressure from the government who want the central bank to lower rates further to make loans cheaper.

On the other hand, while base money has picked up significantly, largely on account of the government’s conversion of its share of the second IMF disbursement into hryvnia, broad money growth has continued to be weak, reflecting both a strong liquidity preference on the part of banks, and weak credit demand from consumers and companies.

Ukraine's exchange rate has depreciated by about 35 percent in effective terms (allowing for inflation) since early September 2008 and has been stable in recent months, allowing the NBU to scale back interventions since March 2009. More recently, since late June, however, moderate exchange rate pressures have reemerged.

The Ukraine banking system remains under strain, but deposits have stabilized, signaling some return of confidence. Non performing loans have increased since the onset of the crisis, but many banks are now reporting ongoing restructuring of their credit portfolios. After loosing some 20 percent of deposits between October 2008 and April 2009, aggregate deposits have stabilized in recent months, allowing the authorities to lift the ban on the early withdrawal of time deposits. The stabilization at the aggregate level conceals significant differences between banks, with the recently recapitalized state and foreign owned banks generally gaining deposits, while the domestic banks continue to experience significant outflows. Domestic currency lending has been picking up recently but this is almost entirely on account of lending by the state banks while other banks continue to reduce their credit portfolios.

As we can see, lending to households peaked at the end of last year, and continues to fall.

Household exposure to forex lending is significant in Ukraine, in this case the exposure is to dollars.

Closing Current Account Deficit Pressures Domestic Demand

As has been said, there has been a sharp fall in Ukraine exports since the crsisi began - 32.3% year on year in the second quarter. Q2 exports were up slightly from the first quarter, but nonetheless they remained at a very low level.

At the same time Ukraine's current account has continued to adjust, registering a small surplus in April-May. Import volumes declined sharply due to contraction of domestic demand offsetting the decline in exports due to continued weak external demand, especially for steel.

As a result of the drop in imports the goods trade deficit has been steadily falling towards zero.

As we can see in the chart below, a significant part of the current account adjustment has been due to the fact that imports have been falling significantly faster than exports.

The current account has continued to adjust, registering a small surplus in April-May. Import volumes declined sharply due to contraction of domestic demand offsetting the decline in exports due to continued weak external demand, especially for steel. The financial account has shown signs of stabilization, despite a sharp decline in FDI. External debt rollover rates for the first five months of the year held up well (about 70 percent for banks and 100 percent for corporations). In addition, outflows of foreign exchange from the banking system have receded in recent months.

The IMF expect the current account balance to swing into a small surplus in 2009 (0.5 percent of GDP). However the drop in both import and export volumes is expected to be larger than previously expected owing to the weaker domestic and external outlook. Lower FDI is broadly offset by lower net outflows of bonds and loans. The take the view that their program remains adequately financed, but they still see risks. Total financing requirements in 2009 are projected to amount to $41 billion, while total financing sources (excluding Fund resources but including $2.3 billion in prospective official financing) amount to $31 billion, leaving a financing need of about $10 billion, which could be fully met by Fund resources. Risks include lower-than expected official financing, renewed foreign currency cash outflows from the banking system, and reduced FDI inflows and rollover rates. If these risks materialize, the IMF suggest the use of reserves buffers and/or additional policy adjustment would be needed.

Ukraine's Looming Demographic Destiny

Ukraine has a serious demographic problem, raising longer term growth issues, and difficulties for the sustainability of public finance. Ukraine's population has fallen back from 51.5 million in 1989 to the current 46 million level. And, of course, the decline continues.

Behind the fall in Ukraine population lie two factors, very low fertility and the out migration of the younger population in search of better employment opportunities and higher living standards elsewhere. Ukraine's total fertility rate hit a low of 1.083 (according to the US Census Bureau) in 2001, and has subsequently rebounded to around 1.252 in 2008, in any event still well below the critical 2.1 tfr population replacement rate.

The “transition” in transition countries refers, of course, to the political and economic passage of these formerly communist, centrally planned states. But there is an equally profound demographic transition in progress: very low fertility levels and ongoing emigration virtually guarantees that these economies will age more rapidly than any other region. By 2025 more than one Bulgarian in five will be over the age of 65 -- up from just 13 percent in 1990. And while countries in other parts of the world are also aging at a phenomenal pace – think Japan, Korea, Germany and Italy -- no other region faces the challenge of building a modern, highly productive economy even as the portion of the population eligible for retirement explodes.

The dramatic declines in fertility in the teeth of post-1990 uncertainty are frequently interpreted as a temporary reaction to the uncertainties of economic and political transition. Yet, while there was a slight blip up in the prosperous years of the post-2000 boom, these economies seem to be past the point of demographic return: fertility would have to increase by more than one-third just to replace the existing population.

Ukraine suffers from a chronic problem of low fertility. A strong uptick in births had been noted in 2008 (see chart above), but the impact of the crisis is now evident, and the rate of increase in live births has now fallen back sharply.
Add a caption

Since the proximate cause of the crisis was to be found in global financial turmoil, it was perhaps only natural that the financial sectors of the countries most dependent on the international flow of funds would be hit first and hardest. In the autumn of 2008, as financial difficulties in the advanced economies led to a decline in global liquidity and a flight from risk, investors begin to differentiate among emerging markets. Ukraine’s high external debt and inflation levels led to a stampede for the exits in mid-October.

Ukraine's biggest single problem is still the persistent high levels of inflation which the economy produces. Given the application of coherent monetary policy the inflation problem could steadily work its way out of the system, but this is a big "if" given the known political risk factors. Inflation is currently projected by the IMF to hit single digits in 2010 and to remain in the 5–7 percent range thereafter.

The current account balance is now likely to remain at financeable levels, and the financial account deficit should narrow as capital inflows recover. Any recovery would be delayed, however, if there were an unexpected further decline in steel prices or another round of stress in global financial markets. On the other hand, a faster global recovery and a return of political stability after the January election could result in a more pronounced rebound of the economy. External and public debt remain sustainable in principal but doubts continue going forward especially in the context of financing constraints.

While Ukraine’s low level of public debt - 20 percent of GDP in 2008 - provides room for letting automatic stabilizers cushion the downturn and absorb part of the bank restructuring costs, fiscal sustainability would increasingly become a concern under unchanged policies, especially if the recession turned out more protracted than currently envisaged. Failure to implement the agreed measures in 2010 (pension-, tax-, and gas sector reform) or new expansionary measures could potentially jeopardize public debt sustainability in the longer run, and this is really what is preoccupying the IMF at the present time. The IMF baseline external scenario shows a rapidly declining external debt ratio but further deterioration in global economic and financial conditions, adverse current account developments, further shortfalls in FDI, or exchange rate overshooting would all negatively affect debt dynamics and create significant problems.

Not an easy picture, but then I guess no one ever thought it was.

Saturday, June 20, 2009

Facebook Links

Quietly clicking my way through Bloomberg last Sunday afternoon, I came across this:

Facebook Members Register Names at 550 a Second

Facebook Inc., the world’s largest social-networking site, said members registered new user names at a rate of more than 550 a second after the company offered people the chance to claim a personalized Web address.

Facebook started accepted registrations at midnight New York time on a first-come, first-served basis. Within the first seven minutes, 345,000 people had claimed user names, said Larry Yu, a spokesman for Palo Alto, California-based Facebook. Within 15 minutes, 500,000 users had grabbed a name.

Mein Gott, I thought to myself, if 550 people a second are doing something, they can't all be wrong. So I immediately signed up. Actually, this isn't my first experience with social networking since I did try Orkut out some years back, but somehow I didn't quite get the point. Either I was missing something, or Orkut was. Now I think I've finally got it. Perhaps the technology has improved, or perhaps I have. As I said in one of my first postings:

Ok. This is just what I've always wanted really. A quick'n dirty personal blog. Here we go. Boy am I going to enjoy this.
Daniel Dresner once broke bloggers down into two groups, the "thinkers" and the "linkers". I probably would be immodest enough to suggest that most of my material falls into the first category (my postings are lo-o-o-ng, horribly long), but since I don't fit any mould, and Iam hard to typecast, I also have that hidden "linker" part, struggling within and desperate to come out. Which is why Facebook is just great.

In addition, on blogs like this I can probably only manage to post something worthwhile perhaps once or twice a month, and there is news everyday.

So, if you want some of that up to the minute "breaking" stuff, and are willing to submit yourself to a good dose of link spam, why not come on in and subscribe to my new state-of-the-art blog? You can either send me a friend request via FB, or mail me direct (you can find the mail on my Roubini Global page). Let's all go and take a long hard look at the future, you never know, it might just work.