Country risk: Ukraine is at another crossroads

Grim in Kiev: But a sunnier investor climate might be closer than you think

High-risk Ukraine is over the worst, at least in terms of macroeconomic instability.

The country enjoyed a second consecutive year of GDP growth in 2017 and is expected to witness further improvement through to 2019 when the next presidential and parliamentary elections are due to be held.

However, that does not mean it has suddenly become a safe option overnight.

Clearly, it’s total risk score of just 32.1 points from a total 100 in Euromoney’s country risk survey is still serving as a warning indicator to potential investors. It remains a high-risk gamble.

Many of the problems go back to before the crisis of 2013.

And it has since become consumed by continual political turmoil, while hosting a tense separatist battleground still undermining Russian relations.

The elections present another hurdle for a country with such history of instability, and heightened institutional and policymaking risks, highlighted by the survey’s political factors all scoring less than four points out of 10.

IMF on ice

The polls are showing the formerly interned ex-prime minister Yulia Tymoshenko and her All-Ukrainian Union ‘Fatherland’ in the lead, but with a broadly even split of support distributed among various parties, with only 50% of the electorate decided and not all presidential candidates declared.

Crucially, an IMF programme is on ice, awaiting evidence of a renewed passion for structural reforms, including a more determined fight against corruption either from this administration or by the new authorities after next year’s elections.

The IMF is demanding more energy-sector and fiscal improvements, and an appropriate law setting up a strong and independent anti-corruption court, making it “fully consistent with programme commitments and the recommendations of the Venice Commission of the Council of Europe”.

The situation could just as easily unravel, as it could improve, with Ukraine the 128th riskiest sovereign borrower worldwide from 186 countries in Euromoney’s survey, facing large foreign debt payments due between now and 2020, and the elections a stiff test of resolve, of instituting a stable government and avoiding more turmoil on the streets.

However, that would also ignore the improvements to date, notably the fact the crisis that caused the currency and GDP to plummet in 2014-2015, and inflation to skyrocket, is now over, with domestic demand and exports recovering.

Foreign-exchange reserves are around $18 billion, sufficient to cover more than three months of imports, and although annual inflation remains high, it has fallen to 13.1% as of April, with the National Bank of Ukraine (NBU) holding interest rates at 17% – raised from 12.5% since September – to keep it on a downward trend.

The European Bank for Reconstruction and Development foresees GDP growth accelerating to 3% in 2018 and 2019, from 2.5% last year, in its latest Regional Economic Prospects Report released in May.

And, crucially, if the authorities make the necessary adjustments, it could receive another $2 billion tranche of IMF funding and other related financing. This, the NBU states, would allow it to further relax FX controls, lending further support to economic growth.

However, the risks remain high.

Ukraine is still within the lowest of five tiers into which all 186 sovereign borrowers are categorized by Euromoney, according to their risk scores.

All five of its economic risk indicators have improved on a year-on-year basis, but are still scoring less than half the marks available. Structural and corruption risk indicators are heavily marked down, despite capital-access improvements.

Cautious outlook

Vasily Astrov, senior economist at the Vienna Institute for International Economic Studies, is one of several ECR experts adopting a cautious outlook on Ukraine, arguing the implementation of the IMF’s demands – such as the hike in domestic gas tariffs – will be difficult and will make the resumption of the IMF programme unlikely in the short run.

“Ukraine can still rely on borrowing from financial markets on relatively favourable terms (by Ukraine’s standards) – around 4% to 5% – to make up for the shortfall in IMF funds,” he says.

“It will continue doing so, as long as the global liquidity and the global appetite for risk remain high.”

Astrov also notes that Ukraine’s external imbalances are not as bad as believed even a few months ago: the data on the inflows of remittances have been revised upwards, resulting in a sizeable narrowing of current-account deficits.

Still, he has some concern – as other experts do – for the potential repercussions from the progressive, albeit slow monetary tightening in the US.

“This can become a big problem in Ukraine, especially if amplified by domestic political uncertainties,” says Astrov.

“President [Petro] Poroshenko also looks unlikely to be re-elected, while his most likely successors – Tymoshenko or [former defence minister and leader of the party Civil Position] Anatoliy Hrytsenko – while being broadly pro-Western, might be less predictable in their economic policy.”

It will not have gone unnoticed that Tymoshenko’s first term in office as prime minister in 2005 was controversial, mostly because of the re-nationalization campaign she tried to launch, while Hrytsenko’s rhetoric is largely directed against oligarchs, which could prove destabilizing.