Mounting Challenges

Economic News

22 Jul 2010
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The Ukrainian government is bracing itself for a tough ride ahead. In an address to the parliament on March 31, President Viktor Yushchenko said the economy shrank 25-30% year-on-year in the first two months of 2009 and that further hardships would have to be endured before there was a return to positive growth.



"We have lost our foreign markets and 60% of Ukrainian exports. All our foreign currency earnings depended on these markets, as did the jobs of nearly 2m people in steel, chemicals and related sectors," he said.



Saying that the country had been "ill-prepared to confront the crisis", the president also called on the parliament to act by responding to the downturn.



And act it did, though not in the way the head of state meant. The following day parliament voted overwhelmingly in favour of a resolution to move forward the date of the next presidential election from January 2010 to October 25, 2009. The move, described by Yushchenko as illegal, has further heightened tensions between the head of state and the government of Prime Minister Yulia Tymoshenko, former allies in the "Orange Revolution" of 2004.



The two have been increasingly at odds over how the economic crisis in Ukraine should be handled, with Yushchenko opposing government plans to strengthen ties with Russia, including seeking a $5bn loan from Moscow, and over what the president claims is the slow pace of implementing reforms required by the IMF under its $16.4bn standby agreement with Kiev, which was brokered in November.



While some in the parliament are reluctant to ratify measures required by the IMF, including raising taxes on some products and bringing the budget deficit down to 3% from 5%, the government is in urgent need of funds to support the economy.



Concerns over the country's financial institutions have prompted the government to announce plans to shore up Ukraine's banks by releasing up to $5.7bn in funds, the equivalent of 2-3% of GDP, to recapitalise the sector.



On March 31, Alexander Savchenko, the deputy chairman of the National Bank of Ukraine, told journalists that between 10 and 15 banks could benefit from the recapitalisation programme, which he said aimed to restore banks' ability to pay on household deposits and meet its obligations to corporate entities.



The question of how to further support banks and encourage them to resume lending to the private sector was being considered, and measures would be taken at a later day, said Savchenko. "It would be difficult, under current circumstances, to demand that all banks provide lending to the real sector," he added.



Many analysts estimate that around one-third of household deposits have already been withdrawn from local banks since late 2008, with many lenders now struggling to meet cash demands from depositors and some banks restricting withdrawals to 20% or less of a customer's account.



The run on the banks has mainly been caused by depositors seeking to switch their holdings to foreign currency as a hedge against inflation and the possible collapse of the hryvni, which has lost 37% against the US dollar since September.



The proposed state funding could help restore confidence in the country's banks, though with Savchenko suggesting a maximum of 15 of Ukraine's 180 banks could gain assistance, the public may remain uneasy over the plight of the unassisted majority.



Furthermore, the planned state bailout may not be enough. According to a recent IMF report, the amount needed to recapitalise Ukraine's banks is around $8bn, some 4.5% of GDP.



A further threat to the stability of the Ukrainian economy is the distinct possibility of another confrontation with Russia over gas supplies, a potential clash that could affect the rest of Europe. Moscow has made clear its displeasure at Kiev striking a deal in mid-March with the EU for $2.5bn in funds to upgrade Ukraine's gas pipeline network.



Moscow is opposed to the plan since it would undermine energy giant Gazprom's monopoly on transiting Russian gas through Ukrainian territory. On March 25, a senior Gazprom official said if Ukraine went ahead with the EU-funded upgrade, there could be "unpredictable consequences".



With exports plunging, industrial production down 34% year-on-year in January, inflation running at around 22% due to surging food prices and government spending, and the IMF blocking the release of the second trance of its standby loan until key reforms are made, Ukraine's government is finding its room for manoeuvre increasingly limited.

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