By: Vladislav Inozemtsev
The start of 2020 in Kyiv was initially thought to be a triumphant one. The last weeks of 2019 brought some de-escalation in the war in Donbas (EADaily, December 30, 2019), new hopes for peace and, importantly, formidable economic successes. Notably, the United States adopted new sanctions that delayed construction of the Nord Stream Two natural gas pipeline, thus forcing Russia to sign a renewed gas transit contract with Ukraine (Ukrinform.net, December 31, 2019) as well as to pay Gazprom’s penalties to Ukraine’s Naftohaz, in line with earlier rulings by a Stockholm arbitration court (Naftogaz.com, December 31, 2019). At the same time, in recent months, fears of a sovereign financial default—widely discussed since President Volodymir Zelenskyy started his tenure last May (EADaily, May 29, 2019)—have now entirely evaporated.
But in mid-January, the situation in Kyiv was roiled again, this time by a political scandal involving the release of tapes on which Prime Minister Oleksiy Honcharuk can be heard rudely dismissing the president’s abilities to understand and analyze the economic situation (Strana.ua, January 15, 2020). Honcharuk quickly submitted his resignation, which, for now, President Zelenskyy has rejected (President.gov.ua, January 17, 2020). Undoubtedly, if the Honcharuk Cabinet is dissolved in the near future, various Ukrainian clans and political groupings will immediately arise, leading to unpredictable outcomes. Nevertheless, an overview of recent economic developments helps to clarify some of the foreseeable challenges and perspectives for the Ukrainian economy going forward.
Since 2017, Ukraine’s economy has been on a relatively strong upswing following the deep plunge caused by the turmoil created by Russia’s aggression against the country beginning in 2014. The national currency, the hryvnia, moderately strengthened against the dollar, allowing the economy to reclaim around a half of its 2014–2015 losses in dollar terms (Minfin.com.ua, December 20, 2019). But Ukraine remains highly leveraged, with state foreign and domestic debt reaching 2.17 trillion hryvnias ($78.3 billion) (Mof.gov.ua, December 31, 2019). In 2018, this debt equaled 60.9 percent of annual GDP (Delo.ua, March 22, 2019), and servicing the loans required more than 13 percent of total government budget outlays the following year (112.ua, January 1, 2019). Since the government had to borrow more to cover growing defense spending while relying on a shrinking tax base, yields on both domestic and external debt went up: in December 2018, they hit 20.5 percent for newly issued three-month domestic government bonds and 9.75 percent for dollar-denominated eurobonds (Epravda.com.ua, December 19, 2018; Emerging Europe, March 19, 2019). With $12 billion of foreign debt to be repaid in 2019 and negotiations with the International Monetary Fund (IMF) postponed, Ukraine seemed to have no other option than to default on its loans. Zelenskyy’s presumed backer, oligarch Ihor Kolomoyskiy, openly suggested this option in his May 2019 interview with the Financial Times (Financial Times, May 25, 2019).
However, under the leadership of Finance Minister Oksana Markarova—one of only two former cabinet members whom President Zelenskyy reappointed to serve in the new government—the authorities began to tighten borrowing to push the yields down (Worldgovernmentbonds.com, January 20, 2020). The National Bank slashed the refinancing rate five times during 2019, bringing it down to 13.5 percent in December (Bank.gov.ua, accessed January 20, 2020). This allowed the finance ministry to extend the average duration of domestic bonds, from less than six months in 2018, to more than two years (Facebook.com, December 7, 2019). After establishing a reliable instrument for domestic borrowing, the government took on additional foreign investors, offering one billion euros ($1.1 billion) of sovereign eurobonds that became six times oversubscribed and selling them with a yield of 6.75 percent in June, reducing the borrowing cost by a quarter compared to the previous offer (112.international, June 15, 2019). Inflation hit a post-2014 low of 4.3 percent (Bank.gov.ua, accessed January 20, 2020). In late December, Markarova noted, the yields on dollar-denominated bonds fell to 3.75 percent (on the euro-denominated bonds to 2.2 percent), providing investors over 30 percent returns in 2019 (Economic Times, December 21, 2019); while domestic bonds, if converted into dollars, secured high-risk-tolerant buyers 40–45 percent returns in 2019 thanks to the hryvnia’s appreciation against major currencies.
Yet, solving one problem often creates another. As Ukraine’s balance of payments last year became positive (by $1.3 billion) (Ua-outlook.com.ua, December 13, 2019), and state debt dropped to 50 percent of GDP for the first time since 2013 (Tsn.ua, January 2, 2020), the hryvnia’s rise grew more intense, causing real issues for the economy. The 19 percent appreciation of the national currency in 11 months has begun to undermine the most dynamic sectors of the Ukrainian economy. Agricultural production last year stayed flat, after growing by 8.1 percent in 2018 (Ukrstat.gov.ua, accessed January 20, 2020). Exports contracted in the fourth quarter, while the producer price index (PPI) has been in decline since August (Minfin.com.ua, January 10, 2020). In November, industrial production contracted by 7 percent year-on-year (Facebook.com, December 25, 2019). Interestingly, the revaluation of the hryvnia was in fact what Prime Minister Honcharuk was discussing with his colleagues on the leaked tape where he criticized the president’s understanding of economics.
Recent months were also marked by growing discontent between Finance Minister Markarova and Minister for National Economy Timofey Milovanov, a former US university professor. The Ukrainian economy minister first introduced new taxes on individual entrepreneurs and small businesses—provoking thousands to take to the streets in protest (24tv.ua, November 4, 2019)—and failed to deliver the final version of a crucial law that would lift the ban on trading agricultural lands. Thus, should Prime Minister Honcharuk ultimately step down in the coming weeks or months, Markarova may be the most experienced candidate for the position of head of government. This is particularly the case because in 2020, Ukraine’s confrontation with Russia is likely to ease now that President Vladimir Putin is preoccupied with domestic issues of constitutional reform and a government reshuffle (see EDM, January 16, 2020). Thus, financial and economic topics, rather than security considerations, can be expected to dominate the political agenda in Ukraine over the coming months.
Having joined the European economic space after the conclusion of the Association Agreement with the European Union, Ukraine now needs to continue with economic restructuring, including creating open market conditions for arable land, implementing effective anti-corruption practices, and reforming the tax system. These, of course, are difficult tasks, but after successfully dealing with the sovereign debt issue, they will finally have to be addressed.
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