Will Ukraine follow Iceland into financial meltdown?

McClatchy NewspapersFebruary 5, 2009 

KIEV, Ukraine — Standing outside the railway station on a cold winter morning, a group of laborers tried to duck the bitter wind as they waited for someone to offer them work unloading trucks or swinging a hammer. As usual, no one came.

"We'll go a week without a job," said Vitaly, who didn't give his last name because the police sometimes round up the workers. "It's probably going to get worse. It's going to get bad."

Vitaly is from the east Ukrainian town of Kryvyi Rih, where many steelworkers have been sent home. The global collapse of steel sales, which make up 40 percent of Ukraine's exports, is just one of the punches that the country has taken lately, and there are fears that the economy could completely implode.

The United Nations said in a January report that the probability that Ukraine would default on its foreign debt more than quintupled from late 2007 through late 2008, putting it almost in the same league as Iceland, whose economy melted down last year. The International Monetary Fund announced an emergency $16.4 billion bailout for Ukraine last October.

In Iceland, with a population of 300,000, the crisis toppled the government amid street protests and fiscal calamity. In Ukraine, with some 46 million people sandwiched between the European Union and Russia, widespread instability would be far more damaging.

"There's no hope," said Petro Romanuk, a minibus driver, who said that the number of passengers coming to the city and looking for work had plummeted in the past few months as people had given up. "The politicians don't care about us. Each day it gets worse; each day we trust them less and less. There may be another revolution."

While no one predicts an immediate default, the numbers are alarming. The national currency plunged 59 percent against the dollar during the past six months. A new gas contract negotiated with Russia last month will end subsidies and expose Ukraine to far higher gas prices.

Credit lines have dried up and steel prices are half what they were. Steel production in Ukraine fell some 13.4 percent last year, the biggest amount of any large global supplier.

"Ukraine has been virtually shut out of the international capital markets," said Pingfan Hong, the chief of global economic monitoring in the U.N. department that produced the January report.

"The economic outlook has further deteriorated recently . . . risks of a deeper recession in 2009 have increased," Hong said in an e-mail to McClatchy.

In the third quarter of last year, Ukraine's imports of goods and services totaled $29.4 billion, according to official statistics. Foreign currency reserves at the end of the quarter were $31.9 billion, dangerously close to not being able to pay for those three months of imports, a redline minimum for a nation's economy.

Ukraine's dwindling currency reserves — less than one-tenth of Russia's — are mixed in a toxic cocktail of soaring debt. Ukraine's gross external debt, from government and private sectors, was about $29 billion in late 2004. By last year, it skyrocketed to $105.4 billion. Much of that increase came from Ukraine's banks, whose debt increased more than 17-fold during those four years, from about $2.4 billion to more than $42 billion, roughly $10 billion more than the national reserves.

"This is the first economic crisis Ukraine has faced as a market economy, and the foundations of our market economy are weak," said Kseniya Lyapina, a parliament member from President Viktor Yushchenko's party.

The level of distrust in the competence of local and national leaders is hard to overstate. Yushchenko's approval rating is in the single digits, and poll numbers for the two main contenders to replace him in elections early next year are slipping.

Kiev Mayor Leonid Chernovetsky — a highly visible politician — had difficulty answering even the most basic questions about the capital's financial problems at a recent news conference. Asked about shortages of gas to schools, city doctors who hadn't been paid for months and a threatened strike by local bus drivers, Chernovetsky responded with mumbles and stream-of-consciousness riffs about the local zoo and his affection for elephants, the need for more trees and flowers in the city, his propensity to dry off naked on a balcony after showering and the importance of the Bible.

"They cannot take the country out of the crisis because they are unprofessional; they are in politics just to make money," said Tatiana Rusinova, a retired physicist and now part-time worker for a medical supply company who was window-shopping at a downtown mall. "They created a small country for themselves, and the rest of us have to live outside of it."

Beyond the issue of official incompetence, an allegation made by many observers and politicians in the country, analysts say that the Ukrainian leadership has relatively few tools to effect large-scale economic change.

"There is this combination of economic instability and political instability; it is not good for Ukraine at the moment," said Olena Bilan, a senior analyst at Dragon Capital, a leading investment company in Kiev. "But the government doesn't have much room to do something" such as a large stimulus package.

Bilan said that her firm — which forecasts the gross domestic product declining by 6 percent this year, after growth of more than 7 percent in 2006 and 2007 — was hoping for an upturn or at least a flatter trend line later in the year if steel rebounded.

However, higher steel prices probably would be part of resurgent commodities prices in general, Bilan said, a mixed blessing for Ukraine. Its new gas contract with Russia requires market prices pegged to the cost of oil and signifies the end of decades of heavy subsidy.

Ukraine will pay about $360 per 1,000 cubic meters of gas through March, compared with $179.5 last year, a price that it struggled to meet.

Ukrainian Prime Minister Yulia Tymoshenko, who brokered the deal, has said that prices this year will average around $230. President Yushchenko, who's feuded with her for years, disputes that, saying that prices will be much higher and the new contract is a "defeat" for the country.

Whatever the prices in the near term, the bigger threat is that if the cost of oil spikes again, taking gas with it, Ukraine won't be able to pay its bill.

Despite the turmoil, Lyapina, the Yushchenko party parliament member, said that there could be a silver lining to the fiscal pain: The country's industrial base and labor market — still hampered by Soviet-era inefficiencies in some quarters, such as work forces at some factories that are too big by a third — will be forced to become leaner.

"Thinking long-term, it's better for our country, because mentally people are not used to competition," she said. "Now they will have to adjust to the market economy."

That, she allowed, might include some problems along the way. How big those problems will be, and how close Ukraine may come to default, is still very much in question.

ON THE WEB

The United Nations report on "World Economic Situation and Prospects 2009"

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McClatchy Newspapers 2009

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