Robert Kahn

Macro and Markets

Robert Kahn analyzes economic policies for an integrated world.

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Ukraine: Economy Matters

by Robert Kahn
February 21, 2014

Value of the Ukrainian hryvnia against the dollar—closely watched by Ukrainians as an economic signal—has sharply depreciated due to recent turmoil in Kiev. (Source:


A deal that would end the violence in Ukraine appears to be holding. It would produce early elections, a return to the 2004 constitution, and a national unity government. It would also set the stage for an urgent western effort to provide financing supported by an IMF program. Good news on the politics, though, does not equate to good news on the economy.

Last week I blogged on the issues that would need to be confronted if the West were to put together a package. If a government is put in place that can work with the IMF, the international community will need to move fast. Experience with crisis situations and failed states suggest that economic fundamentals deteriorate quickly if unaddressed. Capital flees, growth and trade slows dramatically, and tax receipts plunge as the authority of the state activity weakens.  Exchange rate depreciation (see chart) and continued reserve loss exacerbates the risks.  Ugly surprises appear on bank balance sheets.  The longer a deal is put off, the larger the financing gap and the greater the challenge of filling it. S&P’s decision today to downgrade the sovereign on rising expectations of default highlights these risks. This suggests that the window may be short for an adjustment program that can restore confidence and market access, and is consistent with the financing available. Much depends on the IMF.

How generous should a package be, and with what conditionality? In December, the IMF Board noted some achievements, but also regretted the authorities’ insufficient ownership, which undermined the program. Directors agreed that, “in view of Ukraine’s track record, arrangements with lower access and strong prior actions would be most appropriate.” In plain speak, Ukraine has performed badly on past IMF programs, and a large financing program contingent on future economic reform promises is likely to fail again. Renewed funding could in fact could be counter productive.

Of course, the counter argument for a large package is also easy to make. The new government is the best hope in some time for Ukraine, and deserves strong western support if there is to be a credible alternative to Russian financing and the strings attached. A large financing package from the IMF, with politically realistic conditionality, is the best hope to avoid default and chaos.  This would mean financing a large fiscal deficit (which was 7.7 percent of GDP last year) and allowing a gradual adjustment of energy prices.  This will be a tough package for the IMF (and some creditors worried about moral hazard) to accept. If the West goes in this direction, the Fund will want to see its program as catalyzing other support.  I continue to see merit in a “Friends of Ukraine” effort, involving western governments and perhaps major Ukrainian investors and businesses.

Market attention in coming weeks increasingly will focus on whether the Ukraine government will pay upcoming bond maturities. But even more important will be the speed and conditionality of the package the West offers.  The contagion to other markets will likely depend on whether investors see this as a failure of the state and unique due to Russia’s role, or rather symptomatic of a broader increase in EM political risk.  So far, market commentary has been balanced on this point.  How the West responds will matter here too.

Post a Comment 4 Comments

  • Posted by Gilbert Flores

    Any effort will fail as long as Ukranians of Russian descent and Russia itself keeps sabotaging any effort..unfortunately the country has to be divided for Russians to lose interest and leave ukranians at peace

  • Posted by Jason

    This is exactly why Putin still has all the leverage in this situation. All he has to do is sit back and wait. He’ll make statements like, “We support a strong Ukraine and a leader that has the support of the people.” The next leader will have no choice but to fall back into Putin’s lap. He’ll be waiting there with natural gas discounts and a big bailout package. The EU simply can’t write the checks that Ukraine needs.

  • Posted by Peter Duveen

    From what Jason says, it becomes apparent that it is the EU that needs Ukraine, and not visa versa. If so, it would follow that the movement to assimilate the Ukraine into the EU comes more from the US/EU than from inside the Ukraine.

  • Posted by Robert Kahn

    I can’t disagree. Timing matters, too, as the deterioration of the economy means that the government is likely to run out of money before a new government is elected, in place, and able to negotiate with the IMF. The EU/US will need to begin thinking about a bridge loan to buy time for the bigger package, without significant conditions attached.

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