Until last October, Ukraine had been viewed as a quickly developing transition country with bright prospects of economic growth.
Nowadays, one of the questions most often asked is: How close is Ukraine to defaulting on any of its debts?
The topic has often been brought up by leading Ukrainian politicians, who have unreasonably claimed that Ukrainian politics has had no bearing on Ukraine’s economy. The default fears have been inflicting no less damage on the economy than a real default would have. The fears have caused foreign investors to run in droves and pushed interest rates on dollar-denominated debt to the sky, thereby making any foreign refinancing for Ukrainian banks and enterprises impossible.
To make things worse, Standard & Poor’s downgraded Ukraine’s long- and short-term foreign currency sovereign credit ratings to CCC+/C from B/B on Feb. 25. This reflects the agency’s belief that there is a high probability of a sovereign default by Ukraine within one year.
It is natural first to look at Ukraine’s government and government-guaranteed debt. As of Jan. 31, it amounted to $24.1 billion. It is a small amount that has been publicized by the government in its recent attempts to borrow directly from other countries. Then why is Ukraine one step away from default and why does the International Monetary Fund want to help us so desperately?
Apparently, the government will be forced to honor external financial obligations by failed Ukrainian banks and enterprises. From this angle, it is quite possible that the powerful banking crisis that has just started in Ukraine will significantly contribute to a sovereign default in the not-so-distant future.
There is no doubt that the National Bank of Ukraine (NBU) did not perform its regulatory function in a proper manner in 2006-08, when Ukrainian enterprises and financial institutions could borrow from abroad practically with no restraint. The banking sector’s foreign indebtedness has soared from $6 billion in January 2006 to about $40 billion now and accounts for more than 35 percent of the country’s foreign debt.
A large number of Ukrainian domestic banks have been facing insurmountable difficulties as of late. Many of them have stopped performing their contractual obligations and either have been temporarily taken over by the central bank (among those are such big banks as Nadra Bank and Ukrprombank) or have been asking the NBU to introduce a provisional administration (nearly every third Ukrainian bank). In other words, the government will not only pay back a significant part of the $40 billion private bank debt directly, but also will incur significant expenses on overhauling the distressed financial sector.
Many small- and medium-sized banks are doomed to go out of business. To recapitalize and reform the Ukrainian banking sector, the government will need substantial help from international organizations such as the World Bank and the European Bank for Reconstruction and Development.
Following the long-lived Soviet tradition of treating people as disposable, the NBU has been tramping on the rights of bank clients with no hesitation. So the praised moratorium on early deposit withdrawals is, in essence, an outright encroachment on clients’ basic rights. Since most people have kept their savings in hryvnia-denominated deposits, the moratorium accompanied by hryvnia devaluation has led to huge financial losses to those whose deposits have been the cornerstone of the Ukrainian banking system for years. At the same time, chosen banks have been getting refinancing in hryvnias often for a year and, according to the State Tax Administration, transferring billions of dollars abroad, especially in the fourth quarter of 2008.
In a TV interview last fall, Volodymyr Stelmakh, head of the NBU board, called the people trying to withdraw their deposits from Ukrainian banks marauders. He should have paid more attention to Ukraine’s banking statistics. A good indicator of the banking sector’s vulnerability is the loan-deposit ratio. If it is more than one, the banking sector is considered vulnerable. The ratio for battered Hungary is 1.3 and more than 2 for Ukraine. One could have expected a different attitude on the part of the NBU to those who keep their savings in Ukrainian banks.
Another default-related question is how the government will handle the quickly growing budget deficit. After several years of overly optimistic increases in social payments and transfers, the government has found itself in a position where it is simply impossible to make ends meet.
It comes as no surprise to anyone that the IMF’s appeals for the government to curb social expenses have met a deaf ear so far. Apparently the government will try to inflate a considerable part of its social obligations away, which will have a pronounced negative impact on the functioning of Ukraine’s economy as a whole.
Pavlo Prokopovych is a senior economist at the Kyiv Economics Institute and an assistant professor at the Kyiv School of Economics.
