Experts talk about how politics may impact the economy
al situation coming for years, and they’ve been awaiting it eagerly. To them, this ignifies the opening of the economy and improving corporate governance.” – John Suggitt, Concorde Capital.
“Ukraine is a dynamic country with limitless potential. We are onvinced that it will rebound stronger than ever after this situation tabilizes. I urge foreign investors to stay calm and not over-react to the political events in the country.” – Andrew Mac, PricewaterhouseCoopers.
In this Post interview with companies that specialize in consulting and advising investors and local entrepreneurs, the experts discuss the short- and long-term impacts the ongoing political unrest may have on investments and the economy.
U.S.-born Andrew Mac has worked as a senior attorney at the Kyiv offices of PricewaterhouseCoopers for two years. Prior to joining the offices of PwC in Ukraine, 29-year-old Mac practiced law in the state of Pennsylvania and in Washington D.C.
Canadian-born John Suggitt is managing director of Concorde Capital securities brokerage house. He has worked in Ukraine for almost four years, first in senior equity sales at Foyil Securities New Europe and later as vice president of equity sales and trading at Interregional Finance Corporation, known as MFK. 32-year-old Suggitt established Concorde Capital this fall with Ukrainian partners.
43-year-old Robert Schaus is one of the partners at the investment banking and strategic consulting firm Spektor, Sachs and Company, which has been active in Ukraine since 1993. Schaus is a founder of the office in Ukraine.
KP: How have the securities market and strategic investors reacted to the political unrest in Ukraine?
AM: First, there is a lot of surprise that the crisis has deepened to this extent. No one predicted the situation would unfold as it has. Second, there is a general sentiment that this is a temporary crisis and that it will be resolved soon. The hope is that the country will emerge stronger than ever. However, I think there is a strong desire for this period of uncertainty to be resolved very soon.
JS: Experienced investors have taken this as a buying opportunity for two main reasons: They believe in the fundamentals, regardless of the political situation, and see this as a possible opportunity to buy cheap; also, many experienced investors have seen this political situation coming for years, and they’ve been awaiting it eagerly. To them, this signifies the opening of the economy and improving corporate governance.
Also, those who have never invested in Ukraine are attracted to the market for several reasons. Firstly, many of them had never taken a good look at Ukraine until seeing the advertising on CNN and other networks, which has caused them to investigate. When they see the investment opportunities here, they are naturally interested.
Secondly, many investors watch emerging markets for events that can greatly and quickly change the direction of a country. Many view Ukraine as a possible Georgia (only from an investment point of view). Georgian investments improved greatly after the Rose Revolution.
The unrest’s overall positive effect is evident in Ukrainian Eurobond yields, too, which should have a very high beta to political unrest:
Maturity 2013: The price dropped from 106.0 on the eve of the second tour to 101.5 (or -4.2 percent), pushing yield to 7.4 percent, from 6.7 percent. However comparable drops occurred in July-August 2003, and even April-May 2004, hinting to a cyclical effect.
Maturity 2007 has shown a less pronounced effect: The price fell from 107.8, to 105.2 (-2.4 percent). However, a number of rating agencies such as Standard & Poor’s said the political turmoil has had no effect on the Ukraine sovereign rating.
RS: During last week, as news of the events here started to reach Western audiences, reactions of strategic investors were mostly limited to curiosity. The typical question was “What is really happening?” Today, as it becomes obvious that the situation may continue to deteriorate further, we are starting to see Western investors postponing decisions.
As far as securities are concerned, the stock exchange has basically stopped operating as brokers went on strike to protest the Central Electoral Commission’s announcement of election results. On a more informal base, values have falling significantly.
KP: What are the biggest concerns for investors now?
AM: The biggest concern is not the short-term affects of this crisis, but the long-term impact the crisis may have. The biggest concern is that this political crisis will turn into an economic one that will turn back the clock a few years. Many investors still remember the Russian currency crisis in 1998 and the worst fear is that something along those lines may happen in Ukraine now. However, everyone agrees Ukraine is still a long way from such a scenario.
JS: The biggest concern for most investors continues to be the ownership structures and transparency of individual companies. To some extent, the political situation impacts this. Of greater interest is the final winner of the presidential race and which business groups will benefit (which groups will continue to operate in a preferential environment or acquire assets cheaply). Thus, speculation/analysis of possible outcomes is of the most value to investors.
RS: Investors hate instability. The government has almost ceased to operate, the future is unclear, and separatist movements and the like in some regions of the country are only compounding the problem.
KP: How has Ukraine’s economy performed during the recent political chaos?
AM: There is a significant slowdown in activity.
JS: Most macro indicators are not sensitive to these developments in the short-term, but the monetary system is relatively sensitive to short-term events. For example, during the night of Nov. 21-Nov. 22, the National Bank of Ukraine’s payment system had problems, which caused delayed payments and settlements nationwide.
Additionally, the political situation has caused proceeds to the budget from export operations to decrease by $4 million daily; payments for electricity to the wholesale energy market have dropped by around 30 percent in the last month; we will likely face a liquidity crisis within the nation’s banking system, and this has caused the NBU to lower the obligatory reserves rate by one percent (effective after Dec. 25).
At the same time, the NBU has been more active in refinancing Ukrainian banks, now extending financing to 70 local banks instead of the previous 10. Nevertheless, 88 banks in need still do not have access to NBU refinancing. Also, the NBU plans to provide stabilizing loans to the banking system, which would mean money emission and inflation in the short- to medium-run (Q105).
RS: On balance, I believe the economy has not suffered a lot. I am sure that production was significantly reduced over the week, but will recover almost overnight if a solution is found fast.
KP: If the current political instability is settled quickly, say in a week or two, what is your prediction for how Ukraine’s economy will perform in the short- and long-term?
AM: As I said before, the sooner this matter is resolved, the better it will be for the country.
JS: If the crisis is settled peacefully within a week or two, the banking system will recover very quickly and the negative impact of instability will have only a limited impact on monetary stability. Sound international NBU reserves serve as good insurance to fight the crisis. In the long-term, Ukraine will face a great boost in foreign direct investment and portfolio investments. The more favorable conditions Yushchenko can gain, the more pronounced the impact will be.
In the long-term we can expect that positive economic trends will be sustained. We will see fundamental changes in government.
RS: If a solution is found quickly, the short-term impact will be limited. One of the major dangers right now is a banking crisis, and having the Head of State publicly announce as such may very well on its own lead to a financial crisis.
The long-term impact will depend on the specific solution found. The more thoroughly the new executive will strengthen the rule of law, the faster it will reduce corruption, the more systematically it will reform administrative procedures – the better the long-term growth prospects will be for Ukraine.
And don’t forget: if a solution is chosen that is perceived as progress, this will have been the best PR exercise Ukraine could ever had hoped for.
KP: If the current political situation goes unsettled for longer than two weeks, what economic consequences can we expect to see, and how will investors react? AM: This depends on a number of variables that are impossible to predict at this point. If there will be violence, God forbid, or further calls for separatism, it will have a devastating effect on the investment climate.
JS: In this case, we would expect high inflation, lower GDP and lower industrial growth. We would also be concerned that the current liquidity constrains may transform into a deep system liquidity crisis, which would negatively impact investments, savings and interest rates and would slow general business activity and undermine long-term growth.
We estimate that after two weeks, every further week of uncertainty will transform into 2-3 months of economic recession next year. By the end of this year, we will be able to observe only the first symptoms of inflation, which will unfold and may get out of control in the course of 2005.
Under these conditions, sovereign and corporate ratings would most likely be downgraded, perceived risks of investments in different classes of assets in Ukraine would increase, and investors would require higher rates of return, thus reducing investments. It is unlikely that investors would withdraw existing investments from Ukraine, however fresh inflows would be restricted.
And of course, the plans of certain Ukrainian businesses to tap both international and local capital markets for cheap equity financing will have to be delayed for a while.
However, we do not expect investors to be dissuaded if the situation continues for longer than two weeks. Should this occur, we would likely see sellers at lower prices, which will spur market liquidity.
In addition, it is important to note that many funds have to prepare a lengthy annual report at the end of December and generally will be unwilling to make new investments. Thus, a longer resolution of the political situation in Ukraine may actually be beneficial to new investors.
RS: Obviously, the longer the situation lasts, the more projects will be stopped or postponed. Additionally, many businesses will have bills accumulating without corresponding revenue and working capital sitting idle, or – worse – losing value fast.
For the longer run, the only thing that matters is: what is the final solution chosen? In general, a good solution in four weeks is much better than a bad compromise tomorrow.
KP: How do you expect the political situation to develop?
AM: Honestly, I do not know. No matter how it is resolved, it seems to me that there is a new sense of citizenship and civic responsibility in Ukraine from average citizens supporting all sides of the political spectrum. I sincerely hope that whatever the ultimate outcome of the political situation is, it will in no way disenchant this new sentiment.
JS: New elections, new candidates – Tihipko and Moroz – and a new president, Tihipko.
The bottom line is that Ukraine will continue its evolution into a free and fair democracy. Business will continue to develop and will become more competitive and transparent.
In our opinion, this is MUCH better than either [Viktor] Yanukovych or [Viktor] Yushchenko, and the strength of Ukraine’s people has really won the day!
RS: I don’t know. I would hope that more politicians will start respecting the choice of their citizens, and that those ready to sacrifice the future of their country for their own private interests will have to go. On balance, since Nov. 25, I have been optimistic, and still am.
KP: What advice are you giving to foreign investors?
AM: Ukraine is a dynamic country with limitless potential. We are convinced that Ukraine will rebound stronger than ever after this situation stabilizes. I urge foreign investors to stay calm and not over-react to the political events in the country.
JS: Risk-tolerant portfolio investors will face lucrative opportunities to buy and strategic investors will be advised to take time and wait for the situation to stabilize. In any case, especially if Yushchenko wins, we can expect a major change of top level decision makers in economics and politics, at the federal and regional levels. Wait-and-see would be the best strategy for direct investors.
RS: In the medium term, most projects planned before the election will make sense no matter what the outcome. In many cases, there is actually no reason not to move ahead. For some of our clients however, the best is to wait and see, and to postpone, but not to stop projects. Depending on results, we may advise our clients three months down the road to invest much more aggressively into Ukraine. How are investors going to react in the long-term? In the West, the choice Ukraine is facing is seen in very simple terms. On one hand, there is the road chosen by Poland, Hungary or the Baltic States: countries where the law rules, the government regulates without intervening, and companies are free to invest without excessive administrative barriers. On the other hand, there is Ukraine as it was up to now: a moderately authoritarian state, where bureaucracies hold back the economy, where corruption is rampant. This simple dichotomy will determine Western investor reactions in the future.
For Russian investors, even if Ukraine makes a turn for “Western” values, Russians will maintain a natural cultural and linguistic advantage, and Ukraine will remain the natural expansion direction for Russian companies moving abroad. One day, Ukraine may end up as the “Trojan Horse” used by Russian companies to enter Europe.
