Q: How do you now read Ukrainian domestic politics?
Answer: Very messy, and hard to call.
The problem is that my sense is that reformers and international financial institutions want a capable and driven technocrat, like Finance Minister Natalie Jaresko, to take the reins as prime minister, and offering the best hope now of attracting/retaining reform talent and driving forward the reform agenda. The problem is that Jaresko and the reforms she would likely push would risk entrenched vested interests in the Verkhovna Rada, Ukraine’s parliament, and public administration. Hence, she is likely to struggle to win majority backing in the Rada.
Views on incumbent Prime Minister Arseny Yatesntyuk are mixed.
He survived a no-confidence motion last month, and now cannot be removed through the Rada until September.
However, he now lacks a majority in the Rada to actually govern, leaving him and Ukraine in “no man’s land.”
Yatsenyuk’s poll ratings have though collapsed to low single digits, from over 20 percent in the October 2014 elections, so he is unwilling to step aside for fear of going into the political wilderness.
Early elections would see his party, the People’s Front, eclipsed, failing to cross the 5 percent threshold required to secure parliamentary representation. Understandably, therefore he seems eager to either stick it out as prime minister, or to secure some other prominent role, but he is very eager to use his own leverage – he can only now be removed if he resigns, at least until September – to avoid early elections almost at any cost.
President Petro Poroshenko is also seeing his personal popularity plummet as frustrations build over the slow pace of economic reform – particularly in the sphere of “rule of law” related issues.
Poroshenko has called for Yatsenyuk’s resignation, and for the appointment of a new reform administration. However, when it came to the no-confidence vote against Yatsenyuk, many members of the president’s own party failed to support the motion.
Poroshenko’s backing for Jaresko as prime minister also seems less than assured.
It might be the case that he is just going through the motions in calling for a change in prime minister, at least to a reformer such as Jaresko, as he favors the status quo, or his own candidate as prime minister, such as the speaker of parliament, Volodymyr Hroysman.
The question then is how far Poroshenko is really committed to an aggressive reform agenda, particularly in the area of “rule of law” related issues, or whether he just wants to protect the status quo to defend his own business interests.
Time, and decisions with respect to the prime minister’s role, will now tell.
Q: What about early elections?
Answer: Also messy, but these are hardly likely to change the Rada math.
Given current opinion polls, not sure they change very much. The winner in repeat elections would likely be Yulia Tymoshenko, whose Batkyivshchyna Party is currently topping the polls, but she would still fall some way short of a majority.
Yatsenyuk’s People’s Front would lose parliamentary representation, Poroshenko’s Solidarity Bloc would likely lose seats, but still might “win” in the constituency seats.
In the end though I think the parliamentary mix would be quite similar to that existing, with Tymoshenko perhaps ending up as prime minister, in coalition with Poroshenko’s Solidarity.
I don’t think the moderate reform/populist pro-European Union reform outlook of the Rada would change that much.
But managing a Tymoshenko-Poroshenko or some other coalition with Oleg Lyashko’s Radical Party or the Opposition Bloc would be difficult. So early elections might just serve to stall reforms for another 3-4 months, and further sap broader economic confidence with little real political benefit.
Q: So what’s most likely to happen now?
Answer: Muddle through/on most likely.
Given that Poroshenko and Yatsenyuk will likely suffer in early elections, it seems likely they will be avoided, and some compromise deal will be hatched between the two politicians, at least to allow the current government to limp on until September – and the next time that the opposition (Tymoshenko and the Opposition Bloc) can table another no-confidence motion.
It seems unlikely at this stage that Jaresko will end up as prime minister, but the more pertinent question now is would she still want to serve in the revamped cabinet?
Not sure there – her departure though would be very market negative.
Yatseniuk might stay as prime minister, or be moved to some new role, such as head of the National Security Council, perhaps being replaced by Hroysman. His appointment as NBU governor would be very negative in my view as the NBU is one of the few success stories at present on the reform front.
Q? Will the West continue to support Ukraine, and the new administration?
Answer: As long as the Western orientation remains, yes.
Well I think if Jaresko is appointed prime minister, then International Monetary Fund/Western credit disbursements flow relatively freely. I think with Yatsenyuk/Hroysman in charge each IMF review will be painful, and credit disbursements will be fitful. The international financial institutions will set a high bar on rule of law related reforms.
But ultimately I think the U.S. and its close allies (the UK and Germany) see Ukraine still as an important counterfoil against an aggressive and more assertive Russia under President Vladimir Putin.
As long as Angela Merkel remains in office, the UK remains in the EU, and Donald Trump is kept out of the White House, and Ukraine retains the pro-EU/Western reform agenda, this Western support will remain forthcoming.
I even think the West would support a government, including representatives of the Opposition Bloc – if not why has Opposition Bloc leader, Yuriy Boiko, been allowed to play an active part in Ukrainian politics, as he is seen as someone that the West can still deal with, and despite (even perhaps because of) his close relations to Moscow still.
Q: Can Ukraine survive the current period of political instability?
Answer: Yes, for a period (3-6 months) but the cost will be felt in growth.
The extended period of political uncertainty has meant that there have been no IMF disbursements now for six months or so, albeit Ukraine is still being drip-fed some other official financing. Despite this Ukraine is managing to finance itself – the budget is in surplus, helped by the inflation tax which has boosted the revenue side.
National Bank of Ukraine foreign exchange reserves have held around the $13 billion level, more than three months of import cover now, albeit the latter total has been increased only by the collapse in imports.
The hryvnia has weakened, from Hr 24/$1 at year end to around Hr 27/$1 at present, which is higher than the levels assumed in the IMF program, but it has not collapsed.
The reason is largely still the capital controls maintained by the NBU – this helps support the hryvnia and conserve foreign exchange reserves, but at the price of disrupting trade and economic activity. Hopes for recovery are hence being disappointed, with the combination of limited FX liquidity, and political risk stalling growth/recovery. Ultimately this feeds back into social and political pressures, and the lack of any feel good factor. People will become more disillusioned with the political process in Ukraine, and the risk is that they resort to extremes come elections.
Q: Is it all negative on Ukraine?
Answer: No, there have been some very remarkable achievements.
Herein we would list them:
1. The budget deficit has been reined in, from 7-8 percent of GDP a few years back to a surplus at present, and likely only a small deficit his year. Ukraine is financing itself with only limited international financial institution disbursements, which is quite remarkable.
2. The large current account deficit, also close to 10 percent of gross domestic product only a few years back has largely disappeared, and is expected to come in at 1-2 percent of GDP this year – true partially driven by the large foreign currency correction and domestic deflation which comes with recession. But the balance of payments looks much more sustainable at present.
3. The energy sector deficit has collapsed, also from 6-7 percent of GDP in import terms, to perhaps a couple of percentage points of GDP now. Ukraine had been importing 30-40 billion cubic meters of gas per year just 4-5 years ago, and this is now down to 10 billion cubic meters or less, with zero need now to import gas from Russia. This has been achieved with energy price reform and efficiency gains plus reduced consumption caused by recession. But importantly the price hikes have come without the much predicted social unrest and protest. Who had predicted that? No one!
4. Banking sector reform. The NBU has closed 60+ banks, a third of the total, and is making good progress in cleaning up the sector – limiting systemic risks therein to the sovereign balance sheet.
5. NBU reform has proceeded apace, with transformational change in terms of NBU functions, with its headcount cut from 11,000 to 5,000 in just over a year. The institutional capability of the NBU has been raised beyond recognition – positively.
6. A new public procurement system is being rolled out, which could cut budget spending by several billion dollars per year.
7. Police reform has been undertaken and is proving popular.
The above all sounds good, but despite some macro stabilization, the economy has remained in recession, the population is suffering under inflation and foreign currency depreciation and have seen net wealth and living standards collapse.
There is not yet any feel-good factor and this is still likely reflected in political preferences against the administration as reflected in opinion poll ratings.
Importantly also, there is little evidence of any progress on the key “rule of law” issue, which really was key and central to the EuroMaidan Revolution back in 2013-2014. Also, if anything is going to spur future political unrest and a delay in international financial institution disbursements it will be slow progress on this issue.
Q: What about Russia?
Answer: Well Putin seems content to leave Ukraine on the back “burner” for the time-being.
I don’t sense that Putin’s longer term strategic objectives with respect to Ukraine have changed that much – he wants Ukraine to be pulled (dragged kicking and screaming) firmly back under Russia’s “sphere of influence.”
But I think his tactics are constantly evolving to ensure delivery on these objectives.
Military intervention was tried in the Donbas, with mixed results, and I think Putin now prefers to try other tactics.
I think there is a willingness to allow domestic politics in Ukraine to run their course.
I think Moscow is still expecting a political/social collapse, which might give power back to its allies, e.g. the Opposition Party.
I actually still think this is unlikely, but it is what Moscow thinks which is important, and it seems to buy this line, suggesting a willingness to wait a time yet.
Also the global geopolitical setting is perhaps now favorable to Moscow, and suggestive that Putin might be willing to wait before making his next direct intervention in Ukraine.
Herein, I think Moscow is awaiting the outcome of the U.S. presidential elections, assuming a Trump presidency would be more willing to cut deals over Ukraine with Russia.
Also I think Moscow assumes that the prospect of Brexit will further weaken the EU, as would the possibility of Merkel stepping down as German chancellor amid pressure over the migrant crisis, and then even Marie Le Pen’s possible victory in the French presidential elections in 2017.
The EU and the European-Atlantic alliance looks to be weakening, and from Moscow’s perspective, this could all play to Moscow’s advantage in Ukraine. The one caveat to this might be the Duma elections set for September and whether Moscow might look to take further near-term advantage in destabilising Ukraine, to further bolster support for United Russia at home – demonstrating to the domestic Russian electorate that “coloured” revolutions simply do not work.
Q: Do warrants offer value?
Answer: Yes, depending on your call on the outlook for future Russian intervention in Ukraine. If you think that Russia stays out, Ukraine remains whole, then the base is so low, and the pay-out terms so generous, that I think they offer significant upside from current levels.
Q: What’s the long-term outlook for Ukraine?
Answer: Ukraine can be the next Poland.
It can. No doubt in my mind. Just look back to 1994 and the signing of the Copenhagen Treaty by the then EU which opened the way for the first wave of EU enlargement east in 2004.
At that time (1994) the likes of Poland, Hungary, et al were still in a desperate state, and no one thought they could transform in a decade – that’s perhaps why some EU politicians made the offer as they thought it was a cheap option which was never going to be fulfilled.
But these countries did transform, helped by the EU reform anchor and blueprint.
I don’t see a huge difference between the current state of Ukraine and Poland/Hungary back in 1994 – I covered these credits back at that time so have first-hand experience.
Key for Ukraine though will be:
a) the West giving Ukraine a sufficient reform anchor (even EU accession perspective);
b) Russia being persuaded (by the West in effect) to take a neutral approach to Ukraine;
c) Ukraine’s elites grasping the reform nettle, and being encouraged to address fundamental issues such as the rule of law.
And it is not really about the official financial support for me – the current $25 billion IMF/Western support package is more than enough to stabilize the macroeconomis, and lay the foundation for growth and recovery if structural reforms are rolled out.
We have separately argued that this (rule of law) can only be addressed through a South African-style truth and reconciliation process.
If these issues are addressed as above, Ukraine should be able to attract enough foreign direct investmetn inflows to drive the economy forward – helping support warrants.
