MARIUPOL, Ukraine — I have been visiting Ukraine this week at the invitation of the Cabinet of Ministers and their investment conference in Mariupol, where President Volodymyr Zelensky was the keynote speaker.
First things first, well done to the Zelensky administration for thinking outside the box on two things.
First, for running the conference in Mariupol, the Donetsk Oblast city of nearly 500,000 people close to the war front with Russia. The event was attended by more than 700 participants, from business, government and the diplomatic community. The venue choice showed that the Azov Sea port city is safe, friendly and open to investment. The overall message was that if a city like Mariupol, close to the contact line, is safe to visit, then it is physically safe to do business across the vast majority of the country.
Big thank you to the folks in Mariupol for such a warm welcome. It’s now on my list of places to come back and explore a bit more.
Tugboat piloted by Honcharuk
Highlight of the trip? A cruise on a tugboat into the Azov Sea-led (or “captained”) by Prime Minister Oleksiy Honcharuk, defying the “neighbors” and I sense also his security detail if the looks of angst on their faces were anything to go by.
Second, for the Cabinet of Ministers of Ukraine for making themselves open to interaction with me and any investors who made the trip. I managed to speak with most cabinet ministers, and they were all open, frank and very business and reform-friendly.
This was a prime example of them thinking totally out of the box, and it was very refreshing.
I have spent 30 years covering emerging markets and visiting 60+ emerging markets, and I don’t know any other emerging markets that have made themselves quite so open to investor scrutiny. Well done indeed! I was told, ask whatever I wanted, as the government has nothing to hide.
And I did – those who know me appreciate I tend not to be very diplomatic.
So Mariupol was a huge win!
Question: I guess the first question would be so what were my impressions of the cabinet and their reform plans/ideas?
Answer: The clear sense is that this is a team of committed reformers. Young, dynamic, wanting to bring change for the good and recognizing that they have a remarkable opportunity to deliver real transformational change to Ukraine. Perhaps struggling a bit with their inexperience in office, in terms of how the system works – but I think this is why Zelensky chose them. They were hired not to “work with the system” but to change that system. It’s a huge task, but I sense they are up for the challenge.
Initial ideas are good – pushing on with land reform, privatization, deregulation to take away opportunities for corruption, improving tax collection and debt management. The digitalization of government.
Honcharuk has been criticized for setting the target of delivering 40 percent growth over five years or, in effect, 6-7 percent growth per year over this period.
I would commend him for that. If you don’t aim you don’t succeed. And one criticism of the former administration is that they were too content to hail sub-3 percent growth as a success. True, Petro Poroshenko’s administration should be given huge acclaim for stabilizing the macro-financial economy after the 2015 low point. This was itself a remarkable achievement – remember 2015 saw devaluation, banking collapse, recession, high double-digit inflation, and default and debt restructuring. But from a low base, that the economy only managed to sustain growth of up to 3% I think ultimately was a disappointment, especially given the higher growth plain of the rest of Emerging Europe at present and from a higher base. Explanations for this sub-par growth ultimately comes with the slow pace of micro-level reform – macro stability was achieved – but not enough was done to improve the business environment to spur investment which significantly boils down to a failure to do enough to fight corruption.
Question: Can they succeed?
Absolutely: No doubt, and I firmly believe that Ukraine can be the most exciting reform and investment story in emerging Europe.
Many positives
Let’s just think of the positives:
First, in Zelensky, Ukraine now has a popular president, with a huge store of political capital to expend on reform. He also controls the Rada with his Servant of the People faction enjoying a significant majority.
He has the political capital to drive through radical but much-needed reforms, assuming he has the vision (I saw plenty of that from his ministers).
Second, the population are desperate for change. Zelensky was elected on a platform of delivering peace and fighting corruption. And corruption is the main factor holding back higher rates of investment, real GDP growth and jobs and prosperity for the population.
Third, basic macroeconomic stability was delivered by the former administration, and the incumbent teams at the NBU and the MOF. The economy is already growing, albeit at a sub-par rate, inflation is back in single digits and falling, the currency is stable, reserves are rising and twin deficits are of manageable proportions (2-3% of GDP). Public debt is on a declining path, ratings are improving and the NBU is cutting policy rates which should help spur credit growth.
So the macroeconomic foundations are set.
Fourth, Ukraine has a capable team of technocrats in place, able to deliver reform. This is a combination of carryovers from the former Poroshenko administration (the whole team at the National Bank of Ukraine, Oksana Markarova, Max Nefyodov) and some excellent new hires (Honcharuk, Economy Minister Tymofiy Mylovanov, UkrOboronProm head Aivarus Abramovicius, et al.).
Many of these are proven reformers. And indeed, over the past five years, in places such as the National Bank of Ukraine, Ministry of Finance and Naftogaz, the reformers have proven that transformational change is possible.
Ukraine is reformable. Read my lips!
Fifth, Ukraine still has strong backing from the West and international financial institutions The International Monetary Fund, World Bank, European Bank for Reconstruction and Development, European Union, and various bilateral donors remain committed to supporting the development of Western, liberal market democracy in Ukraine. And it is worth saying that, despite all the trials and tribulations over the past five years, this is still what the large majority of the Ukrainian population want. They still have a Western orientation.
So the geopolitical and economic orientation of the country is set – actually helped on by Vladimir Putin as the storm raging from the east has pushed the Ukrainian ship firmly on a course to the West. And the tide has turned, and I don’t think will turn – to labor the nautical terms after my tugboat trip into the Sea of Azov, Putin opened the floodgates! Hello Sailor!
Putting all that together Zelensky has a truly remarkable opportunity to bring much needed and truly transformative change to Ukraine. It would be an absolute travesty if he wasted this once in several generations of an opportunity. No pressure, Mr. President!
So yes, I do think the economy can grow at 6-7 percent annually, but the key is microeconomic reform now, and improving the business environment, transforming the regulatory environment, right-sizing/prioritizing/tasking government, and above all fighting corruption which in my mind means getting oligarchs to play by the same rules as everyone else – read therein creating a truly level playing field.
Is Zelensky up to the task?
Mr. President gave his keynote speech at the Mariupol conference and ticked most of the boxes – he said he wants to fight corruption, create a level playing field (his words), boost investment, productivity, bring jobs.
How PrivatBank can spoil it all
It all sounded great. But…
The most pressing issue for Ukraine at the moment, and I think the proverbial canary in the coal mine for Zelensky’s seriousness about really reforming Ukraine and leveling the playing field, is the issue of PrivatBank.
Privatbank is the largest bank in the country, saved from insolvency by the prompt and extremely brave intervention of the NBU (plus ex-Finance Minister Sasha Danyluk) back in 2016 on the sage advice of the IMF and other international financial institutions, including the EBRD, European Commission, and U.S. government. If the bank had been allowed to fail in 2016 then Ukraine would not be enjoying its current pleasant state of macroeconomic stability. The script would be quite different and hugely more difficult – think the collapse of the banking sector, currency collapse, hyperinflation, deep and extended recession.
Now as we all should know the nationalization of PrivatBank is being challenged in the courts and subject to legal action in the UK, US, and Ukraine. Irrespective of your view as to the origins of the PrivatBank failure in 2016, a ruling to reverse the nationalization would have very serious and very immediate consequences for Ukraine.
If the bank is denationalized and returned to former owners, the Ministery of Finance would have a fiduciary duty to Ukrainian taxpayers to pull the $5.5 billion in capital injected into the bank to save it in 2016. The withdrawal of capital would leave the bank with a serious, even terminal, capital inadequacy.
The responsibility of the new/old owners would be to inject $5.5 billion in capital.
Given they lacked sufficient funds back in 2016, the assumption is they would be unable to this time around. So in that scenario the largest bank in Ukraine would be insolvent (again) in effect, posing a huge danger to the stability of the entire financial system.
Could the Ukrainian authorities then move quickly enough to save the bank second time around, or would they look to declare the bank insolvent and move to a resolution process? I don’t know – neither did anyone else I asked. So assuming an uncertain outcome the question then would be what would be the impact on the behavior of PrivatBank and system-wide depositors, and also now the weight ($4 billion) of portfolio investors in Ukraine, were the courts to rule still in favor of denationalization? Answer – we don’t know, which is in effect a massive red flag.
Attention Mr. President, torpedo rapidly approaching the Good Ship “Servant of the People”. Action needed!
On Oct. 17, the Kyiv Commercial Court did suspend a decision on whether to denationalize the bank – but this decision could well only be a stay of execution. And a ruling by this court and also the Kyiv Administrative court could still overturn, in effect, the nationalization of the bank.
The question is now what is Zelensky’s policy on this absolutely critical issue – critical to the stability of the banking sector and the macro-economy?
Zelensky has said that the bank will not be returned to former owners. Some might take some reassurance in that, but what is the Zelensky administration’s strategy now if the nationalization of PrivatBank is reversed.
This president has said that he will defend the interests of the Ukrainian state. But that is somewhat subjective. Does he view the interests of the Ukrainian state as essentially unchanged in the case of PrivatBank from the time of the original nationalization? In effect does Zelensky understand and support the original decision to nationalize the bank back in 2019? Does he support state institutions – the NBU, the MOF and now PrivatBank in their defense against the denationalization of the bank? Or are the interests of the state now different? We simply do not know and Zelensky has been vague. This is all very worrying.
To help the president figure out what he needs to do EBRD officials in Mariupol were kind enough to go on record as stating what they see as the position of the international financial institutions on the PrivatBank case – and this is taken to be the position also of the IMF.
Zelensky assurances needed
The EBRD stated clearly that they wanted assurance from the president in the form of a clear statement that:
A) The president supports the original nationalization, and will not support the return of the bank to former owners. The president has gone on record now supporting the second demand herein, but not yet the first, as far as I am aware.
B) That there is a Plan B in the case the courts rule against the original nationalization, and that any such plan has to be credible. While I assume such plans are in the works, nothing firm/credible has yet been revealed.
C) That the Zelensky administration commits to recovering losses incurred by the state as a result of proven malpractice from the failure of Privatbank and for that matter similar bank failures for the period 2015-2017. Losses from the failure and subsequent nationalization of Privatbank are thought to total around $5.5 billion and system-wide around $15 billion, or around 12 percent of gross domestic product.
Making bank fraud investigations a priority
Losses incurred by the state were huge. And why would the president not be interested to ascertain who was responsible for those losses, and indeed to try now to recover those losses?
Recent London court rulings were enlightening in regard to developments at PrivatBank in the run-up to the original bank failure, and I would hope that Zelensky would see it in the interests of the state to recover those losses. I hope he actually reads those rulings.
And herein is the crux of the problem – Zelensky has spoken about creating a level playing field, and fighting corruption, but if he does not take seriously the allegations made with respect to Privatbank, as now detailed in the London court documents, how can IFIs and investors take seriously his warm words now about wanting to improve the investment environment?
More specifically the Zelensky team say they want an IMF program as the gold seal of support for their reform credentials and plans. But why should the IMF lend more money into Ukraine when it just seems that these funds are going out of the back door in losses incurred from bank failures and the Zelensky administration seems to show little or no willingness to collect on those – or at least only selectively.
And let’s not forget that very serious allegations of fraud have been made with respect to the bank failures for the period of 2015-2017. Is Zelensky not serious about investigating, prosecuting and eventually convicting on those allegations?
And if he is not willing to address the challenges with respect to fallout from the bank failures for the period 2015-2017 then why not?
Worries over Zelensky priorities
Well, I would hazard a guess that there are a number of explanations:
a) He does not appreciate the seriousness of the risks now to the stability of the banking system, stemming from PrivatBank;
b) His priorities are elsewhere – e.g. peace in the east;
c) He does not want to rock the boat with certain powerful oligarchs. If true, this would suggest that he is not serious about creating a level playing field, instigating the rule of law and delivering on fighting corruption.
d) I could guess a combination of b) and c) perhaps also adding a time dimension. Therein his priority is peace in the east, and feels that now is not the time to rock the boat with certain oligarchs with political leverage in the East. His strategy then with the banking issues and the IMF will be to try and play for time. First get peace in the east, and then address the issue of oligarchs and banks.
I tend to think the latter scenario is the most likely, but taking such a strategy would pose a huge risk to macro-financial stability which ultimately might make it more difficult to deliver peace in the East. And as our trip to Mariupol pointed out, delivering peace and security in the East is also dependent on bringing investment, growth and jobs/prosperity.
In conclusion, I think issues around PrivatBank will provide a clear signal of whether this presidency is serious about bringing meaningful change in Ukraine. And it will be determined over the next few months. Fudge now will send a terrible signal to the investment community and those high plain growth ambitions will inevitably fail on takeoff. I hope Mr. President, you are listening.
