There is I think a narrative amongst investors, and perhaps also some officials, that Ukraine’s balance sheet is strong enough to ride through a period of backtracking on reform – anti-corruption agenda, National Bank of Ukraine independence, institutional weakness and erosion. The line here is that the NBU has a wad of foreign exchange reserves – close to $29 billion at the last count – while the current account is in surplus, and the balance of payments faces no extreme pressures, while even an enlarged fiscal deficit this year and likely next (6-7% of gross domestic product) should be easily financeable in an environment of flush global liquidity and easy market access.
It reminds me a bit of that period under former President Viktor Yanukovych – from 2011 to 2013 – when some big West Coast investors seemed willing to write that regime a blank check despite what was obvious to most Ukraine observers at the time that there was clear backtracking on reform and a clear deterioration in the credit story.
Sometimes I think development market central bank policy actions, and myopic investors, can do a disservice to emerging markets. Plush global liquidity pumping into emerging markets, in an almost indiscriminate way, can give misleading signals to policymakers that somehow things are going well.
Indeed, I remember challenging a Ukrainian finance ministry official in back in 2012-13 about their apparent success in tapping Eurobond markets cheaply. That official really thought it was because he was somehow doing a good job. My response was “hey mate, it’s nothing to do with you, it’s all about global liquidity, and please use the opportunity of flush global liquidity and cheap financing to do the right thing and adopt a good policy.” He ignored me, and well the rest is history – it was obvious to me back at the time, that whatever happened with Euromaidan, Ukraine was heading for the economic wall, and an economic crisis was looming, whatever the Russians did in Crimea and Eastern Ukraine.
Now I don’t think that Ukraine faces the same near term risks given the current macro setting, but with the direction of travel on the policy-setting I am worried that a potentially good story could unwind and pretty quickly – or rather a really wonderful opportunity to impart meaningful positive change for Ukrainians’ lives could/will be wasted. This would be tragic and a sad indictment of this administration if this really came to pass.
It’s been interesting in recent weeks though that Ukrainian asset prices are beginning to reflect the deteriorating policy settings – facts like far-reaching management changes at the NBU which do raise questions about central bank independence, pressures on National Anti-Corruption Bureau of Ukraine and the Specialized Anti-Corruption Prosecutor’s Office, the 47,000 issue, depletion of independent supervisory boards at state-owned enterprises, erosion of the rule of law through recent legal actions. Indeed, Ukrainian sovereign external debt has been an underperformer in recent weeks widening by 100 basis points or so. It’s signaling that investors are beginning to get a bit worried about the future course of reform in Ukraine, the future of International Monetary Fund relations, local elections, and I guess the potential for cabinet changes and even risks on the Donbas peace front.
On the IMF front, I think the temptation for policymakers is to try and paint an upbeat and optimistic picture, that things are fine, and that IMF money is coming soon. I think they do this for domestic and foreign audiences. But investors are not stupid, and I think they should be able to read between the lines of commentary from IMF officials. The list of issues to be resolved with IMF is pretty long at this stage, and it’s not just a case of a few budget tweaks. Most of the problems relate to very subjective calls about the rule of law, the commitment of the government to fight corruption and defend the independence of the central bank.
In agreeing to the new IMF stand-by agreement the President Volodymyr Zelensky government promised to uphold all these areas of reform. The track record in recent months has been, however, in the other direction, with reform institutions eroded more or less across the board, either by neglect or design. I think the IMF is of the view that these structural reform issues are critical to Ukraine’s long-term development and the success of this program and future programs. They are spot on.
Having been disappointed by this administration’s actions on these very structural reform areas – structural reform has arguably not been pushed forward but back, and perhaps even substantially back from 2019. So I think the IMF will adopt a “prove we are wrong by your actions” approach before agreeing to a new program review mission. They will want more time to see how the land lies after the changes at the NBU, and events around NABU, SAPO and Privatbank and the state-owned enterprises. Perhaps even the IMF will want to await the outcome of locals elections at the end of October, and then U.S. elections. The IMF would not say this, but I am sure they are hoping for a U.S. election outcome that sees a new U.S. administration which actually cares about the reform story in Ukraine and is willing to engage with them to push that agenda forward. This suggests to me no IMF money this year, and maybe only the prospect of disbursements after the new administration emerges in the U.S. in the first quarter of 2021.
Now, where the Yanukovych regime went wrong in 2011-13 is it failed to listen to calls for them not to rest on the laurels of cheap market financing and actually push on with reform. The current team needs to look at the widening of Ukraine’s credit spreads, or increased costs of borrowing, as a reflection that the market does not appreciate what they are seeing on the reform front, and that changes need to be made. There needs to be a new commitment to reform. I just wonder here how many investors would actually want to continue to finance Ukraine if they thought the current IMF program was not going anywhere, which is kind of the reality at this stage. I would suggest the current administration needs to commit again to that IMF reform agenda, and not just in words which are cheap, but in deeds.
