Abromavicius has provoked a domestic political crisis, with concerns now over the durability of the ruling coalition government of Prime Minister Arseniy Yatsenyuk, prospects for early elections with an uncertain outcome, and over prospects for continuation of the $25 billion, International Monetary Fund-led support program for Ukraine.
Abromavicius’ allegations of corruption/graft at the very highest levels of the political establishment, and naming a politician with strong personal and business links to President Petro Poroshenko have been particularly damaging, as they question commitment to the key corruption/rule of law agenda which is seen as key to Ukraine’s long-term growth and development, and Westernising drive.
Abromavicius’ move also comes amid limited evidence of substantive progress over Minsk II implementation – the failure of the Poroshenko/Yatsenyuk administration to make progress over constitutional reform, and little real evidence of the withdrawal of Russian troops and of allowing Ukraine control over its border again.
Recent Minsk contact group discussions also appear to have made little further progress of late – Russia’s unwillingness to compromise might relate to limited progress in Ukraine over constitutional reform but also limited evidence of Western concessions to Moscow over the sanctions issue as a result of its military intervention in Syria. In a somewhat menacing move, Russia has in the past few days stepped up military exercises close to Ukraine’s borders.
Russia has also further “stirred” things up over the $3 billion December 2015 Eurobonds, currently in default, and a cause for dispute between Russia and Ukraine. This week Russia indicated that it rejected restructuring proposals from Ukraine, which were shaped around the PSI deal. There is some concern that Russia could persuade official creditors that Ukraine is not negotiating in good faith, thereby breaking the IMF’s lending into official arrears policy, and potentially pulling the plug on the IMF EFF.
So how should we read off this from a market perspective?
First, at this stage I think a further near-term Russian military escalation in Ukraine seems unlikely. Moscow’s prior military intervention achieved mixed results, and the sense at this stage is that Moscow prefers to keep its powder dry on the military front, biding its time on the assumption that Ukrainian domestic politics continues to unwind in its favour. Also I think with all the focus from Moscow in easing the impact of the collapse in oil prices on the Russian economy, it is very eager to secure sanctions moderation at the earliest opportunity, and a further Russian military escalation in Ukraine would surely count against this. Rather further military exercises across the border in Russia are likely, just to remind the West and Ukraine, that Moscow still has the option to escalate at a time of its choosing but this is likely a negotiating ploy – and especially given the Munich security conference is looming this weekend, with major diplomatic initiatives expected on Syria and perhaps even Ukraine.
Second, I don’t see the issue of the $3 billion December 2015s at this stage being “the” major risk to the IMF EFF – there are bigger issues at work here. I think Ukraine will likely seek to make further restructuring offers to string negotiations out long enough, and ultimately this is still more likely to end up in the courts. And at this stage I do not see a willingness to push Ukraine (on this issue) that far on the part of Western creditors – surely, given the political setting, and limited foreign exchange reserve cover of the NBU, Ukraine simply lacks the financing to cover $3 billion in payments over the short to medium term (i.e. over the duration of the EFF).
Third, I think the market was spooked by the harshness and direct commentary from Abromavicius (over corruption), and perhaps was worried of a more generalised resignation of reformers in the cabinet – perhaps extending to the National Bank of Ukraine and Finance Minister Natalie Jaresko.
I think the concern was that this would risk Western financing/credits to Ukraine, putting extreme pressure on the hryvnia, and then the unwinding of the macro assumptions in the IMF EFF.
Remember the IMF EFF is optimistic in its assumptions on real exchange rate appreciation, really as the cornerstone of its DSA – and therein the basis for the very generous debt restructuring agreed back in November.
The UAH in nominal terms than assumed in the IMF EFF DSA – trading at Hr 25.95/$1, versus Hr 22.7/$1 assumed by the IMF for end of 2016, and Hr 23.8/$1 for end 2020. Actually there has been strong REER appreciation over the past six months, which should help the DSA, and the debt stock is lower after delayed official disbursements.
The plus is that Jaresko, et al. are hanging in there for the time being – perhaps also keeping their powder dry, still mindful that we may still see a change at the top of the government, with Abromavicius demanding Jaresko heads the government. The market would likely take the latter move very positively, albeit securing Rada support for Jaresko would likely be very difficult.
And then today we had the further intervention of Christine Lagarde, the head of the IMF, with very pointed remarks suggesting that without further and substantive reforms, the IMF would not in effect be able to support Ukraine. I think the messaging here is that the IMF will delay the release of the latest $1.7 billion credit tranche, until there is better clarity over the form of the government, plus more signs of progress/reforms in the area of rule of law – generally seen now as the number one issue facing Ukraine.
The plus from a reform angle is that the IMF, and other international creditors appear willing to play very hard ball with Ukraine – it also seems clear from recent market price action, that Ukraine cannot survive without IMF/Western financing. Western creditors have leverage – and seemingly from the comments from Lagarde they seem willing to pay hard ball with Ukraine to force change. We have seen that in the past – e.g. over the budget for 2016, that this can still be a powerful force.
Poroshenko now has to make the decision, does he follow the IMF script, and make meaningful changes in the cabinet to reflect a stronger reform orientation, perhaps even extending to key reform bottlenecks such as the prosecutor general’s office, or does he risk going to early elections, but with the risk of no further IMF disbursements in the run up to the vote which could put further extreme pressure on the UAH, and therein jeopardising the hard won macro stabilisation achieved over the past 6 months (twin deficits moderated, real GDP growth bottoming, banking sector significantly “cleansed”, and energy sector deficit/losses reduced) . This seems high risk, and I would guess that Poroshenko will ultimately bow to IMF pressure – we are likely to see some effort to reach out to the reformers and the IMF.
Abromovicius et al are correct that Ukraine is again at a turning point – Poroshenko can now either opt for significant change, going to the heart of the issues around graft, oligarchic capture of the political process, and rule of law, or head for early elections, with an uncertain outlook, and with a weak IMF anchor, and limited FX reserves.
One of the problems for Poroshenko is that removing Yatsenyuk might be the easy part – likely a majority in the Rada can be secured to oust him, but can a majority be agreed for a replacement? Likely not, given that the opposition in parliament and within the coalition would likely now prefer early elections. The best case now perhaps from Poroshenko’s, and Western creditors’ perspective is to somehow retain Yatsenyuk, thereby avoiding early elections, but bolstering the position of reformers in the cabinet – one idea is to give Jaresko the role of first deputy prime minister, in addition to finance minister’s portfolio, with some greater executive authority to drive forward reform – also reform capture of the Prosecutor general’s office is likely to be seen as critical now. It is difficult to see the much-criticized prosecutor general, Viktor Shokhin, surviving all this.
But Poroshenko needs to move fast to re-establish authority/credibility, and the Feb. 16 date by which Yatsenyuk reports his cabinet’s progress seems set to be key – it still seems a long way away from a market perspective.
Fourth, a lot of negatives are now in the price – Ukraine yielding close to 12.5 percent, and despite I think still underlying Western backing, and my assumption still that ultimately Poroshenko will yield to IMF pressure to reinvigorate the reform agenda.
I guess the positive from all this, is that it is clear that the IMF and Western creditors are not prepared to stand on the sidelines and write blank checks for Ukraine, they understand the challenges – rule of law – and are prepared to push Poroshenko et al. along the course of reform.
In many respects some massive reforms achievements have been delivered this year (energy sector, NBU, banking sector, fiscal adjustment, balance-of-payments adjustment, debt restructuring) and the potential is there for more and for this IMF programme to be successful, but Ukraine looks set to benefit from some “tough love” from the IMF and the West.
