The Ukrainian leadership has once again proven to be helpless. Even the real threat of a catastrophic financial and economic crisis has not consolidated the key political leaders who still follow the principle of collective irresponsibility. The “doctors” know the diagnosis and the remedies but prefer poultices and incantations to painful procedures. They are simply wasting time and the short respite given to them by the central bank at the expense of the people’s trust is nearly up…

Tinsel

When the National Security and Defense Council made public the outcome of its postponed meeting on Monday, it was already clear that this week the country would see no concrete anti-crisis steps. President Viktor Yushchenko, commenting on the meeting, stated that the anti-crisis action plan included the adoption of “dozens of bills” and that it would be “extremely difficult to get all political forces to support them.” The only initiatives that he said would be “surely supported by the parliament” were the draft bills on establishing a stabilization fund and on bank deposit guarantees.

The general public was left out in the cold again: the NSDC never published its resolution. No one even took the trouble to explain the direction or objectives of the anti-crisis steps or what they would cost. It looks strange because after the NSDC meeting the President said that the anti-crisis measures would require “one colossal asset – the people’s trust” – which he called “the key factor of overcoming the crisis.” Is that the way the people’s trust should be gained?

The only concrete figure the public heard was disclosed by Prime Minister Yulia Tymoshenko: she said that 49 active laws and regulatory norms would have to be amended. She decided to put all draft bills into one basket – i.e. motion them in a single package. She must have shared Yushchenko’s suspicions that it would be “extremely difficult to get all political forces to support them.”

Both Yushchenko and Tymoshenko have been demonstrating a storm of “anti-crisis activity.” Yushchenko addressed the nation on TV and met with representatives of national and international mass media and the IMF, and his press service diligently rubber-stamped press releases. The tenor of this PR spurt could be found his utterance: “It is in the government’s exclusive competence to turn on the mechanism of support to the national economy.”

Tymoshenko also made a series of public appearances, addressing her compatriots and holding numerous consultative meetings with authoritative economists and bankers. After her meeting with IMF representatives on Monday, she said proudly that Ukraine had “practically completed talks with the IMF” and that an agreement on a multi-billion-dollar loan might be reached on Wednesday.

Nothing of the kind happened on Wednesday (according to some sources, the IMF experts were very much disappointed with a number of legislative innovations proposed by the government). All that the government showed the public was a package of 43 amendment bills. At a closer look, some of them have nothing to do with the financial crisis. The brief explanatory note does not say how the proposed amendments to the laws on melioration or thegeological service are supposed to lift the country out of the crisis.

Real Content

There are some cardinal innovations, though. One of them is the government’s initiative to include its representatives in the boards of “problem” banks as “crisis managers” with the right to block the management’s decisions.

Another innovation is the so-called “stabilization fund” in which the government wants to accumulate all proceeds from privatization and sale of securities in 2009-2010. If the government really means to unblock the privatization process, the stabilization fund can be filled to the brim and very quickly. Serhiy Tyhypko, co-chairman of the Investors Council at the Cabinet of Ministers, believes that “there will be enough money for the fundamental sectors” and that there will be “not one but a dozen investors.” However, far from all experts polled by ZN share his optimism.

The government also intends to give financial support to the Bank Deposit Guarantee Fund “in order to restore trust in the banking sector.”

The government plans to substantially raise customs and excise duties on gasoline and diesel fuel, new cars, alcohol, and beer. Notably, it wants to change customs duties every six months “in case of aggravated internal or external economic environments or due to limited budget resources.” The wording looks rather vague for a serious document…

The government proposes that the 1aw, which sets the minimum wage at the subsistence minimum level take effect two years later than initially announced – on January 1, 2011 instead of January 1 2009. The government also gives up on its plans to raise the minimal monthly wage from UAH 545 up to UAH 605 [$1 = UAH 5.22 according to the official exchange rate set by the National Bank on October 25]. At the same time, the government will continue to subsidize the first installments in the construction or purchase of new dwellings for those entitled to improvement of housing conditions.

One of the most radical steps is to grant banks the long-awaited right to seize mortgage property from defaulted debtors without a court warrant. The seizure procedure should be determined by the Cabinet of Ministers and the National Bank.

Most experts call these steps “half-measures” that can hardly yield the desirable mid- and long-term effects due to the absence of clearly identified priorities.

Correct Diagnosis

Like any disease, this financial crisis has stages and its treatment should have a definite algorithm. First it is necessary to diagnose the disease – i.e. identify the real causes of this crisis. Many officials blame it on external factors, but it is obvious that the “bacilli” have long been present in Ukraine’s body. The most harmful bacillus is the people’s habit to live beyond their means, which was begat and encouraged by the government’s generous populist policy.

ZN last pointed to the symptoms of the most serious structural disproportions in late September (issue #35), citing the analytical note “How to Prepare for a Financial Crisis” written under the supervision of Dr E. Segura, board chairman of The Bleyzer Foundation Ukraine and co-chairman of the Investors Council’s workgroup for macroeconomic aspects of investment policy. The note had been sent to all top officials this summer.

The note emphasized that the current global crisis of liquidity increased the risk of a crisis in the financial systems of many countries and that the most vulnerable economies were those with low coverage (less than 1 percent) against short-term liability claims, a considerably negative current payment balance (over 5 percent of GDP), and rapidly increasing consumer crediting (over 15 percent).

Having analyzed Ukraine’s indices, the experts concluded: the country was facing an imminent crisis exactly due to these factors.

NBU experts calculated that in eight months of this year Ukraine’s negative current payment balance had increased more than threefold to reach $5,500M (6% of GDP).

Ukraine’s positions on foreign markets are very weak because of the critical dependence of its major export-oriented sectors on global fluctuations of prices for raw materials. This primarily concerns the metallurgical industry which accounted for one half of all produce exported by Ukraine in seven months of this year.

The government expects the country’s negative foreign trade balance to reach $17,700M (9% of GDP forecast) by the end of this year and $25,300M (over 10% of forecast GDP) in 2009. An additional negative factor is the price of imported natural gas which is very likely to grow up to $300 or $400 per 1,000 cu m.

Government officials had been reassuring the public until the last moment that there was “no need to worry about the deficit,” saying it would be more than compensated by an influx of new resources to financial accounts. Their amount, however, has turned out to be smaller than anticipated.

Direct foreign investment was increasing at a very good rate, but external debts were growing equally fast. As of July 1 they exceeded the 1-billion-dollar landmark, having increased almost threefold over the last two years alone. The volume of short-time liabilities had increased to $28,200M and almost equaled the country’s gold currency reserves.

Very regrettably, the lion’s share of external borrowings was used very inefficiently. At their expense the government financed consumer loans and mortgage credits (as a result, the “price bubble” on the real estate market swelled enormously). Consumer crediting at the expense of borrowed hard currency also stimulated the malignant tumor: Ukraine borrowed foreign money to pay for imported goods.

The volume of individual crediting has increased almost 14-fold during Viktor Yushchenko’s presidency alone [since January 2005] and by 212 times since January 2001! Notably, over the last four years external borrowings and the amount of credits to individuals have been growing at a precisely equal rate.

The global financial crisis, on which Ukrainian officials pass the buck, only exposed all these structural disproportions. Alarmed by the recent developments on global financial markets and warned by international rating agencies, foreign investors took a closer look at Ukraine’s problems. They reconsidered the risks and stopped lending money to Ukrainian borrowers at reasonable interest without waiting for irreversible aggravations.

Urgent Prescriptions

In this context the global financial crisis has even helped Ukraine’s financial system and makes the number one task – financial stabilization – quite feasible.

As is known, liquidity problems are basically connected with the necessity of refinancing short-term external debts. According to the Credit Rating agency, the external debt that Ukrainian borrowers have to clear by the end of the year nearly equals $200M, but President Yushchenko estimates it at $1,700M. The banking sector accounts for almost half of it – $827M. The major part of the latter sum are liabilities of Ukrainian daughter banks before their foreign mother structures, which means that they will be refinanced in time. That’s a good thing.

The bad thing is any solutions to the problem of external debts do not agree with the central bank’s prime task of maintaining the exchange rate. Trying to keep the liquidity of Ukrainian banks, it makes new emissions of the national currency most of which goes to purchase hard currency for servicing import contracts (often fictitious) and external loans and for converting the savings redeemed from bank deposits into the more trusted $ and €.

Unfortunately, the people’s trust in the National Bank’s ability to keep up the exchange rate was undermined by its own inadequate steps.

The objective fact is that the basic indicator of economic stability for the overwhelming majority of Ukrainians is the UAH/$ exchange rate which they see every day on currency exchange points. It could not be otherwise with the fictitious price stability of the hryvnya: even official statistical data show a steady 20-30-percent growth in consumer prices.

Of course, sooner or later the people must get out of their habit to calculate the value of their banknotes in hard currency equivalents, but not so fast and not under such circumstances!

In October the National Bank lowered the exchange rate twice and very sharply. Is that what it calls “efforts to maintain exchange rate stability”? Interestingly, the first time it managed to stabilize the situation in a mere three days – from October 8 to 10, but the second time it lost control of the situation. The explanation is implied in the statement made by Valeriy Lytvytsky, chief advisor to the NBU governor: the central bank was simply afraid “to burn all its reserves keeping the exchange rate at any cost”. But, as they say, the miser pays twice.

On October 22 NBU Governor Volodymyr Stelmakh told reporters that the bank’s gross reserves had shrunk since early October by 8.6 percent ($3,200M) and totaled $34,400M as of October 21.

One of Yushchenko’s numerous statements boiled down to the following: it is necessary to set “comprehensible parameters of the exchange rate mechanism so that we have one price of the hryvnya instead of two or three”. Ukraine experienced something like this in the mid-1990s when the official exchange rate differed substantially from the real market rate and both differed from the rate at which the central bank made its interventions. Those who enjoyed privileges made quite a fortune then on that difference…

Now the margin is much narrower, but turnovers have increased hugely! Can the central bank guarantee that those who enjoy the restricted access to its resources are not profiting on the exchange rate difference here and now? The people need an exhaustive answer. Otherwise law enforcement should take a closer look.

Long-Term Prescriptions

It is vital and urgently necessary to support the critical industries – metallurgical and chemical. It is clear that the measures taken or planned by the government with regard to the metallurgical and chemical industries do not and can not have lasting positive effects. Measures such as limitations on transportation and energy supply tariffs or a revision of the exchange rate are quite effective, but they are taken at the expense of other sectors – simply by redistributing financial flows. Such measures can be justifiable only for a short stabilization period. The real reserve for the metallurgical and chemical industries lies in a very simple prescription: higher process efficiency. Participants in the Metal Forum that took place in Kyiv last week were unanimously maintained that the best way to raise efficiency would be to reduce production costs through reducing the consumption of electric power, fuels, and raw materials and to reorient production to commodities with a higher added value.

Both prescriptions imply higher investment activity in the metallurgical branch (which had been far from leading in terms of profits before the crisis). In January-September Ukrainian metallurgical plants invested 10%-11% less in technical modernization and re-equipment than last year.

According to Volodymyr Vlasyuk, director of the state enterprise Ukrpromzovnishexpertyza [Independent Industrial Expertise of Ukraine], the metal market is now blocked by the absence of credits, so normalization in this market depends on the situation in the finance and banking sector.

The same concerns the construction industry which, instead of the umpteenth “national program of affordable housing”, needs major infrastructural projects. Such projects are “dead letters” without administrative support from the government and financial support from banks. The main problem here is that banks have to keep from granting loans right when the real sector needs them so badly.

Presenting their analytical report on October 17, experts with the National Institute of Strategic Studies pointed to the close and aggravating interdependence between the negative processes in the financial sphere. The tighter profit and monetary policy – decreased volumes of crediting – lower consumer and investment demand – economic slowdown – mounting non-payments on credit… This chain is fraught with an avalanche that may ruin Ukraine’s poorly balanced financial system.

Besides, the NISS experts note that the post-crisis situation will be characterized by a considerably worse external environment: soaring natural gas prices, Ukraine’s falling credit rating, and the oversaturation of traditional markets for Ukrainian exports. They predict a substantial slowdown in economic growth resulting in nearly frozen salaries and low consumer solvency.

To reanimate the national economy it is not enough to resume economic activity at the expense of higher price competitiveness (artificially raised by devaluating the national currency). The NISS experts conclude, “To overcome this crisis it is necessary to invest heavily in modernizing the Ukrainian economy, raising the labor efficiency and competitiveness of Ukrainian producers, and substantially enhancing the share of the domestic market in the consumption of Ukrainian-made products.”

“It will be not possible to overcome the current crisis without the state’s support. The state should considerably increase its investments into the economy by using several sources: loans from the international financial organizations and other foreign states, funds received from privatization, funds earmarked from the state budget,” asserts the director of the Institute of Economy and Forecast at the National Academy of Science of Ukraine, Valeriy Geyets.

The main anti-crisis steps in this regard are:

— limit consumer goods imports;

— support export and import-substitution industries;

— implement infrastructure projects;

— accumulate the citizens’ savings.

The role of banks, mostly state banks, in implementation of every of the aforementioned points is very important. In this context, the banking system is a fundamental sector of the economy.

However, the state shouldn’t forget about commercial banks. Along with the state banks (Ukreksimbank and Oshchadbank) and Prominvestbank, which is experiencing the problems today, the top ten banks of Ukraine include leader of the financial market Privatbank and NadraBank, the seventh bank in the top ten.

Additionally, there are such large banks as Brokbiznesbank, “Finance & Credit” Bank, PUMB and Ukrprombank. Most of these financial institutions have experience of implementation of joint projects with such international financial organizations as International Bank for Reconstruction and Development, European Bank for Reconstruction and Development, International Finance Corporation and so on. Therefore, the expertise of investment projects conducted by these banks complies with the highest international standards. Thus, it is worthwhile for the state to use the possibilities of the private banks in implementation of its investment policy.

The problem of excessive foreign capital in the Ukrainian banking system is obvious, but this situation is irreversible. Under the condition of sufficient state support, the national banks will be able to compete with foreign capitals.

What sectors of economy should the state invest into? Ukrainian economy has at least three key sectors, which give it indisputable advantages over the neighboring states. They are: infrastructure projects, for instance the projects connected with preparations for hosting Euro-2012; agricultural sector; energy and energy conservation.

Incidentally, as the president of the Ukrainian National Mortgage Association, Ihor Yushko, stated in his interview to ZN, the main difficultly of the current situation is its quick development. “Some decisions we make today have already gone out of date yesterday, or it is often too late today to employ measures that seemed to be quite reasonable yesterday. That’s why prompt and quick decision making is very important in the current situation.”

“The slowness of our state apparatus is a serious problem under the current circumstances. However, the most embarrassing is the fact that every participant of the political process is trying to exploit the current situation for his or her political goals. This hampers the process of economic stabilization. Sooner or later our politicians will have to seriously get involved in this process. Sooner our politicians understand this better it will be for the country’s economy,” remarks the expert.

Will they understand?