Ukraine: Risk Assessment
Country Rating1
Rating: D
Business Climate Rating1
Rating: C
Risk Assessment2
A fragile recovery
Ukraine's macroeconomic situation stabilized in 2010, thanks especially to the ease of the political turmoil early in the year, renegotiation of the oil contract with Russia, and resumption of IMF support. But despite the good performance in export sectors (metallurgy, machine tools, and petrochemicals) and the upturn in private consumption, GDP growth was still constrained with investment limited by the credit crunch and the government forced to adopt austerity policy. Moreover the farm sector suffered from a summer drought. In 2011, the economic recovery will continue but growth is nonetheless expected to slow down with production remaining below its 2008 level: The base effect will be much less favourable than in 2010 and the hryvnia appreciation has wiped the competitiveness gains resulting from the devaluation. The effort to reduce public spending (3.7% of GDP) will also be a crucial factor. It will notably affect civil service wages and some government subsidies. These measures, in conjunction with an inflation upsurge marked by a 50% increase in the price of gas for households (the second such increase since August 2010), will undermine consumption. Nevertheless the upcoming European football championships in 2012 will be likely to speed up infrastructure projects and galvanize investment. The end of the banking crisis, if it is borne out, could also spur domestic demand.
Heavy dependence on international aid
By end 2010, Ukrainian authorities had, overall, reached the initial public-deficit-reduction objectives set by the IMF on the fiscal deficit or the state-controlled company Naftogaz deficit. The cost of the banking sector recapitalization impacted the 2010 budget. In 2011, the IMF conditions call for a two-point reduction in the fiscal deficit and impose a series of far-reaching structural reforms - tax code, pension system, public administration, energy sector - which are delicate political issues. Their implementation will be crucial to maintaining the aid from the IMF and the market confidence: Although the conclusion of the second confirmation agreement with the IMF in July 2010 enabled the Ukrainian government and several companies and banks to issue Eurobonds once again, access to international capital markets would close virtually instantly if the IMF aid were to be frozen. But that is something Ukraine cannot afford to let happen in view of its limited foreign-exchange reserves. The banking system remains weak. It suffered losses for the second consecutive year in 2010 due to provisions for nonperforming loans which still high. At end 2010, some ten banks had yet to comply with the requisite prudential ratios.
The policy of President Yanukovych in question
The election of President Viktor Yanukovych put an end to the paralysis of the domestic political scene thanks to the formation of a parliamentary coalition and a credible government, which produce tangible results in 2010. In the international arena, diplomatic relations with Russia improved substantially due to the close ties of the Ukrainian executive with the Kremlin. And a new conflict over gas seems very unlikely in the near term. But the new regime also gives preference to a greater centralization of power and a weakening of the opposition, which entails risks. The Ukrainian-speaking and pro-Western fringe of the population would not tolerate a "too" privileged relationship with Russia even though the European integration policy has not been called into question. Protest movements and social unrest thus seem likely. Deficiencies in terms of governance and corruption currently place the country at critical levels of risk.
Strengths
- Strategic position between Russia and the European Union
- Substantial farm potential
- Skilled, low-cost labor
- Support of international financial donors
Weaknesses
- Limited economic diversification and dependence on the prices of metals and imported gas
- Dependence on metal and gas-import prices
- Excessive foreign indebtedness of the private sector
- Political instability that complicates the implementation of consistent economic policy
- Very weak banking sector
- Persistent deficiencies in the business environment