Still on the edge

19.12.2015
| The Economist
Exports hold some promise. They powered the economy out of the recessions of 1999 and 2009, points out Tomas Fiala of Dragon Capital, an investment bank.

On the face of things, the worst is over for Ukraine. A ceasefire seems to be holding in the war that has left forces backed by Russia in control of much of the east of the country. The IMF has found a way to keep providing Ukraine with a financial lifeline, side-stepping a dispute with Russia that had threatened to sever it. The economy, which has shrivelled by about a fifth since 2013, even grew by 0.7% in the third quarter, relative to the second.

Yet the hryvnia, Ukraine’s currency, which has lost 70% of its value over the past two years, is sliding again; government-bond yields are rising. Politicians in Kiev are busier brawling (at times physically) than fixing the country’s problems. There is a risk that the hugely unpopular government may collapse, possibly paving the way for a resurgence of pro-Russian parties. For all the improvement in Ukraine’s circumstances, the country’s prospects remain horribly uncertain.

The present economic uptick was inevitable after such a big contraction. Sales of meat and poultry, which had fallen sharply as Ukrainians economised in the depths of the crisis, have started to grow again. Vodka consumption is on the rise too. (Champagne sales are also up, suggesting that the government’s attempts to stamp out Ukraine’s endemic corruption are not going perfectly.) Firms are hiring again: the unemployment rate has fallen from 11% to 9% in recent months.

The government’s finances also look much more healthy. That is largely thanks to Ukraine’s creditors. In August most of them agreed to a restructuring that wiped 20% off its foreign debt. That paved the way for an IMF rescue. It has lent $11 billion to Ukraine since the beginning of 2014, and plans to lend another $11 billion by 2019. To that end, it changed one of its bylaws this month, freeing it to lend to a country that has defaulted on a sovereign lender. That manoeuvre was aimed at Russia, which lent $3 billion to Ukraine in 2013 and rejected the August deal. Ukraine will default on the Russian loan on December 20th. A lengthy court battle looms, but will no longer imperil the IMF’s aid.

Dramatic spending cuts have also helped right the government’s finances. The budget is in surplus so far for 2015. Anders Aslund of the Atlantic Council, a think-tank, says that in two years it has reduced public spending from 53% of GDP to 46%. With private debt markets closed to it, the government has little choice but to cut. “In the last year we have reduced staffing of government by a fifth,” says Natalie Jaresko, the finance minister. Spending on benefits and health care is down.

All this belt-tightening, however, further dampens demand. As it is, consumers are struggling. According to Euromonitor, a research firm, a quarter of outstanding consumer loans and a third of the mortgages are in default. Real wages have fallen by 25% in the past year and high inflation has diminished the value of savings. Even if the hryvnia recovered a quarter of what it has lost against the dollar since 2013—an optimistic forecast—Ukraine would need annual growth of 5% until 2022 to reach its pre-crisis dollar income per person.

Exports hold some promise. They powered the economy out of the recessions of 1999 and 2009, points out Tomas Fiala of Dragon Capital, an investment bank. At first glance the country looks set to repeat the trick. It has an educated workforce, fertile farmland, plentiful gas reserves and a dirt-cheap currency.

However, investment is needed to spur exports. In the past three years capital spending has fallen by 40%. It shrank yet again in the third quarter. A malfunctioning banking system is partly to blame. Many banks borrowed in foreign currencies but lent in hryvnia, exposing them to the currency’s collapse. Other banks were mere fronts for oligarchs who plundered the deposits for themselves.

So far the National Bank of Ukraine (NBU), the central bank, has done a good job of cleaning up the banks. In one-and-a-half years about 60 of the 180-odd banks that existed before the crisis have been shut down, says Mr Aslund. (Fifty more need to go, he adds.) Others are being recapitalised, with the NBU cajoling their wealthy owners into footing the bill. Its efforts are paying off. Deposits of foreign currency are rising.

Efforts to tackle corruption are going less well. No prominent figures from prior regimes have been jailed, points out Timothy Ash of Nomura, a bank, unlike in many other eastern European countries. The government has failed to increase the derisory salaries of civil servants. Even senior officials are paid a measly $300 a month, making corruption especially hard to resist ($50,000 a month is said to be the going rate for a pliable one).

No one has cleaned up the murky but lucrative system for claiming value-added-tax rebates on exports. “Some people are still claiming refunds for exporting air,” says Mr Fiala. The finance ministry has put forward a sensible proposal for the budget in 2016, but it has been hindered by those who resist the abolition of dodgy tax loopholes. The fight has delayed $4 billion of Western help.

The foot-dragging frustrates locals as well as foreigners. Reform-minded officials are fed up and have privately threatened to resign. Some already have. Despite some improvement, Ukraine is still at risk of long-lasting stagnation.