Ukraine: Scope of Ukraine political conflict swells, threatens economic sustainability
March 7, 2014
On 22 February, the Ukrainian Parliament impeached President Viktor Yanukovich. The Parliament appointed Oleksandr Turchynov as interim President and Arseniy Yatseniuk as Prime Minster; it also announced that snap presidential elections would be held on 25 May. Political tensions between Russia and Ukraine took the international spotlight in early March when Russian troops started to perform drill exercises at the western border between Ukraine and the Crimean Peninsula. In order to avoid wide-spread fears that the country could go bankrupt, the European Commission (EC) unveiled an aid package to Ukraine worth USD 15.0 billion on 5 March. The package includes USD 4.0 billion in loans and grants and the majority of the remaining money will be devoted to long-term investment projects. The EC stated that financial aid, “is contingent on Ukraine's government reaching agreement with the IMF on economic reforms.” Meanwhile, the IMF is considering utilizing its “rapid financing instrument” to provide the country with USD 1.0 billion in the coming weeks. The Fund sent a team to Kiev to evaluate the financial needs of the country on 3 March. In addition, the United States announced on 4 March that it would provide Ukraine USD 1.0 billion in loan guarantees. The rapidly changing political environment makes an assessment of the country's growth prospects difficult. Currently, analysts expect the economy to experience a sharp deceleration in 2014 and most are forecasting a recession, as the country faces a host of challenges: first, recent political unrest has disrupted economic activity in the first quarter. Going forward, ongoing internal turmoil and social fragmentation is expected to impact productivity and tax collection. Second, the austerity measures that will probably be attached to the IMF's economic reform plans will likely drag on consumption. Moreover, the cancellation of Russia's Gazprom gas price rebate in April is expected to increase pressure on the country's current account. Once political tensions cool down, the state of relations with Russia will be crucial in Ukraine's external balance, since Russia is the destination for about a quarter of Ukrainian exports. If the political crisis between the two countries is not resolved, Ukraine could lose access to the Russian market altogether. In light of these factors, FocusEconomics Consensus Forecast panelists sharply revised their GDP projections down and now expect GDP to contract 0.3% in 2014, which is down 1.3 percentage points over the previous month's projection. For 2015, the panel expects the economy to expand 1.6%. On the financial side, the country faced strong volatility in the foreign exchange market in the past month. The hrynvia (UAH) fell 32.0% between 11 and 27 February. As a response to the strong pressure on the currency and given the low levels of international reserves, on 26 February the National Bank of Ukraine (NBU) decided to allow the hrynvia to depreciate. International reserves fell to USD 15.5 billion in February, which would cover less than three months of imports. February's level marked a 30.0% decrease compared to the USD 22.8 billion average recorded in the full year 2013. Some analysts expect that the NBU will adopt a regime similar to Russia's, with a target currency basket and a moving intervention corridor. This would allow for a progressive reduction of interventions in the FX market and would help the country eventually move to a free floating regime. FocusEconomics Consensus Forecast panelists project a progressive depreciation of the hryvnia and now expect the rate to end 2014 at 9.94 UAH per USD. In 2015 the panel expects a rate of 10.31 UAH per USD.