Ukraine’s economy suffocates under Russian pressure, but Western aid is scarce

With its war-torn economy threatened by further Russian disruption, Ukraine is in desperate need of a new program of international financial assistance, economists say, but none appear imminent.

The International Monetary Fund’s $ 17 billion envelope in May was not designed to offset the effects of months of fighting between the Ukrainian military and Russian-backed separatist forces. In addition to military costs, lost tax revenue and the urgent need to repair infrastructure, Ukraine faces a crisis of confidence that is leading to capital flight and a depreciation of its currency.

“I now fear a systemic economic failure – unless there is a positive confidence shock,” said Timothy Ash, head of emerging markets research at London-based Standard Bank. He said Ukraine’s banks are fragile, the budget deficit is more than 10% of gross domestic product and the economy could contract up to 10%, more than current IMF estimates.

Ash said there were “a lot of warm words for Ukraine but not a lot of greenbacks” from the United States or the European Union, which is mired in its own economic stagnation. Ash said in an email that during an official visit to Washington recently, Ukrainian President Petro Poroshenko “gave the speech of his life and got $ 53 million which is small change. This finances the cost of the war in the East for 9 days.

The fighting disrupted the entire eastern part of the country, hampering business and tax revenues. Mikhail Afendikov, chief executive of Cub Energy, an exploration company, said his company is drilling just four gas wells in eastern Ukraine instead of the 18 as planned. Two-thirds of Ukraine’s coal production comes from the conflict-torn Donbass region, and production there has been halved. Bridges and railroads were damaged.

Key economic reforms are yet to come, and Western officials hope the government will take more action after the October 26 parliamentary elections. “The hope is that the new government. . . can deliver this reform plan, and the West is accumulating enough money to give these reforms a real chance, ”Ash said.

In the most important sector – energy – a new general manager was installed several months ago at Naftogaz, the public natural gas monopoly. In an interview, he urged the government to cut consumer and industry subsidies from January 1 to reduce waste, cut imports from Russia and increase Ukraine’s gas production.

“This is something we have to resolve,” said Andriy Kobolyev, managing director of Naftogaz. “There is no option to extend and pretend, pretending we can continue this way. The sooner we implement the changes, the sooner we can become financially viable.”

Ukrainian households pay around one-eighth of the market price for natural gas, Kobolyev said; about a third of Ukrainian households pay monthly gas bills of just $ 2, he added. As a result of these subsidies, Naftogaz expects a deficit of 7.4% of GDP this year, Kobolyev said, more than government spending on any other budget item.

Although a large number of households cannot afford to pay market prices for gas, Kobolyev said it would be better for the government to release the prices and then provide direct payments to those who really need them. . This would prevent subsidies from going to those who do not need them and encourage wasting households to reduce their consumption. Ukraine consumes more energy per unit of GDP than all countries except two.

While Kobolyev admitted that many believe that eliminating subsidies cannot happen overnight, he added: “We have been talking about this for 23 years” since Ukraine became independent from the former Soviet Union. . He said a desire to reduce the influence of Russia, the source of most of Ukraine’s gas imports, could help.

Ukraine’s economic instability is undermining efforts to end subsidies. Under the impetus of the IMF, the government increased gas prices for some customers by as much as 40-50% in local currency, but the dollar price fell due to the fall of the Ukrainian currency, Kobolyev said.

Eager to avert an even greater crisis of confidence, the Ukrainian government has made servicing the debt a priority over other spending demands.

While waiting for the price changes, Kobolyev has been working to resolve other issues plaguing the state gas company, including getting rid of middlemen who allegedly stole hundreds of millions of dollars from the company. He blamed RosUkrEnergo for $ 300 million in costs “for nothing”. He also proposed to force a fertilizer company controlled by Dmitry Firtash to find its own sources of gas. Firtash, who ran RosUkrEnergo, is fighting corruption charges in the United States and was freed in Austria on $ 170 million bail paid by a Russian friend after his arrest by Austrian authorities on FBI warrant in March.

The shadow of Russia – the source of 30 percent of Europe’s natural gas – hangs over it all. Kobolyev said he expects Russia to cut gas shipments to Ukraine, which could lead to a 20% shortage of supplies – and Ukraine’s gas storage facilities are not full. at 54%. Part of Ukraine’s deficit could be filled by other European countries by reversing the flow in the pipelines that historically carried Russian gas through Ukraine to Europe. Most of this reverse flow gas originated in Russia and passed through other pipelines. Earlier this month, the Norwegian company Statoil agreed to sell gas to Ukraine via Slovakia. Volumes were not disclosed, but pipeline bottlenecks will limit sales.

Russia has tried to prevent cross-selling by threatening to cut, or indeed, its supplies to countries like Poland and Slovakia. Two weeks ago, Gazprom only delivered half of what Slovakia wanted for three days. Polish gas company PGNIG said on Friday that the Russian gas monopoly, Gazprom, had not supplied all the gas demanded by PGNIG but that Polish consumption was met by domestic production, the lower level of Gazprom’s supplies and imports from countries to the western Poland. Polish storage tanks are full.

“No transit through Ukraine this winter; this is what we expect and this is what we are preparing for, ”said Vaclav Bartuska, Czech Ambassador for Energy Security. But he warned that Europe will adapt by finding more reliable sources of gas or other energies. Facilities designed to import liquefied natural gas are at around 40% of their capacity, Bartuska said. If Russia drastically cuts its supplies, “we’ll have one or two harsh winters, but then Russian gas will be dead in Europe for a generation,” he added.

Negotiations are still ongoing between Ukraine and Russia. Kobolyev said that Naftogaz is only looking for a market price. Although Russia has complained about subsidizing Ukraine, it actually demands a premium on prices paid by Germany, and Russia has rarely cut gas sales to Ukraine.

Bartuska said spot gas prices were about half the price Gazprom demanded in negotiations with other European countries. Final prices depend on Gazprom’s bargaining power, with larger customers such as large German utilities getting better deals. He said Germany pays about half the price Latvia pays.

Russia and Ukraine are also fighting in a Stockholm arbitral tribunal, with Gazprom claiming it owes it $ 5.3 billion and Ukraine claiming it lost assets during the annexation of Crimea.

Russia, which says it has withdrawn some of its troops engaged in exercises near its border with Ukraine, still has other ammunition. If, or when, Ukraine’s debts exceed 70% of GDP, Russia can demand repayment of $ 3 billion in bonds. Ukraine would most likely derive this amount from IMF funds.

“Suffice to say that once again Russia’s strategy will be to make life as difficult as possible for any pro-Western administration in Ukraine,” Ash wrote in a note to clients.

In recent days, Russia has indicated that it may compromise on requirements of how much it expects Ukraine to pay in arrears on gas purchases and that it may also compromise on prices. future. Meetings are scheduled for next week.

But while Russia tries to ease the pressure on the Ukrainian economy, the breath of compromise has not reached all parts of the Russian government, which this week said it will ban cheese imports from Ukraine. .

Christi C. Elwood