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Ukraine's Financial Outlook Is Gloomy

Ukrainian volunteers packing military boots to be sent to government soldiers waging combat against pro-Russian separatists in eastern Ukraine in Kyiv, Friday, Nov. 14, 2014.

Ukrainian volunteers packing military boots to be sent to government soldiers waging combat against pro-Russian separatists in eastern Ukraine in Kyiv, Friday, Nov. 14, 2014.

Ukraine is engulfed in a financial crisis. Without further Western aid, the Kyiv government will run out of money to service its debts. If the situation continues, Ukraine could face possible default on its bonds in four to six months, if Russia demands early repayment on a multibillion-dollar loan it gave Kyiv before the ouster this year of pro-Moscow President Viktor Yanukovych.

Revolution, months of conflict with Russia on its southeastern border and pervasive corruption and staggering economic mismanagement by the Yanukovych regime has “plunged the country into an existential crisis,” warns economist Anders Aslund, a fellow at the Washington-based Peterson Institute for International Economics.

Half of Ukraine’s banks are bankrupt. Ukraine’s hryvnia currency has dropped 80 percent in value against the dollar this year. Inflation has risen to 20 percent and shows no sign of slowing.

A week of large-scale Kremlin reinforcements of pro-Moscow separatists in eastern Ukraine also is piling pressure on the country's faltering economy.

Ordinary Ukrainians are feeling a pinch from rising prices for food, medicine and utilities.
“We are the only country in the World at the moment where the price for gasoline is rising,” complains Yuri, a taxI driver who gets few fares these days, even though he occupies a prime spot outside the five-star Premier Palace Hotel in downtown Kyiv. Retailers in high-end shopping malls in the city center, like Mandarin Plaza and Gulliver, are seeing fewer shoppers and lower revenue.

But in lower-end malls, Ukrainians who fear their currency is spiraling down in value are buying. The government says consumer spending rose 5 percent in the second quarter, compared to the same period in 2013, and that trend is expected to continue when third-quarter results are tallied.

However, that steep decline That is unlikely to last.

In April the International Monetary Fund and Western economic powers bailed out Ukraine with pledges of $27 billion, to be paid over two years in loans and credits. Only about $7 billion has been dispersed so far. And the loan carries conditions: the government must cut spending and reduce the public-sector labor force.

Anders Aslund and other Western economists say the April package won’t be enough, and that Ukrainians won’t be in a position to pay back the money.

“If Ukraine continues drawing on credits at the current speed, while output is collapsing, the country is likely to default on its international payments,” Aslund warned in a policy paper for the Peterson Institute.

He and other economists are reviving calls for a mini-Marshall Plan, modeled on aid the U.S. poured into central Europe after the Second World War.

Aslund says the cuts in government spending - part of the austerity measures the IMF is demanding - will only worsen the country’s economic position.

In part, some of Ukraine’s problems stretch back more than 20 years, to the breakup of the Soviet Union. Just as in Russia, privatizations of state enterprises did not spark a free and open economy; instead they lined the pockets of corrupt oligarchs.

In effect, economic reform transformed Ukraine from a communist system to an industrial feudal state.
The low-intensity war in the eastern oblasts (provinces) of Donetsk and Luhansk, both industrial powerhouses, has added to the crisis: nearly 16 percent of Ukraine’s gross domestic product comes from the east, and the vast bulk of its coal. Industrial production in Donetsk has fallen by more than half, and by more than three-quarters in Luhansk.

Foreign investors are nervous about risking cash on a country that faces the prospect of more fighting, as well as the political turmoil that is expected if long-delayed economic and legal reforms are implemented too quickly by President Petro Poroshenko's government.

A banker in Kyiv who asked not to be named told VOA he has identified some investment opportunities in the metals sector that have opened up as a result of the collapse of industrial production in the east. “Getting others to invest now is a challenge,” he says. The plummeting currency doesn’t help.

“A lot of us have our money in hryvnia. How much is that going to be worth in the next few weeks, and how do we fulfill contracts to import materials from overseas? How do we pay?” he asked. The government has placed severe restrictions on money exchange and purchases of foreign currency in a bid to stop capital flight and to prop up the ailing currency.

For ordinary Ukrainians securing dollars remains difficult. The daily purchase limit is $200. Many banks can’t even keep a stockpile of dollars or euros, so they require several days' notice from customers to supply even this paltry amount. In September the central bank blocked cash advances drawn on credit cards paid in foreign currencies.

With the Ukrainian National Bank’s cash reserves shrinking to $12.6 billion in October - from $16.2 billion the month before - direct intervention to try to prop up the hryvnia has been reduced. Seeking to soothe fears, the country’s central banker, Valeria Gontareva, predicted breezily on November 7: “We’ll see the [foreign exchange rate" going down even further.

That hasn’t happened yet. As of Saturday the hryvnia was trading at 15.5 to the dollar. Most economists think it will hit 18 by the end of this year. The country’s reserves are depleting fast, due to payouts for debt service and for the natural gas Russia provides. JPMorgan estimates the cash pile will drop to $7.4 billion by year-end.

Under terms of the $4.1 billion loan Russia gave Ukraine more than a year ago, if Kyiv’s debt-to-GDP ratio exceeds 60 percent, Moscow can demand early repayment. That could trigger an official default on all of Ukraine’s international bonds. And by winter that threshold is likely to have been broken.