Ukraine squeezed financially, not just geopolitically
February 25, 2014

The recent ousting of Ukrainian President Viktor Yanukovich has sent officials and pundits into overdrive opining as to how this complex and difficult situation might be resolved to prevent a Cold War flashback. UkraineaEUR(TM)s tense political dilemma, however, is sorely complicated by its tragic financial position. LetaEUR(TM)s survey the countryaEUR(TM)s domestic finances, then examine where Ukraine stands externally.

The liquidity pressures on banks have been intense. Deposits fell 3.2 percent in the first half of February, following a 2.3 percent decline in January. Despite attractive yields, domestic bank funding of the government has essentially ground to a halt, leaving the central bank the sole source of debt financing. The new acting Ukrainian president, Oleksander Turchinov, has announced that the countryaEUR(TM)s treasury is depleted and the public pension fund canaEUR(TM)t meet its obligations.

No letup is in sight for the distressed banking system. Nonperforming loans are as high as 40 percent, and with large open foreign exchange positions and a currency under extreme pressure (the hryvnia fell nearly 7 percent today), banks are in dire need of immediate liquidity support and will surely require fresh capital in the months to come. Although the central bank said it was prepared to provide unlimited liquidity, the availability of capital is likely to be more problematic, particularly given that previous infusions failed to stabilize banks.

UkraineaEUR(TM)s external financing situation is even more precarious. With the suspension of financial assistance from Russia, which had agreed to provide $12 billion, the country needs at least $25 billion to meet its debt-service and current account obligations. Its foreign exchange position has deteriorated, with reserves amounting to $16 billion at the end of JanuaryaEUR"representing just two months of imports. Partial data indicate that reserves could be down to about $12 billion by now.

It will be interesting to see what the United States and European countries are willing to do as the geopolitical maneuvering with Russia intensifies. The most likely first step is for the International Monetary Fund to begin negotiations on an adjustment program. This will take time and negotiations will be difficult because the relationship between the IMF and Ukraine has been a contentious one. Importantly, a meaningful program will surely face a good deal of political opposition in Ukraine as it will entail severe fiscal cutbacks, perhaps amounting to 4 to 5 percent of GDP. Natural gas prices, which are managed by the state, could climb 80 to 100 percent, and other utility tariffs could do likewise.

Recognizing the crucial nexus between adequate financing and a peaceful, stable outcome to this crisis, the foreign policy community is hastily searching for imaginative solutions. Zbigniew Brzezinski, the former U.S. national security advisor, wrote in the Financial Times that perhaps the top 10 Ukrainian oligarchs could be aEURoepersuadedaEUR? to donate $1 billion each to their countryaEUR(TM)s financial rehabilitation. Moreover, ex-President YanukovichaEUR(TM)s fabulously wealthy dentist son might be moved to match the resulting $10 billion. Some might view this proposal as more delusional than imaginative, but for Ukraine, itaEUR(TM)s no delusion that these are desperate times.