Bruised But Not Beaten

Global Finance, May 2007 by Hawser, Anita

Amid the growing political turmoil in Ukraine, the country's economy is proving remarkably resilient.

When thousands of protesters took to the streets of Kiev, the Ukrainian capital, at the end of March, to outside observers it must have felt like a repeat of the Orange Revolution of 2004, when supporters of pro-Western opposition leader Viktor Yushchenko protested against election results that saw Prime Minister Viktor Yanukovych, Moscow's favored candidate, swept to power. Back in 2004 Yushchenko alleged that the election was "rigged." The civil disobedience that resulted led to the results being annulled, and a second vote was run on December 26, 2004, ultimately resulting in Yushchenko being declared the winner on January 10,2005.

But any hopes that the Orange Revolution had created political stability were soon dashed as the power struggle between Yushchenko and Yanukovych continued. Since the appointment of President Yushchenko's archrival as prime minister last August, Yushchenko has foundered, seeming more like a lame duck than a president. With the Party of Regions (PoR), led by Yanukovych, having the largest share of seats in parliament and controlling the cabinet,Yushchenko is struggling to exert any political control.

Political scrapping between Yushchenko's Our Ukraine Party and the PoR culminated in the events of March 31 of this year, with Yushchenko threatening to dissolve parliament in response to allegations that Yanukovych's government coalition had increased its majority in parliament by paying opposition MPs to transfer their loyalties. On April 2 Yushchenko followed through with his threat, issuing a decree to dissolve the Rada, Ukraine's parliament, and calling for elections to be held on May 27. So far, however, the Ukrainian parliament has ignored the decree, which it claims is illegal.

Yushchenko's hard-line stance came as a surprise to many. On the Friday before Yushchenko formally issued the decree, for example, Gerhard Lechner, a Ukraine analyst at bank group RZB, said he thought it unlikely the president would dissolve parliament, as the latest polls showed that he might not be in a strong position if fresh elections were held.

Yushchenko's decision has deepened the country's political stalemate, and it is painfully unclear how long the current standoff is likely to last. According to Ukraine-based Alfa Capital, a decision by the Constitutional Court concerning the president's decree must be handed down within five days. But, the bank says, this is unlikely given that the court has not approved a single decision since its inception eight months ago. "The court itself is split, as is the country," explains Volodymyr Dinul, head of research, strategy and banking at Alfa Bank Ukraine.

Dinul says it is also unlikely that fresh elections will be organized by May, as regional election commissions need to be established. Even if they do take place, those elections may not provide the stability Yushchenko craves. "Even if elections are held, the result cannot be guaranteed, as one party may not accept the results," Dinul continues. Furthermore, as the electorate is evenly divided, Alfa Capital maintains both sides may claim to be victorious, leading to further confrontation instead of compromise. "Elections, rather than clearing the air and providing the country with a fresh start, may only serve to institutionalize a more radical body politic," the bank believes.

Impact on the Economy

As the political crisis deepens, its potential impact on Ukraine's economy grows steadily. Markets reacted badly to the news of Yushchenko's attempt to dissolve parliament by selling off Ukraine sovereign dollar bonds. At the same time, the local stock market fell by 7%. RZB anticipates investors may trade Ukrainian eurobonds for Turkish eurobonds.

However, in the short to medium term, most analysts believe the economy is unlikely to be affected drastically by recent political events. Last year Ukraine's GDP grew by a healthy 7% year-on-year, and in January of this year real GDP was up by more than 9% year-on-year, according to the Economist Intelligence Unit (EIU). Since 2005, when foreign direct investment (FDI) reached record levels, foreign investors' interest in the Ukrainian market has also been increasing.

According to Lechner of RZB, last year FDI comprised 4% of GDP, which covered the relatively small current account deficit. RZB estimates that real GDP will grow by 5.5% this year, a slighdy reduced rate compared to 2006 levels. However, it attributes this more to a reduction in energy resource consumption and the impact this is likely to have on the profitability of electric power, gas and water distribution companies. "I don't think foreign investors will be put off by the political climate," asserts Lechner. "There is a lot of potential for investment in the banking and financial sector. There could be further privatizations, but this depends on the government."

European Bank for Reconstruction and Development (EBRD) country economist Elisabetta Falcetti remains optimistic about Ukraine's economic outlook. "We don't expect [current political events will result in] a sharp deceleration in growth," she says, adding that domestic demand, consumption and investment remain strong. According to Falcetti, on the external side metal prices have rebounded, contributing to good trade performance. Non-precious metals make up more than 40% of Ukraine's exports.