Ukraine on edge

Pro-Russian activists at a rally in Donetsk Image copyright AFP

As the situation in Ukraine deteriorates, political turmoil could lead to default, which looks likely, according to one of the major rating companies, S&P.

Another rating firm, Fitch, has downgraded the country from B to CCC, a pre-default level.

In recession since mid-2012 and having had two IMF rescues mooted since the 2008 global crisis, Ukraine's current account deficit is a record 8% of GDP and its currency has hit a record low against the US dollar.

Its economic woes are a reminder of how challenging the process of economic transition can be. None of the key numbers look pretty more than two decades after it abandoned central planning and became a market economy.

Economic growth was tepid in the 1990s and its stalled transition in the early years, until the mid 1990s, made room for oligarchs that came to dominate key sectors. By the end of the 1990s, GDP per capita was only half of what it was before its transition.

But, the picture had looked more promising since 2000, when GDP grew rapidly from $31bn to $140 bn by 2007, with the private sector contributing the bulk of growth after decades of state dominance, established during the time when it was part of the Soviet bloc.

Then the global crisis hit and last year, the only sector contributing strongly to growth was agriculture, according to the European Bank for Reconstruction and Development's (EBRD) 2013 report.

Default prospect

With an average income that is less than one-tenth of that of the eurozone, Ukraine is in need of significant reform. For instance, in the World Bank doing business index, it ranks worse than its neighbours in Europe (112 out of 189) and near bottom for tax payments.

With the country now on edge and under military mobilisation, Ukraine also faces financial challenges. Its central bank two days ago imposed capital controls, limiting foreign currency withdrawals to 15,000 hryvnia or $1,500 per day.

As money has left the country ever since political tensions arose last November, when its government turned away from firming up trade links with the EU, its foreign exchange reserves fell to $16 bn, or perhaps to as low as $12 bn, which covers only about 2 months of imports.

Reserves have also been drawn on to pay for foreign debts which total a whopping 80% of GDP. If it can't pay its debts, or for its goods and services, Ukraine faces the prospect of default.

Ukraine economic indicators compared

Image caption Ukraine's economic growth was severely affected by the global financial crisis of 2008 due to high foreign borrowing and a drop in the price of its top export, steel.
Image caption Rampant inflation took hold in 2008, driven by a spike in global food prices and energy price rises caused by a hike in the cost of imported gas.
Image caption Unemployment appears to be less of a problem than in the EU but a high proportion of unregistered workers means that official figures do not show the whole picture.

Gas supplies

The fallout from the political and financial woes would be notable for its trading partners in Europe as well as some European banks.

Also, the country is a transport link between the EU and its largest gas supplier. Even short stoppages in prior winters serve as a reminder that Ukraine has a key pipeline for gas exports from Russia.

The EU obtains the largest proportion (nearly a quarter) of its gas from Russia, the bulk of which is transported via Ukraine, according to Commerzbank. It estimates that if there was a complete stoppage of gas transport from Ukraine, then only half of the volume could be picked up by the Nord Stream that goes through northern Germany. The pipeline through Belarus carries only half of the capacity of that of the Ukraine.

Recall that disputes between Russia and Ukraine over gas prices in 2006 and 2009, both during winter, led to stoppages in exports to Europe, albeit brief ones.

There are many reasons to be concerned about Ukraine and its people, and financial woes may well be just a small part of what is to unfold in the coming days.