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WORLD | BUSINESS

Ukraine: The Myth of its Salvation through Western Investment (II)

Valentin KATASONOV | 15.12.2013 | 00:00
 

Part I

Attracting capital to a country is a double-edged sword, and foreign investment comes at a price. Firstly, because foreign investors establish control over individual businesses and entire industries, and little by little the country loses its economic sovereignty. Secondly, because after a while foreign investments turn into a pump that siphons off a country’s financial resources. The issue is the income of foreign investors, which is either reinvested in the country, tightening control over the country’s economy, or exported, worsening the state of the country’s balance of payments with all the negative consequences that come with it. 

Let us turn, once again, to the statistics of Ukraine’s balance of payments (BP). In the current operations section, the BP provides information on the income of foreign investors in the Ukrainian economy and the income received by Ukrainian investors abroad. As can be seen from Table 5, the income of foreign investors exceeds the income of Ukrainian investors abroad almost by an order of magnitude. The balance of Ukraine’s investment income is consistently negative with an upward trend. 

The withdrawal of investment income from the country over the period from 2008-2012 amounted to USD 39,991 million. During this period, Ukrainian capital exporters received USD 5,857 million from their foreign investments. The balance of Ukraine’s investment income over this five-year period amounted to:

- USD 39.99 billion + USD 5.86 billion = - USD 34.13 billion. 

In round numbers, this comes out as minus 34.1 billion dollars. 

Table 5.

The balance of Ukraine’s investment income (billions of dollars)

 

2000

2005

2008

2009

2010

2011

2012

Income of foreign investors

-1083

-1733

-6941

-7049

-6712

-9264

-10025

Income of investors from Ukraine

110

399

1790

1198

669

660

1540

Surplus

-973

-1334

-5151

-5851

-6043

-8604

-8485

We will now carry out some simple calculations. As can be seen from Table 1, the balance of the international movement of Ukrainian capital over the period from 2008-2012 amounted to (billions of dollars):

97.3 – 66.7 = 30.

In order to assess the net effect of Ukraine’s participation in international investment exchange over the five-year period, we need to add together the balance of the international movement of capital and the balance of investment income (billions of dollars): 

30.6 – 34.1 = -3.5

So the net effect of Ukraine’s participation in international capital transactions over the period from 2008-2012 is equal to minus 3.5 billion dollars. That is the result we obtained based on the official statistics of Ukraine’s balance of payments. If we take into account the «grey» (illegal) outflow of capital, however, then the net negative result will be immeasurably higher. 

The medium- and long-term consequences for Ukraine of «attracting» capital

The calculations above only show the country’s current losses, but one could, and should, also talk about the medium- and long-term consequences of the arrival and presence of foreign investors in the Ukrainian economy. To begin with, I will emphasise once again that foreign investments have never, and will never, have any kind of visible positive effect on the development of the real economy. Let us look, once again, at the statistics of the State Statistics Service of Ukraine (Table 6). 

Table 6.

Capital investments in the Ukrainian economy and the involvement of foreign investors in their financing (billions of hryvnias)

Year

2010

2011

2012

Total:

189.1

259.9

293.7

Foreign investments

4.1

7.2

5.0

Share of foreign investments, %

2.1

2.8

1.7

As can be seen, only 2-3 percent of capital investments in the country’s economy is provided through foreign investments (the vast majority of financing sources for capital investments is provided by businesses’ own funds – nearly 60%; the rest is bank loans, funds from state and regional budgets and so on). It is possible to assume that the foreign currency flowing into the Ukrainian economy under the guise of direct investments is not being used for the acquisition, creation, expansion or reconstruction of the Ukrainian economy’s fixed assets, but for the generation of working capital. The Ukrainian economy is experiencing a rather pronounced money famine; foreign currency is primarily being used for the acquisition of energy products and raw materials, salaries, the purchase of goods (wholesale and retail) and components (for manufacturing) and so on. Capital construction, the purchase of machinery and equipment, and research and development are of little interest to foreign investors due to their long payback periods and high risks. 

Over the five-year period from 2008-2012, the relative prosperity of the Ukrainian economy was supported by foreign investors who not only drained the country of resources, but also pulled the noose of debt and investment dependency around Ukraine’s neck increasingly tighter. 

At the beginning of 2008, Ukraine’s government debt equalled 12.3 percent of GDP. By the beginning of 2013, Ukraine’s government debt had risen to 38.8 percent of GDP, and by the beginning of next year it could very well reach the 40 percent of GDP mark. According to the latest figures from the Ukrainian Finance Ministry, the country’s total government debt in hryvnia’s equalled 550.2 billion, including internal – 260.6 billion, and external – 289.6 billion. So around 53 percent of Ukraine’s government debt is external debt. 

At the beginning of 2008, the level of Ukraine’s entire foreign debt equalled 56.7 percent of GDP, but by the middle of 2013, the country’s external debt had risen to 75.7 percent of GDP. Table 7 provides the latest figures on the structure of Ukraine’s external debt. As can be seen, nearly three quarters of the total amount of external debt is accounted for by the economy’s non-state sector. 

Table 7.

Ukraine’s external debt and its main elements, on 01.07.2013

 

Billions of dollars

In relation to GDP, %

Share of total external debt, %

Total:

134.4

75.7

100

Public sector

30.4

17.2

26.6

Banks

21.3

12.0

15.9

Other sectors of the economy

82.7

46.6

57.5

* * *

The Ukrainian authorities are urging the public not to worry about the country’s debts. Against countries like Greece, Ukraine is allegedly looking pretty good (you will recall that Greece’s government debt ranges from 160-170 percent of GDP). It should be borne in mind, however, that Ukraine’s investment and credit ratings are inordinately low. Even lower than Greece’s, in fact. This leads to the fact that the interest rates on the debt obligations of the Ukrainian government, as well as Ukrainian companies and organisations, are considerably higher than the average market value. Consequently, debt service expenditure is also incredibly high. 

Analysts from Standard & Poor’s have increased the chance of a Ukrainian default from 34.8 percent in the summer of 2012 to 44.25 percent in the summer of 2013. In February of this year, the Bloomberg agency published its own assessment of a possible default by Ukraine. The probability of a default was defined at the level of «problem» countries like Argentina and Venezuela. 

Following the protests in Kiev in the first few days of December 2013, risk assessments of a Ukrainian default were revised upwards. Quotes for securities called credit default swaps (CDS) are sensitive risk indicators. The higher the quotations (prices) of these market-based instruments of insurance against the risks of default, the higher the risks. And vice versa. Credit default swap quotations for Ukraine were always high, but at the end of November-beginning of December, they immediately shot up by 100 percentage points and reached a value of 1071. What does a quotation like this mean? It means that when purchasing five-year debt securities from the Ukrainian government for USD 10 million, the investor also has to pay another USD 1,071 million for CDS insurance. And that is just the first year. Over five years (the period of time until the security has matured), insurance payments will amount to USD 5.3 million. For the investor, in other words, the security turns out to be more than one and a half times more expensive in comparison to its face value. Only quotations for insurance against default risks in Argentina and Venezuela are higher. For comparison: on 02.12.2013, the CDS quote for Russia was 173.8. According to accepted methodologies, the probability of default in Ukraine within the next five years is estimated to be 53.3 percent. Investors may be getting ready to take steps like only purchasing Ukrainian debt securities on condition of extremely high borrowing costs. Today, the rate of return of government bonds is simply going through the roof. In the first few days after protests began in Kiev, interest rates on the new issues of ten-year Ukrainian bonds denominated in US dollars rose to 10.6 percent. Interest rates on some securities that mature in 2014 have shot up to 19 percent. These are already blatantly extortionate interest rates which mean that Ukraine will have to spend a significant part of its budget on servicing the debts it already has. 

* * *

At the end of 2013, the debt noose around Ukraine’s neck has been pulled as tightly as it can be. According to various estimates, in 2014 Kiev is going to have to pay off between USD 8 billion and USD 10 billion of its external debt. The government does not have the money to pay off that kind of amount, however. After all, the country will still need to service the debts that have not matured. And behind the scenes of our analysis we still have the corporate sector of the Ukrainian economy, in which every second business is essentially bankrupt. The picture of sovereign default therefore needs to be supplemented with the picture of potential mass corporate defaults. 

The declining Ukrainian economy is giving rise to a balance of payments on current accounts leading to an increasing deficit (see Table 8). 

The balance of the Ukrainian balance of payments on current accounts (billions of dollars)

Year

Current accounts

Balance of trade in goods and services

Balance of trade in goods

Balance of trade in services

2000

1.5

1.6

0.8

0.8

2005

2.5

0.7

-1.1

1.8

2008

-12.8

-14.4

-16.1

1.7

2009

-1.7

-2.0

-4.3

2.4

2010

-3.0

-4.0

-8.4

4.4

2011

-10.2

-10.2

-16.3

6.1

2012

-14.3

-14.3

-19.5

5.2

As can be seen from the table above, the balance of payments deficit on current accounts is primarily being caused by the deficit in the balance of trade in goods. The Ukrainian trade balance fell abruptly into a deficit after the country joined the WTO, having opened up its domestic market. At the same time, Ukraine did not gain access to the markets of other countries due to the low competitiveness of its products. The deficit of trade in goods is partially offset by the positive balance of trade in services. A considerable part of the positive balance is due to the payments Ukraine receives for the transit of natural gas and oil. 

The previously low-level of Ukraine’s investment attractiveness, meanwhile, fell sharply following the protests in Kiev at the end of November-beginning of December. Some Western creditors that had previously provided Ukrainian companies with revolving credit facilities (lines of credit) are now starting to ask for the full and final settlement of all loans, while credit lines are closing down. An important indicator of the default that is drawing ever nearer to Ukraine is the fact that foreign capital is starting to leave the Ukrainian banking sector. While its share equalled 41.9 percent on 1 January 2012, by 1 September 2013 this had fallen to 33.8 percent. According to forecasts, it is going to fall below the 30 percent level by the end of the year. There was a report recently that the Austrian bank Raiffeisen International (RBI) had put its Ukrainian subsidiary up for sale – the fourth largest bank in Ukraine.

Two or three years ago, Ukraine’s international reserves showed a healthy growth. While there was USD 26.5 billion in the country’s reserves at the beginning of 2010, by the beginning of 2011 this was already 34.6. At that time, the growth of reserves was not caused by an improvement in the country’s trade balance, but by a considerable influx of foreign capital. In 2011, currency reserves fell to 31.8 billion. Then during the course of 2012, reserves were immediately thinned down by USD 7.3 billion. Their dissolution has even continued into 2013: over the course of 10 months they fell by a further USD 3.9 billion. At the beginning of November, there was just USD 20.6 billion left in the country’s international reserves, which is equivalent to the import of goods for 2.5 months. The National Bank of Ukraine, meanwhile, is continuing to spend the money from its reserves on supporting the falling exchange rate of the hryvnia. According to estimates, the country’s national bank could spent at least USD 2-2.5 billion over the next few months supporting the the hryvnia exchange rate. 

In order to prevent a default, the government urgently needs to find at least USD 10 billion. Talks with the IMF on a new loan reached a stalemate. There is even less chance of getting the money needed from Brussels. The European Union itself is currently in a debt crisis; government debt default could be announced at any moment not just by Greece, but by a number of other countries in the European Union. This would give rise to a domino effect, and Europe would find itself in an even less enviable position than Ukraine. 

*** 

There is still the option of negotiating with Russia. This option logically involves Ukraine’s membership of the Customs Union. It should be remembered that Ukraine’s trade balance deficit is principally formed on the Eastern front. Membership in the Customs Union would enable Kiev to restore its balance of payments and trade. Firstly, through additional customs preferences for the export of Ukrainian goods to the markets of its Eastern neighbours. Secondly, through the preferential prices received by Kiev for natural gas. You will recall that Russia lowered the price to 189 dollars per 1,000 cubic metres for Armenia when it joined the Customs Union. 

It also goes without saying that should Kiev make a U-turn to the East, Moscow would be willing to discuss the issue of providing Ukraine with both banking and commercial loans. This would also include by way of deferring payments on natural gas supplies. Russia is not just Ukraine’s main trade and economic partner; it is also the country’s main creditor. At the end of November, Russian President Vladimir Putin, speaking to reporters, said that the debt on loans issued to Ukrainian banks by Gazprombank, Sberbank, VEB and VTB amounts to a total of USD 20 billion and RUB 280 billion. Furthermore, Russia has made an advance payment for the transit of natural gas through Ukraine until January 2015 to the tune of USD 4 billion. As the Russian president has declared time and again, the Russian Federation is ready to discuss the issue of Ukraine’s membership in the Customs Union and in the Eurasian Economic Union after which, as a member of these unions, the country could be issued with new loans... 

 
Tags: European Union Russia Ukraine US
 

 
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Valentin KATASONOV

D.Sc. (Economics), Economist and the chairman of the S.F. Sharapov Russian Economic Society


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