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Finance Minister Submits Statement of Resignation, "My further service as Ukraine's finance minister makes no sense," Viktor Pynzenyk

U.S.-Ukraine Business Council (USUBC), Washington, DC
Thursday, February 12, 2009

"My further service as Ukraine's finance minister makes no sense."
UkrInform, Kyiv, Ukraine, Thursday, February 12, 2009 

By Timothy Ash, Head of CEEMEA research
Royal Bank of Scotland, London, UK, Thu, February 12, 2009

By Stefan Wagstyl in Kiev, Financial Times, London, UK, Thu, Feb 12 2009

By Timothy Ash, Head of CEEMEA research
Royal Bank of Scotland, London, UK, Wed, February 11, 2009

BYuT Inform Newsletter, Kyiv, Ukraine, Wed, Feb 11, 2009

Analysis & Commentary: By Ivan Lozowy, The Ukraine Insider
Vol. 9, No. 1, Kyiv, Ukraine, Thursday, February 12, 2009

Policy makers continue to face an extremely difficult set of challenges
Timothy Ash, Head of CEEMEA research
Royal Bank of Scotland, London, UK, Wednesday, January 28, 2009

UkrInform, Kyiv, Ukraine, Thursday, February 12, 2009 

KYIV - "My further service as Ukraine's finance minister makes no sense," Viktor Pynzenyk wrote in his statement of resignation submitted to the Verkhovna Rada, the national parliament.

"I have worked in government more than once. I have always adopted a professional position. During my work, I have always abided by such principles as a balanced budget, its minimum deficit ... and non-emission sources of financing the deficit," reads his statement.

"In current conditions, the professional job of finance minister has become a hostage to politics. The finance minister cannot change the situation. Nor can he walk away from his professional actions," Pynzenyk said.

From December 2005 to August 2006, Pynzenyk worked as Ukraine's finance minister in two "orange" governments, one led by Yulia Tymoshenko and another by Yuriy Yekhanurov. On December 18, 2007, he was appointed finance minister in the current government led by Yulia Tymoshenko.

By Timothy Ash, Head of CEEMEA research
Royal Bank of Scotland, London, UK, Thu, February 12, 2009

LONDON - Ukraine’s finance minister Viktor Pynzenyk has tendered his resignation. The news is obviously a blow to the Tymoshenko administration but not entirely unexpected.

Pynzenyk was well regarded (seen as a competent “monetary” economist), and generally seen as been a strong supporter of the IMF’s drive for the government to run a balanced budget in 2009. Incredibly in December Pynzenyk refused to sign the 2009 budget, which was approved by parliament and targeted a deficit of 3% of GDP.

Subsequently a letter reportedly from Pynzenyk to Tymoshenko was published in the local media, in which the former finance ministry stated his objections to the 2009 budget draft.

Pynzenyk stayed on for several months after passage of the budget, presumably, with the objective of trying to keep the budget on track, with the IMF’s requirements. It does seem as though he was managing to curb spending, with public sector employees only getting paid 60-70% of salaries in recent months.

His departure is interesting, given that only this week Tymoshenko had suggested that she was willing to compromise with the IMF, and make budget/macro revisions.

There had been rumours doing the rounds that Pynzenyk would lose his job as part of a wider reshuffle, which would bring in new parties (Regions) into the ruling coalition. This might hence be viewed as a case of Pynzenyk jumping before he was pushed.

Tymoshenko’s ability to fire Pynzenyk though was somewhat limited by the fact that her former finance minister controlled a dozen or more deputies in parliament thought his former “For Reform” faction, which had allied with the Block Yulia Tymoshenko (BYuT) in last parliamentary elections.

Pynzenyk’s departure though is very significant and will force a rethink by Tymoshenko in terms of the structure of the ruling coalition.

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By Stefan Wagstyl in Kiev, Financial Times, London, UK, Thu, Feb 12 2009

KIEV - An economic or political “catastrophe” in Ukraine could trigger a “domino effect” of economic difficulties within the European Union, Austria’s finance minister warned yesterday.

Josef Pröll, who is also the country’s vice chancellor, urged the EU to support Ukraine because of its strategic importance and its political and economic ties with union members.

“Ukraine is a very important keystone country and we must avoid a domino effect inside the EU, if there is economic and political catastrophe in such a huge neighbouring country. There could be a domino effect in terms of economic difficulties in the EU” Mr Pröll told the FT. ”We don’t see this scenario developing now. But we must prepare and keep an eye on Ukraine,” he added.

Mr Pröll was speaking during a trip to eastern Europe made amid mounting international concern about the financial condition of the region’s more vulnerable states.

Ukraine, which like Latvia and Hungary, has secured an emergency International Monetary Fund package, is seeking up to $5bn in extra loans from sources including Russia, the US, the Middle east, Japan and the EU.

Mr Pröll is visiting Ukraine, Croatia, Romania and Bulgaria before a meeting of EU finance ministers early next month where support for vulnerable eastern European states is due to be discussed.

Mr Pröll said that while the EU’s greatest responsibility was for member states, it also had to support candidate members and Ukraine which had no membership perspective but had close links with the EU.

Mr Pröll said he was not calling for wholesale financial support. The International Monetary Fund had to take the lead in giving financial assistance to those states which needed it, he said. But the EU had a range of financial and non-financial instruments available for member states and non-members, including Ukraine.

Mr Pröll pledged Austrian support for its banks, which are among the region’s biggest lenders. Austrian banks which drew on a €100bn government support plan could keep operating in eastern Europe “without restriction”.

Asked about French efforts to link assistance to French carmakers to safeguarding French jobs, which has caused alarm in eastern Europe's carmaking nations Mr Pröll said: protectionism is not the right answer.”

“If we look to the last crisis 80 years ago where one country tried to pass its problems to another country and so on, they did not solve their problems. We can only be successful if work together and keep open the economy,” said Mr Pröll.

Mr Pröll added that western Europe had a particular responsibility to eastern Europe. ”We have made a lot of money in these countries in the last 20 years and now in this crisis we must support them in these difficult times.”

Hryhoriy Nemyria, Ukraine’s deputy prime minister, said Kiev’s bids for extra loans on top of its IMF package were a ”usual and natural” way of complementing IMF aid.


By Timothy Ash, Head of CEEMEA research
Royal Bank of Scotland, London, UK, Wed, February 11, 2009

LONDON - A couple of noteworthy developments in Ukraine today:

[1] PM Tymoshenko is making decidedly dovish comments with respect to prospects for further cooperation with the IMF.

Remember last week the IMF mission departed Kiev, having failed to complete the first review under the US$16.5bn Stand-by arrangement. The key sticking point appeared to be Tymoshenko’s unwillingness to adjust macro assumptions, and indeed the budget to reflect the much more difficult global economic environment.

The government had agreed in the original IMF agreement last October to run a balanced budget in 2009. Subsequently parliament passed a budget planning
for a deficit of 3% of GDP in 2009, and built on the assumption of 0.4% real GDP growth. Now in the context of larger deficits being run globally, as
public sectors are stress-tested by banking sector bail-outs and declining GDP/low inflation, the above may not have appeared that unreasonable.

The Fund, however, appear to have been eager for the government to at least set more realistic macro assumptions. The IMF programme assumes a real GDP contraction of 3% in 2009, and even this looks way too optimistic now, with a likely fall in GDP of 5-7% appearing likely.

Tymoshenko’s comments come after a meeting with G7 ambassadors in Kiev. Note this was G7, and not G8, i.e. Russia’s ambassador was not present. Only last week Tymoshenko had suggested that negotiations were on-going with Russia for receipt of a US$5bn financing facility. She also indicated that she had
also appealed for support from the US, China, the EU and Japan.

Presumably the hope was that in showing that Ukraine had other options, e.g. resort to Russia for funding, it might persuade G7/IMF to be more lenient;
the choice for G7 was hence if it wanted Ukraine to move back into Russia’s orbit or to retain its current euro-Atlantic orientation. Tymoshenko also
asked for US$5bn in financing from the G7.

Net-net, Tymoshenko’s apparent willingness to compromise with the IMF is a credit positive. It suggests the IMF may be able to return to Kiev in the
near future and this could allow the early disbursement of the next credit tranche of US$1.86bn.

[2] The Stats Agency reported merchandise trade data for December, and indeed for the full year in 2008.

For the full year the outturn was as expected with the deficit increasing to US$18.5bn, from US$11.3bn one year earlier. Herein exports rose by 35.9%
YOY, but were outpaced by a 41.1% increase in imports. Clearly the above reflects one of the underlying problems which drove Ukraine’s external
financing crisis in 2008, forced the devaluation of the UAH, and the government’s resort to IMF funding.

However, the December data does suggest that an adjustment is underway, with the devaluation and indeed deflation in domestic demand as credit/monetary
aggregates slow, heavily impacting on import demand. Herein imports in December contracted by 28% YOY, more than making up for the 17.6% YOY
contraction in exports (as metals export prices and volumes were down significantly YOY).

Thus, the monthly deficit actually slowed to just US$819m, a 15-month low and just 45% of the year earlier level. Assuming these trends broadly remain
unchanged into 2009; a not unrealistic assumption on both counts, would suggest the deficit on merchandise trade could fall by as much as US$10bn.

In terms of the current account position, this might then cut the deficit from US$12bn in 2008, to US$2-3bn in 2009, infinitely more sustainable and
financeable, given that net FDI is still likely to come in at US$4-5bn.


BYuT Inform Newsletter, Kyiv, Ukraine, Wed, Feb 11, 2009
KYIV 0 The government of Prime Minister Yulia Tymoshenko has survived a vote of no-confidence by lawmakers in Ukraine’s 450-seat Verkhovna Rada (parliament). Failure of the motion prevents another challenge during this session of parliament and enhances prospects for political stability.

The vote came after the premier reported on the economy and precedes a cabinet reshuffle to be announced this week. The latter will shore up cabinet unity and provide an infusion of talent to help combat the severe economic downturn.
Last Thursday’s vote of no-confidence served only to vindicate the government of Ms Tymoshenko. The motion, put forward by the opposition Party of Regions of ex-premier Viktor Yanukovych, secured 203 votes, falling well short of the 226 needed. On closer scrutiny the number of legitimate votes for the motion was only 200 as three absent lawmakers had their cards used by other lawmakers.
A pleased Ms Tymoshenko said, "I can only say that instead of a vote of no confidence in the government, a vote of confidence in the government was passed."
Voting for the motion were 172 lawmakers from the Party of Regions, 21 from the Communist Party and 10 from the Our Ukraine-People’s Self-Defence Bloc (OU-PSD). Despite President Yushchenko’s efforts to lobby OU-PSD’s 72 lawmakers, only the loyalists of the United Centre party (the party of Viktor Baloha, Chief of the Presidential Secretariat) heeded his advice.
“It all goes to prove that the president has lost the control and respect of his faction,” said Dr Taras Kuzio, editor of Ukraine Analyst, and Adjunct Professor at Carleton University, Ottawa.
Ms Tymoshenko, although pleased with the outcome, was well aware of the political downside to remaining in office to fight the recession. She said, “None of these brave opposition members dare to head up the government and take up ministerial positions for fear of damaging their popularity ratings.” Then talking about her position: "I understand quite well that the prime minister's post is not appealing, because this is a very hard, responsible and thankless task.”
Political Stability
Only one no-confidence vote is permitted in each parliamentary session, meaning there can be no repeat vote until the autumn session. Even then, such a prospect is highly unlikely as the country will be in the throes of a presidential election campaign. This should grant Ukraine a period of relative political stability which should help the government’s anti-crisis measures to take effect.
Volodymyr Fesenko of the Penta think tank, was quoted by Reuters as saying that the vote "will allow Tymoshenko to work quietly for a time and protect her against rearguard attacks from parliament. She still faces some strategic risks, but these are linked not so much to politics as to the social and economic crisis."
Charting a Course Through the Downturn
Charting a way through the severe downturn is a daunting task. Ukraine’s economy has been battered by a dramatic drop in the demand for steel, chemicals and other commodities. Industrial production fell by 26 percent in December year-on-year. Compounding this, bank liquidity issues, a lack of foreign capital and currency woes paint a bleak picture for 2009.
GDP dropped by 14.4 percent in November 2008 and by 9.9 percent in December 2008 year-on-year. Overall, GDP growth slowed down to 2.1 percent in 2008 from 7.6 percent in 2007.
Despite this, Ms Tymoshenko’s government predicts GDP growth at 0.4 percent this year – a forecast at odds with the International Monetary Fund (IMF), which predicts a contraction of 5 percent.
Ms Tymoshenko underlined the point that negative sentiment is also driving down economic forecasts. “It is simply too easy to become reconciled to a fall. I believe Ukraine is strong, with resources and reserves and if the proper actions are taken at this difficult time, we can achieve this indicator as planned," she said.
Although inflation in 2008 was 22.3 percent, the Ministry of Finance has forecast an inflation rate of 9.5 percent in 2009, subject to movements in the hryvnia.
“The forecast is based on producer price indexes which have dropped considerably,” said Ms Tymoshenko “All conditions are there for a decline in consumer prices, but we cannot achieve that unless the hryvnia/dollar rate is settled.”
The hryvnia has come under immense pressure and lost a third of its value since the summer.
Frequent intervention from the National Bank of Ukraine is keeping the lid on exchange rates but at the expense of foreign currency reserves. On Friday the hryvnia closed at 7.705 to the dollar, which is an improvement over a low of nearly 10 to the dollar last December.
Cabinet Reshuffle
The government plans to step up measures to tackle the economic crisis and a cabinet reshuffle is imminent. The reshuffle will strengthen the loyalty of ministers and bring new talent into the cabinet.
“To overcome this economic crisis we must raise the level of efficiency and professionalism in the cabinet,” said Ms Tymoshenko, “we need a cabinet that is unified and pulling in the right direction. The new ministers will be announced very soon.”


Analysis & Commentary: By Ivan Lozowy, The Ukraine Insider
Vol. 9, No. 1, Kyiv, Ukraine, Thursday, February 12, 2009


Ukraine's economic crisis is moving from bad to worse quickly and is set to deepen seriously during the coming 3-6 months.

Because of falling GDP the government has been casting about wildly for additional sources of revenue. The ranks of the unemployed have swelled to
2 million people, government employees have had their salaries cut to the bone and students are not receiving their miserly government subsidies.

Misguided government initiatives aimed at raising revenues have backfired and within two months Prime Minister Yulia Tymoshenko has provoked three
strikes, by truckers, small individual entrepreneurs and automobile owners. At first Tymoshenko dismissed the automobile strikers as an insignificant
group of malcontents. But as the number of strikers and cities encompassed by the strike spread quickly, Tymoshenko did an about-face and acceded to
most of their demands.

Tymoshenko's political base, the Block of Yulia Tymoshenko (ByuT) has trumpeted Ukraine's readiness to receive the next tranche of a $16.4 billion dollar loan from the IMF. The reality, however, is that the IMF has been shocked by the sad state of Ukraine's finances and the next tranche is simply not on its way.

Worst of all, the widespread practice of taking in taxes in advance has been stretched to its limits. Companies across Ukraine have bowed to requests by their local tax service to pay advances through March. But these companies are now off the hook at least until March and will spend the meantime hiding their profits very carefully.

All this means that for the coming two months, as the economy gets much worse, the government has practically no recourse for raising revenues.

Small wonder that Tymoshenko has gone to the extraordinary and humiliating lengths of asking Russia for a $5 billion dollar loan.

In desperation Tymoshenko's government has now also turned to privatization, but this avenue is fraught with risks since current prices for such state giants as the land-line monopolist Ukrtelecom are low and falling.

Tymoshenko's own Minister of Finance, Viktor Pynzenyk, refused to sign the 2009 state budget proposal, which was wildly unrealistic. This budget foresaw just over 9% annual inflation for 2009, whereas the inflation rate for January alone was close to 3%.

Pynzenyk, who wrote a memo on January 6 to Tymoshenko forecasting disaster, including calling an estimated GDP drop in 2009 of 5% as "overly optimistic," has now submitted his resignation.

True to form, Tymoshenko is in denial and publicly claims the crisis will recede by May.

Meantime, Tymoshenko's right-hand man, Vice Prime Minister Oleksandr Turchinov, has let the cat out of the bag. Participating in a meeting of the country's top police officials on February 6 Turchinov said that the current "chaos" is "impossible to stop without strong state power."

Turchinov went on to add that "using this opportunity when there is no one from outside our coalition present in this hall, with full responsibility, I declare to you that we are close to a tragedy and in a condition of military [sic] actions." These expressions have sent some analysts into a hissy-fit, screaming about an impending dictatorship.

For his part, President Viktor Yushchenko has been busy defending the single person most responsible for the deepening crisis, Wolodymyr Stelmakh, Chairman of Ukraine's central bank, the National Bank of Ukraine (NBU).

Last fall Stelmakh and the NBU provided re-financing to 97 Ukrainian banks to the tune of 40.275 billion UAH (about $6.7 billion USD at the time). Then the NBU sold $6.06 billion in US dollars to these same banks. This sent the national currency, the hryvnia, into a steep downward spiral and the hryvnia is now at about half its value compared to Western currencies from half a year ago.

In the past, endemic corruption has robbed the state treasury, but Stelmakh's machinations not only robbed the treasury, these funds were used to make the life of ordinary Ukrainians miserable by deflating their real incomes due to the drop in the hryvnia's worth.

Not surprisingly, Tymoshenko has spoken publicly and loudly of the NBU's misguided policies, accusing the Bank of channeling funds to select banks.
One outrageous example is the NUB's lending 7.1 billion UAH to Bank Nadra, which is controlled by the Ukrainian oligarch Dmytro Firtash, of RosUkrEnergo fame.

But even public exposure of Stelmakh's dealings have not shaken him from his post. Yushchenko has defended Stelmakh by mumbling on about "leaving
the NBU in peace" and "there is no tragedy here."

On January 26 parliament voted to oust Stelmakh. Yushchenko has appealed this decision to the Constitutional Court.

Small wonder that Tymoshenko responded by accusing Yushchenko himself of trying to embezzle 4.55 billion UAH through the NBU's re-financing

Events over the past several months have left most Ukrainians wondering what planet their political leaders inhabit.

Small wonder that the most popular among a recent Internet poll of questions for President Yushchenko was: "How much do we have to pay you, esteemed Mr. President, for you and all the deputies in parliament, all the ministers and government officials to leave Ukraine forever and stop interfering with its normal development?"


The country's main opposition force, Viktor Yanukovych's Party of Regions (PoR), appears to be undergoing a thus-far minor implosion.

Two top associates of Yanukovych, Serhiy Lyovochkin and Yuriy Boyko, have been accused of betraying the party's interests and, in particular, of
screwing up a February 5 vote of no confidence in Tymoshenko's government, which garnered only 203 out of the 226 votes needed.

Lyovochkin responded by accusing his opponents of preparing to "hand over" the Party or Regions to BYut and Tymoshenko.

Boyko is a participant in RosUkrEnergo and a close associate of Firtash's. This public internecine bickering is a first for the PoR and a sign of how Firtash's money has destabilized what until now has been a monolithic party held together tightly in the hands of Ukraine's richest oligarch, Rinat Akhmetov. Akhmetov's henchmen, such as Boris Kolesnikov, are leading the uprising against Lyovochkin and Boyko.

It is understandably difficult for a group such as the Party of Regions, accustomed to being in power, to spend an extended period of time out in the cold. Look for continued destabilization within the PoR.  [In the following issue: after effects of the gas crisis]

THE UKRAINE INSIDER - is distributed via the Internet free of charge to all interested parties as a source of in-depth information on political events
in Ukraine, including behind-the-scenes coverage of significant current issues, the positions of policy-makers, tactics and strategy information on Ukraine's ongoing struggle toward a free and democratic society. Correspondence should be addressed via the Internet to: lozowy@i.com.ua

Policy makers continue to face an extremely difficult set of challenges

Timothy Ash, Head of CEEMEA research
Royal Bank of Scotland, London, UK, Wednesday, January 28, 2009

LONDON - We visited Ukraine between January 25 and January 27, meeting with government and central bank officials, representatives of IFIs, local banks and corporates and members of the local business community.

SUMMARY VIEW: Policy makers continue to face an extremely difficult set of challenges, but unfortunately still appear more focused on settling past scores than focusing on the need for decisive policy action. With 5Y CDS trading at over 3,000bps the question though is are all the negatives now being priced in or will all this eventually lead to a system-wide default scenario extending to the sovereign. We remain somewhat more constructive on the risks of a sovereign default, albeit accept that short term news flow could well continue to have a negative bias.

There does though appear to be evidence of improving trends on the current account of the balance of payments, reflecting the impact of the weaker currency and the lack of financing impacting heavily on imports. The slowing economy and the need to recapitalise failing banks does though shift more of the pressures onto the budget and raises questions over budget financing.

Official financing remains critical and policy makers do need to act quickly to bring the IMF SBA agreed in the fall back on track. A speedy appointment of a new bank governor, and approval by February 5 of a new bank restructuring programme would obviously send positive signals for the market.

•    There was widespread unease over the Tymoshenko-Yushchenko scrap which is increasingly personalised and is acting as a distraction for policy-makers, e.g. as reflected most recently efforts to dismiss the incumbent governor of the NBU, Stelmakh.

•    One possible solution to the above was talk of the formation of a grand coalition, which might see Regions of Ukraine join the coalition and could see changes in the economy/finance portfolios. This would perhaps be a positive as it would offer the chance of more decisive action to address the underlying economic problems.

     Note though that we have lost count of the number of occasions that we have heard similar rumours in recent years of this Grand Coalition, albeit they have all ended in failure. We did though hear these suggestions from people close to BYuT, Regions and Yushchenko which perhaps suggests a higher probability of such an outcome this time around.

•    Stelmakh’s fate appears uncertain. Yushchenko has challenged the decision to sack Stelmakh in the constitutional court. Stelmakh is on sick leave and is thought unlikely to return. There was talk of a compromise candidate being appointed, with names doing the rounds, including former speaker of parliament, Yatseniuk, a former governor Tyhipko, Yushchenko’s chief economic adviser (Shlapak) and even the head of the council of the NBU, Petro Poroshenko. Parliament failed to approve a motion annulling the decree dismissing Tyhipko, which would suggest that that he will struggle to win parliamentary approval.

     Shlapak has gone out of his way in recent weeks to criticise government action over the budget and indeed the gas price agreement so it is difficult to see him winning parliamentary approval. Yatseniuk, a former vice governor of the NBU, would appear as the most likely “compromise” candidate, and has stellar reform credentials having been instrumental to securing parliamentary approval for key IMF-related reforms in the fall. Yushchenko nominates the governor of the NBU, subject to approval by parliament.

     The fear is thus that given the state of relations between Tymoshenko and Yushchenko the matter could drag on, undermining the standing of the NBU itself; which arguably has already been damaged greatly in recently weeks over the management of exchange rate policy and on the back of various allegations lodged against its officers. No one would doubt that the NBU is in need of urgent reform, albeit the key question is whether this should be undertaken at the height of a crisis.

•    The economy is being heavily impacted by the decline in steel prices, with real GDP expected to contract by 5-10% YOY in 2009, a marked turnaround on the trend 6-7% growth recorded in recent years; albeit the economy grew by just 1.6% YOY in 2008 as the credit crunch hit in the last quarter of the year with double digit contractions in GDP.

     There was some evidence of a recovery in steel exports over the past 4-6 weeks, on the back of increased sales to China, but it is uncertain whether this could continue. Note that the down in output in October – November may have been exaggerated by the near complete collapse of trade; steel producers told us that it was near impossible to secure letters of credit in the immediate aftermath of the collapse of Lehman.

•    The gas price agreement reached earlier this month with Moscow is seen as a positive, for 2009, as it suggests a broadly flat impact on gas import costs: the higher import price (US$228 per 1,000 cu metres assumed for 2009) will be offset by much reduced import volumes (40 billion cu metres, down from 52 billion in 2008), due to use of gas in storage and also reduced gas consumption given the on-going decline in the economy, and particularly on heavy industry.

     There seemed some optimism that the above deal could provide the basis for some normalisation in the gas-supply relationship with Moscow: at least Rosukrenergo is out of the equation and there is clear path now to market prices for gas imports and indeed transit fees. The big debate on-going now rests with the need to hike domestic gas prices so as to help ease the financial burden on Naftogaz. The government is considering measures which will significantly hike household and municipal heating prices over the next year, with increases beginning over the next few months.

•    The budget is appearing as an increasing concern, given a massive (one fifth) drop in revenues as economic activity slows; as import demand, and trade overall has collapsed, customs dues have fallen rapidly. Given limited financing options the MOF seems to be responding by drastically cutting spending; we heard that civil servants are only getting 60% of their salaries, and government officials are being asked to identify cuts in their departments. There was concern that, given the election cycle, the government might run a bloated budget, pressing the NBU to fund this via new un-backed monetary emission, i.e. by printing money.

     The NBU is legally prohibited from doing this by law, but obviously given pressure for personnel changes at the bank, and other legislative efforts deemed to be limiting the NBU’s independence (e.g. a new law giving the MOF oversight over NBU financing of banks) the concern was commonly expressed. Note that Finance minister Pynzenyk failed to sign off on the 2009 budget deficit (of 3%) and he seems to be fighting a lonely battle at the MOF to keep the budget balanced.

•    MOF external financing needs are limited in 2009, and could be significantly met by official financing; e.g. the World Bank might disburse in excess of US$1.2 billion in 2009 in funds which could meet shortfalls in budget financing.

•    The current account deficit is expected to narrow significantly, and we even heard the view expressed that it could post a surplus in 2009. Import demand has collapsed, reflecting the 50% drop in the value of the UAH and a dearth in credit/financing; imports are running around 50% lower YOY now. Excluding payments by Naftogas for imported gas, the merchandise trade account might have moved into surplus in December.

     Net-FDI is likely to cover the CAD in 2009, albeit it will still slow considerably on the annual US$10bn+ total received in 2008; a figure of US$4-5 billion was more likely. On the export side, the bumper grain harvest in 2008 will boost exports of agricultural produce in H1 2009. On the capital account, debt amortisations falling due are likely to be covered via a combination of foreign bank roll-overs, local oligarchs drawing down overseas assets, inevitably some restructuring of private sector liabilities, along with a draw down of FX reserves/resort to official financing.

•    Note that the report carried in the FT some weeks back reporting that foreign debt restructuring advisers had been appointed did not seem to be widely known/understood locally; the advisers appear to be adopting a low profile if our discussions were anything to go by.

     On the sovereign side, ability to pay remains strong in our view, with the key risk being that willingness to pay could dwindle as part of a global decline in default/restructuring stories. The question which policy makers will perhaps begin to ask is what is the downside from restructuring when Ukraine is likely to be locked out of capital markets in almost any scenario now for the next 1-2 years.

     Herein, and somewhat going back on trends in recent years we think that official creditors are likely to argue strongly against “bailing-in” private sector creditors given that arguably the key global challenge for policy makers now is to kick-start private sector lending. Given the minimal weight of sovereign external liabilities (likely less than US$3 billion in 2009 including quasi sovereigns) the benefit in terms of debt sustainability will be minimal, but perhaps the longer term consequences, both for the sovereign and more importantly private sector borrowers will be more significant.

•    The key risk on the BOP and the currency remains capital flight, as problems in the banking sector mount, risking a flight of deposits. The NBU still has close to US$30bn in FX reserves, but even this amount will not be sufficient if the existing run on bank deposits accelerates.

•    Problems in the banking sector are mounting, as asset quality deteriorates rapidly and banks suffer a continued flight of deposits. On this latter note we heard different figures with one source suggesting stability over the past 4-6 weeks, and another very credible “official” source suggesting continued hefty flight (up to UAH60 billion lost from the end of November). There does appear to have been a flight to quality as better (perhaps foreign-owned banks) see deposit inflows at the expense of their local counterparts.

     NPLs could rise to well in excess of 15-20%, and obviously this increases the cost of bank recapitalisation. The IMF-bank restructuring programme is progressing, but slowly, with the diagnostic test on the 17 top systemically important banks having been completed. The purchase of Prominvestbank by VEB appears encouraging, as it shows continued foreign interest in assets in the banking sector; Russian entities now control 23% of the sector. Other local oligarchs appear to be struggling to raise cash to purchase banks which have fallen under NBU administration, e.g. Nadra.

•    The IMF mission was in town during our own visit and we were not able to meet team members; the mission appears to be trying to keep a low profile and get on with the job in hand. In any event the mission has only just begun so it is difficult to assess the likely outcome; note that there has been much speculation that the May credit tranche disbursement will be delayed.

     The obvious question is how much slack the IMF is likely to cut the Ukrainian authorities; given the much lighter conditionality attached to recent IMF programmes across the region. Our sense is that the programme is reasonably on track with respect to banking sector restructuring (parliament is due to vote on the bank restructuring bill on February 5, 2009), but there are obvious question marks over exchange rate policy and fiscal policy (note the 3% deficit target in the 2009 budget against the earlier balanced budget commitment made in the programme).

Given the lengthy duration of the IMF stay (2-3 weeks) our sense is that the Ukrainian authorities can still act to rectify problems and bring the programme back on track; experience from the last mission suggests that politicians/policy makers in Ukraine tend to do things at the last minute, when over a barrel.

We did hear concerns expressed that the Ukrainian authorities are too blaise over the prospect of getting the next IMF disbursement; assuming that Western allies would pressurise the IMF to be more lenient, eager to support Ukraine against the growing assertiveness of Russia. No doubt the Fund would deny this but it is a concern that this is a view being expressed in Kiev, and may undermine the willingness to take key action to bring the programme back on track.