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Election matters as Ukraine's economy is facing huge challenges

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These elections do matter as they come at a time when Ukraine's economy is facing huge challenges
Analysis & Commentary: By Timothy Ash, SBS, GBM
Royal Bank of Scotland (RBS), London, UK, Thu, Jan 14, 2010

Sunday's elections will pose the same old politicians when investors just want a stable economy. 
By Parmy Olson, Forbes, New York, NY, Fri, Jan 15, 2010

Viktor Yanukovych and Yulia Tymoshenko will likely face off in second round
By Polya Lesova, Reporter, MarketWatch, Frankfurt, Germany, Thu, Jan 14, 2010

By Stefan Wagstyl, Financial Times, London, UK, Wed, Jan 13 2010

By Stefan Wagstyl and Roman Oleachyk, Financial Times
London, UK, Friday, January 15 2010

Analysis, Mar'yan Zablotskyy, Analyst, Ernst Ukraine Research
Ernst Bank Group, Kyiv, Ukraine, Wed, Jan 13, 2010
By Stefan Wagstyl and Roman Olearchyk, Financial Times, London, UK, Jan 6 2010

Presidential elections could usher in political stability and give the dismal economy a chance to grow again 
By James M. Gomez and Daryna Krasnolutska, Bloomberg News Reporters
Business Week, New York, New York, Fri, January 15, 2010

Royal Bank of Scotland (RBS), London, UK, Thu, Jan 14, 2010

LONDON --- These elections do matter...

Ukraine goes to the polls on January 17 2010 in presidential elections which look set to be key in shaping the country's future direction and more immediately its ability to quickly bounce back from the global credit crunch which has had a devastating impact on the economy.

...as they come at a time when the economy is facing huge challenges...

To summarise the economy's performance over the past year or so, and
therein the challenges facing the victor in Sunday's vote we would highlight:

(-) [1] As the global credit crunch hit from the summer of 2008, Ukraine saw key export markets (metals account for 40% of exports) collapse. Thus, exports by dollar value for the period January through October 2009 were down by close to 50% YOY. As a result of the shock from the loss of exports (volumes and prices were significantly lower), from peak to trough real GDP has probably declined by around 20%, with industrial output falling by around one-third over this same period.

(-) [2] Faced by a wide current account deficit, and a weight of external debt amortisations in 2009 (estimated at US$30-40bn), the UAH was "allowed" to weaken from an average of UAH5.26:US$1 in 2008, to an average of around UAH8:US$1 for the full year in 2009, and it remains around this level at present.

       The external financing gap was further closed over the course of 2009 through the deflation in domestic demand (as reflected in the sharp real GDP contraction noted above) which saw imports by dollar value fall by 54% YOY over the first 10 months of 2009, restructuring of some private sector external liabilities (e.g. the Naftogaz restructuring) at the margin, and a draw down of perhaps as much as US$15bn in official NBU reserves, or close to one-third accepting for IMF disbursements.

       For the full year in 2009 the current account deficit probably came in at just 1-2% of GDP, down from 6-7% of GDP in 2008, and was fully covered from net FDI (perhaps amounting to 2-3% of GDP).

(-) [3] The banking sector saw both the erosion of its deposit/funding base, and a marked and very significant deterioration in the quality of its asset base. Perhaps as much as one-third of deposits were drawn down through the crisis, while NPLs have risen to an excess of 30%, i.e. amongst the highest in the region (perhaps bar Kazakhstan). Banks' capital bases were as a result rapidly eroded.

       Encouragingly, foreign banks (perhaps now 50% of the sector by assets) have generally proved willing to recapitalise/refinance their local subsidiary operations in Ukraine, but the Ukrainian authorities were forced to fund the recapitalisation of many domestically owned banks (local oligarchs appeared more willing to fall back on state support, when push came to shove), at a significant cost (perhaps UAH50bn, or the equivalent of around 8% of GDP) to the public sector balance sheet, albeit assisted by IMF/WB funding programmes agreed in 2008.

(-) [4] From running small budget deficits for the period 2005-2008 (~2% of GDP), the budget deficit rose in 2008 through 2009, reaching an estimated 8-9% of GDP for the full year in 2009. With the IMF programme in effect suspended late in 2009, and with the government facing limited funding options arrears (e.g. for public sector wages) are thought to have been built later in the year.

       The deficit in 2009 was also augmented by the quasi-fiscal deficit from subsidies in effect paid to the state-owned gas transit company, Naftogaz, to cover the shortfall between gas import prices (~ US$250 per 1,000 cu metres) and domestic prices (~ US$150 per 1,000 cu metres on average).

(+/-) [1] As noted above, as a result of the crisis, Ukraine was forced to conclude an emergency IMF SBA for US$16.4bn in November 2008; of which some two thirds had been drawn to date.

..but light is just appearing at the end of the tunnel

Despite the developments noted above, we would argue that Ukraine's position is far from forlorn, and there is a chance of a significant bounce in 2010, albeit it crucially depends now on a stabilisation in the domestic political scene, the speedy resumption of IMF lending and for the government to push forward with key reforms, for example the privatisation of a number of key strategic assets remaining in state ownership, gas price liberalisation/reform, and broader reform of public finances, plus the completion of the bank reform/restructuring process.

Positives for 2010 which we would highlight include:

(+) [1] The depth of the downturn in 2009 has created a low base period effect which should act to spur something of a recovery; real GDP growth of 2-3% in 2010 is now statistically quite probable. Meanwhile, the recovery in global commodity prices, particularly metals, is already bringing some improvement on the ground, as reflected in MOM growth in industrial output from mid-year, and finally YOY growth in merchandise exports of around 7% YOY in November 2009; albeit admittedly from a low base.

(+) [2] As noted above the balance of payments has been squared or "balanced" and the UAH no longer appears over-valued, indeed on a number of measures it is arguably "cheap". The NBU, meanwhile, still has US$27bn in FX reserves - true, down from US$38bn at their peak in 2008, but nonetheless, providing 5-6 months of import cover (albeit somewhat artificially bolstered by the collapse in imports).

(+) [3] Problems in the banking sector are being worked through, with the support of foreign banks/IFIs. Russian interest in the sector is strong, and we expect substantial efforts by Russian banks to secure further market share in the Ukrainian market after the elections; they probably already have a good 15-20% market share.

       This will help in the recapitalisation of the sector, helping share the burden from the state; the plus still is that the sector is still relatively small, banking assets/GDP of ~ 70-80%, which will act to cap the size of the contingent liability on the sovereign.

(+) [4] N While the fiscal deficit is wide, the public sector debt/GDP ratio is still modest by regional comparisons, i.e. ~ 35-40% of GDP, albeit rising fast. Given that the nominal FX depreciation of the UAH, and the marked real GDP contraction, US$ GDP is much reduced, hence the actual numbers in terms of the size of the deficit are not large, and could be filled via a combination of official financing, and some bigger ticket privatisations.

       On the debt service front, public sector external liabilities falling due are modest (several billion US dollars at most) for 2010, and the risk of default is over-stated in our view, at least for 2010.

(+) [5] Relations with Ukraine's key trading partner, Russia, have improved markedly over the course of the Tymoshenko premiership. The gas price agreement reached in January 2009, which moved gas pricing/imports to market prices from 2010, with monthly payment for gas deliveries, has done much to help simplify/clarify the relationship (taking much of the politics out of the gas price issue), reducing scope for dispute. Moscow increasingly sees the incumbent prime minister, and her supporters, as people with which it, and Russian business, can do business with.

(+) [6] The West remains supportive of Ukraine. Evidence of this is provided, in our view, by the generally (some would say remarkably) constructive stance of the IMF in terms of its relations with Ukraine. Indeed, the IMF has shown remarkable flexibility with Ukraine through 2009, cutting the government slack over delayed domestic gas price liberalisation (gas prices were scheduled, under the SBA, to be hiked in September and October), and latterly by increasing the floor on NIRs to allow the NBU to help cover the December monthly gas import bill to Russia.

       Where the Fund was unable to compromise was on parliament's decision to hike pensions/wages by 20%, a move which (if implemented by the government) would have blown a huge hole in budget financing. What is clear though is that the Fund is eager to return to Ukraine, and get the existing programme back on track as soon as possible after the presidential elections.

        Ukraine's strategic position as a key energy transit route to Europe seems to be key in shaping the more constructive/supportive stance of the IMF and other official/bilateral creditors towards Ukraine.

(+) [7] Ukraine remains a large, important economy in a strategic location in Europe. With 48 million people it provides a large domestic market, a huge industrial/manufacturing base, it is a key transit route for energy supplies to Europe, and historically its black earth lands were the bread basket of Europe; the agricultural sector has huge albeit massively under-utilised resources.

     As a result Ukraine should continue to attract significant interest from strategic and direct investors; its potential remains huge as a market, a transit hub and as a manufacturing base, food/agricultural supplier, in its own right.

From a wide field, only half a dozen contenders are in the game...

Eighteen candidates are registered to run in the presidential election, with election by universal suffrage. Of these only perhaps half a dozen or so have potential to shape the domestic political landscape beyond the presidential poll. Note that in the 1994 presidential election, Leonid Kuchma came from relative obscurity and a lowly standing in the run up to the polls, to take the presidency, but we do not expect a surprise this time around.

[1] Victor Yushchenko, the incumbent president. He rose to international fame/acclaim during the Orange revolution around the 2004/05 presidential election. While initially seen as the great hope for Ukraine, he has generally failed to live up to expectations, and is currently languishing in opinion polls, with a low single digit rating. Indeed, he has virtually no chance of getting into the second round of the presidential vote and therefore of securing a second term in office.

As a result, his game plan at present seems to be to try and secure a sufficiently large share of the vote to put him in a position of being something of a king-maker, perhaps then forcing early parliamentary elections to take a position in parliament for himself and then to re-emerge perhaps as leader and prime minister in a new coalition government.

There has been speculation in the local media of a back-room deal being cut between Yushchenko and Regions of Ukraine (see below) which in the event of a victory by Viktor Yanukovych (Regions' candidate) in the presidential election would see Yushchenko leading a new coalition government as prime minister. We think that this is unlikely in practice (and likely very negatively received by the market), largely as Yushchenko now has few supporters either inside or indeed outside of Ukraine.

More particularly Yushchenko has greatly irked Russia over a vast range of issues (e.g. Georgia, NATO enlargement, gas supply, language rights, and responsibility for Holodomor, the famine of 1932/33 which saw the death of millions of Ukrainians, and indeed Russians, which was largely the result of Stalin's Kulakisation drive); that he is now Moscow's arch nemesis/enemy.

Meanwhile, Yushchenko's star has also waned in the West, as his inability to work with PM Tymoshenko, and indeed some would say obsession with keeping her from the presidency, has been seen as a major driver of political instability in Ukraine. If anything, the challenge is managing a smooth transition from the Yushchenko era.

[2] Yulia Tymoshenko, the prime minister, and former ally of Yushchenko during the Orange Revolution but who is now his arch nemesis/rival. Tymoshenko is eager to be seen as the true inheritor of the "spirit" of the Orange revolution, after Yushchenko's own fall from grace. Amongst the former leaders of the Orange she is best ranked in opinion polls, albeit lagging the front-running, Viktor Yanukovych.

Tymoshenko currently polls in the mid-teens, a good ten percentage points behind Yanukovych. Tymoshenko is though an electoral machine, highly charismatic, attracting extremes of opinion: you either love her or hate her.

She also enjoys support across Ukraine, something which cannot be said of any of the main candidates, with Yanukovych's support tending to be concentrated in Eastern Ukraine, amongst ethnic Russians. Tymoshenko has worked hard to canvass support throughout Ukraine and has a well honed and financed campaign organisation.

While her popular appeal has perhaps been reigned-in by her position as prime minister managing the economy through the worse crisis to have hit the country, since the mid-1990s, her big advantage this time is that she is seen as the best (or by some, least worse) candidate by Russia, the EU and even the US.

During her second stint as prime minister (she was forced from office in the first Orange administration by President Yushchenko in 2005) she has proven extremely pragmatic, particularly in terms of the seeking to normalise the key relationship with Russia.

Moscow sees her as someone with whom they can do business, and is seen as being relatively open to Russian (and indeed international) capital investment into Ukraine, perhaps in contrast with Yanukovych and Regions of Ukraine.

At the same time, Tymoshenko is keen to promote Ukraine's European democratisation/reform agenda, and for this she has won plaudits in the West. Meanwhile, her willingness to go the extra mile to keep the IMF programme on track in late 2009, e.g. going against parliament and seeking to block wage/pension hikes late in 2009 has begun to show that she is more than simply a populist icon.

She has the ability to be the game-changer for Ukraine, and very much sees herself as the Margaret Thatcher of Ukrainian politics. Whether she can live up to the billing is another matter.

[3] Viktor Yanukovych, the former prime minister and defeated candidate in the re-run 2004 election, who is currently leading in the polls with a mid-20s rating. Yanukovych leads the Regions of Ukraine (RU) party, the largest party in parliament, whose electoral base lies amongst ethnic-Russians in Eastern Ukraine. Yanukovych has proven to be a survivor, and a capable political operator, jettisoning accusations that he was just a front for other oligarchic leaders within RU, and emerging as something of his own man.

Yanukovych and RU have tended to sell themselves as the pro-Russian party, offering the prospect of stable and secure relations with Moscow; and cheap energy to boot - Yanukovych has suggested he could renegotiate the 2009 gas price agreement with Moscow to secure for Ukraine lower gas import prices.

In reality Tymoshenko has now emerged as a challenger for Russia's favour. Moscow seems to be eager to "play the field" or not make the same mistake it made in 2004 when it arguably put all its eggs in the Yanukovych basket, a strategy which backfired. However, there is some frustration in Moscow that despite Yanukovych/RU promising Russia much over more than a decade (extending into the Kuchma era), in reality they have delivered little in terms of tangible benefits to Russia, and in particular control/ownership of strategic assets in Ukraine.

Cynics argue that while selling themselves as the pro-Russian party, RU's agenda is in fact to keep Russia sweet, but Russian oligarchs out of Ukraine, thereby defending the local market for oligarchic groups which underpin/support RU.

While currently leading in the polls, Yanukovych lacks pan-Ukrainian appeal; many Ukrainian nationalists in Western Ukraine could simply never stomach voting for Yanukovych and Regions. His current advantage is that he remains in opposition, and can escape some of the flak for the poor performance of the economy over the past year.

His core support is also loyal and will turn out and vote; the fear in the Tymoshenko camp is that a large chunk of the Orange vote, her natural constituency, might just not bother to vote given the general disillusionment with Orange leadership over the past 5 years. Yanukovych is certain to get into the second round presidential vote, and will run Tymoshenko hard this time around, albeit ultimately we think he will just lose out to Tymoshenko.

[4] Arsenyi Yatseniuk, the former speaker of parliament, former foreign minister and former economy minister. Young, articulate, a fluent English speaker, who had been seen as the great new hope for the Ukrainian political scene. His campaign got off to a good start initially, when from nowhere he had managed to secure ratings in the low teens just 5-6 months ago, and seemed a genuine challenger to Tymoshenko for second place in the first round presidential poll.

Since then though his campaign has gone off the boil, perhaps lacking clear focus/direction and amid uncertainty surrounding his funding and over his ultimate political allegiance. Critics argue that he lacks the political acumen of Tymoshenko or even Yanukovych. He is likely to poll in the 4-5% range, but could be important in creating momentum behind the two contenders in the second round poll.

[5] Volodymyr Lytvin, the leader of the Lytvin block in parliament which has 20 or so deputies and has proven in the past to be a kingmaker. He has run in several previous presidential elections, and has a solid core support of 5-6%, which gives him some political capital which he has tended to deploy with alacrity. Previously he has served as speaker of parliament, and he would likely use his solid showing in the presidential elections to boost his own, and his party's standing in parliament, and its ability to remain in the political mix. He is centrist, and has proven willing to work with all the main political camps in parliament.

[6] Serhiy Tyhikpo, a former minister in the Kuchma administration, who served as acting central bank governor for a time in the opposing camp to the Orange revolution. He then took something of a political sabbatical to run one of Ukraine's most successful private banks which was subsequently sold to a Western banking group. Has returned to the political scene over the past year, and has built bridges both with Regions and the Tymoshenko camps; he had been touted as a possible compromise candidate to replace the incumbent governor of the NBU (Stelmakh), after efforts by the Tymoshenko camp to force the incumbent from office.

He is another candidate who could score 4-5% of the first round vote (I simply do not believe a poll reported by the BBC which had Tyhipko up at 14%), and would then likely use this political capital to position himself for a new role in the new administration to emerge after the elections. He could end up as governor of the NBU, or even a compromise candidate as prime minister in a coalition government. Generally regarded as a reformer, and obviously he knows the Ukraine's banking system and the NBU well.

...Yanukovych will win the first round, with Tymoshenko second...

Having set out the runners and riders, its time for us to call the election result; no mean task this time around. What seems clear now is that Yanukovych is an almost cert to win the first round vote, but he will be unable to secure more than 50%, and hence the vote will go to a second round on February 7. We predict that Yanukovych will get around 35-36% in the first round vote.

Tymoshenko is almost equally certain to come second in the first round, but there is some uncertainty about how high her vote will be in the first round. Our best guess would be 25-27%. While she is currently only polling in the mid-teens, she does tend to do better in actual elections and this, along with her awesome campaign machine, and the dogged loyalty/zeal of her supporters, who will run the extra mile for her, is probably worth another ten percentage points.

...but the second round is difficult to call

The second round vote is much more difficult to call. Candidates falling by the wayside in the first round vote will be looking to extract promises of patronage from Tymoshenko and Yanukovych as the price of directing their supporters in the second round vote. Herein we just cannot see Yushchenko finding it in himself to back Tymoshenko, reflecting all the bad blood that now exists between the two candidates; that said I am not sure how far his supporters will follow his own lead.

Supporters of Yatseniuk will probably fall in behind Tymoshenko, in some kind of final act of loyalty to the Orange cause. Litvin and Tyhipko's supporters will probably split 60:40 for Tymoshenko, while the 5-10% or so Communist/Socialist vote will probably go mostly to Yanukovych. What seems evident therefore is that It will be an extremely close second round vote, with turnout likely to be crucial to the result, but our best guess still is that Tymoshenko will just carry the vote with a wafer thing majority.

We doubt that attempts to challenge the result will get much traction...

Tymoshenko has already signalled that she is preparing for a possible legal challenge (over postal ballots) to the vote, in the event of a narrow victory by Yanukovych. A similar challenge could come from Yanukovch on a Tymoshenko victory. However, this time around we expect a generally fair election, as the media is generally free, and scope for electoral fraud is significantly reduced given the likely significant oversight from various international observers (after the experience of 2004/05).

We do not expect a repeat of the mass demonstrations that followed the 2004 elections, also partly because the Ukrainian population is now generally much more disillusioned with the entire Ukrainian political class, and much less willing to get out on the streets.

Also we think that given the huge economic challenges facing the country, external pressure will be for politicians to get on with it (forming coalitions) and to govern more effectively, allowing the IMF to return in a timely manner. There will hence be much less truck with political game-playing/indulgence this time around.

...as the focus will quickly turn to coalition building in parliament...

Once the second round vote is out of the way, and assuming no repeat saga over the soundness of the vote, the obvious question then is what next? Either Tymoshenko or Yanukovych will emerge victorious as president, but how will they manage to govern a country, parliament and even government riven by rivalries.

The first act for the new president will be to try and reshape the government, and this will require the formation of a majority coalition in parliament to back a new administration. There could be early parliamentary elections, but we doubt that these would fundamentally change the balance of power for either of the two main political parties.

Arguably the only person with an interest in early elections at this stage is incumbent President Yushchenko who sees early elections as a means to create a new power base for himself having departed the presidential palace and having seen his support in Our-Ukraine - Peoples Self Defence (the presidential party) eroded.

But it does not seem logical for either of the two main parties to play into Yushchenko's hands; indeed most in both camps would probably prefer his speedy departure from the domestic political scene. Rather we think Tymoshenko and Yanukovych will try and work with the current parliament to form a working and stable majority.

...which will not be easy...

Reviewing the current parliamentary math, Regions is the largest party in parliament with 172 deputies, followed by Block Yulia Tymoshenko (BYT) with 153, then Our-Ukraine/Self Defence with 71, the Communists with 27, the Block Litvin with 21, and there are 6 unaligned deputies.

The Communists will most likely line up with Regions, while the Litvin Block can swing both ways, i.e. it could ally with either BYT or Regions, depending on what political capital it can extract in either coalition arrangement. Our Ukraine/Self Defence is the most difficult to call, as while the party was originally formed in support of President Yushchenko, it has subsequently fractured into around 14 parties, and of the 71 deputies 40-50 (including Yatseniuk herein) are considered loyal/likely to back a coalition with Tymoshenko, rather than with Yanukovych.

 Under current electoral rules, the majority would carry the faction into an alliance with Tymoshenko, blocking a coalition with Regions. There is a question as to whether the rump of the party supporting Yushchenko could still act as spoilers herein preventing also a deal with Tymoshenko.

This might in effect then leave parliament "hung", i.e. with Regions/Litvin Block/Communists with only 222 deputies, and/or the BYT plus the Litvin Block with 174 deputies, and the rest, including OU-PSD remaining non-aligned.

...and our most likely scenario is "cohabitation"

The prospect of a hung parliament, with neither of the main factions, BYT and Regions able to form a majority without the other, does then open the possibility of cohabitation between BYT and Regions. Indeed, this is our most likely end-game in all this. Such a coalition would have a large majority in parliament, i.e. a good 330-odd deputies out of 450, and would avoid any need to horse trade with small minority parties.

Both camps could sell the alliance as some kind of "government of national unity", to face up to the remarkable and unprecedented challenges facing the economy. In terms of economic policy, I doubt there is that much clear blue water between the parties, perhaps the only difference might be openness to foreign capital, with BYT preferring a much more level/open playing field. Indeed, the main challenge will be dividing out ministerial portfolios/spheres of influence.

Interestingly over the past couple of years it is widely known that that the two factions have held extensive negotiations over trying to forge such a coalition, which has only in the end fallen at the last hurdle. Tymoshenko, in particular, is thought to have baulked at inking such a deal in the past for fear of isolating the Orange vote in the run-up to a subsequent presidential poll.

However, with the presidential election out of the way, and the Orange vote cast, she would perhaps feel less inhibited in going against the spirit/soul of the Orange revolution and allying with the former enemy, Regions of Ukraine.

In the bigger interests of Ukraine, even hardcore Orange supporters will perhaps see the bigger picture need for former enemies to work together. Hence, seeing through the murky political landscape in Ukraine - some might argue with somewhat rose-tinted spectacles - might suggest a more constructive outcome.

At least the elections offer the hope of an end to the hugely damaging trench warfare between President Yushchenko and prime minister Tymoshenko which has characterised most of the period since the Orange revolution, that is assuming Yushchenko does finally depart the domestic political scene.

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Sunday's elections will pose the same old politicians when investors just want a stable economy. 
By Parmy Olson, Forbes, New York, NY, Fri, Jan 15, 2010

LONDON -- Elections used to be an exciting time in Ukrainian politics. The Orange Revolution of 2004 had seen Viktor Yushchenko wave to large crowds that were ecstatic at the prospect of political change, his face scarred with the pockmarks of an alleged dioxin poisoning by government agents. Apparent vote-rigging in favor of his opponent met public outcry, and Yushchenko eventually won the vote, ushering in a new era of high hopes for Eastern Europe's rising economic star.

This Sunday's election in Ukraine will be a more sobering affair.

Following years of political infighting, the now-hugely unpopular Yushchenko has ruled himself out of the running, leaving the race between his old rival from 2004, Victor Yanukovych, and incumbent prime minister Yulia Tymoshenko. Both are consummate politicians, but their fatigued electorate now needs more than charisma to get them out of the doldrums.

Ukraine's economy was one of the worst hit in the global financial crisis, its gross domestic product tanking by 14% in 2009 as capital hemorrhaged out of the country, while its currency, the hryvnia, went on a roller-coaster ride.

So distrusting is the bond market of Ukraine now that it is seen as the second most likely sovereign in the world to default on its debt, after Venezuela, according to credit market analysis firm CMA. Ukraine has a five-year cumulative probability of default of 54.6%.

At the height of the credit crisis, Ukraine's government made the mistake of issuing a moratorium on the withdrawal of local bank deposits, says Renaissance Capital's Ukraine analyst Anastasia Golovach. This heightened distrust among the populace, who withdrew individual funds in droves, drying up liquidity for the local banking system.

Facing a lack of funds itself, the government wasn't able to inject Ukranian banks with the capital they needed and sought external funding from foreign investors. Though this helped to an extent, the country desperately needed emergency funding from the International Monetary Fund. That eventually came through, with two tranches of loans and special drawing rights totaling $13 billion, and marking some of the only significant investment the country received last year. (See "Ukraine Is Europe's Problem.")

Today things are slowly improving, though Golovach points out this has nothing to do with the government's limited attempts at supporting the economy. Improvements in the global trade picture means the country's all-important steel sector, along with industrial output, is slowly recovering (November steel production reached its highest level since September 2008), banks are starting to lend again and the hryvnia has be stable since autumn 2009. Economist Ivan Tchakarov of Nomura International expects Ukraine's GDP to grow by 3.6% in 2010.

Yet politics are still important for the country's fragile economy. Drawn out political uncertainty will make foreign investors wary of putting their money back into Ukranian euro bonds or equities. And it could also affect the country's already-protracted talks with the IMF on the re-negotiation of its stand-by agreement.

Opinion polls suggest that none of the election candidates will manage to secure the 50% of the votes needed to win the election on Jan. 17. This means Tymoshenko and Yanukovych will probably have to advance to a run-off on Feb. 7. Yanukovych, the opposition-party leader who who is most preferred by the markets, is mostly likely to win, but that could also be followed by snap parliamentary elections in May, prolonging the political campaign until mid-year, says Tchakarov.

Worst-case scenario: the second round run-off between Yanukovych and Tymoshenko fails to produce a clear winner, leading to a lengthy political battle with challenged results.

But Tchakarov thinks this is unlikely. He's actually optimistic about Ukraine's economy, pointing out that the country lacks any major sovereign debt repayments in 2010--heartening news for those worried about a default.

Golovach agrees. "We think the main implication of the political situation is that politics are not damaging a rebound in the economy," she says. "Even if this election triggers political struggles and instability, I think the impact of this situation will be rather minimal. Fundamentally, we see positive trends in the economy."
So much for politics.

LINK: http://www.forbes.com/2010/01/15/ukraine-elections-default-markets-economy-banks-imf.html 
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Viktor Yanukovych and Yulia Tymoshenko will likely face off in second round

By Polya Lesova, Reporter, MarketWatch, Frankfurt, Germany, Thu, Jan 14, 2010

FRANKFURT -  Ukraine's upcoming presidential election may bring some measure of stability, but the deep economic crisis and the specter of more political volatility make this country a tricky place to invest.

No candidate is expected to win 50% or more of the votes in Sunday's election. The latest polls suggest that Viktor Yanukovych, seen as the pro-Russia candidate, and Yulia Tymoshenko, the prime minister, will likely face off in a second round.

Yanukovych is ahead of Tymoshenko in the polls, but given the high number of undecided voters, the result seems too close to predict. One thing seems certain, however: President Viktor Yushchenko, who led the so-called Orange Revolution of pro-democracy protests in late 2004, stands almost no chance of winning.

Tymoshenko, Yanukovych and Yushchenko have dominated Ukrainian politics in recent years, and the ongoing fights among them have spooked investors and largely paralyzed policy-making at a particularly dire economic time. The election is expected to abate some -- though not all -- of the political uncertainty in the country. 
"We expect more stability," said Aivaras Abromavicius, Kiev-based partner at East Capital, which is currently invested in Ukrainian stocks. "We're at a rock-bottom situation now with a very high cost of capital and still fragile banking system. Everyone realizes it all can change and improve when stability returns."

Ukraine, a country roughly the size of France, has a strategically important location between the European Union and Russia. Its economy contracted 15% in 2009, as demand for its key steel exports collapsed. The International Monetary Fund has provided a $16.4 billion aid package, but the fund recently suspended further loan disbursements because of Ukraine's failure to put in place tough economic reforms.

Investors have taken notice. As measured by CDS spreads, Ukraine is the second most likely country to default on its debt after Argentina, according to data from CMA Datavision. The local currency, the hryvna , has been very volatile, but finished 2009 basically flat against the U.S. dollar. Other emerging-market currencies, such as the Brazilian real, however, posted strong gains.

Both Tymoshenko and Yanukovych "realize they seriously need to address corruption and they need to resuscitate the economy," said Lilit Gevorgyan, an analyst at IHS Global Insight in London. "They desperately need to restart negotiations with the IMF."

The IMF is particularly important, since Russia is not in a position to help its neighbor financially because of its own economic troubles, Gevorgyan said. Under Ukraine's political structure, the president, to be effective, has to cooperate closely with the prime minister. Both Yanukovych and Tymoshenko lack sufficient support in the Ukrainian parliament, the Rada, to muster a majority, so a period of political uncertainty after the presidential election appears inevitable.

"We expect a difficult political battle during and after the election to trigger a new round of negative news flow," said Anastasia Golovach of Renaissance Capital in Kiev. "Investors could decide to sell some instruments [stocks and bonds] because the stabilization of the political situation in unlikely in the short term," she said.

Ukraine's benchmark PFTS stock index rose 90% in hryvna terms last year after tumbling 74% in 2008. In dollar terms, the index rallied 83% in 2009, just as much as it dropped the previous year. Still, over the last decade, the index has surged 858% in dollar terms and 1,366% in hryvna terms, according to data from the PFTS Stock Exchange.

"Liquidity is very poor here, but if we have a stable political situation and a stable exchange rate for a few months, investors will start looking at this country," Abromavicius said.

The market capitalization of the PFTS, which consists of 20 companies, was $10.1 billion last year. The sectors that stand out are steel and iron ore, utilities and banks.

"Whoever wins the election, I really think it's going to be a positive watershed for Ukraine," said Jack Dzierwa, global strategist and co-manager of the $440 million Eastern European Fund at U.S. Global Investors. The fund had no investments in Ukraine as of last September.

"Having seen this rally last year, Ukraine -- considered one of the most risky markets - is not cheap, so you have to be selective and compare companies with their peers," especially in Russia, Dzierwa said.

Motor Sich, a manufacturer of aircraft engines, is one publicly traded company that investors should look at, observers say. Other potentially attractive firms include power generation company Centerenergo, Azovstal Iron and Steel Works, as well as Ukrtelecom, according to Dzierwa.

Investors can also get exposure through Ukrainian companies listed in London, such as Ferrexpo PLC /quotes/comstock/23s!e:fxpo (UK:FXPO 240.40, +9.25, +4.03%) , a Swiss-based producer of iron ore pellets with assets in Ukraine, poultry producer MHP S.A. and London-based JKX Oil & Gas PLC /quotes/comstock/23s!e:jkx (UK:JKX 292.40, -5.10, -1.72%) , whose principal interests are located in Ukraine and Russia.

Sugar producer Astarta-Kyiv and sunflower-oil producer Kernel Holding SA are among Ukrainian stocks listed in Warsaw.

Oleksandr Zholud, senior analyst at the International Center for Policy Studies in Kiev, said that investors see Ukraine as a risky and high-margin market. He expects the IMF to disburse the next tranche of money after the presidential election.

"All [presidential] candidates offer some additional social spending, and there is no means to increase budget spending other than by increasing the deficit," he said, adding that the central bank may have to finance the deficit by printing money.

"The question is whether the National Bank [of Ukraine] will be able to keep its ground and try to preserve the stability of the domestic currency," Zholud said.

The stakes are high not only for Ukraine's population of 46 million, but also for foreign investors. A number of international firms, especially banks, have moved into Ukraine in recent years, mostly by buying up local assets.

Austria's Raiffeisen International /quotes/comstock/11i!raiff (RAIFF 61.30, +0.65, +1.07%) , Hungary's OTP Bank, as well as France's BNP Paribas /quotes/comstock/24s!e:bnp (FR:BNP 58.05, -0.59, -1.01%) and Credit Agricole SA /quotes/comstock/24s!e:aca (FR:ACA 12.97, +0.07, +0.50%) all have a local presence. Russian banks, such as state-owned Sberbank and private lender Alfa Bank, are also represented.

Global steel producer ArcelorMittal /quotes/comstock/13*!mt/quotes/nls/mt (MT 46.58, -1.28, -2.67%) bought a major steel mill in 2005, while a Russian group is reportedly close to acquiring control of Industrial Union of Donbass, one of Ukraine's biggest steel companies.

"Ukraine is always promising," said Abromavicius of East Capital. "Let's hope that one day, sooner rather than later, it will live up to this potential."

LINK: http://www.marketwatch.com/story/ukraine-grasps-for-stability-with-vote-2010-01-14?pagenumber=1
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By Stefan Wagstyl, Financial Times, London, UK, Wed, Jan 13 2010

LONDON - Ukraine’s presidential election, the first since the 2004 Orange Revolution, is taking place in a far different atmosphere from the heady days of five years ago.

Then, many Ukrainians had high hopes the pro-west Viktor Yushchenko’s victory in a disputed poll would usher in a new age of fairness, stability and the rule of law.

But Mr Yushchenko has failed to deliver the political progress he pledged to make, in the face of political confusion, the power of corrupt vested interests and intense opposition from Yulia Tymoshenko, his prime minister and former ally, and Viktor Yanukovich, the opposition leader and Mr Yushchenko’s opponent in the 2004 election.

His failures have left many Ukrainians disillusioned with politics as they prepare to vote for a new president in two polling rounds, on January 17 and February 7.

To Mr Yushchenko’s fury, the opinion polls put Mr Yanukovich in the lead, with Ms Tymoshenko second and all other candidates trailing far behind, including the president himself. If the polls prove correct, Mr Yanukovich and Ms Tymoshenko will come out on top in the first round and fight each other in the second round run-off. Mr Yanukovich, with his base in the wealthy industrial east, has a strong core constituency.

But the charismatic Ms Tymoshenko, who is more popular in the west and centre, may have more success in gathering support from uncommitted voters and, in the second round, from those backing other candidates in the first round.

Mr Yushchenko’s likely defeat will remove from the presidency Ukraine’s strongest supporter of pro-west policies, including integration with the European Union and Nato. Ms Tymoshenko and Mr Yanukovich both seek to balance integration with the west with good ties with Russia, Ukraine’s powerful neighbour and principal energy supplier.

Both say that Nato membership is now off the agenda but insist they will not be in Moscow’s pocket and will persist with efforts to integrate with the EU. Mr Yanukovich, with his base in the east, has a long history of cooperating with Russia. But Ms Tymoshenko, as prime minister, has tried to convince Russian leaders that she has abandoned her former hostility towards Moscow.

The process of the elections and their aftermath may be as important for Ukraine as the identity of the winner. Deep in economic crisis, Kiev needs to persuade the International Monetary Fund to resume lending under a $16.4bn rescue programme that was suspended in the autumn after Ukraine failed to implement promised reforms. With gross domestic product down about 15 per cent last year, there is little time to waste if Ukraine is to fulfil hopes of modest growth of 3-5 per cent this year.

But there are dangers that the polls could be hit by claims of electoral fraud, which might take weeks to resolve, or be followed by uncertainty as the winning candidate tries to put together a majority in a fractious parliament. Early parliamentary elections cannot be ruled out.

Both leading candidates are committed to working with the IMF. The problem will be achieving the necessary political stability to implement tough IMF-linked economic reforms.

LINK: http://www.ft.com/cms/s/0/c4fc90da-fbb0-11de-9c29.00144feab40a.html
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By Stefan Wagstyl and Roman Oleachyk, Financial Times
London, UK, Friday, January 15 2010

KIEV/LONDON - Ukraine's business oligarchs are split over the country's presidential contenders, with some backing Viktor Yanukovich, some Yulia Tymoshenko, and others hedging their bets.

"Ukraine's elite is tied up in political rivalries," says Sergey Taruta, a steel billionaire who favours Ms Tymoshenko, the prime minister, in the first round of the election on Sunday. "Some leading business groups are actively involved in [politicians' battles], manipulating the political situation for personal gain."

Unlike their Russian counterparts, who have seen their freedoms curtailed, Ukraine's oligarchs retain considerable influence. The top 10 businessmen dominate the steel and chemicals industries, Ukraine's biggest exporters, own much of the media, and channel money into politics, including funds for election campaigns.

The economic crisis hit Ukraine hard, forcing many oligarchs to scramble for funds, lobby for state support and cut political spending. Vadim Karasiov, a political adviser to Viktor Yushchenko, president, says: "Their pockets are not as deep as they were."

But still deep enough to make a splash. In the first presidential election since Mr Yushchenko's Orange Revolution triumph in 2004, the biggest beneficiary of billionaire backing is Mr Yanukovich, the opposition leader then defeated by Mr Yushchenko but now the clear frontrunner.

He is supported by Rinat Akhmetov, Ukraine's richest man and president of Shaktar Donetsk, Ukraine's second most successful football club. Both men hail from the east Ukraine steel belt, where Mr Yanukovich launched his career and Mr Akhmetov founded his fortune. His other business backers include Dmitry Firtash, the gas trading billionaire, for whom the election is particularly important.

Mr Firtash was last year stripped by Ms Tymoshenko and Mr Putin of his key role in the east European gas business when Rosukrenergo, a company he co-owns with Gazprom, the Russian gas group, was cut from the trade. Mr Firtash's hopes of regaining influence rest on a Yanukovich victory.

Ms Tymoshenko's wealthiest backers are Mr Taruta and Vitali Gaiduk, former partners in ISD, a steel group. In 2004, they backed Mr Yushchenko but they moved to Ms Tymoshenko since Mr Yushchenko's perceived weaknesses as president emerged.

Mr Taruta says Mr Yushchenko, languishing among the electoral also-rans, failed to promote economic reform, involved himself in "political fights" and pursued pet projects "such as reawakening Ukraine's national identity".

Petro Poroshenko, a confectionery magnate once close to Mr Yushchenko, has also migrated to Ms Tymoshenko, alongside a successful younger oligarch, the 36-year-old Kostyantin Zhevago, majority owner of Ferrexpo, an iron ore company. Mr Yushchenko now receives only sporadic business support.

Businessmen hedging their bets include Igor Kolomoisky and Gennady Bogolyubov, shareholders in the Privat Group, a diversified industrial and banking combine. They stayed out of the electoral fight in 2004 and are doing the same now - avoiding giving one politician their support but retaining a keen interest.

Viktor Pinchuk, head of the Interpipe group and son-in-law of Leonid Kuchma, Mr Yushchenko's predecessor, is in a similar position. In 2004, as an MP he backed Mr Kuchma's choice, Mr Yanukovich, for the presidency. He has since left parliament, avoided day-to-day politics and concentrated non-business activity on promoting Ukraine's European Union integration. In the current campaign, Mr Pinchuk's television channels have given candidates equal time.

Despite their divisions, business leaders all claim to want political stability, effective government and EU-oriented reforms. While Ukraine has little hope of rapid EU membership, it is negotiating a deep free trade agreement with Brussels - a deal that would improve Ukrainian companies' access to markets.

In practice, oligarchs drag their feet over change that might hurt their positions. Viktor Pynzenyk, a former finance minister, says: "The business and political elite can adjust to competition from abroad and it would boost the value of their assets in the long run. But they avoid it."

Mr Taruta says: "We see that the government is split with each political grouping controlling separate branches of government for personal gain . . Monopolies are thriving in the fight and the infighting is not allowing Ukraine's economy to develop."

LINK: http://www.ft.com/cms/s/9a4ec166-0149-11df-8c54-00144feabdc0,s01=1.html
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Analysis, Mar'yan Zablotskyy, Analyst, Ernst Ukraine Research
Ernst Bank Group, Kyiv, Ukraine, Wed, Jan 13, 2010

KYIV - On January 17, Ukraine will hold the first round of its presidential election. Two major candidates are expected take two leading positions: Viktor Yanukovych (runner up in the previous election) and current Prime Minister Yulia Tymoshenko. Neither seems to have the necessary support of 50% +1 vote and a second round is expected to be held on February 7.

Third place in the first round is likely to be battled for by Sergiy Tigipko (current CEO of Swedbank Ukraine, former head of the Ministry of Economics, the NBU), Arsenij Yatsenyk (former head of the NBU, Ministry of Economics, Ministry of Foreign Affairs) and current President Viktor Yushchenko (former PM and head of the NBU). The strong positions of Tigipko and Yatsenyk indicate the demand for qualified professionals and economic reforms.

The political news is overshadowed by ratings from numerous agencies. Often, these ratings are not unbiased and tend to favor a particular candidate. Even so, among the ratings published during December, none show a possible victory for Tymoshenko in the second round. Thus, any result other than a victory for Yanukovych on February 7 would come as a surprise.

Tymoshenko is often perceived (especially by Western media) to be a more investment-friendly and pro-Western candidate, as well as a proponent of an open market economy. However, there have been a number of policies and actions in recent years that have contradicted this image.

Examples include:

       (1) the surge in non-returns of VAT tax to exporters;
       (2) the state Treasury did not return collateral to bidders in a privatization auction;
       (3) the Naftogaz and Ukrzaliznytsa debt restructurings; and
       (4) the non-implementation of numerous obligations to the IMF.

Also, Tymoshenko's political party deputies in the Parliament proposed a law that was supposed to ban foreigners from getting top positions in commercial banks, as well as limit foreign banks' capital and asset shares in the Ukrainian market. There have been numerous attempts from the government to
undermine the independence of the National Bank. Altogether, it would be difficult to assume increase in positive sentiment from investors in the case of a Tymoshenko victory.

Yanukovych's campaign has been based on promises of high social expenditures and a tax decrease in the longer term. Yanukovych was the proponent of the increase in social expenditures worth 5% of GDP for 2010. This became one of the main reasons why the IMF has refused to continue cooperation with Ukraine. Yanukovych is most commonly perceived by the Western media as a 'pro-Russian' politician, following Russia's strong backing in the previous

However, unlike in previous elections, Russia's dominant political party United Russia has not provided any official backing for Yanukovych this ime. Currently, Yanukovych's official program does not propose EU integration, unlike that of Tymoshenko. However, both candidates' official programs are rich with promises of European standards of democracy, business and social environments.

Both candidates do not propose NATO membership for Ukraine. It is widely expected that, despite any tendencies in terms of foreign policies, the new president will be forced to follow national interests and adopt a pragmatic approach in this area.

Similarly, economical policies leave little room for maneuver. Fiscal consolidation and implementation of economic reforms are necessary. With all of the promised expenditures, Ukraine may find itself with financing needs close to 15% of GDP (up from 10% of GDP in 2009), which is hardly manageable.

Thus, it is quite likely that we will see steps quite different from those declared during the campaign. Otherwise, Ukraine will face the risk of high inflation or significant bilateral debt to foreign countries.

It is expected that the IMF mission will return to talks over the rest of the USD 17bn loan (USD 6bn for disbursement remains). The new mission chief will head the IMF mission this time - Athanasios Arvanitis, after Ceyla Pazarbasioglu decided to quit the position.

Should there be a joint position held by the president, government and NBU to implement fiscal consolidation and economic reforms, Ukraine would have good chances of receiving the next tranche of the loan from the IMF.

However, such a joint position may prove problematic, as Tymoshenko at least formally still holds the majority of seats in the Parliament, which is necessary for electing the government. Thus, there are chances of preliminary parliamentary elections soon after the presidential election, should Yanukovych fail to gain comfortable support in the Parliament. This could put Ukraine in a full election cycle until June.

NOTE: This research report was prepared by Erste Group Bank AG ("Erste Group") or its affiliate named herein. The information herein has been obtained from, and any opinions herein are based upon, sources believed reliable, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions, forecasts and estimates herein reflect our judgement on the date of this report and are subject to change without notice. The report is not intended to be an offer, or the solicitation of any offer, to buy or sell the securities referred to herein. From time to time, Erste Group or its affiliates or the principals or employees of Erste Group or its affiliates may have a position in the securities referred to herein or hold options, warrants or rights with respect thereto or other securities of such issuers and may make  a market or otherwise act as principal in transactions in any of these securities.
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By Stefan Wagstyl and Roman Olearchyk, Financial Times, London, UK, Jan 6 2010

KIEV/LONDON - Vasyl Humeniuk, a veteran small-town Ukrainian politician, has changed his name in an attempt to capitalise on the crisis-hit country's widespread political disillusionment.

With Ukraine holding presidential elections this month, some voters are so disgusted with political turmoil, economic recession and rampant corruption that they want nothing to do with any of the main candidates. They can register their anger by putting a cross on the ballot form beside the words "against all". But many see this rejection of all candidates as a wasted vote. So the enterprising Mr Humeniuk is offering a new option. He is running under the name Vasyl Protyvsikh - or Vasyl Against All.

"I have now been watching for 19 years how the elite is ripping Ukraine off. It is time for a man of the people to take charge," says the 63-year-old head of a chamber of commerce in the western town of Ivano-Frankivsk. Mr Humeniuk is no democratic idealist, having worked closely with Leonid Kuchma, the former authoritarian president of Ukraine. He is an opportunist, seizing his 15 minutes of fame, but his candidacy shows the depths to which Ukrainian politics has sunk on the eve of the first presidential election since the disputed 2004 poll that sparked the Orange Revolution.

In spite of the public disillusion, however, the poll matters to Ukraine, a strategically important state lying between Russia and the European Union which was, pre-crisis, among the continent's top emerging markets.

The new president willneed to secure political stability, revive the recession-hit economy, maintain an International Monetary Fund rescue programme and balance the competing foreign policy demands of Moscow and the west. With Ukraine sitting astride the main route for Russia's EU-bound gas exports, Kiev can influence life far beyond its borders, as in last winter's gas dispute with Moscow when supplies to a big slice of eastern Europe were cut off for two weeks.

The victor's policy plans will matter less than his or her ability to stabilise the political order enough to permit economic recovery. Rory MacFarquhar of Goldman Sachs, the US investment bank, says that even more important than the identity of the winner is the way politicians handle the campaign, the election and any post-election manoeuvring. "There is a sense that anything is possible because the stakes are so high."

Eighteen candidates, including Mr Humeniuk/Protyvsikh, are standing in the first round on January 17, with the two who get the most votes going into a second on February 7. Whoever wins, the biggest loser is likely to be President Viktor Yushchenko, who is clocking under 5 per cent in opinion polls. The hero of the Orange Revolution wins praise for replacing Mr Kuchma's feared regime with multi-party democracy.

But, in the view of many Ukrainians, he has lost the public's trust by failing to control corruption or impose his authority on his rivals, including Yulia Tymoshenko, his prime minister, or Viktor Yanukovich, his opponent in 2004.

The president's heroic reputation has also suffered from some decidedly unheroic financial allegations. Ms Tymoshenko has accused his "inner circle" of profiting corruptly from the shady gas trade. Mr Yushchenko has denied the claim.

For the tens of thousands who took to the streets after the previous presidential election, it is a bitter disappointment. As Boris Kryvytsky, a 56-year-old businessman who helped organise the protests, says: "The ideas that we stood for in the Orange Revolution were right, but we made the mistake of trusting the wrong leaders. Nothing will change until we rid this country of the bandits."

To Mr Yushchenko's fury, the election frontrunners are Mr Yanukovich and Ms Tymoshenko. They differ greatly in style but not so much in policy - nor in the drive of followers hungry for the spoils of office.

In many European countries, Mr Yanukovich would have lost all political credibility for fighting in 2004 a campaign widely condemned as fraudulent. But in Ukraine he has retained control of the eastern industrial heartland and leads the largest party in parliament. He is also supported by key oligarchs, headed by Rinat Akhmetov, Ukraine's richest man.

The tough 59-year-old former lorry driver, who worked his way up the administrative ladder in Soviet times, has refashioned himself as a democrat. With the help of US public relations advisers, he has learnt to work the crowds, listen and smile. In interviews, he has adopted the soundbite. Serhiy Lyovochkin, an aide, says spending time out of power has changed Mr Yanukovich.

Ms Tymoshenko, 49, came to prominence in the 1990s by making a fortune in the murky Russia-Ukraine gas trade, in which little known companies act as intermediaries between Gazprom, the Russian gas group, and its customers. Since backing Mr Yushchenko in the Orange Revolution, she has comprehensively upstaged him and captured the support of the revolution's followers.

To her critics, she is an unpredictable populist with authoritarian instincts. After the Orange Revolution, she frightened business by threatening to renationalise scores of privatised companies - an attack on the oligarchs who, under Mr Kuchma, had won highly prized state assets in privatisations beset by charges of cronyism. She gave up in the face of overwhelming odds but the assault has not been forgotten.

In the past year, she has won some praise for her handling of the economic crisis and relations with the IMF. But business people have complained about her penchant for direct intervention in markets, with threats of caps on prices, margins and profits in key sectors, including agriculture.

Many in business are also sceptical about Ms Tymoshenko's goal of changing the constitution to end the division of power between parliament and the presidency in order to return to the strong presidential rule that prevailed before the Orange Revolution. While the chances of forcing such reforms through the fractured political system are low, the very idea worries her critics.

Even some liberals who backed the Orange Revolution now find themselves favouring Mr Yanukovich as the least bad choice. The pollster Ilko Kucheriv says: "If we have Yanukovich as president it will be shameful for Ukraine. But he is not as cynical as Yulia. Our parliamentary democracy has weaknesses but it is fundamentally better than the alternatives."

However, the price of a Yanukovich victory in the presidential election could be further political uncertainty because Ms Tymoshenko holds a majority, albeit slim, in parliament. Mr Lyovochkin says if there is even "a small chance" of forming a coalition, Mr Yanukovich will try. Otherwise there will be parliamentary elections, bringing extra turmoil. JPMorgan, the US bank, sees this risk as so significant that it backs Ms Tymoshenko, saying she would stabilise Kiev faster than Mr Yanukovich.

Post-election instability would bode ill for the fragile economy. The IMF came to Kiev's rescue in autumn 2008 with a $16.4bn loan to stabilise the crippled banking sector and the bud-get. But, with election drums beating, and president and prime minister in conflict, Kiev failed to deliver promised reforms; in October the Fund suspended a $3.8bn tranche.

Ukraine responded last month with a plea for emergency finance to help pay bills - including crucial monthly gas payments to Moscow. Citing a lack of political consensus, and desperate to stay out of Kiev's politics amid claims by Ms

Tymoshenko's critics that it has been soft on her government, the IMF declined. But late last month it allowed Kiev to stay afloat by approving a $2bn transfer to government accounts from IMF-backed central bank reserves to cover external liabilities including Russian gas bills.

The public finances are in "an extremely difficult situation", Hryhoriy Nemyria, deputy prime minister, told the FT last month, warning of risks of a spill-over to other states. "The cost of inaction is greater than the cost of action," he said.

Both Mr Yanukovich and Ms Tymoshenko have pledged to stick with the IMF programme, which includes spending cuts to reduce the budget deficit from about 10 per cent this year to 4 per cent. But they will not spell out the details before the polls.

After dropping about 15 per cent in 2009 in the biggest decline in Europe outside the Baltic states, Ukrainian gross domestic product is expected to stage a moderate recovery of 3-5 per cent in 2010. But the country remains vulnerable to new shocks.

One such surprise could come from the Russia-Ukraine gas trade. Ms Tymoshenko and Vladimir Putin, her Russian counterpart, have promised that this winter there will be no repeat of 2009's contract dispute and supply break. But that depends on Kiev's ability to pay its bills.

Ms Tymoshenko and Mr Yanukovich both approach Moscow pragmatically. Mr Yanukovich has a longer record of co-operating with Russia than Ms Tymoshenko. But, to Mr Putin's satisfaction, she has accepted chunky rises in gas prices. Mr Yanukovich's recent pledges to fight for a better deal for Ukraine will not have en-deared him to Mr Putin.

Both have distanced themselves from the pro-west policies of Mr Yushchenko, who irritated Russia by pursuing Nato membership. The Kremlin in 2008 made clear its intention to stop further Nato expansion through the war in Georgia, which had also hoped for membership before its defeat. Sergei Karaganov, head of Russia's Council on Foreign and Defence Policy, says a renewed Nato push into Ukraine would cause "a threat of a large-scale war in Europe". In Kiev, the matter is no longer on the agenda.

But integration with the EU remains popular. Among Mr Yushch-enko's few successes was securing World Trade Organisation membership, which opened the way for deep economic co-operation with Brussels, including a free trade agreement now under negotiation. However there are many difficulties, with institutions, notably the courts, falling far short of EU standards. Mr Kucheriv says: "We have a simulation of European behaviour. Not the reality . . . When

Ukraine's political leaders talk of integration with the EU they don't know what they are talking about."

Neither a Yanukovich nor a Tymoshenko presidency would change that very much. Ukraine's best hope is that the new president can provide the stability that has been missing in the past five years. That may sound meagre but, for a country mired in prolonged instability, it would be something.

With its 46m people and abundant coal and iron ore and farmland, Ukraine has great economic potential - but also suffers from instability, poor infrastructure and corruption. Foreign investors swallowed their doubts, contributing to growth of 8 per cent in 2007. But the economic crisis - which hit steel, the main export, hard - led to a fall in gross domestic product of about 15 per cent last year.

With support from an International Monetary Fund package, the country could enjoy a 3-5 per cent recovery in 2010, largely due to rebound effects and improvement in steel markets. But with the currency down about 50 per cent against the dollar since mid-2008, debtors may still struggle to pay foreign creditors. The credit default swap rate, a measure of perceived default risk, remains among the world's highest.

'There are all sorts of regulations, some useless, most unevenly enforced'

"I would not advise anyone to open a small business here," says Euan McDonald, the Scottish owner of Baraban, a bar in central Kiev that is popular with foreigners. "There are all sorts of regulations, some useless, most unevenly enforced. It's just one thing after another. As soon as you handle one problem, another comes along. The regulators can come after you any time to generate some extra pocket cash."

The daily struggle of Mr McDonald, unsure whether to shut or keep "bumping along" in Ukraine's muddy sea of graft and red tape, is not an exception. The country ranks among the worst in terms of corruption perceptions, according to Transparency International, the watchdog. It is 146th - alongside Russia and Zimbabwe - out of 180 states.

Ukrainians routinely bribe underpaid public officials to cut through red tape and secure access to services. Around $10-$100 can get traffic police, sanitation or fire safety officials to overlook alleged violations. Kiev's constitution guarantees free healthcare but doctors demand payments on top of their $100-$200 monthly official salaries for "quality care".

Securing favourable court rulings is big business. One regional judge, Ihor Zvarych, is awaiting trial for taking bribes, with more than $1m in cash found in his home. He has denied the claim.

Corruption is learnt from an early age. Students bribe teachers to pass exams. Politicians have been accused of purchasing diplomas without ever attending classes. Andriy Kislinsky was relieved of his duties as deputy head of the secret service late in 2009 after officials found his degree was illegitimate.

In one survey, 63 per cent of Ukrainians indicated they had been involved in corrupt transactions with officials over the past 12 months. An illegal payment to inspectors can, for example, quickly secure a building permit. If not, "it takes 476 days to get a construction permit for a two-storey warehouse in Ukraine. In the US it takes just 40 days," says Georges Massoud, managing partner in Ukraine for McKinsey, the consultancy.

This environment keeps investment at bay and stifles competition, leaving Ukraine's economy dependent on inefficient steel and chemical factories controlled by a handful of oligarchs.

In a break from normal diplomatic language, José Manuel Pinto Teixeira, the European Union representative in Kiev, recently said: "Corruption, red tape, administrative obstacles of every kind - these are only things that serve the interests of those who today control the economy because they do not want competition. They are allergic to competition."

Viktor Pynzenyk, a former finance minister, says: "The business and political elite can adjust to competition from abroad and it would boost the value of their assets in the long run. But they avoid it."

LINK: http://www.ft.com/cms/s/0/429056c6-fa62-11de-beed-00144feab49a.html
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Presidential elections could usher in political stability and give the dismal economy a chance to grow again 
By James M. Gomez and Daryna Krasnolutska, Bloomberg News Reporters
Business Week, New York, New York, Fri, January 15, 2010
It's not even February yet, and 2010 is shaping up to be a bad year for Viktor Yushchenko, who survived a poisoning attempt by political opponents in 2004 and went on to be elected president of Ukraine. Voters are tired of Yushchenko and seem far fonder of two other candidates vying to succeed him this week: opposition leader Viktor Yanukovych and populist Prime Minister Yulia Timoshenko.

Yushchenko, 55, feuded with Russia and cozied up to the U.S. and the European Union, so should Western policymakers and investors be worried about a Ukraine tilted more toward Moscow? Probably not. Both Yanukovych, 59, who is ahead in the opinion polls, and Timoshenko, 49, say they want better ties with both Moscow and Europe.

Political stability under a new president could unfreeze a $16.4 billion bailout loan from the International Monetary Fund, ease conflicts with Russia, and improve the prospects for a free-trade accord with the European Union, predicts Sacha Tessier-Stall, head of foreign policy at Kiev's International Centre for Policy Studies. "No matter who wins, there will be an improvement," he says.

The election may also improve Europe's energy security. The EU relies on Russia for a quarter of its natural gas, and 80% of that passes through Ukraine, a country of 46 million that's about as big as France. Disputes over prices led Russia to turn off the gas to Ukraine in January 2006 and January 2009, which in turn caused fuel shortages in the EU.

In November, Timoshenko and Russian Prime Minister Vladimir Putin renegotiated the two countries' gas contract for 2010, easing concerns about a shutoff. "The risk to Europe has decreased," says Gergely Varkonyi, an energy analyst at Deutsche Bank (DB) in Budapest.

With 18 candidates competing, no one is likely to gain the 50% majority needed to win outright. That means Yanukovych and Timoshenko will likely face each other in a runoff on Feb. 7. Whoever emerges triumphant already knows how bad the path forward is. Ukraine's gross domestic product shrank an estimated 14% in 2009.

The country's currency, the hryvnia, was the world's worst performing vs. the U.S. dollar in the year ended in September. And Ukraine is the world's second-least creditworthy economy behind Argentina, as measured by the cost of credit-default swaps that protect bondholders.

High on the agenda for the new president will be unfreezing IMF money. Ukraine secured the loan in late 2008 after the global credit crisis crippled its exports and financial sector. But the IMF delayed a $3.4 billion installment in November after lawmakers failed to pass a 2010 budget while raising social spending. "The political infighting that has paralyzed the country has to stop," says Jorge Zukoski, president of the American Chamber of Commerce in Ukraine.

If Ukraine stabilizes its politics after the election, the country stands a chance of returning to growth. That could give foreign investment a boost. Since Yushchenko took over the presidency in early 2005, Ukraine has attracted some $36 billion in foreign direct investment from companies such as Luxembourg's Arcelor-Mittal (MT), Italy's UniCredit Group, and French retailer Groupe Auchan. Between 1999 and 2004, the country pulled in just $5.7 billion in foreign direct investment.

Under Yushchenko, the country won membership in the World Trade Organization and the EU declared Ukraine a market economy. Now, both Yanukovych and Timoshenko support signing an association agreement with the EU, which includes a free-trade pact. Says Ivan Tchakarov, an emerging markets analyst at Nomura Holdings in London: "Ukraine can be a positive surprise this year."

NOTE: Gomez is a reporter for Bloomberg News. Krasnolutska is a reporter for Bloomberg News.

LINK: http://www.businessweek.com/magazine/content/10_04/ b4164023476878.htm
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