I spent the past day in Kyiv trying to pick up the pieces and put them back together in terms of what happened over the last month in Kyiv to change risk perceptions of Ukraine from being a sub-6% yield country to over 11%. True in this latter respect C-virus explains a lot, albeit I would put around 150bps in widening in hard currency spreads to specific local factors and particularly the cabinet reshuffle which saw 10 ministers lose their jobs, and many quite unfairly/inexplicably.

While the expectation had been that prime minister, Oleksiy Honcharuk would get the chop in favour of a more experienced manager (perhaps with Shmyhal that is the case - or still to be proved) the ousting of the dream team of reformers, Milovanov and Markarova is pretty inexplicable prior to getting final agreement on a new IMF programme. 

I mean what on earth was Zelensky thinking on this one?

With hindsight the timing of that cabinet reshuffle was absolutely dreadful, coming just before the full force of the C19 crisis hit global markets. And as of writing, several key cabinet positions are still to be filled - including energy and economy. It’s hard to explain really why you would not have all cabinet positions filled already, weeks after the initial putsh. 

I heard various explanations of the reshuffle and all have some logic to them:

First, I guess after the ousting of administration head Andriy Bohdan, his replacement, Andriy Yermak, perhaps wanted the cabinet to be loyal to him. Fair, I guess.

Second, PM Honcharuk was heavily criticised for being inexperienced and the accusation was that he struggled to manage government, and be effective in policy implementation. That may well have been the case but still you have to feel sorry for Honcharuk as his inexperience was seemingly the prime reason that Zelensky hired him in the first place, because he wanted to do things differently, and to shake up the status quo.

Firing Honcharuk was then surely an admission of failure in the first instance by Zelensky. My own personal rules of management are 1. Hire the right people; 2. delegate; 3. Back them to the hilt once you have hired them. On my own management play book you could thus argue that Zelensky by firing Honcharuk accepted his error on the first point, on the second he really failed to give Honcharuk real authority to act - and when Honcharuk tried to take some authority over the Centrenergo issue, Zelensky failed on the third count. 

It is hard not to think that Honcharuk should have been given a little longer to prove himself, at least until securing final agreement on the IMF EFF.

But then, if it was all about the effectiveness of Honcharuk, then why remove Markarova who had proven a highly effective minister of finance over several years?

Third, an arguement goes that Zelensky rejigged the cabinet as he needed to buy some political capital from various oligarchic groups to secure support in the Rada for key prior actions required by the IMF to get board approval for the new EFF. Possible.

Fourth, but an equally plausible argument I have heard is that Zelensky rejigged the cabinet as he decided that he was never going to get Rada approval for the IMF prior actions and he was sold an alterative economic vision which the new ministers will now deliver on - pro growth, pro-big business, with fiscal pump priming and a weaker currency all part of this agenda.

I heard something of an extension of this that oligarchic groups would back the Yermak peace plan with Russia, and this would see some kind of economic outreach back to Russia which could be an alternative to IMF cooperation. A similar conspiracy theory is that Russia is behind all this.

After events post 2014, the very latter scenario is simply unsaleable in Ukraine and I sincerely hope any potential proponents of any such plan realise that too - otherwise the consequences would be extreme danger of instability and social unrest in Ukraine. Surely they get it, right? 

Fifth, and perhaps even related to point four, that Kolomoisky is behind all this and the reshuffle is meant to stall the IMF, and improve Kolomoisky’s position on the Privatbank case.

Sixth, that Zelensky simply is slave to his show business background, and therein craves popularity and instant gratification by his adoring public audience. Opinion polls were sagging in response to unpopular reform policies, and Zelensky decided to change the cast, and perhaps even the script. Time will tell. 

Seventh, there is no logic at all, but this was just a cock up with no particular underlying strategic plan.

Actually I have no idea which of these stories explains the cabinet reshuffle, and it may have been a combination of a few of these. 

But we are where we are, or Ukraine is. The country now has another politically inexperienced PM (albeit by all accounts a decent manager), a partially staffed cabinet, and ten new ministerial hires, and likely many deputy ministerial changes.

And all this comes as Ukraine is, like other countries, facing the biggest global crisis since 2008, with a credibility gap now about its own policy direction, and with some months yet (best case) before it is wrapped in the cotton wool of an IMF programme, and while its markets are now in free fall. I would add also concerns expressed that the management of the NBU is imminently going to be changed - please let this not be true.

Another really inexplicable part of this is prior to the cabinet reshuffle I would have argued that Ukraine likely faced the best macro mix that I have seen at any time over the 30-odd years I have been covering the country. Low inflation, stable currency, falling policy rates, rising currency reserves, falling debt, low budget deficit and solid balance of payments position. With this backdrop the country was poised to benefit from increased investment, growth and jobs.

Why oh why did Zelensky decide to risk all this and shuffle the pack? See above, but perhaps someone sold him snake oil story, that disappointing growth in the short term is due to hot money inflows the NBU mismanagement of the exchange rate and an overvalued currency, No, no, no! I don’t think any decent economist believes the latter view.

In any event, we are where we are, and I was encouraged on this trip by seeming recognition from the new team that the country is now facing a serious crisis. There seems now to be understanding that there is no Plan B, that in the current global conditions, that Ukraine cannot finance itself without the IMF. That the IMF is the only show in town - well technically not given the travel bans now doing the rounds, but you get the drift.

I was assured that the new administration is serious about delivering on IMF prior actions, even accelerating reform (land bill), and having the new IMF programme in place by May/June. This still presumes the land bill is agreed by the Rada over the next few weeks and the banking bill sometime in April. Let’s hope the C-virus does not interfere with the Rada’s calendar or else this timetable could seriously lag. 

I was also reassured that no imminent changes are planned in the management of the NBU - despite lots of media hype therein. Note herein the NBU has proven itself an astute and very capable manager of monetary and exchange rate policy and if Ukraine is to navigate through the current storm the experience of the existing team will be absolutely mission, or voyage, critical. Making any changes to the current (winning) team would be suicidal for the economy, and coming so soon after a very disruptive cabinet reshuffle.

To stretch, or mix, the metaphor, the good ship Zelensky’s Ukraine is heading into the perfect storm, and it would not be wise to replace the seasoned old sea captain and crew, with an underground driver who is used to staying on the right (party) line - nothing against underground drivers but, horses (or drivers) for courses as they say - but has zero sea faring experience and likely will get sea sick upon the first swell.

Trying to think positively, the positive macro ratios noted above mostly still remain in place, and Ukraine could actually be a net winner from the current Saudi - Russia oil price war, bringing a much lower energy import bill and lower inflation. It has strong international backing and decent teams at the NBU, MOE and MOF still - the latter two of which I understand capable deputy ministers are being retained.

NOTE: Please note that any views expressed herein are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions. The views expressed do not reflect the opinions of all portfolio managers at BlueBay, or the views of the firm as a whole. In addition, these conclusions are speculative in nature, may not come to pass and are not intended to predict the future of any specific investment. No representation or warranty can be given with respect to the accuracy or completeness of the information. Charts and graphs provided herein are for illustrative purposes only


USUBC NOTE:  The views expressed in this article by Timothy Ash are solely those of the author and do not necessarily reflect the views of USUBC, its staff, or members.  The article is distributed for information and educational purposes only. 
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