Ukraine After the Crisis

POLICY BRIEFS No. 04/2010 ISSN 1653-8994 Ukraine After the Crisis: Recovery and Reform, not Revolution or Russification Fredrik Erixon Fredrik Erixon ([email protected]) is Director and co-founder of ECIPE It could be the libretto of a grand opera. The Prince powers and terrifying his enemies into silence. In the and Princess of a democratic revolution, who gained third act, the decline and fall of the country begins. power after a long struggle against the old guard, fall out with each other. The political love affair ends and But it is not a libretto, nor is it a tragedy by Shake- they spend all energy fighting each other rather than speare. It is how many observers view the modern representing the people that brought them to power. history of Ukraine. And as with many grand stories, it The old villain from the dark period returns, and his builds on a combination of real substance and manu- reputation recovers as the Prince and the Princess factured spin. While political romantics believe in the quarrels. Amid destruction and economic collapse, transformational power of revolutions, realists tend the fire of the democracy revolution burns out. People to see history evolve endogenously and incrementally. yet again turn to the villain for leadership. He returns Ukraine’s Orange Revolution was the beginning of a to power, but uses it again to benefit his own kin. He new wave of soft revolutions in parts of the former solidifies his own position by colluding with foreign Soviet Union where the old guard had resisted funda- SUMMARY This Policy Brief aims at examining posed to adverse development on inter- There are also hesitations based on Ukraine’s economic woes and what it national credit markets. President Yanukovych and his political needs to do to improve economic per- The reform agenda set out by the orientation towards Russia. Sceptics formance. At the centre of the Brief are new Ukrainian government is ambitious. may or may not be proven right – it is the effects on Ukraine of the economic If the government delivers on its prom- too soon to tell. What seems clear, how- crisis and the policy programme devised ises – and obligations to the International ever, is that Ukraine favours a much more to improve economic performance. The Monetary Fund – economic policy will pragmatic approach to its neighbors in crisis hit Ukraine hard and Gross Do- move in a liberal direction and economic the east and the west. It is not difficult mestic Product fell by 15 percent in growth is likely to pick up. There are hesi- to understand why. Ukraine’s relations to 2009. The economy is now recovering, tations about the ability to push through Russia had to improve and as long as the but economic growth will not return to all reforms, but the Ukrainian government EU does not wish to start the process for pre-crisis levels anytime soon. Ukraine has been forced to tie itself to the IMF full accession, Ukraine needs to find its went through a classic emerging-market mast and should make full use of this own way and build a reform and future crisis – it was too dependent on export opportunity to liberalize economic policy agenda on other foundations. of steel and metals, and it was too ex- and modernize the economy. mental political change that would bring democracy, in- CRISIS AND RECOVERY dividual liberties and market economy. It was an historic and important moment for Ukraine. Yet as with other The global crisis hit Ukraine hard. Gross Domestic revolutions, it could not alone bring fundamental change Product (GDP), which had grown at steadily high lev- of the society and the economy. Predictably, new leaders els in the pre-crisis period, plunged in 2009. GDP per were taken hostage by political realities. It is understand- capita fell by close to 15 percent (see Figure 1). Ukraine’s able that many people inside and outside Ukraine is dis- economy contracted more than most other economies in appointed by the inability of Viktor Yushchenko and Yulia the region – and in the world. Only Latvia plays in the Tymoshenko to deliver on the promises set out during same league, when compared to other European coun- the Orange Revolution. But the task now should be to tries. Ukraine suffered a contraction twice the size of the pave the way for the reforms needed to change the socio- contraction in Russia and the average contraction in the economic structure of Ukraine – the reforms that were Europe-Central Asia (ECA) region. neglected in the post-revolutionary period. What explains the sharp fall in Ukraine’s economy? Two This Policy Brief aims at examining Ukraine’s economic explanations are central in order to understand the sever- woes and what it needs to do to improve economic per- ity of the economic collapse. Firstly, Ukraine’s economy formance. Naturally, developments during the crisis and was highly dependent on the export of commodities, the various packages by the International Monetary Fund steel and agricultural produce in particular, and as world (IMF) will be at the centre of the paper. Furthermore, the prices and demand fell, Ukraine’s export revenues col- reforms initiated by the Ukrainian government will be lapsed (see Figure 2). Export revenues fell by a greater discussed in light of the overall reform needs. Finally, the degree than GDP, and the current account deficit ex- paper discusses what approach policymakers in the EU panded in the first quarters of the crisis. Revenues from should take in relations with Ukraine and its new govern- steel exports were particularly hit and some of the miners Indicator ment. Name 2003and steel producers2004 had to stop2005 production. For a sector GDP per capita growth (annual %) UKR 10.29132275that represents 12.95365583a big share of GDP,3.455340233 the contraction in the GDP per capita growth (annual %) RUS 7.867704831world metal market7.702296374 had a devastating6.919976918 effect. Steel pro- GDP per capita growth (annual %) KAZ 8.932709773 8.840764671 8.729523998 GDP per capita growth (annual %) ECA 6.563458381 8.404229781 7.120846065 FIGURE 1: GDP PER CAPITA GROWTH (ANNUAL %) 15 10 5 UKR 0 RUS 2003 2004 2005 2006 2007 2008 2009 -‐5 KAZ ECA -‐10 -‐15 -‐20 Source: World Bank, World Development Indicators 2 ECIPE POLICY BRIEFS/No 04/2010 2000 2001 2002 Exports of goods and services (BoP, current US$) 19.522 21.086 23.351 FIGURE 2: EXPORTS OF GOODS AND SERVICES (BOP, CURRENT USD, MIO) 90 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: World Bank, World Development Indicators duction in Ukraine fell by approximately 30 percent in also expand consumption on the back of increasing asset 2009; overall production of metals shrunk by 55 percent values, and in that way push domestic demand with the between November 2007 and November 2008. Naturally, help of external credit. But this driver of growth ended the eastern parts of Ukraine, the heartland of industrial abruptly with the crisis. The property market collapsed steel production, were hit the hardest. Other key export in the second half of 2008 and continued to fall in ear- goods of Ukraine, like cereals, were less affected by the ly 2009. House prices in Kiev fell by 40 percent. Fixed crisis. But no product category in the portfolio of Ukrain- investments, to a large degree denominated by invest- ian export managed to expand during the crisis. ments in real estate, dropped by 46 percent in 2009. A few months into the crisis, Kiev looked in many ways as Secondly, Ukraine was highly exposed to international a ghost town – a city that had ceased to exist. It was still capital markets. Banks and firms had taken up considera- a construction site with building cranes everywhere. But ble loans on the international debt markets and needed to not actual work was going on. Construction workers and roll over debt as loans matured. Fortunately, Ukraine was firms had left the sites. About half of the real estate devel- not exposed to toxic debt in the same as many European opments in the country were put on hold. banks, but as the credit markets generally dried up, and as the share of Non-Performing Loans (NPL) in Ukrain- These two factors, falling export revenues and adverse ian banks increased as the property market collapsed, effects from the credit squeeze, were the main drivers of Ukrainian banks run into difficulties. Seven Ukrainian- the contraction in the Ukrainian economy. Domestic de- owned banks have been put under the authority of the mand fell by almost 25 percent in 2009. The construction Ukrainian government. Recapitalization needs have de- and retail sectors, which had lifted domestic demand in creased considerably in the past 18 months, but there are the pre-crisis years, were now the main factors behind the still remaining fragilities in the banking system. fall. Construction output, for example, fell by 35 percent in 2009. As employment shot up and as wages were cut Furthermore, the property boom in pre-crisis Ukraine for many workers in the industrial sector, the adverse ef- was driven by an expansion of debt. In the three years fect on demand became very strong. before the crisis, property prices in Ukraine went up by around 600 percent. Kiev and other development hubs In other words, Ukraine went through a classic emerg- in Ukraine were for many years vast and vibrant con- ing economy crisis. In Ukraine, the force of the crisis struction sites. With rising property prices, people could was stronger than usual as it was fostered by a global 3 ECIPE POLICY BRIEFS/No 04/2010 credit squeeze and a recession in key export markets growth in the construction and retail sectors.

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