Why Ukraine Should Not Default
Based on data from The Economist

There has been a lot of talk recently about a possible Ukrainian default.  Economically the reasons for this are really only due to a short term and rapid deterioration of the economy (don’t mention the war….)  but overall Ukraine is not a basket case and not in the league of Greece or some of the other PIIGS.[1]

Some of the talk has come from the IMF and other donors but this was mainly to ensure the Government and Parliament understood that real reforms have to be made quickly and ‘business as usual’ was not an option. The Parliament voted through what amounts to an austerity package last week which was a rapid reduction in subsidies for energy and a substantial reform of the pension system. Last year the Government removed the fixed exchange rate for the Hryvne (under IMF advice) and this has resulted in (an expected) severe devaluation where it has dropped from around 11 UAH/€ to as low of 35 UAH/€ (from 8 UAH/$ to 32 UAH/$).  This has caused panic buying, increased speculation about bank failures and generally contributed to instability. Of course on the plus side it has dramatically reduced imports and made exports much more attractive and already restored a positive trade balance. 

On top of this we have the political and military situation which, of course, has stopped virtually all foreign investment and resulted in capital flight for those who can get some funds out.  However if we look at the economic fundamentals Ukraine’s external debt was relatively low (41% of GDP in 2013). The bubble chart below shows 2014 data from the Economist and the vertical left axis shows public debt as a percentage of GDP.  Ukraine is listed as 45% (although many sources now say it is between 80-100%) whereas Spain is 81% and Greece 151%.  Remember that maybe half of the Ukraine economy is a shadow economy which would reduce this.  More interesting is the debt per capita which is only around $1,500 in Ukraine but $23,000 in Spain and $30,000 in Greece.  This is represented by the size of the bubbles. 

Data Source:  The Economist Interactive Debt Map online at the Global Debt Clock

There are really four main aspects to economic stability in Ukraine at the moment.  The economic fundamentals, perception (by the population and investors / market players), the ability of the economy to reform and, of course, the geo-political situation.

Broadly the economic fundamentals are not as bad as many would have you believe – debt is lower than in the PIIGS and the real problems are corruption and the difficulty of doing business[2]. The fact that more than half of the banks were controlled by the Yanukovych ‘family’ is a huge problem and that the exchange rate was fixed since independence at progressively unsustainable rates, combines to create the current short term economic instability. Also the EU forced Ukraine to pay a disputed $3 billion to Gazprom to ensure that gas would continue to flow to Europe which helped to push the forex reserves into the red zone of just over a month’s cover. IF the West is going to help financially then it must ensure that it is sufficient and on time and not like the Euro crisis where Europe has always been too little and too late.

Don’t mention the war……..  well we have to and it costs a huge amount, has decimated the economy in much of Donbass[3] which was the industrial heartland of Ukraine and used to contribute over 60% of economic output.  There are probably 1-2 million displaced persons and, of course, it has destroyed investor confidence, which is one of Putin’s goals. 

There is some good news. Reforming the economy is much more likely than in more mature economies like Greece and Spain where local vested interests, trade unions and the unpopularity of austerity limits what a democratic government can deliver.  Ukraine knows this is about life or death so most people will suffer economic hardship and hopefully allow the government enough time to deliver.  Putin, in less than a year, has united all of Ukraine against closer ties with Russia and in favour of closer integration with Europe and building a real democracy.  The difficulty of doing business means that maybe half of the economy is a ‘black cash only’ shadow economy which means if regulations and corruption are permanently cut that much of this ‘entrepreneurship’ will come back into the real economy.

The government is delivering on real reforms – I am working in 3 of the 8 working groups in the Ministry of Agrarian Policy and Food and all the groups have quickly identified the problems and are proposing radical reforms and the Government has started to implement them.  Corruption will not disappear overnight but Georgia went from a ranking of below 100 in the IFC Ease of Doing Business Survey 10 years ago up to 15th in the World today, which is above Canada, Austria and Switzerland.  This does not mean that there is no corruption there anymore but for the ordinary citizen it has meant a dramatic change in his everyday life as most administrative tasks (that used to be difficult and corrupt) can now be done online. Georgia brought in a completely new traffic police force overnight and key Georgian officials are now working in senior positions in Ukraine.  The IMF, EU, USA and other large donors are correctly tying their aid and financial support to real reforms in Ukraine.

The failure of the West to support Ukraine now would provide Putin with a major victory and would cause huge problems in the EU – A default by Ukraine could mean a major crisis in Austria and other countries with large exposures in Ukraine and there is a real risk of that contagion spreading and further undermining the Eurozone. Whilst the West has been slow to give a tough response to Putin, slowly, very slowly the USA is realising it needs to give Ukraine the means to defend itself and while that debate continues it is politically easier to provide financial support to Ukraine.  


The article was written on the 9th March and the IMF Board approved the extended finance facility of $17.5 billion for Ukraine on the 11th March, 2015.


[1] Portugal, Ireland, Italy, Greece and Spain. Although Ireland is the one example of where austerity and tough reforms are working.
[2] The World Bank IFC Ease of Doing Business for 2014 ranks Ukraine at 112th in the World just below Egypt and Zambia.
[3] Donbass is a broad economic region including Lugansk and Donetsk (where the war is) but also includes some of Dnipropetrovsk which is not yet in the conflict zone