By Chris Weafer, Founding Partner, Macro-Advisory, Moscow.
Chris Weafer’s career includes top research positions with Sberbank, Troika Dialog, UralSib, Alfa Bank and NatWest. Mr Weafer, who has worked in Russia for more than fifteen years, is the author of a wide variety of articles about Russia, Central Asia and the trend in macro oil. He is also widely quoted in the international financial press and appears regularly on CNN International, BBC, and Russia Today. Most recently he was voted the best Russia investment strategist for 2013 by investors in separate polls carried out by Thomson Reuters Extel and Institutional Investor magazine. He has regularly placed in the top three of these respective polls over the past ten years.
“Luck always seems to be against the man who depends on it” – Ukrainian Proverb
This week’s events in Ukraine appear to have bought little or no more time for President Yanukovych to try and come up with a mechanism to end the protests and to hang onto power. If anything it seems as events, and the intensity of the protests, are set to accelerate. For investors that means a high level of uncertainty will continue to hang over the economy and the markets.
I recommend staying away from all asset classes for now.
– An accommodation between the protestors and President Yanukovych (very unlikely) which would delay elections until the scheduled date in February next year would be a buy signal.
– Any evidence that the protestors will now switch their focus to ousting the president will hit all asset prices hard, as happened in early December.
It is clear that neither the reversal of the anti-protest law nor the resignation of the prime minister are enough to clear the streets. The protestors have now rejected the proposed amnesty for people convicted of protest actions. The protestors’ key demand has always been, and remains, the resignation of the president leading to fresh elections. President Yanukovych has shown no evidence that he is contemplating that move.
So, after a very brief interlude, the level of violence is very likely to increase over the short-medium term, as the core issues remain unresolved. That means the uncertainty will continue to hang over the bond market, the currency and equities. All three asset classes remain speculative. Standard & Poor’s lowered Ukraine’s long-term rating in foreign currency to CCC+ with a negative surprise. No surprise there, albeit late in coming.
S&P did also point out another obvious fact which is that Russia’s debt support is conditional on a pro-Russia government and if Yanakovich is ousted the debt support may cease. There are “mixed-signals” on the aid deal coming from several Russia government sources but fair to say that full implementation was always conditional on a Moscow biased government remaining in power in Kiev.
So, taking the latest developments and still unresolved issues into account, there are several scenarios which may play out in Ukraine’s markets over the next few months.
– If the protestors now focus on ousting Yanukovych and his position starts to look unsafe then Moscow could delay payments under the agreed bailout deal until the situation clarifies. That event would spike the yields on Ukraine sovereign and corporate debt to levels seen in early December
– If the protestors were to succeed in forcing Yanukovych out then the existing Russia-Ukraine deal would likely be abandoned. The EU would be forced into re-opening bailout talks and would be expected, by the new Kiev government, to write a large rescue check. But, given that the EU/ECB backed off from rescuing bond holders in Greece and large bank depositors in Cyprus, both of which are EU member states, it is most unlikely that a bond restructuring could be avoided in Ukraine. If the protestors look likely to “win” then the bond market should weaken in anticipation of a debt restructuring including write-offs.
– Assuming the standoff continues, the longer the issue remains unresolved the greater will be the negative impact on the economy. Prospects for a (previously expected) return to GDP growth in 2014 (from a drop of 1.1% in 2013) will dim quickly and lead to earnings downgrades
– The Hryvnia is completely over-valued. That much has been clear for some time. It looks set to slide all year regardless of the outcome of the continuing standoff. But if Yanakovich hangs onto power then the government would continue to ease the slide, probably towards 9.0 or just below. On the other hand, if Yanukovych goes then so too will the currency peg as this was a key part of the EU/IMF package last year. A steep slide in the currency would quickly follow.
– The equity market will remain unloved until the uncertainty is resolved. Afterwards it will be a case of factoring in the impact of the crisis and resolution in the economy/earnings and also the currency impact. Winners and losers are yet to be determined based on how this ends.
Russia’s probable position
The escalation of violence in Ukraine could not have come at a worse time for Russia. With less than two weeks to the Sochi Olympics opening ceremony the last thing the Kremlin wants is to be dragged into a fresh conflict with the EU/US over Ukraine. Hence President Putin’s comment at yesterday’s EU-Russia Summit that all foreign influence should stay out of Ukraine.
The ideal outcome for Russia would be an end to the violence, a return to business as normal with the terms of the deal agreed between both sides in December unchanged. That would almost certainly eventually lead Ukraine into the planned Eurasian Union.
But all of that is now clearly at risk.
– Russia and Ukraine signed a deal in December under which Russia will loan $15 bln to Ukraine by subscribing for new Eurobond debt.
– Gazprom will sharply cut the price it charges Ukraine for imported gas and will ease the payment terms for the $2.7 bln Naftogaz Ukraine owes under the previous contract
– In return, Ukraine and Russia undertook to work to improve trade and political ties between both countries.
– Russia transferred $3 bln of the promised $15 bln before the end of last December
– An additional $2 bln is scheduled to be transferred by the end of this week.
– Naftogaz Ukraine was scheduled to pay the $2.7 bln it owes Gazprom by last Saturday (25th). Media reports now claim that a formal request to delay/restructure has been made by Naftogaz to Gazprom. This is still unconfirmed.
A lot less vociferous than it was in December. We have heard the expected condemnations of violence and abuses but mainly sticking to “let’s all calm down” rather than taking a stronger pro-protest position. It remains to be seen if that position changes to one of greater intervention now that the protestors have won some victories.
The problem for the EU political leaders is that if the protestors win the day and succeed in ousting Yanukovych from the presidency then it is the EU budget which may have to pick up the rescue tab rather than Russia. A new opposition backed president is unlikely to have any more of an appetite for the EU/IMF austerity package offered last year than the present incumbent has.
There would also have to be a fast-track entry into the EU which is unlikely to play well in many of the larger core EU countries.
That’s not to say that an EU rescue package would be as easy as the current Russia deal. Recall that the EU/ECB was in no mood to bail out the holders of Greek debt or of major depositors in the Cypriot banks. If it has to write a bailout check for Ukraine, a non EU member, you can be sure that the pain will be shared amongst the bond holders.
Reminder: Ukraine statistics
– The total value of Ukraine’s economy is approx. $180 bln. That compares with $190 bln for Kazakhstan and over $2 trillion for Russia.
– Preliminary estimates show that Ukraine’s economy fell 1.1% in 2013. Growth of 1.5%-2.0% had been expected in the current year but all bets are off until the impact of the current unrest can be assessed.
– Retail sales and disposable income rose modestly in 2013 but were showing definite signs of easing as last year ended.
– Inflation is near zero thanks mainly to the currency peg…obviously now a risk as the Hryvnia slides.
– Industrial production (-5% YoY) and investment spending (-13% YoY) were major drags on growth last year.
– The country had a current account deficit of over 8% of GDP in 2013.
– The budget is expected to run a deficit of about 4% to GDP in 2013.
Fiscal and Monetary policy
– The Central Bank maintains a Hryvnia peg to the US dollar at 8.0. The current inter-bank rate is closer to 8.50.
– From 2014 the top corporate tax rate will fall from 19% to 16% and to 10% from 2015.
– VAT rate will from 20% to 17% in 2014.
– Top marginal personal tax rate is 17%.
– The Central Bank has cut the benchmark rate from 12%, in 2009, to 6.5% currently. It cut 100 basis points this year.
– Ukraine’s total foreign debt is $140 bln (approx.) or over 80% of GDP…. $30 bln is owed to the Russian state banks.
– The value of Foreign Exchange reserves is today approximately $15 bln
– 27% of the value of Ukraine exports is to Russia…mainly agriculture, food.
– 30% of imports are from Russia, mainly gas and oil.
– The value of both imports and exports to the EU are similar to trade with Russia.
– Ukraine is a member of the WTO
Social and politics
– Ukraine’s population is approx. 45 million and is in slow decline.
– Approximately 3 million Ukrainians currently work in Russia according to the Russian FMS.
– In December Yanukovych’s government survived a no-confidence vote in the Rada as the opposition mustered 186 votes against the 226 it needed.
– Next presidential election is scheduled for February 2015.
– The most recent parliamentary election took place in October 2012 – the result by party is in the table below.