UKRAINE COMMENT: Muted response by markets to Tymoshenko sentence

 Arthur McCallum, Head of Strategy at Eavex Capital.

The October 11 sentencing of Yulia Tymoshenko to seven years in jail and a fine of UAH 1.5bn (USD 188mn) for abuse of power has caused quite a stir internationally.

We maintain our view that the escalation of the Tymoshenko situation is a reflection of the highly diverse players and objectives within Ukraine generally and Yanukovych’s Party of Regions specifically.  Tymoshenko has positioned herself as a focal point for several economic and political issues, effectively raising the stakes for an administration being pulled in multiple directions, and forcing Yanukovych to take an active personal role in the resolution of what has quickly become a public relations failure.

Prior to the Oct 11 court verdict, expectations were that Tymoshenko would be sentenced, but then see her charges reduced, resulting in her quick release from custody.  A draft law to decriminalize the article of Ukrainian Code brought against Tymoshenko has been widely discussed by the Yanukovych administration and EU officials as a so-­called “soft landing” option. These expectations, however, did not foresee the severity of international condemnation which occurred within minutes of Tymoshenko’s sentencing. In what appeared to be a direct reaction to the international uproar, Yanukovych quickly released a statement calling the decision “regrettable” and noting the aforementioned draft law.

With Yanukovych scheduled to visit Brussels on Oct 20 to review the terms of an EU­-Ukraine Association Agreement, it seems that the administration has found the limits of European patience. It is on this basis that we expect action from the administration to defuse the situation with the next several days.

Assuming the administration acts decisively to defuse, we view the economic effects of the Tymoshenko situation as minimal. The market reaction was mixed. An initial spike in 5 and 10 year CDSs and rise in sovereign yields recovered, while corporate bonds moderately strengthened. We see this volatility as part and parcel to the new global norm of fear in low liquidity, as investors sell the rumor/headline and buy the analysis. An obvious example would be the behavior of MHP during Oct 3­-10.

Taking into account the benefits that Ukraine already receives as a member of the WTO, we view the approval of an EU Association Agreement as more symbolic than substantive for Ukraine’s economic relationship with Europe. Rather, the Agreement would give comfort to the EU that Ukraine is serious about moving forward in its long­-term relationship with the union. Furthermore, we believe that Tymoshenko’s fate should have a limited effect on Ukraine’s relations with the IMF. To date, the IMF has maintained a certain distance from particular political issues falling outside the scope of its agreements. If Ukraine successfully implements pension reform and raises domestic gas tariffs, we would be surprised to see the IMF refuse to resume tranche payouts of the country’s USD 16bn standby loan.

Major press outlets have begun comparing Tymoshenko to former Yukos Chairman Mikhail Khodorkovsky. We view these comparisons as simplistic and inaccurate, for reasons too numerous to cover here. However, one very obvious difference in the two cases was demonstrated by the conciliatory nature of Yanukovych’s Oct 11 statement. This is an indication that the relative power of Yanukovych to Tymoshenko today is of a lower order than that of Putin to Khodorkovsky in 2003.

This brief is a follow-­up to our previous reports Rising Pressure: Yanukovych’s Gas Gamble from 13 Sept 2011 and Ukraine Market Monitor,from 12 Oct 2011, available on www.eavex.com.ua and Bloomberg.