Will Loans Become a Lifeboat for Ukraine’s Economy?

BY VADYM SYROTA

In the spring of 2019, Ukraine’s poultry producer tycoon, Yuri Kosyuk, ruffled the feathers of Europe’s political elite by seeking a €100 million loan from the European Bank of Reconstruction and Development (EBRD) to develop his business empire. This request came on top of Kosyuk’s exploiting a loophole in the EU-Ukraine deal to vastly expand his multinational business and is viewed as an affront to the many European farmers who rely on subsidies to stay afloat. Most compellingly, it turned a bright light on a real problem for Kyiv: Ukraine’s banking system isn’t able to meet local business demand for loans.

Ukraine’s recently appointed prime minister, Oleksiy Goncharuk, has shown he understands this problem. Despite accusations of trying to restrict the central bank’s independence, the cabinet has identified a revival of credit issuance as among its tactical priorities. Cooperation with the EBRD may become the engine to drive such a breakthrough. This specialized organization is the largest institutional investor in Ukraine, having poured a cumulative €13.5 billion into the development of Ukraine since independence. However, ambitious plans to use this leverage to reinvigorate the economy may be hamstrung by the local credit market situation. At the same time, the EBRD’s activities in Ukraine are out of line with its activities elsewhere in Central and Eastern Europe.

Ukraine’s banking system is the world leader in terms of nonperforming loans (NPLs), which only recently fell below 50 percent of loans issued. Moreover, prospects for recovery are poor. According to the S&P rating agency, Ukraine has the lowest rate of bad loan recovery in Europe, about 9 percent (9 cents are reimbursed on $1 of a loan). By comparison, the bad loan recovery rate in Western Europe is 76 percent, while in the CIS countries it is slightly below 40 percent. Insofar as the local banking system factually serves as a storehouse of bad debt, it is not surprising that the EBRD tries to avoid investing in Ukraine’s economy through banks’ equity participation. The proportion of financial institutions in its Ukraine portfolio is 11 percent, whereas for Georgia it is 35 percent and for Turkey it is 24 percent.

A credit revival in Ukraine is not likely to be achieved with a trivial reduction in interest rates or long-term funding channeled to local financial institutions. The National Bank of Ukraine’s Financial Stability Report (June 2019) has identified poor lending standards as the main reason for the heavy NPL burden. However, the reasons are much broader and include not only the incompetence or fraud of those issuing credit but also such structural problems as the lack of strong property rights and the notorious practices of Ukraine’s justice system. Maybe that’s why, in Ukraine, the EBRD faces conflict with its core statutory goals: to facilitate the transition of countries to an open market economy on the basis of private and entrepreneurial initiatives, including “promoting the development, education and expansion of a competitive private sector, … in particular, small and medium-sized enterprises.”

The conflict with statutory goals arises in that the EBRD is actively financing the public sector of Ukraine. Indeed, private sector funding makes up only 46 percent of the EBRD’s Ukraine portfolio, whereas in Belarus, where the economy is dominated by state-owned enterprises, the figure is 65 percent. In Russia, with its ideology of state capitalism, this indicator is 91 percent, in Lithuania it is 80 percent. The EBRD—Ukraine’s largest institutional investor—apparently prefers to deal with the Ukraine’s public sector companies, while their solvency in turn greatly depends on the state of sovereign finances. The health of Ukraine’s public finance raises well-founded concerns over the near term (the next one to two years).

Investing by using project finance tools is an alternative option to allocating credit funds. Thus, financial institutions could start implementing the “grow your client” principle. The World Bank could provide solid assistance in this process. The World Bank’s newly appointed head, David Malpass, expressed interest in focusing on promoting economic growth “breakthroughs that materially raise median incomes.” This goal may well be achieved through project financing and the use of different credit programs. World Bank insiders say Malpass has shown a close interest in the world’s ten biggest emerging markets. Unfortunately, Ukraine is probably not on this list, as suggested by the EBRD’s reticence in funding projects in Ukraine by investing in equities: the proportion is 9 percent. For comparison, this indicator in Russia is 75 percent, in Lithuania it is 34 percent, and in Poland it is 25 percent.

In light of the above, it seems clear that the use of trivial monetary tools and even the removal of formal obstacles to global banks entering Ukraine’s financial market will not guarantee a “lending renascence.” Local banks now cannot allocate financial resources effectively. One possible solution is to cooperate with the international financial organizations providing technical expertise and to closely monitor the implementation of specialized credit programs. However, in Ukraine there are significant barriers to using such funds comprehensively.

Certainly the lawsuit filed by Sevki Acuner, the ex-director of EBRD for Ukraine, against the National Bank of Ukraine for reputational damage, after the NBU decided not to appoint him chair of the board of Kyiv’s Oschadbank, will not facilitate such desired cooperation. Ukraine’s banking community assumes the decision was driven by the interests of various political groups competing for the CEO position of Oschadbank (State Savings Bank), Ukraine’s second largest bank and one of the leading state-owned corporations. On the other hand, the EU is actively considering how to increase the efficacy of its development finance institutions within the “High-Level Group of Wise Persons.” Ukraine’s government should stay in touch with the new European bureaucracy to align domestic economic needs with the revamped agendas of these financial institutions.