Due to a number of factors, Ukraine was more vulnerable than other emerging markets to the detrimental effects of the current global financial crisis. Despite this, Edilberto Segura, Partner and Chief Economist, SigmaBleyzer, Kyiv, believes that Ukraine can still contain the impacts of the crisis if it implements certain economic measures. At an April 7, 2009 Kennan Institute lecture, cosponsored by the U.S.-Ukraine Business Council, he identified those measures and assessed Ukraine's future economic prospects.

OVERVIEW OF THE UKRAINIAN ECONOMY

From 2003 to 2007, Ukraine had one of the fastest growing economies among its neighbors.
This growth was supported by booming domestic demand and strong exports. From January to September 2008, Ukraine continued to enjoy good economic results:

• Real GDP grew by 6.3 percent
  
• Inflation decreased
  
• The fiscal budget was in surplus
  
• Public debt declined
  
• Exports grew by 50 percent
  
• The Current Account deficit was being met by capital inflows
  
• International reserves reached $37 billion
  

In October 2008, however, the global crisis hit Ukraine harder than other emerging markets, as real GDP declined by 8 percent in the last quarter of 2008 and exports declined by 16 percent from November to December 2008. From January to February 2009, the contraction continued, with industry declining by 32.8 percent and construction by 57 percent. Exports began to fall more drastically than before – by 38 percent.

Segura posited that the poor performance of the Ukrainian economy was due to both decreasing exports and falling domestic demand. Roughly 50 percent of Ukraine's exports consist of metallurgical and chemical products, whose prices have declined sharply since September 2008. This decrease, coupled with significant economic slowdown in the rest of the world, has resulted in the drastic decline of Ukrainian exports. Falling domestic demand has similarly contributed to Ukraine's poor economic performance. In the past, Segura explained, domestic demand was spurred by large increases in wages and pensions, booming credit, the rising profitability of enterprises, and a strong inflow of foreign capital. Since September 2008, however, these drivers have been rapidly vanishing, leading to a sharp reduction in domestic demand.

CAUSES OF THE CRISIS IN UKRAINE

According to Segura, Ukraine was more vulnerable to the current global financial crisis than other emerging markets due to a combination of three factors:

1. Large Current Account Deficits
   
2. Large External Debt Burden
   
3. Banking Sector Weaknesses
   

1. Large Current Account Deficits

In 2008, exports grew fast at 33 percent, but imports grew even faster at 39 percent. As a result, the Current Account deficit reached around $13 billion in 2008, or 7.2 percent of GDP. Although the net inflow of foreign direct investment (FDI) comprised a substantial $9.7 billion, it did not cover the Current Account deficit. To absorb the gap, Ukraine used reserves and depreciated its currency, the Hryvnia.

2. External Debt Burden

In the last two years, Ukraine's total external debt doubled, growing from $53 billion to $103 billion by the end of 2008. Amounting to 60 percent of the country's GDP, Ukraine's external debt ranked above the median value for similar countries. In the last quarter of 2008, net external debt outflow from Ukraine amounted to $6.6 billion and was among the main sources of Hryvnia depreciation pressures.

3. Banking Sector Weaknesses

From 2006 to 2008, bank credit in Ukraine grew by 70 percent, supported by increases in money supply and borrowings from abroad. As in many other countries, these high rates of credit growth led to high levels of non-performing assets (sub-standard, doubtful, and loss loans – NPLs). The share of NPLs in the Ukrainian banking sector is higher than in other countries. Additionally, a flight in deposits started in September 2008, and by February 2009, about $12 billion had flown out of the banking system.

FIVE PILLARS OF CRISIS RESOLUTION

With these factors in mind, Segura hinged the resolution of the crisis in Ukraine on the successful implementation of the following five measures:

1. Establishing strong organizational arrangements to confront the crisis
   
2. Securing substantial foreign financial assistance
   
3. Implementing a comprehensive program for troubled banks and their borrowers
   
4. Implementing a macroeconomic stabilization program
   
5. Implementing structural reforms to revive economic and export growth
   

Segura noted that Ukraine has made relatively good progress in securing substantial financial assistance and implementing a macroeconomic stabilization program. The country has secured loans from the IMF ($16.5 billion) and the World Bank ($500 million), and has also applied for bilateral and multilateral financing. Ukraine has also implemented temporary measures to curb imports and reduced budget expenditures on public administration. "Long-term foreign financial assistance is vital to assure foreign creditors that the country has the resources to cover all of its external debts," Segura explained.

In contrast, in establishing organizational arrangements to confront the crisis and implementing a comprehensive program for troubled banks and their borrowers, Segura judged that the country has made only moderate progress. In Ukraine, there is no special crisis authority. Both the national bank and the government have taken measures to address the crisis, but poor coordination has often resulted in conflicting statements, undermining public confidence. "In the absence of a formal authority," he suggested, "a crisis coordination memorandum of understanding should be signed by all relevant agencies."

According to Segura, Ukraine has made poor progress in implementing structural reforms to revive growth. Since stabilization measures will reduce growth, Segura advised that the program implemented by the government also include measures to restart economic growth and exports. "The most realistic option to revive economic growth," he stated, "is to improve the business environment to attract private investments." Currently, he put forth, Ukraine's competitive disadvantages are systemic and can only be remedied with a strong reform program. Some of the reforms he recommended included the following:

• Getting rid of corruption in customs administration by transferring customs management to a reputable foreign company
  
• Improving transparency in the judiciary by mandating that court decisions are immediately published on the Internet and subject to review by an independent entity
  
• Promptly entering into an Enhanced Free Trade Agreement with the EU
  
• Removing the moratorium on land sale
  
• Reducing the cost of doing business by reducing and consolidating taxes/duties and improving tax administration and VAT refunds
  
• Improving public governance by reducing overlapping functions, improving transparency and decision-making, and reducing administrative corruption
  
• Reforming the judicial system
  
• Improving fiscal sustainability by eliminating privileges and reforming the pension system
  

PROSPECTS FOR THE FUTURE

Segura believes that if Ukraine successfully implements the five measures he outlined, Ukraine will be able to contain the impacts of the financial crisis during 2009. Though a number of medium and small banks may fail, Segura postulated that if the country addresses its economic vulnerabilities, following the recovery of the world economy, Ukraine's exchange rate could stabilize and GDP recovery could take place in 2010.

Written by Sarah Dixon Klump