Kiev’s decision to impose martial law for the next 30 days will hurt Ukraine’s economy by further undermining investors confidence in the future of the country.
The Ukrainian parliament, the Verkhovna Rada, greenlighted the declaration of martial law in the country for 30 days on November 26 following a dramatic escalation of a Ukraine-Russia conflict in the Sea of Azov on the weekend.
At the same time, the nation’s President Petro Poroshenko shied away from imposing it for 60 days that would have caused the March 2019 presidential elections to be cancelled. However, while there will be no direct impact on Ukraine’s economy – and most importantly martial law will not prevent Ukraine’s main donor, the International Monetary Fund (IMF), from distributing its next tranche of badly needed cash – it will undermine the already fragile faith investors have in the future of the country and prevent both investment and privatisations from happening.
According to teh IMF, there are no legal restrictions to further cooperation with Ukraine over a new $3.9bn Stand By Agreement (SBA) with the IMF in October after the introduction of martial law.
“We are following recent developments, including the imposition of martial law, and hope for the prompt de-escalation of the current situation,” Resident Representative in Ukraine Goesta Ljungman said in Kyiv on November 26. “The IMF does not have any legal restriction to the continuation of cooperation with Ukraine in this situation.”
Last week, the Verkhovna Rada, adopted the national budget for 2019 with a planned deficit of 2.3% of the nation’s GDP, which is less than the maximum 2.5% acceptable to the IMF.
The budget also included an increase on defence spending to circa 5% of GDP, which is a burden for the otherwise cash-strapped economy. Spending on defence and security (which includes the police force and boarder guards) in 2019 was increased to UAH211.9bn ($7.6bn) from the total spending of UAH1.11 trillion ($39.6bn). The approval of the budget compliant with the IMF is crucially important for Kyiv’s cooperation with the donor.
Among other conditions for possible repackaging of undrawn funds from the existing $17.5bn Extended Fund Facility (EFF) agreed in 2015 into a $3.9bn SBA are the increase the gas price for households, as well as the implementation of anti-corruption measures. Ukraine has received $8.4bn from the IMF so far under the multinational lender’s EFF.
Bond prices tank
The immediate affect of the imposition of martial law was to send Ukraine’s international bond prices tanking as the tensions on the waters of the Sea of Azov flared.
Ukrainian government bonds fell to their weakest level since issuance as a the conflict flared. The incident took yields on some bonds to the highest since they were sold over the past 12 months, reports Bloomberg. The hryvnia was on track for its biggest daily drop in five weeks against the dollar.
The yield on dollar-denominated bonds due 2032 rose 31 basis points to 10.24 percent as of 9:03 a.m. in London, the highest since it was sold a year ago, reported Bloomberg. The hryvnia slipped as much as 1.6% against the dollar.
There were also reports that the NBU may cancel this week’s bond auction, which has become an important source of financing for the government as it struggles to meet some $3bn worth of debt obligations maturing this year, despite issuing a $2bn Eurobond in October after the new IMF deal was announced.
If the tensions continue they will raise the cost of borrowing in 2019 as Ukraine has some $6bn of public debt to refinance and a total of some $15bn that comes due next year, Finance Minister Oksana Markarova told reporters on last week. This high level of debt repayments comes from the debt refinancing of 2014-2015.
Central bank steps in
Meanwhile, the National Bank of Ukraine (NBU’s governor Yakiv Smolii believes that the decision on the introduction of martial law in no way would affect the operation of the Ukrainian banking system.
“I would like to say that decisions that would be made would not affect the operation of the banking system,” the governor said on November 25. “Banks’ branches and offices will operate as usual, and the decisions would not influence the operation of banks.”
Later, on November 26, the central bank urged commercial lenders to keep enough cash in ATMs to satisfy the possible increase in demand due to expected panic triggered by the introduction of martial law in the country. “The NBU asked banks to take measures for keep enough cash in ATMs and promised, if necessary, to support banks with refinancing,” Smolii said during an extraordinary meeting with heads of largest 40 banks, an unnamed source told Interfax.
Meanwhile, the nation’s deputy Prime Minister Pavlo Rozenko believes that in all social payments, allowances, pensions, wages and other payments will be made on time, in full and without restrictions.
“To stop speculation on this sensitive topic, a few words about the impact of the possible imposition of martial law on the social payments system in the state,” the minister wrote on his official Facebook page. “Considering the stable and predictable financial and economic situation in the country, all social payments, benefits, pensions, wages and other payments will be carried out on time, in full and without restrictions.”
General business environment
While there is unlikely to be an immediate affect on Ukraine’s economy, the escalation of tensions and the imposition of emergency powers can only further undermine Ukraine’s already poor investment image.
New foreign direct investment in Ukraine was only $1.9bn in 2017, the State Statistics Service said. About one quarter, or $506mn, was from Cyprus, presumably offshore Ukrainian or Russian money. The next four sources were: Russia – $396mn; the Netherlands – $262mn; Britain – $212mn; and Germany – $119mn.
Ukraine needs to raise several times this amount of investment if it is to start growing again.
In addition, the heightened uncertainties could derail the privatisation programme, which is another key reform process.
Ukrainian Finance Minister Oksana Markarova said a week ago that the target of UAH17bn of payments from privatization announced in the national budget for 2019 is realistic.
At the same time, Markarova recalled that the previously expected revenues of the national budget from privatization were replaced by borrowing. “Every time we borrowed more than we planned to replace this amount, which was not received from privatization,” she said.
Top of the agenda this year is the sale of a 78.3% stake in power generation company Centrenergo by a November 21 deadline with a start price of UAH6bn ($215mn) for which five companies have registered. However, the rules require at least two bidders for the auction to go ahead, one of which must be a foreign company, which will be harder to do now.
The tender to sell the Centrenergo stake is scheduled for December 13, which will fall within the martial law regime and as such will very likely be delayed until the new year now.