When Will the Building of the Debt Pyramid in Ukraine Come to an End?

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UkraineDestructionBy Valentin Katasonov

[Photo courtesy Strategic Culture.]

[A]ccording to expert evaluations, nearly $6 billion has entered Ukraine from various sources (the IMF, the World Bank, the EU, the US) between the time of the February revolution and the end of September. Nearly 95 per cent of this has been spent on debt refinancing. No more than 5 percent has been used for other purposes in some way related to solving the country’s more urgent problems, which is crumbs in comparison. The evil tongues of those who orchestrated the February revolution and found themselves on the sidelines of the revolutionary process are revealing a strange secret. They allege that this five per cent is kickbacks and fund siphoning by the new government. Which means that the total left for ‘national development’ is exactly 0 per cent.

Today, many say that Ukraine is a ‘testing range’ (for Maidan Square activists to develop their techniques and for revolutionary techniques to be refined) and a ‘military foothold’ (for the preparation of NATO aggression against Russia). It is still a ‘goldmine’, however, for greedy speculators and financial oligarchs (global rather than Ukrainian), and a debt enslavement mechanism is being set up for Ukraine. Possible new loans will be used to quickly increase Ukraine’s public external debt, while the hryvnia exchange rate will slide even further downwards. At some point in time, the loans will come to an end, and that moment will be determined by two types of considerations.

Firstly, considerations regarding the significance of Ukraine as a ‘military foothold’, which I am not going to touch upon here, and secondly, purely mercantile considerations. [pullquote]The aid tap will be turned off for good once Ukraine has exhausted its resources to cover its external obligations. These are all assets of ‘independence’: black soil; shale gas and other mineral resources; remaining state enterprises; and the entire infrastructure, including pipelines.[/pullquote] These assets will be transferred to the balance sheets of those companies, banks and funds that are ‘lateral’ structures of Kiev’s Western ‘benefactors’. One of these structures is the Franklin Templeton Fund, which, over the last year, has purchased a significant share of the Ukrainian treasury’s debt securities. One can expect that when this happens, the hryvnia exchange rate will be down by the skirting board somewhere.

Speculators are not yet that interested in a full normalisation of the situation in Ukraine – military offensives and a lack of stability allow them to continue their bear transactions. They want to make their investments in Ukraine as ‘effective’ as possible. Take the Odessa Port Plant (OPZ), for example, which is one of the chemical industry’s leading plants. Seven years ago, in 2007, the plant was valued at 2.5 billion hryvnia (which is approximately $312.5 million at the pre-revolutionary exchange rate). Today, it is already being valued at just 600 million hryvnia (nearly $40 million), and it will continue to get worse.

The situation in Ukraine and around the country is almost schizophrenic. Speculators are operating on the principle of ‘the worse the better’ (in the sense of ‘the worse it is, the cheaper we’ll buy for’), while the Ukrainian authorities are going above and beyond to show that not everything in the country is as bad as it looks at first glance.

On the financial ‘achievements’ of the new regime

The Ukrainian finance minister is joyfully reporting that the amount of taxes entering the Ukrainian treasury this year is even slightly higher than the corresponding figures for 2013, and some people really believe this statistical Kabbalism.

In September, the governor of the National Bank of Ukraine (NBU), Valeriia Gontareva, reported that inflationary price increases this year will amount to 19 per cent. The devaluation of the Ukrainian hryvnia against the US dollar has already reached 60 percent. It therefore works out that the revenue side of the Ukrainian budget in real terms should be reduced by this same 19 per cent. But in relation to last year’s revenue expressed in constant hryvnia, the revenue side of the Ukrainian budget this year will shrink, according to my estimates, by 17-18 per cent.

However, I think that the real reduction in the revenue side of the budget will be considerably more. Until the middle of this year, Donetsk and Lugansk regions maintained financial ties with Kiev. In other words, taxes were transferred to the general treasury, and these regions received budgetary funds to pay the salaries of state employees, pensions, benefits and so on. Today, these financial ties have been severed. The tragic events have meant that the majority of businesses in the region have either been destroyed or have ceased operations. Even according to Kiev’s estimates, 600 businesses in these two regions have been destroyed as a result of ‘anti-terrorist operations’.

[pullquote]The shutdown of businesses in Novorossiya has seriously impeded the work of many sectors of the Ukrainian economy as a whole, and its tax potential is falling before our very eyes.[/pullquote]

Ukraine’s GDP: a statistical illusion

The statistics of Ukraine’s gross domestic product (GDP) also raises some questions, and the Ukrainian media is actively discussing the issue of how much the country’s economy will fall in 2014. Yatsenyuk belongs to the optimist’s camp and is citing a 5 per cent reduction in GDP. Some Ukrainian officials are boldly disputing the Prime Minister’s estimate and are talking about a 6 per cent fall, while the IMF is predicting a fall of as much as 7 per cent. Personally, I do not believe any of the above estimates.

Firstly, because this year there has been a deduction from the Ukrainian economy amounting to 16.5 per cent of GDP. I refer here to the share of Donetsk and Lugansk region’s GDP. Secondly, because the physical volumes of all types of production even in the rest of Ukraine will be lower in 2014 than last year. By way of example, one could take the production of energy, iron and steel, freight cars and locomotives, the volume of goods traffic by rail and so on and so on. There are ample reasons for such a fall. As mentioned earlier, the shutdown of mines and factories in Donbass has had a painful impact on many businesses in Ukraine that used to have stable and strong industrial and economic relations with the southeast of the country. In addition, Ukraine is punishing itself with sanctions against Russia. For example, by banning the supply of military products to Russia. Here is just one example: the aircraft industry giant Antonov was forced to stop supplying the Russian Federation with aviation technology and is now on the verge of bankruptcy. Finally, the situation of many businesses has been severely complicated as a result of the fact that Kiev is heading towards an association with the European Union and these businesses have lost the Russian market. These businesses will not receive adequate compensation in the EU market. The impact of these factors has only begun to appear since the middle of this year; it will increase and become even more evident in 2015. Experts believe that as a result of the current war in Ukraine, the country’s economy could lose three key industries – its iron and steel industry, its engineering industry, and its chemical industry. The latter of these industries could perish as a result of the Russian gas supply disruptions already underway.

According to my own rough estimates, the real fall in Ukraine’s GDP in 2014 will amount to no less than 20 per cent. However, the Ukrainian government’s economic departments together with the IMF are holding hypnotic séances called ‘The Statistical Illusion in Ukraine’. There are various ways to create statistical illusions. For example, the Ukrainian statistical office and the IMF are still including figures relating to the Donetsk People’s Republic (DPR) and the Lugansk People’s Republic (LPR) in their overall statistics on the Ukrainian economy. One can only speculate how they are gathering primary statistical information if the Ukrainian statistical office has ceased to operate in the DPR and LPR. Such methods of statistical manipulation as the use of cost indicators that have not been ‘cleaned’ of inflation are no less convenient. If inflation in the country is greatly accelerated, then it is possible to not only put an end to economic collapse, but even to achieve relatively good rates of ‘economic growth’.

On currency doping and the Ukrainian economy

As has already been noted, 2014 saw a sharp fall in the hryvnia exchange rate. Since the beginning of the year (over the course of eight months), the population has withdrawn money to the tune of $2.2 billion from banking deposits, while purchases of foreign currency in cash have increased dramatically. The authorities accused the population of undermining the national currency and introduced restrictions on the purchase of foreign currency (no more than 3000 hryvnia, equivalent to $220). [pullquote]To prevent the loss of its vanishing currency reserves (which amounted to $16.1 billion on 1 August 2014), the National Bank of Ukraine stopped foreign exchange market interventions, fully liberalising the hryvnia. This is playing into the hands of international speculators.[/pullquote]

For the first eight months of this year, the country’s surplus trade balance was minus $2.62 billion. Again, the authorities are proudly saying that this is a great achievement given that the trade balance deficit last year (goods only, not services) was $19.6 billion. However, if one looks into this, then it becomes clear that the deficit reduction did not happen as a result of increased exports, but because of a sharp fall in imports. After liberalising the hryvnia exchange rate and devaluing it by 60 per cent, the authorities have been heavily relying on the mechanism for the quantitative easing of commodities exports snapping into action. It has been enough for other countries to devalue their currencies by around 10 per cent to make significant progress in their trade balances, but it has not turned out like that for Ukraine.[pullquote] ‘Currency dumping’ (or rather ‘doping’) has by no means revived Ukraine’s goods exports. [/pullquote]The quarterly figures for goods exports from Ukraine in 2013 were as follows (billions of dollars): Q1 – 15.6; Q2 – 15.9; Q3 – 16.0; Q4 – 17.5. And here are the figures for 2014 (billions of dollars): Q1 – 14.6; Q2 – 14.9. The Ukrainian economy is dead, and not even a huge dose of currency doping can revive it.

A Ukrainian default and Russia as a ‘contingency factor’

In 2013, Ukraine’s balance of payments, despite a deficit in the balance of foreign trade, was positive and equalled $2 billion. This year, however, in just the first eight months alone, Ukraine’s balance of payments has registered a deficit of $4.6 billion. This overall deficit does not just reflect the trade balance deficit, but also the process of sustained capital outflow from Ukraine. If current trends continue, then Ukraine’s trade balance deficit for the whole of 2014 could be in the region of $7 billion. In the second half of this year, however, a number of aggravating factors are beginning to take effect which could easily increase the country’s trade balance deficit to $10 billion or more.

The very latest figures on the size of Ukraine’s GDP are to be published in November. These figures are of interest to everyone, and it is not just idle interest, either. The size of Ukraine’s GDP will enable the level of relative public debt to be determined. If it rises above 60 per cent of GDP, then Russia, which gave Ukraine a loan of $3 billion in December 2013, may demand immediate repayment of the total debt (the principal plus interest). These are the conditions of the loan. Already because of this alone, the trade balance deficit is exceeding the $10 billion mark. If Ukraine does not receive any new financial aid over the remaining months of 2014, then it will have to close the $10 billion hole with its own currency reserves. Which means that by New Year, there will be less than $6 billion left in Ukraine’s currency vault. And if we include in the calculations a factor like the repayment of Ukraine’s long-standing debt to Gazprom for natural gas, then this is another $3 billion minimum. The mere thought of such a scenario is causing a shiver down the spines of the many Western holders of Ukraine’s public debt. The same default that Yatsenyuk assured would never happen could, in fact, happen. Someone is going to lose billions on this default, while someone else is going to make huge amounts of profit. As global experience shows, however, defaults rarely happen off the cuff. More often they are routinely prepared, sometimes for years. Ukraine is no exception, and there will be a default. But not before the patrons and modest beneficiaries of organisations like the Franklin Templeton Fund have given the go-ahead. However, the same global experience shows that events in preparation of the default do not always go according to plan. Sometimes an unplanned participant can edge his way into the ‘game’. Ukraine’s breakdown of financial obligations cited above shows that Russia could, and in our opinion should, be that ‘unplanned participant’.


Originally published at the Strategic Culture Foundation.

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