Ukraine faces tough crossroads as hryvnia continues to fall

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Ukraine stands on the brink of economic disaster as the battle between the European Union and Russia plunges the fraught nation’s currency to a four-year low.

Mass protests swept across Kiev in November 2013 after Ukrainian President Viktor Yanukovych walked away from a trade deal with the EU, instead announcing his intention to form ties with Russia.

Thousands of demonstrators have packed the capital since then, in an unavoidable display of a country split between the generally pro-European west and pro-Russian east.

Tug-of-war

The Ukraine Government was caught in a tug-of-war between the two economic giants whilst it waited to see who offered the best deal.

As the policy U-turn suggests, Russia, with its USD 15 billion support package offering and deals on natural resources, was the winner.

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But the political backlash after Ukraine’s Government choice has put the deal – and the very nation – in jeopardy.

After investing USD 3 billion in December into Ukrainian bonds, Russia’s leaders have now signaled they are unwilling to hand over further installments until a new Government is formed.

In response, many of the world’s leading rating agencies have raised doubts over Ukraine’s ability to pay its debts – with Moody’s cutting Ukraine’s sovereign rating as the political anxiety increases the “risk of a large-scale conversion to foreign currency.”

Ukraine’s currency, the hryvnia, is pegged to the American dollar. After falling sharply last Friday, the hryvnia sunk a further 0.5% on Monday – falling in line with the central bank’s dwindling foreign currency reserves.

This takes the losses since the start of 2014 to 5%.

Yet many believe the currency can fall further still – causing even more damage to a suffering economy.

Crossroads

According to the International Monetary Fund, Ukraine only managed 0.4% in growth last year.

“When you have an unstable currency, it will hit your banking system,” notes Lilit Gevorgyan, a senior economist at IHS Global Insight.

“It will hit the pockets of consumers. It will increase the cost of debt repayments and servicing. Investors will be very hesitant to enter Ukraine.”

Now, Ukraine is faced at a crossroads.

Whilst Russia awaits a new government, the EU – which has been the Ukraine’s biggest international donor with EUR 3.3 billion since 1991 – seems ready to give further support to contain and reduce the crisis.

This support would however be provided on the proviso of an IMF programme of reforms – including measures to move to a flexible and weaker exchange rate and debt restructuring methods.

As long as there is a stalemate however, Ukraine will continue to struggle with account deficits created by imports dwarfing exports, leaving its economy increasingly vulnerable to hryvnia fluctuations.

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