REUTERS
Although the Ukrainian government is trying to maintain a fragile peace along the country’s eastern border, it has many more battles yet to fight to rescue its economy, according to Bloomberg.
The Ukrainian economy could be rescued when there is an agreement on debt relief for the country, according to the article entitled "Ukraine's Next Battle Zone Is Its Economy", which was published on Bloomberg.com. This task may prove to be as difficult to achieve as the suppression of the insurgency in the east of Ukraine. However, it’s not impossible.
The disastrous combination of war and the devaluation of the hryvnia has pushed Ukraine to the brink of bankruptcy. Its debts, denominated mostly in dollars, make up about 100% of its GDP, compared with about 40% a year ago and well above the 70% level that the International Monetary Fund considers excessive for emerging market economies. Principal and interest due over the next three years will exceed $27 billion, equivalent to about a quarter of government spending.
Only swift and radical debt relief can help the country out of this economic swamp. Production decreased by 15% in the fourth quarter of 2014 on a year-over-year basis. If the government tries to cut spending or raise taxes to the level required to enable the country to pay its way out of its debts, it will all but guarantee a collapse. This terrible scenario - a total write-off - is something that creditors will have to consider as an alternative to a negotiated agreement.
It will not be easy to come to such a decision. The first obstacle is Russia. In late 2013, Russia provided Ukraine with $3 billion loan to support Viktor Yanukovych, the much-hated Ukrainian leader, who fled the country during the Maidan revolution. And when the debt comes due in December, Putin will ask for it to be repaid in full.
As the instigator of the Ukrainian conflict, Russia actually has no moral right to demand money. Unfortunately, it has indisputable economic and military leverages based on natural gas supplies to Ukraine and its ability to foment conflict. Ukraine may simply not have a choice but pay the debt back.
The second obstacle is the constant uncertainty about Ukrainian economic prospects. The country’s private creditors, one of which is U.S. investment group Franklin Templeton, simply cannot assess how much of the government debt actually has to be refinanced. There are early signs that the new leaders of Ukraine may be no less corrupt than their predecessors. There is a lack of stability and confidence necessary for the conclusion of a comprehensive and final agreement on external debt.
Thus, the best solution would be a two-step process. Firstly, private lenders must agree to the introduction of a multi-year moratorium on debt payments, covering the period of the loan program in Ukraine under which the IMF may allocate $17.5 billion. This would give the Ukrainian leaders the time and resources they need to improve the economic situation and gain experience in effective financial management. Then, assuming that the country remains intact, all parties will be in a better position to assess the government's ability to repay debts and to reach a final agreement.
Such a plan could go wrong for various reasons. But if Ukraine wants to have a chance of recovery, it is the best path to pursue. To make it work, the IMF and Western countries that offer financial support should be very pragmatic, flexible and alert. They will have to monitor how much of their money is used to pay debts to Russia. They will have to allow the Ukrainian government to stimulate the economy, which could imply a budget deficit that is incompatible with the stabilization of the external debt. And last, but by no means least, they will have to demand transparency and closely monitor the public expenditures to make sure that their money is not looted.