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Elliott Morss | November 24, 2014

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Western Financial Support for Ukraine: The Greek Analogy (continued)

Western Financial Support for Ukraine: The Greek Analogy (continued)
© Elliott R. Morss, Ph.D.

Introduction

In my last piece, I looked at the IMF/EU bailout efforts for Greece to see what can be expected as the West launches a bailout for Ukraine. And every day, what the West will do becomes clearer. Let’s back up to December of last year. At that time, the Russians agreed to provide ex-President Yanukovych with $15 billion for not entering into an association with the European Union. To date, $3 billion of that amount has been given to Ukraine. Russia has now pulled back and urged Ukraine to ask the IMF for assistance. And IMF staff is now in Ukraine working on a new program.

I say “new” because twice in recent years, the IMF has agreed to a plan to Ukraine only for the IMF to withhold funds when the country failed to meet agreed-upon “performance” targets.

Sidebar on the Role of the IMF in Greece and Ukraine

Whenever Western nations want to offer assistance to other countries, they like to have the IMF as the “front man”. This is because before the Fund ever offers assistance, it works out a reform program with the recipient country. When and if that program is implemented, it is intended to allow the country to move ahead in a sustainable manner. The reform programs have date-specific targets and countries do not get Fund moneys until they achieve the IMF targets. Do the targets always make economic sense? No. For example, in the case of Greece, the initial austerity program adopted by the IMF with support from Germany was too extreme and caused the unemployment rate to skyrocket. To its credit, the Fund saw what was happening and gave up on austerity measures. Its first bailout program was ended early, and its new one emphasizes labor market reforms and other measures to make Greece “competitive”.

The Greek Bailout Program to Date

Table 1 provides summary information on the EU/IMF bailout program for Greece along with selected economic data. The first point to note is how much the Greek bailout is projected to cost through 2016 – $1.7 trillion! And the Ukraine GDP is one third larger than Greece’s. So far, the US is offering $5 billion in loan guarantees and the EU has pledged $15 billion for Ukraine. The IMF is in Ukraine now, and much larger commitments will be needed if meaningful economic reforms are to take place.  

Table 1. – Greece: Bailout Amounts and Economic Performance

Source: FocusEconomics

 Econ 101

The last three rows in Table 1 are important. Here is why. In both Greece and Ukraine, everyone agrees the government deficits are too high and not sustainable. There are two ways to reduce deficits: increase taxes and lower government expenditures. Both reduce purchasing power, consequently slowing economic growth and causing unemployment to increase. Look at what has happened in Greece since 2010 when the IMF/EU bailout program started. Unemployment shot up and now stands at about 28%. As I have written, the IMF realized it was pushing austerity too hard and increased the time from for reform. For this to work, the EU will have to forgive more Greek debt that FocusEconomics now estimates stands at a whopping 188% of GDP!  

The Ukraine Situation

Table 2 presents economic data on Ukraine.

Table 2. – Ukraine – Key Economic Indicators

Source: FocusEconomics

The IMF program for Ukraine is in the formative stage. But by reviewing past communications between the IMF and Ukraine, the following components are likely to be included:

  • A reduction in the government deficit;
  • A reduction in energy subsidies: the Fund estimates these subsidies are as much as 5% of GDP, and
  • Government pension reform: the Fund estimates Ukraine has one of the highest pension payout ratios (pensions as a percent of GDP) of any country in the world.

So what do all these “reforms” have in common? All three reduce purchasing power, thereby slowing economic growth and causing unemployment to increase. How reducing government deficits will cause this to happen was covered above. Lower subsidies will mean higher energy prices and consequently consumers will have less money to spend on other goods and services. Lower pensions will also reduce purchasing power.

The key question is: how austere will the IMF program be and what will the Ukrainian political reaction be to it? Keep in mind earlier fund programs were cancelled when Ukraine did not meet targets agreed to for IMF disbursements to continue.

A most pressing economic issue in Ukraine is its international trade deficit. In 2013, it was $19.6 billion or 11.5% of GDP. This is critical inasmuch as the country’s international reserves are only $20.4 billion or about 3 months of imports. About 20% of the country’s imports are energy fuels, and energy subsidies exacerbate the situation.

Conclusions

There are a number of uncertainties for Ukraine going forward. A major issue will be what sort of bailout program the IMF will prepare at the behest of Western nations. It will be designed to put Ukraine on an economically sustainable path. It will not be popular in Ukraine and will cause even more political unrest.

Investment Implications

As indicated in my earlier piece, this is not a good time to invest in ETF’s with any Ukrainian exposure such as: Junior Miners ETF (JUNR), iShares MSCI Poland Capped ETF (EPOL), Frontier Markets ETF (FRN), MSCI BRIC Index Fund (BKF), or iShares MSCI Emerging Markets Eastern Europe ETF (ESR).        

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