Eastern Promises: Ukrainian Angst, Russian Influence And Market Reactions

Dec 23 2013, 4:47pm CST | by

Eastern Promises: Ukrainian Angst, Russian Influence And Market Reactions
Photo Credit: Forbes Business

On November 22nd of this year, Ukrainian President, Viktor Yanokovych, backed out of a financial cooperation and support agreement with the European Union. Since that time, large-scale protests in Ukraine’s capital city of Kiev have gained international attention as the country’s 46 million people publicly debate the state of their government and its relationships with Russia and the EU. On December 17th, a deal between Ukraine and Russia was signed giving financial support in the form of Russian purchases of $15 billion of Ukrainian government bonds and significant discounts on Russian natural gas. In essence, Ukraine is deciding which sphere of influence it will be beholden to in the near future – that of “Mother Russia” or a move away from Warsaw Pact times and into greater European dominance of Ukrainian domestic affairs. This has broad implications for Europe, markets, and for the idea of austerity.

The original negotiation between Ukraine and the EU was a way to deal with a sovereign debt problem and general economic malaise in Ukraine. Although Ukrainian debt to GDP ratios look to be reasonable, domestic growth is lacking, industrial and corporate development is non-existent, and wages have not kept up with bouts of inflation. Third quarter GDP fell by 0.4% after having fallen the previous quarter by 0.5%. Forecasts for next year’s growth in the Ukraine are tepid at best with the average of a 1.5% growth rate.

Ukraine has limited foreign reserves on hand and is currently in its third recession in five years which is why Fitch Ratings recently lowered its foreign and local currency debt rating to B- with a negative outlook. With global investors awash in liquidity courtesy of central banks, higher yielding Ukrainian bonds looked attractive as did the Ukrainian stock market. From January 2009 to May 2011 the Ukrainian PFTS stock index gained 250%. However, the Ukraine now has to pay back $15 billion of sovereign debt in the next two years which would be very problematic absent new external liquidity flows or a rescue package.

Enter the Russians to their generous cash! Prior to the Russian deal, Ukraine sought assistance in the form of financing from the EU, just like the European PIGS (Portugal, Ireland, Greece and Spain). However, the EU’s offered terms came with strict repayment conditions, structural economic reform, and IMF involvement. All of these terms seemed bitter pills for a President and political party that have tended towards their Russian relations and where corporate cronyism between Russian and Ukrainian elites is embedded.

The backdrop to Ukraine’s current plight is geopolitics. Russia desperately wants to exert its control in a westerly direction. Losing Ukraine to further EU influence would certainly hurt Russian pride and would be thought of as an unwanted economic incursion. Russia views western meddling in its geographically closest former Soviet Union countries as interloping which is why Russia masterfully offered Ukraine a bailout program at the last minute. The idea of expanding NATO further east is the one thing that brings disparate Russians to the table in denunciation of the west and EU. In addition, to enjoying Ukraine as the “bread basket” of Eastern Europe and holidays at fine resorts, Russian politicians are worried about Russian domestic unrest especially with the Sochi Olympics approaching and President Putin’s somewhat weaker popularity at home. Preventing unrest in Ukraine from becoming a template for internecine Russian squabbles is tantamount to actually helping an old Soviet ally.

While emerging market investments are obviously fraught with risks, Ukraine is a perfect illustration of the theoretical becoming the actual risk. When Ukrainian GDP was growing or stable (far too infrequently) and the political landscape of Ukraine was more hospitable towards closer relations with Europe, there were logical reasons to own Ukrainian assets. That was especially true of carry trades funded by generous central bank liquidity. Those investment notions of high yield, but “safe” emerging market bonds have been severely eroded by Federal Reserve tapering and in the case of Ukraine, intensely messy domestic politics.

In the last ten days, credit traders have profited handsomely by selling Ukrainian credit default swap protection or buying Ukrainian bonds as the snap-back on prices was dramatic after the Russian agreement was announced. For example, Ukrainian dollar-denominated bonds saw their yields go from more than 15% to less than 9% in a handful of trading sessions. That type of volatility is likely to dissipate as the market re-prices sovereign default risk and traders focus on next steps in Ukrainian politics.

Ukraine is a country with massive agricultural potential. It has a special type of black soil which makes agribusiness efficient and profitable when run on industrial scales. In addition to farming and other agribusiness, Ukraine has tremendous industrial potential and is frequently thought of a type of a type of “Poland in waiting” for further industrial-manufacturing development.

Notwithstanding Ukraine’s potential, it is the political atmosphere including the rule of law, corporate transparency, and electioneering that must change if Ukraine is to attract more emerging market investment managers and greater foreign direct investment. Year to date, Ukrainian stocks are down almost 10% and have returned almost nothing over the past five years. That negative performance indicates investor nervousness about future volatility in financial and real Ukrainian assets.

Until Ukraine aligns itself closer to Europe or until a strong rule of law is established, retail investors are probably wise to avoid Ukrainian financial assets. For large institutions or hedge funds, there may be some justification to owning Ukrainian bonds at these levels as a future deal with the EU, although not imminent, is also not outside of the realm of possibility. To a certain extent, the EU needs Ukraine to “play nicely in the sandbox” with Russia as EU countries nervously receive huge quantities of Russian natural gas through Ukrainian pipelines. The best case scenario for Ukraine is snap elections (not likely), immediately political reform (also not likely) and the implementation of business-friendly and investor-friendly laws (possible). The upside-optionality trade is that Ukrainian politicians will embrace the EU much sooner than consensus believes.

Macro style investors seeking longer term exposure to Eastern Europe, would do well to investigate, Polish real assets instead of trying to thread the economic and political environment of Ukraine. Polish real assets seem moderately attractive, especially if the Polish Zloty strengthens. Alternatively, if investment managers must put money to work in Ukraine, highly liquid and transparent assets should be the first choice, even if they trade at a premium.

Disclaimer: Nothing herein should be relied upon to make an investment decision and nothing herein is intended as investment advice or a recommendation.

Source: Forbes Business

 
 

Don't miss ...

 

<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.

 

blog comments powered by Disqus

Latest stories

China to use new test to prevent Ebola
Beijing, Nov 28 (IANS) Chinese health authorities have approved three home-grown Ebola test reagents to be used for preventing the virus' spread.
 
 
Uganda, UN sign $6.5 mn deal for Ebola fund
Kampala, Nov 28 (IANS) Uganda and UN agencies operating in the country have signed an agreement to establish a 6.5 million dollar Ebola and Marburg Response Fund.
 
 
Ebola virus detected in semen three months after symptoms end
Geneva, Nov 28 (IANS/EFE) The World Health Organisation (WHO) warned Friday that the semen of men recovering from Ebola can contain the deadly virus up to three months after the symptoms disappear.
 
 
Hitachi evinces interest in developing Andhra ports
Hyderabad, Nov 28 (IANS) Japanese multinational conglomerate Hitachi has shown interest in developing ports in Andhra Pradesh.
 
 
 

Latest from the Network

Abigail Breslin slams ex Michael Clifford
Abigail Breslin has slammed her ex, Michael Clifford. The 'My Sister's Keeper' actress went on a date with the 5 Seconds of Summer guitarist last year but it seems as though it didn't end well after she released a song...
Read more on Celebrity Balla
 
Kevin Bacon to sizzle in Jungle
Kevin Bacon is to star in 'Jungle'. The 56-year-old actor will appear in the survival drama, which is based on the true story of Yossi Ghinsberg, an adventurer who found himself lost in the Amazon rainforest for three...
Read more on Movie Balla
 
Mickey Rourke to return to boxing at 62
Mickey Rourke will return to boxing aged 62. The actor will come out of retirement and step into the ring tonight (11.28.14) for the first time in 20 years as he competes against 29-year-old Elliot Seymour. He said: ''...
Read more on Celebrity Balla
 
Kristen Stewart: Actors are isolated
Kristen Stewart claims actors become ''isolated'' because of their fame. The 24-year-old actress has become one of the biggest movie stars in the world following her portrayal of Bella Swan in the 'Twilight' franchise...
Read more on Celebrity Balla
 
Burt Reynolds to sell memorabilia
Burt Reynolds is selling over 600 personal items to stave off bankruptcy. The 78-year-old Hollywood star is reportedly struggling financially so will see awards, cars and costumes go under the hammer in Las Vegas next...
Read more on Celebrity Balla
 
Eddie Redmayne's fear of failure
Eddie Redmayne has a fear of failure. The 'Theory of Everything' star has admitted that like fellow actor, Rachel Weisz, he worries about ever getting hired again. He said: ''I was reading an interview with Rachel Weisz...
Read more on Celebrity Balla
 
Where to Find Black Friday Car Deals
The Black Friday Car Sales events have gained traction over the past couple of years. This year several major brands ran nation-wide commercials announcing their Car Black Friday deals. In the beginning it was creative...
Read more on Auto Balla
 
Indian Aces win inaugural IPTL tie
Manila, Nov 28 (IANS) The much-awaited inaugural International Premier Tennis League (IPTL) got off to a flying start with the Indian Aces notching an impressive 26-16 first victory against the Singapore Slammers at...
Read more on Sport Balla
 
Australian navy's largest ship commissioned
Canberra, Nov 28 (IANS) HMAS Canberra, a 27,000-tonne landing helicopter dock (LHD), was commissioned Friday, providing the Royal Australian Navy (RAN) with one of the world's most capable and sophisticated amphibious...
Read more on Politics Balla
 
Sindhu, Prannoy enter Macau Open semis
Macau, Nov 28 (IANS) Indian shuttlers P.V. Sindhu and H.S. Prannoy came out with contrasting wins to enter their respective semi-finals at the $120,000 Macau Open Grand Prix Gold here Friday. While defending champion...
Read more on Sport Balla