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

Finnish scientists identify new type of black hole
Helsinki, Oct 31 (IANS) Finnish researchers have discovered a new type of low-mass black hole, which is a bright celestial body that emits X-ray, the University of Turku has said.
 
 
Union Carbide ex-chief Warren Anderson is dead
Washington, Oct 31 (IANS) Warren Anderson, former chief executive officer of the Union Carbide Corporation, is dead, a media report said Friday. He was 92.
 
 
Himalayan Viagra fuels gold rush for local Tibetans
Washington, Oct 31 (IANS) Overwhelmed by people trying to find the prized medicinal fungus known as Himalayan Viagra, two isolated Tibetan communities have managed to implement a successful system for the sustainable harvest of the precious natural resource, suggests research.
 
 
Oceans were always there on Earth: Scientists
Washington, Oct 31 (IANS) Debunking previous theories that water came late to Earth well after the planet had formed, researchers have significantly moved back the clock for the first evidence of water on Earth and in the inner solar system.
 
 
 

Latest from the Network

Julia Stiles and Ray Liotta cast in Go With Me
Julia Stiles and Ray Liotta have been added to the cast of Anthony Hopkins' new film 'Go With Me'. The action-drama, which will begin shooting in mid-November, tells the story of a young woman who returns to her home...
Read more on Movie Balla
 
Seth Rogen to star in Steve Jobs biopic
Seth Rogen is in talks to star in Sony's Steve Jobs biopic. The 'Bad Neighbours' star is in negotiations with the studio to take on the role of Apple co-founder Steve Wozniak - who created the Apple I computer and co-...
Read more on Movie Balla
 
Jennifer Lopez has struggled to love herself
Jennifer Lopez say she's spent much of her life beating herself up for not being good enough. The 'Dance Again' hitmaker, who has six-year-old twins Max and Emme with her third ex-husband, Marc Anthony, puts a lot of...
Read more on Celebrity Balla
 
Julianne Hough's teary tribute to sister
Julianne Hough broke down in tears while praising her older sister. The 26-year-old singer/songwriter made an emotional speech in which she praised her older sister, Sharee Wise, admitting her sibling inspired her to...
Read more on Celebrity Balla
 
Tom Parker vows to look after Lindsay Lohan
Tom Parker has vowed to look after Lindsay Lohan. The former Wanted star is keeping a watchful eye over the 28-year-old actress as she performs in play 'Speed-the-Plow' in London because he wants to help the flame-...
Read more on Celebrity Balla
 
Kaley Cuoco-Sweeting fell for husband over animals
Kaley Cuoco-Sweeting knew her husband was 'The One' because he loves animals. The 'Big Bang Theory' star, who married tennis player Ryan Sweeting in December after just six months of dating, admits she fell in love with...
Read more on Celebrity Balla
 
Orson Welles last film to be released
Orson Welles' final movie will finally be released next year. The acclaimed filmmaker had worked on 'The Other Side of the Wind' - which chronicles a temperamental film director battling with the Hollywood establishment...
Read more on Movie Balla
 
Game of Thrones stars get pay rise
'Games of Thrones' cast members will be paid $300,000 an episode. Five of the shows biggest stars - Peter Dinklage, Kit Harington, Lena Headey, Emilia Clarke and Nikolaj Coster-Waldau - have landed bumper payrises after...
Read more on Celebrity Balla
 
Mike Tyson: I was abused
Mike Tyson claims he was sexually abused as a child. The 48-year-old retired boxer was ''snatched'' off the street when he was seven by an ''old man'', who he never saw again after the shocking one-time incident....
Read more on Celebrity Balla
 
Amanda Bynes released from psychiatric facility
Amanda Bynes has been released from a psychiatric treatment facility. The 'Easy A' actress was spotted walking around Sunset Strip, West Hollywood, last night (30.10.14), 19 days after she was admitted to the hospital...
Read more on Celebrity Balla