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

Spanish health worker flown home after possible Ebola contagion
Madrid, Nov 21 (IANS) A Spanish health worker with Doctors Without Borders (MSF) arrived back in Spain Friday morning from Mali after being deemed at risk of contagion from the Ebola virus.
 
 
Japanese government concerned by yen's rapid fall against dollar
Tokyo, Nov 21 (IANS/EFE) Japanese Finance Minister Taro Aso Friday expressed concern over the sharp depreciation of the yen against the dollar this week, and said abrupt movements in the foreign exchange market were not beneficial to the Japanese economy.
 
 
WHO declares DRC Ebola-free
Geneva, Nov 21 (IANS) The World Health Organisation (WHO) Friday declared the end of the Ebola outbreak in the Democratic Republic of Congo (DRC).
 
 
Ultra rich population getting richer: Study
Washington, Nov 21 (IANS) Only 0.004 percent of the world's high networth adult population controls almost 13 percent of the world's total wealth, according to a new study.
 
 
 

Latest from the Network

Kris Jenner keen on Kourtney and Khloe double wedding
Kris Jenner wants Kourtney and Khloé Kardashian to have a double wedding. The 59-year-old manager reportedly thinks Kourtney should marry Scott Disick and Khloé should marry French Montana during the same ceremony for...
Read more on Celebrity Balla
 
Miley Cyrus and Patrick Schwarzenegger planning holiday
Miley Cyrus and Patrick Schwarzenegger are planning to go on a romantic holiday. The 'Wrecking Ball' hitmaker is said to be smitten with the 21-year-old hunk - the son of Hollywood legend Arnold Schwarzenegger and Maria...
Read more on Celebrity Balla
 
Kelly Brook's Winter Chunderland
Kelly Brook was nearly sick at London's Winter Wonderland attraction yesterday (20.11.14). The 34-year-old model attended the VIP launch of the annual festive fair in Hyde Park, and admitted to feeling worse for wear...
Read more on Celebrity Balla
 
Katy Perry and will.i.am to cover Imagine for UNICEF
Yoko Ono, Katy Perry, will.i.am and David Guetta are among the celebrities who have recorded a cover of John Lennon's 'Imagine' to raise funds for UNICEF. The star-studded cover will be accompanied by an interactive...
Read more on Celebrity Balla
 
Spanish health worker flown home after possible Ebola contagion
Madrid, Nov 21 (IANS) A Spanish health worker with Doctors Without Borders (MSF) arrived back in Spain Friday morning from Mali after being deemed at risk of contagion from the Ebola virus. MSF confirmed the female...
Read more on Business Balla
 
Ukraine accuses Russia of cross-border shelling (Roundup)
Kiev, Nov 21 (IANS) Ukraine Friday accused Russia of carrying out cross-border shelling against Ukrainian positions in the eastern part of the country even as pro-Russian separatists put the toll in the ongoing...
Read more on Politics Balla
 
Obama set to be chief guest at India's R-Day (Lead, changing dateline)
Washington, Nov 21 (IANS) Signifying a renewal of the India-US strategic partnership, President Barack Obama has accepted Prime Minister Narendra Modi's invitation to join India's Republic Day celebrations as chief...
Read more on Politics Balla
 
Chinese court upholds life sentence against Uyghur activist
Beijing, Nov 21 (IANS/EFE) A court in western China has upheld the conviction and life sentence handed down against Uyghur activist Ilham Tohti, who appealed the sentence when it was first passed in September, one of...
Read more on Politics Balla
 
Matt Smith to star in Patient Zero
Matt Smith has been cast in 'Patient Zero'. The former 'Doctor Who' star has signed on to appear in the infection film which will see him have to cope with the aftermath of a worldwide viral pandemic across the Earth....
Read more on Movie Balla
 
Mick Jagger praises 'amazing' Chadwick Boseman
Sir Mick Jagger claims Chadwick Boseman is ''amazing'' as James Brown in the singer's biopic 'Get On Up'. The 71-year-old Rolling Stones rocker co-produced the movie and praised the young actor for his portrayal of the...
Read more on Movie Balla