Inside Ukraine’s economic crisis

It’s a blossomy spring morning in Kiev and Stepan Kubiv, Ukraine’s new central bank governor, steps briskly into his natural habitat.

But Kubiv’s comfort zone is not where Euromoney usually finds central bank bosses, in their sterile offices of chart-toting advisers and economists, brows furrowed in the essentials of the national accounts.

No, the burly Kubiv has plunged, without a security detail, into a rowdy crowd of disgruntled depositors that’s only a few decibels removed from a mob, engaging protestors gathering by the minute in number and noise outside the National Bank of Ukraine’s renaissance-inspired palazzo on Institutskaya Street, in the capital’s official district.

As businesses fail by the score across this struggling land engulfed by political and economic crisis, Kubiv is meeting victims of a crashed regional bank who have come to Kiev to vent to the central bank, or to anyone who’ll listen, their all-too-common story of today’s Ukraine. “Our money has been stolen,” 40-something housewife Irina laments. “They are all corrupt, everything is corrupt, Ukraine is corrupt. We will always be corrupt.” This is an affecting neighbourhood for Ukrainians. From the balconies of the central bank above, just three months earlier, a dictator’s snipers killed pro-democracy protestors surging into this government quarter from Independence Square, the capital’s now legendary Maidan.

Institutskaya Street and adjacent Hrushevskogo Street are home to Ukraine’s two other key economic centres: Oleksandr Schlapak’s finance ministry and Pavlo Sheremeta’s economy and trade ministry. These two ministers, with Kubiv, have been generously dubbed Ukraine’s economic dream team.

Much blood was spilt along these streets during February’s violence that ended president Viktor Yanukovych’s rule. Moving impromptu memorials to the martyred Heavenly 100 have been erected all around here, in the bloodstains where they fell. In a park across the street, victims of the 1986 Chernobyl nuclear disaster protest about their unpaid pensions. Maidan is still volatile, can still be turned on.

All of this, three months on from the revolution, makes it a tricky time for officials like the 52-year-old Kubiv and his colleagues Schlapak and Sheremeta at the heart of Ukraine’s unelected post-Maidan cabinet.

They all hail from Lviv, the biggest city of Ukraine’s EU-leaning west, the core of what has been called the ‘western clique’ now running the country, usually by those from the country’s Russia-tilting east who no longer do.

And expectations are high that these three men will transform Ukraine, and set this troubled country of 46 million on a path toward membership of the European Union, the destiny many believe its corrupt post-Soviet past and complicated relationship with Russia has denied it.

With his populist touch, Kubiv is a former parliamentarian, commercial banker and one-time member of Komsomol, the Communist Youth League of Ukraine’s Soviet past. The central bank and its council have been a passage to the presidency in Ukraine – ex-president Viktor Yuschenko ran the NBU through the 1990s and the recently elected Petro Poroshenko was a council member – but Kubiv got the job primarily because of his leading role at Maidan.

“Although my background is banking,” Kubiv tells Euromoney, “when I was the commandant of the Maidan protest in the trades union building, I never thought I would become the governor of the central bank.”

The tieless central banker – he only wears one at international meetings, he tells Euromoney – adds: “I stayed at Maidan for 101 days, always communicating with the people. And I am very grateful for all the people, I could see it in their eyes; that they strongly believe this was a victory for them.

“The normal people today, from credit unions and insurance companies and commercial banks, wanted to meet the central bank governor on the street, and I couldn’t reject this idea I wanted to meet them too.”

Kubiv placates the distraught depositors – for now – and they eventually move on. They didn’t get the money they demanded – Ukraine’s broken guarantee fund doesn’t cover their ‘unofficial’ bank even if it had enough funds anyway – but they got Kubiv’s prayers, a sympathetic ear and a promise to work harder and fulfil the spirit of Maidan.

But will that be enough, Euromoney asks?

“I told them what reforms we are making at the central bank,” Kubiv says, “and I thanked them for their role in supporting the revolution, and they ordered me not to steal the country’s money. And I will not.”

THE CARNEYS, YELLENS AND Draghis don’t do things like this but, with the spirit of Maidan still evident in Kiev, this was no stunt. Inside the NBU with Euromoney a few minutes later, Kubiv unexpectedly breaks down during our interview. “I saw dead people at Maidan,” he remembers. “I took them in my arms, I closed the eyes of the dead with my own fingers. Even today, these memories hurt me and I have dreams about it every night.” His eyes well with tears, and he takes a few moments to compose himself before resuming discussion of the profound problems that plague his nation.

Kubiv managed to salve the depositors’ pain because, in large part, he agrees with them. “It’s true, Ukraine is corrupt,” he says, insisting that the country’s notorious billionaire oligarchs “must play by the same rules as everyone else”.

He says: “We need an explosion of the mentality people have. In the last 23 years [since the collapse of the Soviet Union], there were not many big changes. People didn’t come to Maidan for politics or for power, they came for themselves, for their children, for the independence of the country. Two generations met, the parents fought for independence 20 years ago and their children came for change in the country.”

But the slow progress of change since Maidan has Ukrainians wondering when reform will come. There has been a revolution here, but Ukraine’s uprising is by no means secured. The economy and currency have been in free fall, interest rates have soared and inflation is becoming unwieldy.

Finance minister Schlapak says: “Very decisive moves need to be made, maybe something close to shock therapy.”

Vasyl Filipchuk, director of the Kiev-based think-tank the International Centre for Policy Studies, articulates the growing impatience with the sclerotic reform agenda. “What type of reforms have they launched?” he asks. “The current government does not show any appetite or any willingness to make systemic reforms. They don’t really develop economic policy.

“This government’s first decisions were not of a technocratic nature. They appointed party friends or personal friends in key important posts. They have the power – they came from Maidan. What else do they need? They don’t care about reforms. They are happy they are in power, enjoying life, and it doesn’t lead us anywhere good.”

Filipchuk snorts at the government’s forecast that Ukraine’s economy will shrink by just 5% this year. He says it will be closer to 10%, probably more. He says the European Bank for Reconstruction and Development’s forecast of a 7% contraction is “misled”.

He adds: “The loss of Crimea alone means automatically minus 4.5%. Does that mean everywhere else is booming? In this situation? There will be a 5% loss minimum. We are saying minus 9% to minus 12%.”

He cites the rent for his think-tank’s own office, in a street directly off the Maidan, in the heart of the capital. Two years ago, the monthly rental here was $10,000. Today, it is $3,000, but he’s moving nearby to premises near the central bank double the size for the same amount.

“The economy is dying,” says Filipchuk. “People are afraid of investing. Whoever was able to send money out of the country did.” As he speaks, he takes a call from his bank, where he’s a so-called VIP client. The bank has received a payment to him from a foreign client, but before it will forward it on, it wants a notarized Ukrainian-language translation of all of his external contracts. “The banking system is broken, a total waste of time,” he says. “No wonder people set up foreign bank accounts. Why would they stay in this country?”

UNDERMINED BY MOSCOW, UKRAINE teeters on the edge of civil war, as tracts of territory are sliced off by Moscow-backed separatists in Crimea and in the Russified east, where 25% of Ukraine’s industrial production is located.

If that wasn’t enough, Russian president Vladimir Putin is playing hardball on the price at which Russia sells its gas to Ukraine, insisting Kiev pay almost double the prices Moscow agreed with the friendlier Yanukovych regime to keep Europe at bay. Post-revolution Ukraine has become a political football kicked between Moscow’s adventurism and western goodwill, dependent on aid cloaked as investment from the IMF, the World Bank, the EU, the EBRD and Washington.

“We are practically the only functioning investor in the country,” notes the EBRD’s external relations officer, Anton Usov.

Although reduced in numbers, the Maidan movement that inspired February’s triumph is by no means over, both literally in the scruffy square’s continued occupation by protestors and symbolically as an emblem of what people power can achieve. It’s now de rigueur for foreign dignitaries to be taken on a tour of Maidan, almost as a reminder, to show where power partly resides.

And Kubiv and his colleagues, their jobs forged in Maidan’s ashes, know it well. “I am happy Maidan is still there,” economy minister Sheremeta tells Euromoney. “It’s a powerful reminder to all of us that we have not delivered yet.”

As was clear a week earlier in Warsaw at the EBRD’s annual meeting, the bank set up in 1991 to help the former Soviet bloc’s transition to the market has patently failed its task in the case of Ukraine.

In the best-attended session of the three-day EBRD gabfest, the three men pleaded for international support. Finance minister Schlapak was blunt, saying investors could lose their money, but that high risk could also yield high reward. Kubiv said Ukraine’s banking system needed billions to stabilize, while Sheremeta reminded the meeting that “Maidan hasn’t gone away”. In an adjacent room, Russian officials were selling the virtues of investing in Russia’s regions, including the recently acquired Crimea. That meeting was also very well attended by the EBRD delegates.

An ex-diplomat who ran Kiev’s office for EU economic integration, Filipchuk says Ukraine is due a massive administrative clean-out. He highlights three separate ministries, or “three massive bureaucracies” – finance, economic development, revenue and duties – that exist where one would suffice. “These ministries are from old Soviet times; they are unable to implement any policy, good or bad. The key problem here is administrative reform. We need to change the way these ministries perform and operate. The senior desk officers don’t really develop policy, they just sit and wait until they receive instructions.

“The minister of economy, he’s really the minister for statistics. If this ministry was cancelled, this country would not notice it missing. They have zero influence.”

TO GET TO THE VAST EDIFICE shared by Schlapak’s finance ministry and Sheremeta’s economy and trade ministry, visitors must negotiate another picket, this time of the angry employees of Forum Bank, a former offshoot of Germany’s Commerzbank and yet another Ukrainian bank in administration.

Ukraine has around 180 banks, of which some 130 were authorized by previous administrations under very loose regulations, and many of them are now struggling and expecting the state to bail them out.

As if that wasn’t enough, Sheremeta’s grasp over his vast ministry is so untested that he still hasn’t mastered the building’s security procedures to allow his visitors in. They wait and wait, and wait some more until Sheremeta finds the right person to authorize another person to let his visitors pass. 

Once inside Sheremeta’s office, it’s like a scene from a Ukrainian West Wing or Borgen. With his young aides, he gathers in front of a TV beaming live from Ukraine’s parliament, everyone anxious about the outcome of a vote. Sheremeta has submitted bills designed to remove technical obstacles in the economy, to allow synchronization of regulation with the EU. These are the small but “absolutely essential” things, Sheremeta says, that help modernize Ukraine, the detail impatient protestors don’t care much for. The vote passes, but only just. “The resistance is still there,” says a vexed Sheremeta.

A former economic adviser to Malaysian prime minister Najib Razak, Sheremeta was skiing in Austria when he got a call from the then prime minister-to-be, Arseniy Yatsenyuk, the young lawyer-economist and former official of the central bank who memorably described his new government as being “on a kamikaze mission”.

A regular on the international conference circuit and devotee of the Korean economist W Chan Kim’s ‘Blue ocean strategy’, Sheremeta had cut short a World Economic Forum appearance in Abu Dhabi when Maidan broke out in November. He says he was there most days of the three months it took to oust Yanukovych. “Day 2, I was there,” he says. “Day 3 or Day 4, I made a speech there. The trigger was Europe but the underlying reasons were something else.”

Sheremeta says that once in office the immediate request was to help bring financing into the country. “This was something I could help with because of connections, because I spoke English, so I said without hesitation: ‘Sure’. And Crimea started the next morning.”

In between there have been urgent shuttles to Brussels, Washington and Warsaw with colleagues Schlapak and Kubiv to explain Ukraine’s plight, secure emergency funding and plead the country’s case to brave investors. “It’s been a crazy few months,” he says.

Finance minister Schlapak too is struggling with the scale of the reform task before him. Like Kubiv at the central bank, Schlapak was a Komsomol member in Soviet days. Aged 54, his career has been spent between the private and public sectors. 

A computer engineer by education and, later, an economist, he worked for the country’s biggest bank, oligarch Ihor Kolomoysky’s PrivatBank, in the 1990s before joining the civil service, where he rose to be a council member of the central bank and head of the national treasury. 

He briefly held Sheremeta’s economy portfolio in 2001/02, as did prime minister Yatsenyuk and president Poroshenko.

“It’s critical,” Schlapak says. “We require urgent and fast reforms – our social sphere is extremely hard to deal with.

“For example, the education and health ministries eat lots of money because they remain in the old Soviet condition.”

He says, for example, that since 2006 the number of students in Ukraine has reduced by a third while the number of teachers has stayed the same. “The state has taken on funding of so many responsibilities it’s impossible to go on with them as they are.

“In the park near here, we have the tent occupied by the victims of Chernobyl, and the current law requires their pensions to be raised three to four times, a legal requirement, and this is not possible. In a way, there are so many such laws and obligations it would require two budgets to sustain them.”

And then there are Ukraine’s oligarchs, their businesses advantaged by their closeness to previous regimes. Numbering around a dozen, they were a particular target of derision for the Maidan protestors. But Filipchuk wonders if anything has changed.

“What we need to change are these extractive institutions,” he says. “Without this we will have the same oligarchic, inefficient economy when people can be rich only when they have access to public spending and to have monopolies in the economy. They are rent-seeking.”

He cites the example of Kolomoysky’s PrivatBank. It is based in the south-eastern city of Dnipropetrovsk, a region sandwiched strategically between Kiev and the breakaway regions of Crimea and Donbass. It controls at least 25% of the wider Ukrainian banking sector. In one of the first decisions of the new government, in March it appointed Kolomoysky as governor of the Dnipropetrovsk region. That prompted a furious reaction from president Putin, who singled out Kolomoysky, describing him as a “unique crook” who had reneged on a deal with Roman Abramovich, one of Putin’s closest Russian oligarchs. Kolomoysky riposted that Putin was a “schizophrenic shorty”.

Kolomoysky has since taken a hard line on separatism in his region, and is offering rewards for the capture of militants in other regions, such as in breakaway Donbass to the northeast. That makes him, for the time being, a crucial ally of the new Kiev administration, despite it coming to power vowing to break the oligarchs’ grip on the Ukrainian economy.

For the moment, finance minister Schlapak seems to be opting for pragmatism. “I have had a long acquaintance with Ihor Kolomoysky,” he tells Euromoney, “and I always considered him a citizen of the world rather than a really patriotic person.

“Kolomoysky is making very big sacrifices now. In my last conversation with him, I asked him if he understood that he will not have any economic or business advantages [from the government] in the future, to which he replied: ‘Yes. My main task is the independence of Ukraine.’ Right now these oligarchs are allies.”

AT UKRAINE’S LEADING HOMEGROWN securities trader, Investment Capital Ukraine, in the smart Leonardo business complex, founder and chief executive Valeria Gontareva seems pretty miserable. In 2012, the hedge fund she ran was ranked by Bloomberg among the top five most profitable in the world. A year on, the situation is very different.

“Deals? What deals?” she laments. “Business? What business?”

The depth of her despair is evident in Ukraine’s sputtering bond market, where ICU and its 50 staff comprise the country’s biggest fixed-income house.

“Before the crisis we traded maybe 60% government bonds and 40% corporate,” she notes. “But right now its 99% in government bonds because there is no public market for corporates this year.”

After more than 20 years operating in what passes for Ukraine’s post-Soviet capital markets, Gontareva is somewhat resigned about the country’s potential. “Ukraine has always been a promising market – in each of the last 20 years,” shrugs the woman once touted as a possible finance minister here.

“When I first made this presentation to international investors about our potential, the population was 50 million. Today it is 45 million. Right now it’s really a very critical situation here. It’s absolutely impossible to develop anything in such circumstances.”

Gontavera says ICU is holding its own this year, but adds that “it’s difficult to sleep when your performance is not good”. The big investment banks have left Ukraine, leaving the market, if there was one, to ICU and a Morgan Stanley representative office headed by Ihor Mitiukov, a former finance minister.

This post-Maidan sclerosis in the economy is sharply documented in ICU’s April research paper into Ukraine’s banking system, entitled ‘Time to fix it. Again.’

It makes for grim reading: withdrawals of up to 13% of total deposits; already poor asset quality worsening by the day; sector-wide ratings downgrades to CCC; billions in undeclared or covered-up bad bank debt; and near-zero growth in lending – and much of this even before the political and territorial standoff with Russia.

“There is little reason for optimism,” says ICU’s banking analyst, Mykaylo Demkiv, understatedly. “The Ukrainian banking system had barely resolved any of its already existing problems when the escalation of tensions between Ukraine and Russia created new challenges.

“The newly appointed top management of [the central] National Bank of Ukraine must now take adequate measures to deal with these new challenges.”

Gontareva says Ukraine will be fine economically if it simply follows the IMF terms.

That might be a tough ask. Dmytro Sogolub, chief economist at the Austrian-owned Raiffeisen Aval Bank, points out that Ukraine has been under international care before and struggled to comply. He tells Euromoney that Ukraine has a great chance to reform, but it’s “perhaps its last chance.”

The terms of the IMF package were generous, he says. “The IMF has cut a great amount of slack to Ukraine, despite the extreme political turbulence and a very poor historical record of Ukrainian authorities in complying with IMF conditionality.”

It’s not the only tie with the past that the three men charged with reshaping Ukraine’s economy need to break.