Ukraine can win the economic war with Russia

Michael Zienchuk, MBA, CIM
Investment Advisor, Credential Securities Inc.
Manager, Wealth Strategies Group
Ukrainian Credit Union

As things now stand, Russian aggression against Ukraine increasingly looks like a war of attrition. Both countries’ economies are presently quite ineffective and the fears were widespread that Ukraine’s economy would not lift any time soon. But it seems that Ukraine’s economy has escaped the worst and is finally leveling off. On February 10, Ukraine’s Ministry of Economic Development and Trade said that the country’s GDP grew by 2% in the fourth quarter of 2015. Although the GDP for the full year of 2015 still dropped by a sizable -10.4%, the turnaround from the -17.2% decline in the first quarter is very hopeful.

Meanwhile, Russia’s GDP in late 2015 accelerated its decline to -4.2%. Although the rate of decline for the full year was much lower than in Ukraine, about -4%, one needs to take into account that Ukraine lost at least 20% of its economy due to the occupation of Crimea and the Russian invasion and destruction in Donbas. The following chart demonstrates that, starting in May 2015, the Russian ruble has weakened relative to the Ukrainian hryvnia – from 2.5 rubles fpr 1.0 hryvnia to about 3 rubles for one hryvnia currently. The ruble’s weakness against hard currencies is widely known, but the fact that it has significantly dropped against the distressed Ukrainian hryvnia is quite revealing. This dichotomy is the result of Western financial assistance to Ukraine combined with Western sanctions on Russia, and low oil prices.

At the same time, several things have happened in Ukraine and Russia over the last week that are pulling both countries along similarly poor trajectories. In Ukraine, the crisis in government worsened as the Minister of Economic Development and Trade Aivaras Abromavičius resigned. Following that the International Monetary Fund dropped a bombshell on February 10^th as its managing director, Christine Lagarde, stated that the IMF would suspend financial assistance to Ukraine unless immediate steps were taken to fight corruption. This is probably one of the few times that the IMF ever stressed the problem of corruption in its dealings with Ukraine. The IMF’s stance was immediately seconded by the US State Department. The West is clearly disappointed with the way President Poroshenko, the government and the Parliament have dealt with Abromavičius’ accusations of corruption and interference in government. The West’s patience is over and the rumours are abound that if it had not been for the war with Russia, the West’s financial help, which prevented Ukraine from going over the cliff, would have ended long ago.

In Russia, more problems are showing up as wages and social payments across the country are being delayed, while small and large businesses are closing and laying off many workers. There are reports about instances of extreme poverty among unemployed in some industrial regions. News about foreign companies closing their Russian subsidiaries, cutting their ties with Russia or selling shares of Russian companies continues. The situation is worsening: truck drivers are facing prohibitive taxes on transporting goods, while those with mortgages denominated in hard currency are getting desperate. The backlash against a ridiculously unlawful demolition of dozens of shopping malls in Moscow on February 9 is showing the extent of the contempt that the Russians are starting to show towards their government (although reliable polls on this issue are scarce in Russia).

So, some may question which country is winning this economic war? If Ukraine could clean up the corruption it is struggling with, it would be a clear winner, especially if the sanctions against Russia hold and the oil prices stay lower. Christine Lagarde’s words later on February 10, that she had a “constructive” discussion with President Poroshenko, following her earlier criticism, gives some hope for Ukraine’s future.

Michael Zienchuk, MBA, CIM

Investment Advisor, Credential Securities Inc.

Manager, Wealth Strategies Group

Ukrainian Credit Union

416-763-5575 x204

mzienchuk@ukrainiancu.com

www.ukrainiancu.com

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