Second Russia-Ukraine gas war on the cards for March?

Graham Stack for business new europe (www.businessneweurope.eu)

Concerns are growing at Gazprom that Ukraine gas distributor Naftogaz could miss a $400m payment due by March 7, forcing Gazprom to cut off gas supplies to Ukraine March 8.

Kommersant today February 26 quotes a source as saying the head of Gazprom’s Finance Department, Andrey Kruglov has expressed concern about the situation with payments by natural gas consumers in Ukraine. “If $400m has not been paid by by March 7th, we will have to again switch off the gas to Ukraine March 8,” the source quotes Kruglov as saying at a meeting of the Gazprom management Tuesday February 24.

Another high-ranking official confirmed to Kommersant that such a plan is being developed. “The company will fulfill all obligation to customers and transport gas at previous volumes. But the volume of gas at the point of entry to Ukraine will be reduced – we will not deliver gas to Naftogaz for free,” said Kommersant’s source.

While a formal ten-year agreement on the terms for supplying gas to Ukraine was reached in January, Gazprom appears to be concerned about the ability of Naftogaz of Ukraine to pay for the supplied gas in a timely manner.

Kiev has reportedly already given notice that it may not be able to pay, according to analysts. Last week Naftogaz informed Gazprom that it may experience payment delays due to unpaid debts (US$ 552mn) from Ukrainian utilities companies. Naftogaz Ukrainy Deputy CEO Igor Didenko saidtoday February 26 in an interview with Dzerkalo Tyzhnya that Ukraine plans to reduce gas imports in 2009 to 33 bcm from the earlier planned volume of 40 bcm (also below 55 bcm imported in 2008). Other reports have said volumes could go down as far as 20bcm.

Should Naftogaz miss the payment date, the contract stipulates moving to a 100% up-front payment format in future months.

Ukraine is rapidly sliding into a massive domestic non-payments crisis similar to that of the 1990’s. And just as in the 1990s, non-payments impact most heavily on the energy sector, the source of much cross-subsidization. For instance, in January, the Defence Ministry already said it had to shut down strategic defence installations, leaving holes in Ukraine’s air defences, due to want of funds to pay electricity bills. Yesterday February 25 it was reported that Kiev metro will cut the frequency of trains due to mounting debts to Kiev’s power suppliers.

The knock on effect for Naftogaz is that currently only 10% of utility companies pay their gas bills on time, with municipal heating enterprises now owing Naftogaz UAH 4.6 bln (4bn euros).

Naftogaz has already been forced to implement extreme measures to collect payments. Heating in the cities of Dnipropetrovsk and part of Lugansk was cut off, because Naftogaz throttled gas supply for non-paying utility companies, and the same has been threatened for Lviv and Zaporizhia. In Ivano-Frankivsk a planned stop to gas supplies failed due to local demonstrations.

Gazprom is making clear the buck stops with Naftogaz.

Another aspect of Naftogaz payments to Gazprom is the additional pressure on the hryvnia that these payments will cause. However, the National Bank of Ukraine (NBU) plans to provide Naftogaz with the necessary funding by selling dollars directly to the company on Friday, which, according to NBU Deputy Head Anatoliy Shapovalov, will reduce the impact on the FX market, according to Galt & Taggart Research

VTB Capital’s Lev Snykov writes, “we believe it is premature to talk about the likelihood of yet another supply crisis, given that the agreement sets 7 March as the payment deadline for February supplies. However, Gazprom’s concerns clearly reflect the difficulties faced by the [Ukrainian] economy and so we cannot rule out there being nonpayments for gas later this year. This would put European supplies at some risk and result in negative sentiment on the stock.

However, according to Alfa’s Ronald Smith, “this raises again our chief concern about the contracts that resolved the January gas crisis – the fact that Ukraine may simply be unable to pay market prices for its gas. While the new contract signed in January gives Gazprom the right to demand 100% prepayment for gas upon the first missed payment, we can hardly see how this clause will help the Russian side much, and unfortunately we can see another round of Russia-Ukraine dispute in the nearest future.”

Tymoshenko calls hryvnia fall ’sabotage’ aimed to introduce state of emergency

Prime Minister Yulia Tymoshenko has declared that the hryvnia exchange rate to the dollar is being deliberately weakened by the National Bank with the aim of introducing a state of emergency in Ukraine.

“Unfortunately the government cannot influence the National Bank … We believe that the exchange rate is collapsing deliberately, as an act of sabotage.. There are no financial, economic or crisis-linked reasons for this exchange rate,” Tymoshenko said, according to Korrespondent.net and RBK Ukraine.

“This is being done so that certain political groups can criticize our work and so that there emerges the chance of introducing such a unique situation as a state of emergency, meaning that no elections, including the presidential elections, will take place,” Tymoshenko continued.

According to Korrespondent.net, the interbank hryvnia rate is 9,235-9,375 to the dollar.

Over the last two days, the hryvnia has fallen over 10% against the dollar.

Russia’s GDP reported to have shrunk 8.8% YoY in January

Graham Stack for business new europe (www.businessneweurope.eu)

Interfax cited a Russian government official as indicating yesterday February 24 that real GDP fell by 8.8% YOY in January, following a 9.9% YOY decline in December 2008.

Last Friday February 20, Minister for the Economy Elvira Nabiullina announced that GDP contracted 2.4% MoM in January.

According to business daily Vedomosti, Russian exports dropped about 41% YoY in January to USD 20.2bn, with a 5.5% YoY decline in physical volumes. Oil and gas exports contracted 3.1% YoY and 41% YoY, respectively. Imports declined 34.2% YoY to USD 10.3bn in January, bringing Russia’s trade balance to USD 9.9bn. Real imports contracted 5.5% YoY.

VTB Capital’s Aleksandra Evtifyeva writes, “while the recent economic data and the PMI-based GDP Indicator suggest that economic activity almost froze in January, the 8.8% YoY decline in GDP still came as a negative surprise. Although fixed capital investment plunged 15.5% YoY, retail sales were still up 2.4% YoY last month.”

One reason Evtifyeva forwards for the sudden drop is Russia’s gas dispute with Ukraine, that saw a cut in Russian gas exports to Europe. Other analysts pointed to the “base effect” – the high rate of growth recorded in January 2008 of roughly 8 per cent year on year.

However, even if exports recover in February, Evtifyeva see “serious risks of consumption taking a lead from declining industrial production (which was down 16% YoY in January).”

According to Royal Bank of Scotland’s Head of CEEMEA research Timothy Ash, “these are pretty grim figures, and are showing the Russian economy is contracting at a much more rapid pace than expected; primarily related to the fact that it is commodity-based, and has been credit-fuelled in recent years. The commodity/credit underpinnings of the economy have been removed, hence the downturn.”

Ash argues this figure makes even the revised official forecasts for a 2.2% YOY contraction in real GDP over 2009 appear unattainable.

“The sheer extent of the slowing in the economy has obviously clear implications for the budget, as revenues are likely to subside, while spending pressures will increase, boosting the deficit, perhaps beyond the 8-10% of GDP currently being suggested by various government officials,” says Ash. “It also raises concern over the durability of the current 41 top end of the rouble basket. With growth in near-free-fall pressures will build for the CBR to relax its current relatively restrictive monetary policy, and to allow the exchange rate to bear a bit more of the burden in helping the economy come to a soft landing.”

“The more statist elements within the Putin/Medvedev administration are likely to become increasingly critical of the more orthodox reformers in the cabinet (Kudrin et al) and this could also suggest less orthodox policy responses; note comments last week by a prominent parliamentarian for the imposition of capital controls,” adds Ash.

Other analysts argue that the high interest rates the central bank is using to keep the rouble stable have also hurt growth. However, the rouble appears to have stabilised, at least temporarily, and authorities are hoping the banks will begin lending again, instead of hording dollars.

Deripaska says he doesn’t need state help to restructure debt

Graham Stack for business new europe (www.businessneweurope.eu)

Oleg Deripaska, trying to restructure billions of dollars in debts owed to Western banks, said he does not need financial help from the state.

Deripaska controls the world’s largest aluminum producer, United Company RusAl, and has been in talks with Western and Russian banks to restructure billions of dollars of debt. RusAl has about $14 billion in bank debt.

“The state should be left alone. We do not need financial help from the state,” Deripaska said February 24, 2009, according to newswires.
“We, on the contrary, are striving to return the debt to it [the state] and already have a mechanism,” he added.

“RusAl hopes to sign an agreement at the start of March on a moratorium of payments on the principal of the debt. Then we will have three to four months to agree about restructuring,” Deripaska said.

“Banks not only know and like RusAl, but they must earn money. … After the crisis, there will remain only three centers for aluminum production — Russia, the Middle East and China — and the banks understand this,” Deripaska said, as quoted by Moscow Times.

Deripaska said reports that his debts totalled $30bn “had nothing in common with reality.” He said the debt of his holding company, Basic Element, was less than $1.5bn, according to Moscow Times. RusAl also owes $2.8bn to Mikhail Prokhorov for Prokhorov’s 25 percent stake in mining company Norilsk Nickel.

Elaborating on RUSAL’s negotiations with its creditors, Deripaska said yesterday February 23 that he plans to reach a stand still agreement with foreign banks and sign a relevant agreement in early March.

“I think that we will agree in early March. The price of our debt is less than 4%, and it is easy to understand that they [banks] want to raise it. But this is a matter of balance: what they are ready to cede as to dates and terms and what we are ready to accept,” he said, as quoted by Interfax.

“After we secure stand still, negotiations will be rather long – three or four months,” Deripaska added.

Deripaska also said that talks on convertible bonds could start after the stand still agreement with banks is reached. “There are investors, who have been insistently wishing to become RUSAL shareholders for a long time,” he said. “We think that the current price level is not enough for selling shares; however, fixed-income instruments with a possibility to come in the capital on beneficial conditions will be interesting to them,” Interfax quoted Deripaska as saying.

Deripaska’s plans for his automotive holding Russian Machines are also in disarray.

Mr Deripaska has been seeking state support for Gaz, which is Russia’s second-biggest carmaker and has cut one in five staff as demand plummets and non-payments spiral.

Some production lines have also been halted. The company this month failed to make payment on a put option on a Rbs5bn loan and is seeking a 30-day grace period to restructure the debt.

VTB Capital writes today that GAZ has suffered another setback after its new passenger car model was excluded from the list of government support. “The price of GAZ’s new passenger car, the Siber, exceeds the required threshold, which was probably why it was not included in the list. GAZ has suffered from a series of misfortunes of late: just before the crisis it launched two unsuccessful models, last autumn its liquidity problems were the most serious of all the Russian auto producers, it defaulted on its bonds last week and its car sales will now not benefit from the government initiatives.”

The Financial Times reported yesterday that Deripaska is seeking a UK government bail-out of LDV, the UK van maker he owns, to help a management buy-out.

Galt & Taggart Research writes today that Deripaska’s deal to buy Belarus truck maker MAZ is probably off. “News of the project has gone quiet since Deripaska began selling off his assets outside of Russia and we suspect the deal is on the ropes. “

Deripaska had to divest a minority stake in Canadian car components giant Magna in autumn 2008

Deipaska however stated yesterday February that his holding company BasEl is about to “soon” close its acquisition of Russian oil company Russneft, despite his debt troubles.

“We will not reverse the deal. Our position is that there are not only short-term but also long-term interests. That is why any harsh movements with partners, banks, and creditors are not decent and do not create benefits. This is our position in all companies we have stakes in,” Deripaska said yesterday February 23, as quoted by Interfax.

World Bank calls on EU to help Central and Eastern Europe

Graham Stack for business new europe (www.businessneweurope.eu)

Robert Zoellick, World Bank president, has added his voice to calls for the EU to initiate global support for central and eastern Europe (CEE) countries.

In comments made to the Financial Times February 18, Zoellick said the bank was collaborating with the International Monetary Fund and international institutions for a financial aid package for CEE, but needed the support of the EU as well.

“It’s got to have support from the European governments,” Zoellick said, as quoted by FT. “It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again.”

But the European Commission has said it would distinguish between EU members and non-EU members and preferred a country-by-country approach.

Joaqun Almunia, EU monetary affairs commissioner, said the CEE countries fell into different categories, with some being EU members and some, most prominently Ukraine, not, according to the FT.

CEE leaders also called for stronger EU-led action. Andrius Kubilius, Lithuania’s premier, told the FT: “It would be good to see a more co-ordinated approach from the EU authorities.” Ferenc Gyurcsany, Hungary’s leader, urged wider support for Austria’s proposals for an EU bank package.

Backing up words with deeds, the regional director of the World Bank for Ukraine, Belarus, and Moldova, Martin Raiser, said today February 19 that the bank could provide a $750m loan to refinance Ukraine’s leading banks. Moreover, the bank is committed to providing $1 bln to finance infrastructure projects involved in the preparation for EURO-2012.

Alfa Bank’s Denis Shauruk writes that, “we see the news as positive for the Ukrainian economy, which is seeing more and more commitments to refinance its banking system’s outstanding debt and international financial organizations are showing a willingness to finance infrastructure projects, despite the crisis. Prior to the announcement from World Bank officials, EBRD confirmed its commitment to provide euro 500 mln to refinance Ukrainian banks this year. According to the latest information, 20 banks will receive this aid. Furthermore, EBRD has already begun negotiations with OTP Bank Ukraine, the country’s seventh-largest bank by assets.”

Royal Bank of Scotland senior analyst Timothy Ash writes, “don’t hold your breath though, as we still don’t think that the key movers and shakers in Europe have entirely got the message yet. Herein, the powerhouse of Europe, i.e. Germany, has to be central to any efforts in this regard, but it still seems to be preferring to take a back seat, perhaps surveying the damage being wrought across the periphery of Europe as somehow pay-back for others’ excesses of the past, with an unwillingness to let the German taxpayer foot the bill for someone else party.”

“There may well be some truth in this,” Ash continues, “but the fact is Germany remains hugely dependent on manufacturing exports, and with global trade in decline we doubt that demand for high end German exports is going to hold up very well as this crisis continues to unfold. Core-EMU economies cannot escape any back-draft from the deepening problems in Emerging Europe. Let’s hope that politicians in Europe finally begin to get the message.”

Putin associate calls Afghan heroin “weapon of mass destruction”

Graham Stack for business new europe (www.businessneweurope.eu)

Putin associate and currently Federal Drug Control Service chief Viktor Ivanov said yesterday February 18 in front of the State Duma that Afghan heroin is a “weapon of mass destruction.”

“Every day 82 people younger than 27 die in Russia [due to Afghan heroin], so yearly losses stand at 30,000. This number twice exceeds Soviet casualties in the entire ten years of the Afghan War,” he said, as quoted by Interfax.

CIS countries commemorated 20 years since the end of the Afghan war this week.

“No less than 12 tonnes of pure heroin are smuggled from Afghanistan to Russia, which is sufficient to make 3 billion doses,” Ivanov said. He proceeded to call Afghan heroin “is a special kind of weapon of mass destruction. This is also a selective weapon targeted at the younger generation,” he said, according to Interfax.

With Obama in the US White House and pushing for a surge in Afghanistan, Russia is positioning itself as transport corridor for NATO in return for concession on other fronts.

The extent to which eradicating heroin cultivation in Afghanistan in the key to defeating the Taliban is a bone of contention between US generals and their NATO allies, especially Germany. US generals have been pushing for NATO military targets to include opium dealers, while the Germans are for emphasizing infrastructure construction.

Viktor Ivanov, a KGB veteran, served in Afghanistan in the 1980s.

Moody’s says Eastern Europe crisis could threaten Euro stability

Moody’s is warning that western European banks with East European subsidiaries are at risk of ratings downgrades.

“The relative vulnerabilties in east European banking systems will be exposed by an increasingly tougher operating environment in eastern Europe as a result of a steep and long economic downturn coupled with macroeconomic vulnerabilities,” Moody’s said in a report published February 17.

Moody forecast “continuous downward pressure on east European bank ratings” because of deteriorating asset quality, falling local currencies, exposure to a regional slump in real-estate and the units’ reliance on scarce short-term funding.

Eurozone banks have CEE liabilities of $1,500bn, led by Austria’s Raiffeisen and Erste Bank, Société Générale of France, Italy’s UniCredit (which owns Bank Austria) and Belgian group KBC.

The Austrian banking system is the most vulnerable, according to the FT, with half of its loan book going to Eastern Europe. In 2007, Raiffeisen and Erste Bank earned the vast majority of their pre-tax profits in eastern European countries. Italian banks are exposed to Poland and Croatia and Scandinavian banks to the Baltics.

Pressure on East European countries is starting to put pressure on the Euro, with the euro falling to a two-month low against the dollar February 17 over concerns over West European banks’ exposure to eastern Europe.

Russia and China sign US$25bn loans-for-crude deal

Graham Stack for business new europe (www.businessneweurope.eu)

Rosneft, Transneft, China National Petroleum Corporation (CNPC) and China Development Bank have signed off on a deal for $25bn in loans for the Russian state-owned companies in return for Russian crude oil supplies to China, according to newswires

The agreements were signed in Beijing on Tuesday February 17 at a meeting between Russian Deputy Prime Minister Igor Sechin and Chinese Vice Premier for Energy Wang Qishan.

Following the meeting, Sechin, who is also chairman of the board of Rosneft, said that Russia is expected to export 15 million tonnes per year (301,000 barrels a day) to China over a period of 20 years in exchange for the loans.

“We agreed on supplies of 15 million tonnes of oil every year over a period of 20 years,” Russian Deputy Prime Minister Igor Sechin told state news channel Vesti 24.

The China Development Bank signed the loan agreements with Rosneft and Transneft. Rosneft and CNPC signed documents on Russian oil deliveries to China for a 20-year period.

Transneft Vice-President Mikhail Barkov told Reuters his company would receive $10bn of the loan and Rosneft the other $15 billion.

“The maturity is around 20 years and this credit is linked to supplies,” Barkov told Reuters. “It is a historic event and the start of a big journey.”

China agreed to reduce the annual interest rate by one percentage point to 6 percent, RIA reported. Vedomosti speculates that the interest rate for the loan is 5.5-6% annually.

The deputy premier also signed a second deal on construction of a branch of the Eastern Siberia-Pacific Ocean pipeline (ESPO) to the Chinese border. CNPC and Transneft signed a corresponding contract on construction and operation of the ESPO branch, according to Prime Tass.
Russia will supply 30 million tonnes through the pipeline link to China when it reaches full capacity, a Transneft spokesman told Prime Tass.

VTB Capital’s Lev Snyvkov writes, “Rosneft could resolve its debt repayment issues without the Chinese loan, but it could be more expensive and problematic given the current tight liquidity conditions. We estimate Rosneft’s net debt at the end of 2008 at about USD 24bn, with USD 8.5bn to be repaid in 2009. The company’s 1Q09 repayments (USD 0.9bn) were covered by operating cash flow, while the 2Q09 repayments (USD 4.1bn) have already been agreed with banks (refinancing). In 2H09, Rosneft needs to repay USD 3.5bn.

The pricing parameters of crude supplies (as yet unknown) are important for assessing the true cost of the loan. The news is in line with what was announced earlier but is still marginally positive for Rosneft and Transneft as the agreement is an additional source of liquidity in the tight liquidity conditions on the market.”

UralSib’s Viktor Mishnyakov writes, “we believe the loans received might provide an impetus to massive development of Eastern Siberia. Assuming the government will exempt the East Siberian fields from export duty, the biggest winners will be Rosneft (which has the most projects in Eastern Siberia), TNKBP, Surgutneftegas, Slavneft and Gazprom Neft. Regional development would also likely trigger the extensive use of independent oil field services in the region, with Integra benefiting the most.” We think China might receive certain benefits in return. We believe that two options are possible: greater access to the East Siberian fields (currently two upstream projects via a JV with Rosneft) and the potential transformation of ESPO into a joint stock company, with China getting 49% or 50% control in it.”

Sting in Serpent Island tale leads to political strife in Romania

Graham Stack in Kyiv for business new europe (www.businessneweurope.eu)

When the International Court in the Hague awarded the lion’s share of the hydrocarbon rich northwestern Black Sea to Romania over Ukraine, many in the Latin county saw this as poetic justice for disrupted gas supplies in January. But Romania’s politicians have again showed their mastery of snatching defeat from the jaws of victory

Maritime border disputes are usually mind-bogglingly arcane affairs. So it was with the decade old dispute between Romania and Ukraine over maritime border delimitation in the North-Western Black Sea. The main bone of contention was an ‘insular feature’ known poetically as Serpent’s Island, the size of a few football pitches, and located not far off Romania’s Danube delta. Ukraine is the proud sovereign of what it claimed was a fully fledged island, replete with a Potemkin village of settlers – and entitled to a zone of exclusion giving Ukraine control over resource-rich seabed.

Romania was intent on calling a rock a rock, denying Serpent Island was an island, and thus arguing it had no implications for the maritime boundary.

However arcane the arguments, at stake was sovereignty over an estimated potential 70bn cubic meters of natural gas – enough to supply Romania’s entire gas needs for five years – and 12m tonnes of oil.

The significance of these reputed riches was greatly heightened by January’s gas dispute between Russia and Ukraine, which saw supplies to Europe, including Romania, severely disrupted. Both sides claimed the resources could limit dependency on imported gas.

After years of deliberations, the International Court of Justice in the Hague reached a decision February 3 – and awarded the four fifths of the disputed area question to Romania. 9,730 square kilometres of the continental shelf of the Black Sea.

Ironically the entire rock / island issue turned out to be a red herring. “The ICJ decided that it was not necessary to determine whether Serpent’s Island is a rock or an island in order to delimit the maritime boundary,” says Martin Pratt of Durham University’s International Boundary Research Unit.

Ukraine put a brave face on yet another international setback, while Romania celebrated, with President Traian Basescu calling it a “big success for Romanian foreign policy”. Prime Minister Emil Boc immediately promoted Romanian representative at the ICJ, Bogdan Aurescu, to a senior post in Romania’s Ministry of Foreign affairs. And commentators pointed to the poetic justice of the award after Ukraine’s spat with Russia had cut off gas supplies to Romania in January. And the even more enthusiastic called it a victory for Western civilization, with the NATO and EU border shifting to its easternmost point.

A sting in the tale

But the Serpent Island tale quickly proved to have a sting to it.

On the day after the celebrations, the hangover set in. It transpired that two weeks before the November 30 2008 elections that voted out the government led by Calin Tariceanu of the National Liberal Party (PNL), a cabinet resolution had granted a production-sharing concession for blocks in the Serpent Island area to Sterling Resources Ltd, a little-known Canadian firm. The agreement, some annexes of which were classified secret, had apparently awarded Sterling Resources production rights in addition to existing exploration rights, in the event that ICJ ruled in Romania’s favour.

The government’s reactions was immediate, with new Democratic Liberal PM Emil Boc dismissing the head of the National Agency for Mineral Resources (ANRM), Bogdan Gabudeanu, Romania’s natural resource regulator, on the same day.

Romanian investigative reporters quickly claimed murky ties existed between ueber-oligarch Dinu Patriciu, head of Romania’s largest energy company Rompetrol, and regarded as sponsor of Tariceanu’s PNL, Sterling Petroleum, other foreign concession holders, and sundry officials.

Apart from Gabudeanu, attention is focusing on current Environment Secretary, former head of the prime minister’s chancellery, Doru Badulescu. It was Badulescu and Gabudeanu who signed off on the concession agreement. Question marks also hang over the role of former justice minister Catalin Predoiu.

Of course, with the economic situation for Romania in 2009 looking increasingly grim, PM Emil Boc is keen on blackening the name of his predecessor, adding fuel to the fire. For his part, former PM Tariceanu has said he will sue Boc over publicly-made corruption allegations.

Sterling Resources says that all relevant ministries signed and approved the resolution. “The Eleventh Amendment took over 20 months to be approved and followed the approving process by the line ministries, as provided by the existing regulations, until final approval by the Government on November 12, 2008,” the Canada-listed company said in a statement denying all allegations. The company admits however that the November 12 agreement “transfers greater control and decision-making to the operator”.

Dinu Patriciu for his part also denied the allegations in a Rompetrol statement, and is dismissive of the Black Sea resources as a whole, adding his voice to that of other experts in saying that the potential reserves are over-stated and the costs prohibitive.

This week is likely to see the scandal continue to roll, as the government has now ordered the disclosure of the secret annexes to the agreements.

Whatever the truth of the affair, it bodes ill for Romania’s corruption-dogged relations with the EU that have led to suspension of billions of euros of structural subsidies.

The EU called on Romania February 12 in its biannual review of corruption and judiciary to “regain momentum on judicial reform and the fight against corruption so as to reverse certain backward movements of recent months.” The EU pointed to parliamentary obstructionism in hindering anti-corruption measures. Victor Alistar, executive director for Romania of corruption watchdogs Transparency International Romania, backed up the EU’s findings, saying that in Romania “the air is thick with corruption.”

Romanians will be worrying lest their courtroom victory over Ukraine, at least in the short term, costs more EU subsidies than it produces gas and oil revenues.

Raiffeisen Bank Aval deputy CEO calls for direct EU support for Ukraine

Graham Stack in Kyiv

With the Ukrainian economy in freefall, Austria’s Raiffeisen International, owner of Ukraine’s second-largest bank Raiffeisen Bank Aval, has taken the lead in calling for an EU support package for troubled Eastern European economies.

“If a country goes from an economic forecast of plus 7% to minus 5% in a short space of time, even if that country is not an official EU candidate, we think that a country the size and strategic position of Ukraine should get EU support to avoid a total collapse of the financial system, and consequently of the real economy,” argues Raiffeisen Bank Aval’s deputy CEO, Gerhard Boesch.

“It is Raiffeisen’s position that there should be action on a European basis to prevent such a collapse,” adds the Austrian. “The IMF package [for a $16.5bn standby loan agreed early November] is simply no longer enough to guarantee even relative stability, because the situation has changed so dramatically in the last three months.”

Head of Raiffeisen International, Herbert Stepic, has assembled a powerful lobbying group calling for EU support for Central and Eastern European countries – both EU and non-EU. As well as Raiffeisen, the group includes Italy’s UniCredit Group and Intesa Sanpaolo, Austria’s Erste Bank, Société Générale from France, Belgium’s KBC, German Bayern Landesbank, Sweden’s Swedbank and SEB, and EFG Eurobank from Greece. At the recent Davos Economic Forum, the financier George Soros also voiced his support for the initiative.

However, such arguments have been largely rejected in Brussels. The European Commission and the European Bank of Reconstruction and Development have acknowledged the extent of the crisis in the emerging markets of Europe, but said it’s the responsibility of the foreign parent banks themselves, backed by their national governments, to support their subsidiaries. However, Boesch counters that, “if a country like Ukraine can be stabilized, then it is in the interests of all Europe.”

According to Boesch, the loan exposure of Austrian banks, including Bank-Austria owned UniCredit, to the CEE region is around €180bn. “This is roughly two-thirds of Austrian GDP,” he points out. Countries at risk account for around 40% of the exposure, says Boesch, with Ukraine the most threatened.

Acknowledging such support is unlikely to be popular in the EU, Boesch points out that Western national bank bailouts have also been unpopular, but they have been seen as necessary. “The headline figure [of a support package] would look small compared to such national bank bailout packages. It’s simply a fact that the parent banks cannot increase our exposure to the region at the same time as all international investors pull back. These countries, especially Ukraine, might now face a real credit crunch beyond what we have seen.”

Parent trap

Boesch says that the parent banks are now feeling the pinch themselves. “There is no doubt that the situation for parent banks is not the same as it was. The parent banks are also affected by the crisis.”

“Raiffaisen Bank Aval was very successful in raising financing 2007-2008 – from the parent company, bonds and as syndicated loans. We raised a lot of capital, and most of these 80-90 investors are very reluctant to prolong. So we will need to pay back all of these loans.” Raiffeisen Bank Aval has to pay back a $500m syndicated loan in April, and $80m in June, and won’t disclose private transactions.

The parent bank has provided extensive support to date with over $600m cash in the fourth quarter of 2008, so that the actual recapitalization requirement calculated by the IMF is assessed as moderate by the bank. But the parent companies in general, says Boesch, cannot replace wholesale funding that isn’t rolled over. The resulting large capital outflow, as foreign currency loans are paid back, will pressure the currency, creating a vicious circle. Further depreciation will also worsen banks’ asset quality. “On balance, the pure numbers are not unmanageable,” says Boesch of Ukraine’s finances. Ukraine has low public sector debt and a low current account deficit. “But the situation has been exacerbated by the global situation and political crisis.”

Boesch makes no bones about the political mess that Ukraine is in, which has seen European enthusiasm after the Orange Revolution in the winter of 2004 turn to hand wringing. Specifically, he sees a lack of credible central bank independence as a factor in the chaotic devaluation of the hryvnia. European intervention, he argues, could help focus minds and overcome the political paralysis. “In the long term, an offer to Ukraine to become an EU candidate might be the preferable solution,” believes Boesch.

Deposits at risk

Besides further hryvnia depreciation, a ‘Negative’ outlook from Moody’s Investors Service on Ukrainian banks at the end of January identified hemorrhaging deposits as a second systemic risk. A rough total of UAH60bn, around a third of all deposits, have been withdrawn since October on deposits maturing. The situation would have been worse but for the National Bank of Ukraine imposing a moratorium on preterm withdrawal of deposits in October to stem a run on the banks. However, the IMF has called for this moratorium to be lifted, and influential chairman of the NBU advisory board, Petr Poroschenko, suggested February 1 that this could soon happen.

Boesch sees such a move as fraught with risks, despite the moratorium contradicting civil law. “Lifting the moratorium would be a risky test of the degree of nervousness among the population.” Raiffeisen Bank Aval, says Boesch, has always paid out 100% of deposits in any currency on any client requesting, and could benefit from a flight to quality, with pressure on Aval deposits easing in January relative to November-December.

“But we already see other Ukrainian banks unable to pay out deposits that have expired, or current account deposits. And many more banks give you $100 a day, so it takes 3 weeks to withdraw $2,000. In other banks you can see people queuing up,” he says. “If a lot of people decide to withdraw, a large number of banks are going to be in trouble. The price that would be paid then would be a rather big one.”

The management of distressed assets will be an important business line in 2009, says Boesch. Raiffeisen Aval put a brake on its loan book growth in the first half of 2008, while other banks were still steaming ahead. “We lost market share as a result, with credit growth of 17% against market growth of 35%,” says Boesch. But caution was rewarded when the currency collapsed.

Even so, Aval NPL figures amount to 2.7% at the end of 2008. “We are now seeing a deterioration in the ability of clients to service their debts. It’s easy to see that, if the currency falls by 60-70%, a lot of customers are going to be simply unable to pay 60-70% more at the same time that the economy is going into recession, people are seeing income decrease or losing their jobs.”

The bank has limited options. “Aggressive repossession would simply put huge pressure on asset prices,” says Boesch. Instead, the bank hopes to draw on its extensive branch network to work with customers in restructuring loans. Staff who previously issued credits are now busy restructuring them. However, the bank will still lay off 10% of its 17,000 strong workforce.

Boesch argues that one of the systemic flaws in the Ukrainian banking has been the population’s overwhelming preference for dollars over the local currency – simultaneously for both credits and deposits. “It’s actually an irrational position – the population has gone long on dollar deposits, and at the same time has a huge short position in dollar credits,” he points out. “It was basically an enormous carry trade, which is now just starting to unwind. The unwinding is going to take several years and be extremely painful.”