Taking stock of Russian growth prospects

Graham Stack for Russia Profile (www.russiaprofile.org)

Rumours of imminent growth may be exaggerated by sketchy inventory statistics. A chorus of analysts are attributing Russia’s 10% GDP contraction this year to companies selling down inventories rather than producing, and are gung ho about growth restarting as soon as inventories empty. But others are warn against drawing strong conclusions from Russia’s sketchy national statistics on inventory levels.

 

Alexei Moiseev, macroeconomic analyst at Renaissance Capital, speaks for a number of analysts arguing that Russia’s astonishing GDP collapse of 10.2% – in the first half of 2009 was the result of huge selling down of inventories by industrial enterprises rather than demand collapse.

 

“Very expensive money resulted in massive de-stocking in fourth quarter 2008,” he argues. “The trend intensified in the first quarter of 2009, with the negative contribution to GDP in this quarter exceeding 7 percentage points of a total decline of 9.8%.” 

 

Similarly, Anton Nikitin of UralSib argues, “the fall of GDP and slowdown in industrial production was mostly driven by the huge disposal of inventories” which started late 2008 and continued into early 2009. Citibank’s Elina Ryvbakova also estimates that at least one third of the collapse in production in the first half of this year resulted from destocking.

 

Since GDP is a pure production statistic, it plummets when enterprises en masse stall production lines to sell down inventory, even if turnover stays steady. And the harder they come, the harder they fall: overheated growth in 2008 brought about unprecedented stockpiling due to anticipated future demand. “Spiraling costs of raw materials 2007-2008 also caused companies to massively build up their inventories,” says Rybakova. Moisseev speaks of “a crisis of overproduction” starting in the first quarter of 2008, with inventories at 150% of their 2007 value.

 

If destocking rather than demand collapse was so much to blame for the economic disaster this year, then logically when inventories are empty stalled production will start up again. According to Moisseev, “some of the damage done to the economy has resulted from overheating in 1H08, and some of the damage will be easy to recover. Unfortunately, inventory statistics come with a significant delay, so we have no way of knowing what has been happening since, but historical experience suggests de-stocking cannot last for longer than two-to-three quarters”

 

Shadowy statistics

 

As Moiseev admits, the catch with betting on emptying inventories to kickstart growth is that no one knows very much about them. The problem is that Russian Federal State Statistics (Rosstat) reports inventory statistics only sketchily, on a quarterly basis and aggregated across the economy. The next figures won’t appear until October, meaning that forecasting growth on their basis is very speculative.

 

“The question of inventories has advanced to be the one of the key questions, especially because the economy ministry has focused on it,” explains Vladimir Sal’nikov of the Centre of Macroeconomic Analysis. “But the problem is that inventories are not counted directly and there is a high level of statistical error involved. It is very difficult to separate the real inventory level from the margin of error.”

 

According to VTB Capital analyst Aleksandra Evtifyeva, “Rosstat only provides quarterly aggregate inventory figures that don’t allow close analysis. The Economy Ministry has a wider base of statistics available and said in August that inventories were drying up. However we don’t know for instance if oil companies are included in their statistics or not.”

 

Business daily Kommersant has reported that Bank of Moscow analysts report that inventories have remained stable over the last three quarters, and that as a proportion of turnover inventory has grown by a third compared to 2006-2008. If true, this would point to demand collapse that Sal’nikov also feels has been underestimated. “It seems to us to be the case that markets have contracted more strongly than is reflected in statistics,” he says.

 

Citi’s Rybakova admits that the quality of inventory statistics provided by Rosstat is very poor. However, she says  “the magnitude of the production collapse in the first quartern 2009 is hard to explain by any other factor. It was more severe than in 1998.”

 

“Restocking however won’t be a panacea to cure the economy,” she adds. “Instead, we are seeing an adjustment down to a new production level, meaning inventory will never return to pre-crisis levels.” Rybakova believes restocking could add 1-3% to annual GDP growth, but not before 2010. Instead, she believes that consumer demand will pull Russia back up, if it strengthens. Sal’nikov also prefers demand as a growth factor – but tips deferred demand for investment goods instead of consumers.

 

With the government still holding out for growth driven by an end to destocking, skeptical voices are growing stronger. The Finance Ministry forecast for August was for 1.5% growth, but the result disappointed at 0%. Electricity consumption statistics, a proxy for industry, show demand still contracting.

 

Timothy Ash of Royal Bank of Scotland is consequently dismissive about the talk of growth. “Brokers seems to be jumping over themselves at the moment to talk up the Russia story, that recovery has begun, and that Russia will bounce back quickly. While favourable base period effects should come into play in the final few months of the year, the data flow is far from convincing,” he says.

Unistream money transfer network expands despite crisis

Graham Stack in Hamburg for Business New Europe (bne)

 

Unistream, the biggest player on the money transfer market in the CIS, tells bne the crisis has not impacted on operations, and the network is set to expand into Germany.

 

One year ago, as the economic crisis struck, it seemed the Central Asian countries would soon plunge into crisis as the remittances from Russia they depend upon dried up.  However, Suren Ayriyan, president of Unistream bank, the biggest operator of money transfers in the CIS region, tells bne that the money transfer volume has remained stable on the year. “After a short blip, transfer volumes are back to their level of one year ago,” says Ayriyan.

 

Unistream is the Western Union of the East, with a share of 27% of  the money transfer market for the CIS corridor at the end of 2008, according to the Russian Central Bank. With remittances from Russia accounting for 20-45% of GDP for the countries of the Caucasus and Central Asia, the severity of the crisis descending on Russia at the end of 2008 seemed to bode ill for Eurasia. Alarmist scenarios predicted even state collapse in Tadzhikistan as workers returned home empty handed.

 

“Nothing like this has happened,” says Suren Ayriyan, president of Unistream. “Money transfers did fall at the start of 2008, but recovered by the spring. People simply did not return home even if they lost their jobs,” Ayriyan explains. “They stayed in the country, and found other work, even if only in the informal economy. No one went anywhere.”

 

Another factor supporting money transfer volumes during the crisis: with fuel prices staying high, the cost of transport home has become unaffordable for many migrant worker. “That’s why, although the average amount of a single transfer has fallen, the number of transfers has risen,” explains Ayriyan.

 

This means that despite the 30% dip in the market in the first quarter, money was quickly flowing again as things stabilised. With Russian companies looking to cut costs, cheap immigrant workers outcompete Russians on the Russian labour market. Tadzhikistan, Uzbekistan and Kyrgyzstan are among the few CIS countries to have experienced growth this year, not least due to the stable level of remittances facilitated by Unistream.

 

Unistream’s total volume of transfers in 2008 was $4bn (at current dollar rates) and in 2009 is looking to reach $4.5bn, despite the crisis.

 

The Unistream network has snowballed. With a turnover of $760m in 2005, the company reached $1.85bn volume in 2006, and $3.7bn in 2007, with the number of customers soaring from 870,000 in 2005 to 3.7m in 2007,

 

In 2008, the company took 57% of the market in Armenia , 45% in Kyrgyzstan , 41% in Moldavia , 25% in Tajikistan , and 22% in Uzbekistan.

 

Unistream is not just about remittances: Russia being the size it is, and the banking system still underdeveloped, Unistream’s Russian in-house network adds up to more than 40% of the system’s total turnover.

 

The particularly strong showing in Armenia is not coincidental. Both Ayriyan and co-owner of the bank Gagik Zakarian are of Armenian origin, one of the historic diaspora nations. “$4bn flow to Armenia from Russia annually,” Zakarian tells bne, “and about another  $500m from the US.”

 

Going German

 

The awareness of the West as a source of remittances is now prompting Unistream to roll out its system in the EU countries, including Britain and Greece, but first and foremost Germany.

 

“Today more than three million of the country’s residents are economic migrants from the CIS, which, given the decidedly high standard of living in Germany , is inevitably a dynamic growth driver for the money transfer market,” says Ayriyan.

 

Analysts at Unistream estimate that Germany’s money transfer market in all directions will be annually worth more than $12bn even in the immediate post-crisis period, which is absolutely colossal, bearing in mind that the Russia-CIS corridor added up to a total $15bn in 2008. The Germany-CIS corridor’s value is around $4bn. Unistream is looking to take 10% of this corridor’s volume in the mid term, according to Ayriyan.

 

A particular challenge to setting up in Germany is the toughness of the money laundering laws and general supervisory requirements of financial sector, that make obtaining a license a time-consuming and exhausting process. Despite strictness of personal identification rules for money wires, the extent of Internet coverage here means Unistream is developing an online service. “At the same time, taking into account that many migrants in Germany from the CIS are of the older generation, it is important to have a physical presence including Russian speaking staff,” says Ayriyan.

 

Powerful backing

 

Unistream is owned by its founders Georgii Piskov and Gagik Zakarian, with a 26% stake spun off to Aurora private equity group in 2006. Piskov and Zakarian were the founders and owners of Russia’s Uniastrum Bank, until selling 80% of the bank to the Bank of Cyprus in 2008 for 447m euros, months before the financial crash. This means the Unistream owners have deep pockets with which to finance the further expansion of the system, which was not included in the deal.

 

“Unistream is a highly solvent, highly liquid system,” Piskov tells bne, “which does not need any extra financial support presently. However, any funds it requires for business purposes will be forthcoming.”

 

Piskov makes no bones of his ambitions in the money transfer business. “We want to go global, and expand beyond the CIS corridor. When you have created such a system, it’s simply logical to roll it out in country after country,” he says.

Erste Bank Ukraine’s first bank to admit to double digit bad loans

Erste Bank has become the first of Ukraine’s banks to officially acknowledge that its bad loans are in the double digits, declaring 10% of the gross loan portfolio to be non-performing at the end of the second quarter. However, the bank claims the figure is actually well below the true market average, and more a sign of the bank’s strength than weakness.

“We do not do window dressing. Honesty is the best policy,” Jozef Sikela, the 42-year-old CEO of Erste Bank Ukraine, Austria’s Erste Bank subsidiary and 22nd largest bank in the country, tells bne in an interview. “The result is considerably healthier than the real market average.”

Sikela declines to provide a figure for the sector as a whole. National Bank of Ukraine (NBU) statistics hold that the level of non-performing loans (NPL) stood at 4.9% as of June 1, but the consensus is the real level is nearer 15-20%. Ukrainian banks have developed numerous ways of jiggering the NPL figures they publish – by extending or rolling over loans that are obviously non-performing – and thus avoiding mandatory requirements to create provisions for loan losses.

According to Sikela, Erste in fact ran a far more conservative lending strategy than most other Ukrainian banks, especially locally-owned banks. Sikela accuses Ukrainian-owned banks of inadequate risk management during the last few years’ lending splurge. “Ukrainian-owned banks were lending in a specifically flexible manner in comparison to international banking groups like Erste,” he says. “Our customers were complaining of how conservative our lending policy was one year ago, now they are entrusting their deposits to us.”

Sikela says Erste never entered the consumer loan market, and almost all its loans are collateralized with tangible assets. As such, he expects international banks like Erste – which constitute around 50% of the banking system – to dominate in post-crisis Ukraine, while local banks will wither away. “The system will remain loss-making for the time being, and only foreign-owned banks will be able to access the resources to continue functioning.”

Staying the course

Sikela’s comments indicate the bank will get the supports it needs from the parent group. Indeed, CEO of the parent Erste Bank Group, Andreas Treichl, told bne in Vienna following the release of the bank’s second-quarter results at the end of July that while Ukraine is not a core market for his institution, in the long term he sees huge potential in the country and so there are absolutely no plans to pull out.

However, the NBU sees things differently. Erste Bank Ukraine posted a €31.9m loss for the first half of 2009, partly due to increased provisions for NPLs. The NBU now views all loss-making banks with great suspicion, and on July 22 issued regulations placing significant restrictions on their activities. Among other things, the regulator prohibited loss-making banks from paying bonuses, growing intangible assets and providing unsecured loans, steps that Sikela decries. “There are different reasons for losses, and different capacities to cope with them. You cannot treat large international banks the same as small local institutions with minimal possibility to inject new equity.” Sikela says the measures effectively freeze his bank’s development, stymieing IT investment and bonus-motivated projects.

Another major headache is pending populist legislation aimed at “protecting” mortgage borrowers against repossession. Erste was a leader in mortgage lending in Ukraine, “traditionally regarded as one of the safest forms of lending if done properly,” says Sikela. Mortgages account for round half of Erste’s retail portfolio, which in turn is two-thirds of its total loan portfolio. If the legislation goes through, critics fear the measure will encourage even solvent borrowers to suspend payment. “You can’t explain something like this to international shareholders,” warns Sikela, who adds that he is “very surprised” the International Monetary Fund (IMF) has been silent on the issue.

At stake is the larger issue of whether the Ukrainian authorities will exploit foreign banks’ continued loyalty to Ukraine rather than reciprocate it. This could crucially tip the scales when parent banks decide on whether to continue to support subsidiaries or withdraw altogether from Ukraine, as Dutch bank ING has done with its retail operations.

A Moody’s Investors Service report published on July 31 highlights potential rating implications for Raiffeisen, Erste, Societe Generale, UniCredit and KBC due to their Central and Eastern European commitments. In particular, according to the report, the “Austrian banking system is most exposed as Eastern Europe accounts for nearly half of that country’s global bank claims.” The report points to a possible vicious circle arising where “deteriorating financial strength of East European subsidiaries has a negative spillover effect on their West European parents,” which in turn reduces parents’ capacity to support subsidiaries, forcing them to choose which country subsidiaries to support and which to drop.

A report published on August 13 by Kyiv investment bank Sokrat argues that parent banks will continue to support their Ukrainian subisidiaries due to the amount of money already invested, the strengthening position relative to local competitors, and image damage for the parent bank should a subsidiary get into trouble.

A crucial factor in the equation will be the hryvnia exchange rate. Erste is typical of Ukrainian banks in having 70-80% of its credit portfolio denominated in foreign exchange, so the ongoing devaluation of the hryvnia should cause NPLs to soar further. This means that in Ukraine a second wave of the crisis resulting from bad assets is widely expected in the autumn.

For his part, Sikela doesn’t expect any second wave. “The country is still buried under the first wave,” he argues. “There are two major factors. Firstly, there is the ongoing credit crunch, there is basically zero lending going on, so no liquidity even for survival. Secondly, borrowers have to make repayments from their working capital, and will be unable to pay suppliers and workers.”

Cut the budget deficit and raise energy prices, Biden tells Ukraine

Graham Stack in Kyiv

In a speech in Kiev yesterday July 23, on the last of his Ukraine visit, US vice president Joe Biden told Ukraine to do exactly what the IMF says, and on two specific points: “The Fund requires that your government, and your government agreed to critical reforms to cut the budget deficit, revive a striving [sic*] banking system, and phase out energy subsidies, which I know from experience is a very difficult thing to do. Carrying out this agreement requires very hard choices and tough action, but it will help put you on the road to growth and competitiveness.”

Biden told Ukraine that, “moving toward market pricing for energy is brave, but also absolutely necessary pre-condition.”

Biden argued that shifting to market prices would strengthen Ukraine’s energy security. However, it also the Russian position that Ukraine must shift to market prices for gas.

If the US is resetting its relationship with Russia, it appears the US is also rethinking its relationship with Ukraine.

Biden as expected committed to Ukraine’s independence and sovereignty, and praised Ukraine’s democracy as the ‘the freest country in the region.” He emphasized however NATO or EU membership would be entirely Ukraine’s choice, and that the US would not push Ukraine to join. “The USA supports Ukraine’s deepening ties to NATO and to the European Union. But again, we recognize they are your decisions, your choices, not ours whether you choose the EU or seek to, or NATO. We recognize that how far and how fast to proceed on your choices is, again, a uniquely Ukrainian choice — it is not ours.”

Yesterday, Biden warned that the sustainability of Ukraine’s democracy was threatened by economic collapse and pervasive corruption.

“Mature democracies survive because they develop institutions such as a free press, a truly independent court system, an effective legislature – all of which serve as a check on the corruption that fuels the cynicism and limits growth in any country, including yours,” Biden said. Referring to Ukraine’s economic problems, Mr Biden asked: “Can you name me a place where democracy has flourished where the economic system has failed?”

He also harangued ruling politicians for their failure to work together. “Communications among leaders has broken down to such an extent that political posturing appears to prevent progress.”

Committing the US to respect for national sovereignty is a retreat from the neocon supremacist position, and, although delivered with an anti-Russian twist in the Georgian context, in facts coincides with longheld Russian and Chinese demands for the US to abide by international law.

Underlining the shift, Biden said the US was committed to a “multi-polar world” – an expression straight out of the Putin / Primakov phrasebook.

Problems bubble up as Tymoshenko cooks Ukraine’s books

Graham Stack in Kyiv for business new europe (www.businessneweurope.eu)
Naftogaz’ payment difficulties could be first sign that Tymoshenko’s budgetary house of cards is folding.

“We have doubts about Ukraine’s ability to pay,” said Russian President Dmitry Medvedev on Friday, May 22, referring to whether Ukraine’s gas monopoly Naftogaz would find the $4bn Medvedev says it needs for stockpiling of gas for the winter.

Medvedev’s comments were hardly off the cuff: he was speaking at a press conference together with EC President Jose Manuel Barroso following the EU-Russia summit in Khabarovsk. He went on to call on the EU and Russia together to syndicate a loan to cover Ukraine’s gas needs.

Naftogaz has had cash flow problems all this year, but these were a problem of hard currency liquidity. With liquidity problems receding in Ukraine, and considering the strategic significance of summer gas stockpiling for energy security in winter, the new payment problem points instead to Ukraine’s overstretched state budget. Naftogaz is massively dependent on direct and indirect state subsidies, so much so that the International Monetary Fund (IMF) wants its finances consolidated as part of the budget

How overstretched is not yet clear. Naftogaz has apparently settled a large part of its April gas bill against future 2009 transit payments from Gazprom, meaning the company is already burning up future revenue flows.

“The government is concealing the fact that Naftogaz cannot collect the money from consumers to pay for the imported gas it is using. In these conditions, the company is forced to turn to Gazprom to get an advance against future services in transporting gas to European customers,” said Roman Zhukovsky, head of Ukraine’s Main Service of Social-Economic Development, in documents published on the website of Ukraine’s president Victor Yushchenko in May.

“Naftogaz is not paying for the gas it receives from Russia, and instead settling up against future transit fees, which means basically that it is running a deficit,” authoritative former finance minister Viktor Pinzenik told Ukrainian weekly Zerkalo Nedeli May 16. Pinzenik resigned his post in February on questions of principle regarding a budget for 2009 he regards as wildly unrealistic.

“The country cannot continue continue to sell gas to the population at a price several times cheaper than it buys it for. But that’s exactly what it does, creating a huge hole in the budget,” Pinzenik added.

Cooking the books

If Naftogaz can’t find the cash to stockpile crucial gas for the winter, this is the first indicator that the Ukrainian budget is in big trouble, despite or because of the government’s attempts to paper over the cracks.

Prime Minister Yulia Tymoshenko, who recently declared her candidacy for presidential elections in January 2010, has been fighting tooth and nail to protect an expansionist budget, and the high level of vote-winning pension and social payments it contains. The budget remains predicated on 0.4% GDP growth assumption for 2009, despite an economic collapse of 8% of GDP on the year in fourth quarter 2008, and accelerating in the first quarter of 2009.

The method she has used to do this, according to critics and experts, is essentially the same as used for Naftogaz – using future revenues to prop up current finances, leaving a budget black hole gaping later in the year.

As a result, Sergei Buryak, head of the State Tax Administration, could announce May 13 to general disbelief that tax revenue collection plans as laid down in the 2009 budget had been fulfilled and even exceeded in the first four months of the year.

However, ever the killjoy, President Viktor Yushchenko weighed in against these claims. The Presidential Secretariat published on its website an in-depth analysis of the manipulations employed by the government to attain these miraculous results.

Their analysis of how Tymoshenko has cooked the budget books is widely accepted by experts.

“Everyone was surprised by the tax collection rate, but after we saw the analysis done by the Presidential Secretariat, we understood what was happening. I largely agree with their analysis,” Renaissance Capital’s Anastasia Golovyakh told bne.

“If you take the Secretariat’s view, along with the quasi-neutral view put forth by ex-Finance Minister Pinzenik, and add in the unwillingness shown by the government to report first quarter GDP results, all signs point to an attempt to present the books in a better light,” agrees brokerage Galt & Taggart’s analyst Danylo Spolsky.

Even the Tymoshenko government seems to agree with the Secretariat’s analysis – it promptly imposed a statistics embargo on the Presidential Secretariat following publication of the detailed report.

The basic argument of Yushchenko’s number-crunchers is that the government boosted its revenues in the first four months of 2009 at the cost of revenues in the second half of the year: by having companies make advance payments on taxes due in 2009, (i.e. having companies pay tax due for the whole year straight off); delaying payment of VAT rebates for exports; having the National Bank of Ukraine (NBU) pay its entire annual contribution to the budget straight off in the first quarter; and one-off customs charges on gas owned by gas trader Rosukrenergo and now transferred to Naftogaz.

In addition, media have reported that the State Tax Administration has been overtaxing companies at the end of each month, booking the cash, and promptly returning the difference in the next month, thus inflating revenues.

The Secretariat’s analysis also details that payment of Pension Fund contributions is off track: the Pension Fund has simply revised downwards monthly collection targets to avoid registering a deficit. This means the sum remaining to be collected later in the year rises.

The motivation for such short-term machinations is apparently to create superficially acceptable parameters allowing the IMF to sign off on the second and third tranches of its $16.5bn stabilization loan.

The IMF seems to have turned a blind eye to the manipulations, and is otherwise showing unprecedented patience with Ukraine. Despite its articles specifying that funds be used to only tackle balance of payments problems, it has even agreed to cover part of Ukraine’s planned 4% budget deficit – a first for the IMF.

Ukraine’s government has also found an unprecedented way of helping the IMF help it. It has delayed publishing its GDP data for the first quarter of 2009 until July. By postponing publication until after the IMF has reached a decision on the second and third tranches, the government ensures that the 4% deficit will be measured for the last available GDP figure – for the fourth quarter of 2008.

Estimates of subsequent GDP collapse in the first quarter of 2009 range from 10% to 25% ,=meaning that the actual budget deficit as GDP proportion will be considerably higher.

Ukraine hopes for economic stimulus from gas transit system overhaul

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

The Russian-Ukraine gas dispute in January set alarm bells ringing about the condition of the Ukrainian gas transit system (GTS) that transports 80% of Russia’s gas to Europe. Its organizational and technological backwardness meant it wasn’t possible to verify the conflicting Russian and Ukrainian claims about gas flows through the system. Another point of contention was the amount of “technical gas” that Ukraine needed to pump gas through the system, due to outdated compressor stations.

And as if the January dispute wasn’t enough, in April a major Ukraine-Bulgaria gas pipeline exploded in Moldova, causing supplies to Bulgaria to fall by 70%. The pipeline, it transpired, was over 40 years old. One week later, on April 9, the same thing happened to a Soviet-era pipeline in Turkmenistan. This confirmed dire warnings by Ukrainian experts in 2008 that the former Soviet Union’s over 40-year-old GTS was already living on borrowed time. And that Ukraine, at the heart of the system, was most threatened.

So the EU-Ukraine declaration of March 23 that committed Ukraine to revamp its GTS in return for billions of EU and international investment was long overdue. “We have been aware of the potential need for investments to modernize the GTS and of its importance as an economic asset for Ukraine for some time,” Martin Raiser, head of the World Bank mission to Belarus, Ukraine and Moldova, and one of the signatories to the EU-Ukraine Declaration tells bne. “With rising gas import prices and the move to more transparent gas trading relations between Russia and Ukraine, there is now an opportunity to realize this potential.”

Engineering a boost

Soviet Ukraine was not only at the heart of the gas transport system. The main engineering companies building and equipping this system were also located in Ukraine, which is why Gazprom still sources approximately 75% of its engineering needs from Ukraine. This means that any investment in the modernization of the GTS could have knock-on effects for Ukraine’s crisis-stricken engineering industry.

“Ukrainian companies are standing ready to participate in the GTS modernization, including Sumy Machinery Plant, Motor Sich, Khartzysk Pipe Plant, and Novomoskovsk Pipe Plants,” says Alfa Capital Ukraine analyst Denis Shauruk. “If Ukrainian producers will supply the modernization project with domestic equipment, the economic impact from such modernisation may range from 0.5% to 3% of GDP contribution annually, depending on the amount of investment in any particular year.”

Ukraine’s master plan for the modernization of the GTS, incorporated in the EU-Ukraine declaration, envisages a first phase of modernizing the existing transport and storage infrastructure, requiring $3.5bn over seven years, before a second phase sees new pipelines being built. Half of the sum for the first phase would to go to new compressor stations, with the rest divided between improvement of pipelines, underground storage facilities, and gas measuring stations at entry and exit points. This first phase holds most promise for machinery producers such as Sumy Machinery Plant, Gazprom’s supplier of choice, and turbine manufacturer Motor Sich, which can supply high quality gas compressor stations and gas pumping aggregates.

Ukraine’s authorities have apparently been quick to seize on the beckoning opportunities for local manufacturers. Ukrainian media reported in early April that Ukraine’s Fuel and Energy Ministry had taken steps to prioritise local companies in awarding contracts. According to Kommersant Ukraine, immediately following the EU-Ukraine declaration, a memorandum was signed by the Fuel and Energy Ministry, Ukraine’s pipeline operator Ukrtransgaz, state gas planners Urkgazproect, the Ukrainian Oil and Gas Institute, and engineering companies Zorya-Mashproect and Sumy Machinery Plant. The memorandum ascertains that the Ukrainian companies are “capable of satisfying all the needs of Ukraine’s GTS,” says the newspaper, and that pipeline operator Ukrtransgaz has named them as its “most likely suppliers” due to their positive collaborative history to date.

However, Ukraine’s authorities might not find it that easy to channel GTS modernization orders to Ukrainian companies. The memorandum in fact contradicts the sixth point of the EU-Ukraine declaration, which specifies the observation by Ukrtransgas of “best practice international procurement rules,” ie. competitive international tenders. Raiser emphasizes that the World Bank, as well as the European Bank of Reconstruction and Development (EBRD) and the European Investment Bank (EIB), prescribe procurement rules ensuring competitive and open tendering of goods and services. But this need not be to the detriment of Ukrainian companies. “Our rules do allow for some preferences for domestic manufacturers, and our experience shows that Ukrainian suppliers can often win under competitive tenders, particularly in civil works,” says Raiser.

However, funds provided directly by the EU or national governments are likely to be tied to procurement sourced in those countries. “Ukrainian manufacturers can supply both high-quality pipe and compressor equipment, but the major share of any EU loan is likely to be spent on imports of goods and services from the EU. This is a normal condition of governmental loans,” believes Mikhail Korchemkin, director of East European Gas Analysis.

Germany and Japan, both of which have shown interest in financing the GTS modernisation, have advanced engineering companies specialized in the natural gas sector, namely Man Turbo and Mitsubishi respectively.

Moreover, Prime Minister Yulia Tymoshenko agreed on April 29 with her Russian counterpart Vladimir Putin that Russian companies will also be involved in the work, possibly in exchange for Russian funding. This means that Ukrainian engineering companies could find that their slice of the action is less than they initially hoped. “The impact of the GTS modernisation plan on the Ukrainian economy may differ, depending on the degree of participation of Ukrainian companies, in the modernization contracts,” says Alfa’s Shauruk. “If a consortium of international banks will provide financing for modernisation of GTS and these funds will be channelled to purchasing imported equipment, the impact on the Ukrainian economy will be short term and negligible.”

But World Bank’s Raiser points out that Ukraine’s GTS is a priceless asset in and of itself. “The benefit is not just the linkages that investment spending has on domestic producers, but also the maintenance of a critical asset, earning several billions of dollars in revenues a year,” he says.

Kudrin and Aven sound the alarm on banks

President of Alfa Bank Pyotr Aven yesterday March 26 said the level of overdue loans in the Russian financial system in 2009 could reach 15-20%, and that hundreds of banks could disappear. Deputy Prime Minister Aleksei Kudrin  in separate comments put the current level of non-performing levels at already 10%.

“We can expect that the level of overdue loans for the whole system might reach 15-20 per cent” by the end of the year, Aven told the Financial Times March 26.

“Maybe the 20-30 biggest banks, including Alfa, will receive state support – we’re sure. But the future of hundreds of small banks is under big question … we believe that hundreds of banks will disappear by the end of the year,” the FT quotes Aven as saying.

Royal Bank of Scotland’s emerging market analyst Tim Ash says Aven’s comments meanthat, “we are still far from convinced that we are anywhere near the end of the adjustment process in the bigger picture credit crunch/global de-leveraging/de-globalisation process.” “We would expect a similar feed through from the real economy slowdown to banks/public finances across the CEEMEA region,” adds Ash.

Deputy Prime Minister Alexei Kudrin recently warned that non-performing loans would constitute the ‘third wave’ of the financial crisis in Russia. Yesterday Interfax reported that during a meeting with bankers Kudrin estimated the ‘real’ level of NPLs in the banking system at close to 10%. Although as of end of February, ‘official’ NPLs stood at only 3.4%, Kudrin attributed the difference to banks’ unwillingness to recognise all bad debts as such,including debts subject to restructuring.

According to the newswire, he suggested that such a level of overdue loans might provoke the situation in the sector to deteriorate further in
the near future.

VTB Capital’s Dmitry Dmitriev writes, “we believe Kudrin’s estimate to be realistic if restructured loans are also included in the overdue numbers (which they are not in the CBR’ statistics). Nevertheless, we believe that the official data will converge with Kudrin’s assessment and are reiterating our forecast of 10% NPLs in 2009 and 14% in 2010.”

Alfa president Aven, in his comments to the FT, criticised the Russian central bank for keeping refinancing rates high at 15 to 19 per cent. He said this forced commercial banks to lend on at even higher rates of 25 per cent, making loans expensive.

Aven anticipated bankruptcies hitting the banking system in the third quarter 2009, when loans start to fall due. Aven also anticipated serious changes in the ownership of industrial groups. “When we are at the bottom we shall see some very serious bankruptcies,” the FT quotes him as saying.

EBRD head calls for European solidarity with Ukraine

In a speech given by European Bank of Reconstruction and Development (EBRD) President Thomas Mirow at the London School of Economics, 10 March, Mirow called on European solidarity for Ukraine to prevent it turning into a “no man’s land”. Specifically he said West European states should not restrict their domestic banks from using financial support they receive to assist subsidiaries in Eastern Europe.

Mirow called Ukraine EBRD’s “biggest concern,” where “an inherently instable political situation only exacerbates a grave economic situation.” The ERBRD president called on Ukrainian decision-makers “to honour their commitments” saying the problem was “not only about much-needed finance, but also about restoring trust in the country.”

He said however he was encouraged by the recent declarations of unity among Ukrainian politicians, the appointment of a new vice prime minister in charge of crisis management and the imminent return to Kiev of an IMF delegation.

Mirow argued Ukraine was “a test case for international solidarity,” and called for West European states to allow funds channelled to their domestic banks to also flow to their subsidiaries in Eastern Europe.

“As a signal of European solidarity but also of economic sense we endorse the view taken at last week’s EU Summit that in providing support to their own banks, west European countries must not prevent those funds being used to help their subsidiaries in eastern Europe,” Mirow said.

“The stability of Ukraine is of crucial importance for the future of all Europe. Many scholars hold that the modern name Ukraine is derived from “ukraina” in the sense of “borderland, frontier region”. We must not allow it to become a no-man’s land,” he concluded.

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

Ukraine moves towards IMF agreement

After signing a joint declaration to the Fund together with the president and central bank governor last week, Ukraine’s government yesterday March 12 made further steps towards renewing the IMF’s $16.5bn lending Program, according to Interfax. Deputy PM Hryhoriy Nemyrya said it was very likely the IMF would approve disbursement of the second loan tranche to Ukraine by the end of March.

Nemyrya said yesterday following a meeting between President Viktor Yushchenko, Prime Minister Yulia Tymoshenko, National Bank of Ukraine (NBU) head Volodymyr Stelmakh, and Verkhovna Rada Speaker Volodymyr Lyvtyn that the government made several decisions to ensure the independence of the NBU, make changes to the state’s bank recapitalization program and cancel contentious articles in the state budget law for 2009. He said the measures made disbursement of the second tranche of the IMF stand-by credit attainable by the end of March.

Regarding central bank independence, NBU Deputy Head Anatoliy Shapovalov said amendments to a government decree introduced yesterday meant that the Bank was no longer required to coordinate disbursement of refinancing loans with the government, though it would continue to report on its refinancing decisions.

Regarding the deficit, IMF Resident Representative in Ukraine Max Alier said the Fund and Ukrainian authorities reached an “understanding” with respect to the budget deficit. He did not provide any numbers, but mentioned ageement on an “acceptable and adequate level.” Alier alluded to decreased government spending, and sources report the government and IMF agreed to a 3% deficit, according to Galt & Taggart.

Dragon Capital’s Olena Bilan likewise expects the IMF to agree to a deficit of 1-2% of GDP net of bank rehabilitation costs, “or even higher if Ukraine makes the revenue target more realistic in view of the ongoing economic decline and succeeds in securing non-inflationary financing on top of IMF aid.”

The Cabinet meeting was held with the presence of IMF and World Bank representatives, who confirmed that the decisions made at the meeting complied with the IMF agreement.

The Cabinet also approved the budget of Naftogaz Ukraine with a surplus, which may signal that the Cabinet has also approved increased tariffs for natural gas supplies to households, according to Alfa’s Denis Shauruk.

“Nemyrya’s involvement and cooperative rhetoric, as well as wide agreement among key domestic figures, point to an improvement in Ukraine-IMF collaboration in the near future” says Galt & Taggart analyst Danylo Spolsky.

Further negotiations will probably center on budget parameters and ways to reduce budget expenditures without hurting the most vulnerable social groups, according to Dragon’s Bilan.

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

Ukraine’s government starts to implement IMF conditions

Deputy Prime Minister Hryhoriy Nemyria  announced that Ukraine’s government has approved all decisions required by the International Monetary Fund (IMF) prior to disbursement of the second tranche of a $16.5bn stand-by credit. Russian Finance Minister Alexei Kudrin is also considering Ukraine’s request for a $5bn loan.

“I would like to note that due to constructive cooperation between all of the components of the process today at a meeting of the government, we took an agreed decision, which we think will allow us in the near future to achieve practical results regarding the return of the IMF mission, and after some time, [allow the IMF] to make a decision to provide the second tranche of the loan,” Nemyria said at a briefing in Kyiv on Wednesday, March 11, according to Interfax Ukraine.

Nemyria also said that “a number of important decisions” were made at the meeting of the government to ensure the independence of the National Bank of Ukraine (NBU).

Nemyria said a number of other issues had been resolved in a way acceptable to the IMF: amending a resolution of the Cabinet of Ministers and the NBU on bankrefinancing; amending a government resolution on the issue of the state participation in bank capitalization; canceling Articles 84 and 86 of the Law of Ukraine on the 2009 national budget.

The Association of Ukrainian Banks today cited Steen Edzerskov, the advisor for the NBU from the IMF, as saying the IMF wanted Ukraine “to simplify the procedure of receiving of refinancing by banks and removal of subjective factors in decision making on refinancing of banks.” This refers to abolishing the present requirement for case-by-case government consent for NBU refinancing of banks.

Resident IMF representative Max Alier, yesterday told Troika Dialog analysts that the IMF had agreed to soften the budget deficit target criteria from its previous zero deficit less bank recapitalization costs, according to Troika. However, no specific number was mentioned.

The IMF had previously said it would soften its stance on the deficit if Ukraine could find non-inflationary ways of financing it, such as loans from foreign countries. This week Russian finance officials confirmed that Ukraine had officially requested a $5bn loan. Russian finance minister Alexei Kudrin said yesterday March 10 that he was considering the request.

Such a loan is however likely to be politically very divisive. President Viktor Yuschenko has compared Prime Minister Yulia Tymoshenko’s negotiations with Russia for a $5 billion loan with the Molotov-Ribbentrop Pact between Nazi Germany and the Soviet Union in 1939.

Leading political forces – the Prime Minister, the President, the speaker, the governor of the NBU and the opposition leader – are set to meet today as part of the necessary process in acquiring the second tranche of the IMF loan. The previous letter – drafted after similar meetings – was considered by IMF officials and returned to the authors with relevant remarks.

“One of the IMF’s main concerns is the restored independence of the central bank as well as a realistic forecast for the state budget deficit and sources of its financing,” says Alfa Bank’s Denis Shauruk, adding, “we expect all disputed issues to be addressed by the end of March.”