Two years after Euromaidan Ukraine is again in a difficult situation: tensions between the President and the Prime Minister, a split in the ruling coalition resulted in deceleration of reforms and the suspension of financial assistance from the IMF. Furthermore, last week Russia filed the promised lawsuit against Ukraine to the English court for failure to pay $3 billion for the bonds.
Under these conditions a high risk that Ukraine will not be able to return to normal servicing their debt, according to the authors of a joint study (has) two scientific and educational centers of economic faculty of Moscow state University and Russian Academy of Sciences. The study was written under the direction of co-Director of the center of the world economy Sergey Afontsev and with the assistance of the former Deputy Minister of economic development Andrei Klepach (acted as chair of the Department of macroeconomic policy and the strategic management of the Economics faculty at Moscow state University).
In March 2015, the IMF approved a financial assistance package to Ukraine of $17.5 billion, However, these measures are palliative in nature, the authors of the study. “The implementation of appropriate measures can at best lead to debt reduction by 2020 to 71% of GDP, but this would mean that the debt indicator will simply return to the level of 2014,” they write. At the end of 2015 the national debt of Ukraine amounted to 79% of GDP, reported the Ukrainian Ministry of Finance this month.
Exacerbating the situation, according to economists, a sharp increase in total public and private external liabilities to reach 122.8% of GDP (or 260% of the level of exports in annual terms) against 95,1 and 184.5% in 2014. An additional negative factor is the vulnerability of subnational debt. In October 2015, the default on debt by $250 million was recorded in Kiev, which resulted in a reduction of its credit rating — and in such a scenario, according to experts of the Moscow state University, may face many subnational borrowers. According to the study, there are four possible scenarios for the situation in the Ukrainian economy. Which one is implemented will depend on the Ukrainian side, and from the decisions of its key partners.
Limited or a large-scale default
One of the scenarios — scenario restricted default. It is about the violation of the schedule of payments for servicing foreign debt and forced restructuring of debt in conjunction with the budget crisis — “cut costs by 20-30%, arrears by state contracts, payment of pensions and salaries of state employees” — as well as acceleration of inflation and the fall of trade, especially with the Eurasian economic Union (EEU includes Russia, Belarus, Kazakhstan, Armenia, Kyrgyzstan).
The probability of this scenario experts of Moscow state University and Russian Academy of Sciences is estimated at 75%. Conditions of its realization — Ukraine’s default in its obligations to Russia (already happened), delays in the receipt of tranches from the IMF because of failures in the implementation of credit conditions, the rejection of free trade with Russia and increase sanctions against the two countries, increasing gaps between revenue and expenditure articles of the budget.
Second, the most pessimistic scenario, the probability of which is estimated at 20%, suggests a “massive default”: failure to repay a “significant portion” of the foreign debt, mass non-payment of pensions and salaries of state employees, acceleration of inflation, a sharp reduction in trading volumes and “reduction in energy imports to the volumes associated with normal maintenance of functioning of the Ukrainian economy and public infrastructure”. It is associated with the suspension of financial aid due to failure of the IMF, a sharp increase in military expenditures and reduction of tax base on the background of aggravation of the situation in the East of the country, the defaulting within the framework of the Association Agreement between Ukraine and the EU, the preservation of mutual restrictions on trade with Russia. This is an option, if the deterioration of macroeconomic indicators of Ukraine will be so pronounced that the country will no longer meet the requirements of the IMF.
The GDP contraction in the case of restricted default will amount to 2-2. 5%, in case of a major default from 7 to 9%. Due to the devaluation of the hryvnia and inflation acceleration (up to 16-20% or 40-45% in the two scenarios, respectively) will decrease the real incomes of the population. Would reduce the amount of social transfers will increase the budget deficit, the collapse of export industries oriented to the markets of the EAEC, with a corresponding release of the labour force. On the background of increasing uncertainty due to the problems of domestic demand, exchange rate fluctuations and an acute shortage of borrowed funds in the economy will continue to decline investments: 5-7% in case of default and limited to 10-12%, if the default scale will be. Will decrease the volume of Ukrainian export to Russia and the EU: in the framework of the scenario restricted default on $2.4 and 2.5 billion respectively; in case of a catastrophic default on $3.4 billion and $4.9 billion
As a result, to restore the economic indicators to the levels of 2013 will need at least 3 years with a limited default and about 5 years — with a scale, and the pre-crisis level of 2008 will be achieved not before 2020. “Ukraine will lose at least 12 years for its economic development,” summarize the authors.
Partners in misfortune
“The danger lies not in default of the financial system, and that between the EU and the EEU is a large country with a large population and a good prerequisite, which is in a situation of impending disaster, — says the Dean of economic faculty of Moscow state University Alexander Auzan. The consequences will go through breaches of different kinds of production chains, business practices, trade relations between Europe and Russia.”
Even in case of a major default direct deadweight loss of the EU related to public debt, not to exceed $1.5 billion, the study authors write. Irretrievable loss for Russia could reach $3.6 billion in the event of restricted default — and up to $4.55 billion in the case of large-scale. Russia is the only country in the EEU has provided Ukraine with loans, so that other members of the economic Union “direct financial consequences of a default of Ukraine will not be affected”.
More substantial are the indirect losses from government default. According to the national Bank of Ukraine, written by experts of Moscow state University, was nominated in EUR 8.3% of the external liabilities of the financial sector of Ukraine ($1.2 billion), 10.6% of the external liabilities of real sector companies ($6.2 billion) and 24.9% intercompany obligations under the trades of foreign direct investment ($2.3 billion) — a total of more than $9.6 billion, of which at least half will be under the threat of default. For Russia additional hazard is the possibility of seizure of foreign direct investment (about $14.7 billion, according to the EDB project “Monitoring of mutual investments in CIS countries”), but the probability of such events is determined by political factors and not the direct consequences of a default on public debt, according to the authors.
Another two channels that will spread the negative consequences of default of trade and migration. In the event of restricted default of Ukraine losing Russian and European exporters $1.7 and $3.4 billion respectively. The default scale will lead to lower European exports to Ukraine at $8.2 billion, Russia — $3.6 billion, assess the study’s authors. “Irrevocable losses of the Russian exporters, depending on the scenario, can be as high as $1 billion and 2.2, irretrievable loss of European exporters $1.6 and 4.1 billion, respectively,” they write.
The fall of Ukrainian exports entails search costs for alternative sources of supply of products. “Violated sanctions trade interaction, now there will be broken by the default of the financial. What will be left? Production: they are there, on both sides of the border. We can talk about import substitution, but there are very serious problems with it in those areas where there was close cooperation”, — says Alexander Auzan.
Critical to Russia, according to the authors of the study, a reduction of the import from Ukraine of civil engineering products. Critical volume of import of machine-building to 2013 was estimated at $2 billion, the Volume of irrevocable losses of Russia against this background, is estimated at $0.3 billion in the event of restricted default and $0.5 billion through full. For the EU, the volume of irreversible losses associated with import substitution from Ukraine, will not exceed $0.3 and $0.6 billion, respectively.
Within the scenario of large-scale potential default caused by the crisis of migration from Ukraine is 1.6 million people. For the EEU, this means additional costs of $0.3 billion (most of which will come to Russia) and the EU — given the higher costs of hosting refugees — in $5.7 billion.
The likelihood of a return to the status quo December 2015 — that is the scenario in which Ukraine will pay its debt to Russia, will receive assistance from the IMF in full, timely perform all the obligations under the restructured debt owed to commercial creditors and will return to the free trade regime with Russia — the team of experts considers close to zero.
This option may lead to restrained growth of GDP by 1.5—2% in 2016-2018. However, he linked the fall in effective demand caused by the austerity measures needed to sustain stability of public finances. The budget deficit in this case would be equal to 3.5—4% of GDP. The foreign trade balance deficit will be at $3-3. 5 billion.
Low probability — around 5% — the authors have appropriated and fourth scenario, involving a coordinated international assistance to Ukraine. Urgent “anticipatory” help, which will help to serve its internal and external obligations, economists MSU is estimated at $30-34 billion in two years. Another $55-60 billion “recovery” assistance, “the minimum necessary” to restore pre-crisis levels of development at the level of 2008. Finally, $82-90 billion dollars — “resource development” that would lead the country on a trajectory of growth and improved performance compared with 2008.
Thus, the amount of funds to achieve “any ambitious goals of national economic development” of Ukraine, is estimated at $167-183 billion for 2016-2017. In this scenario, Ukraine’s economy could grow by 3-5% per year, and investments by 5% per year, annual inflation will equal 4% to 6%, the budget will be executed with a 3% surplus, and the balance of foreign trade is positive — $8-9 billion.
Under scenario of restricted default minimum “anticipates” aid in two times exceeds the total scale of losses of Russia and the EU, which does not create incentives for its release. However, when a large default losses of the EU are consistent with the annual scale “anticipatory” care of him. Russia will need additional financial incentives for participation in the “coalition of donors”, say the economists of Moscow state University. They could be the access to the financial markets of the EU (abolition of financial sanctions) and the “solid guarantee of repayment of Ukraine’s debt to Russia in full”.
What’s the point of Russia and Europe to go on providing Ukraine with financial resources? “First of all, to have an expanding black hole near its borders is bad — in Poland, Germany, Belarus, and Russia,” explains Auzan. Secondly, it could be a turning point in relations between the two countries. If the Minsk process of the economic component, it will have a greater chance of success, says Auzan. “If this is a purely military-political process, we see how he is stalling. If there is the economic component, where there are wider interests of the region, then maybe something will happen”, — the economist believes.