Ukraine Gets an IMF Bailout

The IMF has agreed to lend Ukraine $16.5 billion, helping the country to avert a run on its banks and its currency, the hryvnia

The victims of the global financial crisis just seem to be getting bigger and bigger. First it was financial institutions, then came entire countries. After Iceland, the latest domino to wobble is Ukraine, which on Oct. 26 reached an agreement with the International Monetary Fund for a $16.5 billion bailout.

Ukraine desperately needs the money to stave off a run on its banks and currency. With ordinary depositors rushing to withdraw their cash, one major Ukrainian bank, Prominvest, is in receivership and faces possible nationalization, while a second, Nadra, has been rescued with a $300 million central bank loan. Meanwhile, the Ukrainian currency, the hryvnia, has fallen sharply. "People are still worrying about the currency, and continuing to convert their savings into U.S. dollars," Olena Bilan, an economist at Dragon Capital brokerage in Kiev.

Ukraine is hardly the only country in Central and Eastern Europe feeling the financial heat. Just a day after the rescue package for Ukraine, Hungary's government also revealed that it is in negotiations with the IMF (, 10/14/08), expected to be concluded in the next few days. Belarus, a country once loath to have dealings with the West, has recently requested IMF help (, 10/23/08) to replenish its depleted reserves. Even Russia, a country that enjoys massive foreign exchange reserves and a healthy trade surplus, now faces a full-scale financial crunch, forcing the government to provide hundreds of billions of dollars in emergency finance.

Borrowed Billions from Banks

And if oil-rich Russia has problems, then pity the poor Ukrainians, whose country is even more dependent on foreign loans to keep its economy humming. "They want the Western banks to start lending again," says Frank Gill, director of European sovereign ratings at Standard & Poor's (MHP) in London. "But the principal reason Western banks have stopped lending has nothing to do with Ukraine. This is a classic exogenous shock, exacerbated by highly leveraged banks with poor asset quality."

During the good years, Ukraine's banks and companies had few qualms about taking out billions of dollars in short-term loans from international banks. Now much of that debt has to be repaid, but the global credit crunch means that there's simply no more money available to refinance loans. "Any company that needs to refinance a foreign loan essentially goes bankrupt," says Anders Aslund, senior fellow at the Institute for International Economics in Washington and an adviser to the Ukrainian government.

Ukraine's foreign debt has risen from $54 billion at the start of 2007 to over $100 billion today. Overall bank lending grew by some 75% last year, as foreign banks rushed to set up in the country. The risks have been amplified by a common practice of extending hard-currency loans to local households and companies, whose debts will spiral dramatically if the Ukrainian currency continues its downward slide.

Steel Slump Hurts

That's now a distinct possibility. As if the credit crunch weren't bad enough, Ukraine also has been hit by a collapse in the price of its main export, steel. With global recession clouds looming, steel prices have fallen by half in the past four months, wiping 20% from the value of Ukrainian exports at a single stroke.

Although the external shocks have been massive, Ukraine's problems have been exacerbated by poor domestic policies. Long before the recent turmoil in international financial markets, the country was showing plenty of worrying signs. Lax monetary and fiscal policies meant that inflation hit 30% in the month of May, and is on track to reach 25% for the year as a whole.

Nor has it helped that the country is in a state of almost constant political turmoil caused by bitter infighting between the three main political parties, none of which seems able to work with the others for any length of time. Parliament was dissolved on Oct. 8, after the governing coalition collapsed. It means that Ukrainians are set to hold their third parliamentary election in as many years.

Mills Facing Bankruptcy

Perhaps one good thing to come out of the crisis is that Ukraine's bickering politicians may be forced to put aside their differences long enough to push through long-overdue reforms. A crisis law now before Parliament will include many desirable economic measures, such as a hike in gas prices and privatization of land. But any political truce will probably be short-lived at best.

At least the IMF bailout, together with the government's $34 billion in foreign exchange reserves, means that Ukraine probably has enough money to pay the $50 billion in foreign debts that are falling due next year, staving off impending financial meltdown.

But the measures are already too late to prevent the financial crunch from seriously affecting the real economy. Many of Ukraine's troubled steel mills face bankruptcy and are already laying off thousands of workers. Once-bustling construction sites in Kiev are now deserted, as financing for real estate projects has evaporated. Economists now predict that Ukraine's gross domestic product, which grew by 7% in the first nine months of 2008, is heading for a shuddering halt next year. "Ukraine is looking at 0% growth next year, or worse," says S&P's Gill.

Rigid Exchange Policy

That's a sobering lesson not just for Ukraine, but for many other countries, particularly in Central and Eastern Europe, now reeling from similar problems. High levels of international borrowing are inevitable when economies run high current account deficits—in other words importing more than they export, requiring foreign capital inflows to plug the gap (, 10/23/08). In Ukraine, that problem has been exacerbated by an over-rigid exchange rate policy, pegging the hryvnia to the U.S. dollar instead of allowing it to float.

As a result, Ukraine was running a sizable current account deficit even before the collapse in steel prices blew a hole in its exports. "The lesson is that you have to watch your current account deficits: the same lesson that East Asian countries learned in the crisis of 1997-98," says Aslund.

During recent years, countries in the region have more or less abandoned an old rule of thumb that external deficits shouldn't exceed 4%-5% of GDP. In the first half of 2008, Ukraine ran an external deficit of some 8% of GDP. But even that looks prudent compared with several countries in the region: Bulgaria, Estonia, Latvia, Lithuania, and Romania all have current account deficits over 15% of GDP.

In other words, countries, just like companies and individuals, will have to earn money the hard way in the future, instead of living on the never-never. "If external credit shuts down, all of Eastern Europe is vulnerable," says Gill. "They have been addicted to low-cost credit for the last four to five years."

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