Friday, November 28, 2008

Window to Ukraine is open - peek in if you dare

Well, after a 5-month stint helping Microsoft build its Windows Mobile presence here in Ukraine, I finally have some time to once again open the curtains on my personal window into Ukraine. While I have lots of new gleams flashing through my head about the mobile industry and now smart devices, the hot topic on my and everyone else's mind is the economic crisis. How bad is it? How bad will it get? How long will it last?

I say from the start that no one outside the handful of banks and puppet masters controlling the Ukrainian economy have a good idea which way things will go, particularly over the next 6-9 months. In fact my wife recently attended the Adam Smith Conference on real estate last week, and some of the analysts said they've given up for now trying to forecast the real estate market. I've heard similar utterings from other business people I've spoken with. So while I am far from an economist or even a financist, given that everyone's crystal ball seems to be foggy, I guess my opinion is as good as anyone else's - which is scary.

I've heard varying opinions about the economic outlook, ranging from the very negative to cautiously positive. The positive say that Ukraine is facing an "artificial crisis" caused by the credit crunch, and that the current fall in demand will quickly bounce back once the credit situation stabilizes and NBU unfreezes bank accounts. Yes, many people including myself cannot get access to some of their money in local banks. The impact on consumer demand, they contend, was driven primarily by the panic caused by the fallout of the sub-prime mortgage crisis in the U.S., and the hryvnia's subsequent 20% devaluation versus the dollar in October. Beyond that, everything else is largely psychological. So, if everyone calms down and doesn't over-react, they say, everything will go back to normal.

I agree that people should not panic and, in fact, most people have calmed down to a state of heightened anxiety, which is probably quite rational right now given the current instability. However, I think the impact on people (i.e. consumers) will be more than psychological, and that things are going to get worse before they get better. In a nutshell, my reasons are the following:
  1. A large part of Ukraine's economy are commodities and depend on exports, so when other economies fall like dominoes into recession, that will severely hurt these industries.
  2. Business expansion and consumer demand during the past several years was fueled largely by credit denominated in foreign dollars or euros. The hryvnia's devaluation has pushed up interest rates and the monthly payments of these loans, creating a high risk of default and a drag on additional consumer spending.
  3. While consumers' monthly loans payments are increasing, as well as the cost of most other items, more and more are being laid off or being forced to take salary cuts as businesses go into survival mode. Granted, salaries also rose a lot during the past several years, so certain segments of the population will be relatively unscathed. But, as usual, the middle-class will take the hardest hit just as it was beginning to develop.
  4. High-level corruption is still alive and well. You can be sure that the economic power brokers and government officials will take care of themselves first. And I'm not talking about simply taking advantage of the "buy low, sell high" approach or doing what it takes to merely stabilize their companies and take a reasonable profit. You can be sure they see this huge opportunity for siphoning off more state and foreign funds, and are actively expropriating as much money as they can as fast as they can during this period.
  5. Not only is the Ukrainian parliament on vacation (physically and mentally) during this crisis, the entire government is not functioning. The politicians are using this as an opportunity to either gain more power or simply weaken their opponents. There is no patriotic feeling to put country above self.
So, I believe the economy is going to get worse over the next 6-9 months before it gets better. On the bright side, I also think that it will be somewhat healthier when it comes out on the other end. Real estate prices may come out of the stratosphere, smart companies should be somewhat more efficient, corporate balance sheets should be stronger, and lenders should improve their loan practices and may even finally drive widespread use of credit history checks when making loans. But I say this with a good deal of skepticism. As they say, hope dies last.

Making matters worse are the external political pressures that Ukraine is enduring now, and will continue to endure, over the next several years. In case you haven't been following the news, Cold War II has started between the US and Russia. The chess board looks quite a bit different than it did 60 years ago, but the rhetoric and tactics coming from Russia are from the same playbook. Ukraine, now that it is an independent state, is the focus of a tug of war between the two countries. And while it seemed like the US and Europe were set to win at the end of 2004 a l'Orange Revolution, Russia is now gaining back some lost ground.'s "Countries in Crisis" series on Ukraine gives a very concise analysis of the situation in its "Countries in Crisis" series. Suffice it to say that Russia is using its considerable leverage over Ukraine in the areas of politics, energy, military, economics, intelligence, organized crime, population and even religion to either bring Ukraine firmly back into Russia's orbit or completely destabilize it.

A few of its latest high-profile tactics are:
  1. Doubling Ukraine's price for gas, suing it for apparent non-payment, and threatening (again) to turn off Ukraine's supply this winter. It did this a couple of years ago as well.
  2. Russia's TV channels, most of which are effectively under the Kremlin's control, are broadcasting anti-Yushchenko propaganda into Ukraine. Yushchenko recently pulled the licenses of several of these channels to broadcast in Ukraine.
  3. Financial support of Yulia Tymoshenko's presidential ambitions. Until recently, Russia and Yulia were bitter enemies, but now they seem to have buried the hatchet for some reason.
  4. Issuance of thousands of Russian passports to pro-Russian Ukrainian citizens, most likely with the intent to give it an excuse to "rescue" those of its new citizens who might claim persecution by the Ukrainian authorities.
  5. Russia's action in Georgia was also meant to send a signal to Ukraine and the other CIS countries. Even if Georgia did fire the first shot, Russia had been looking for, if not actively provoking, a confrontation with Sakashvili and relished the idea of making an example out of him.

I understand why Russia is doing all of this, and were the US in the same situation it would probably be doing the same thing. However, if one believes in democracy, rule of law, free enterprise, and personal freedom are the ultimate end game, the difference between our two countries becomes very clear.

Regardless, the fight itself will only have a negative impact on Ukraine by dividing its citizens, encouraging the current corrupt system, and thereby delaying further the reforms needed to bring the country to European economic standards.

Sorry to make my first post in 5 months so gloomy. But I call 'em like I see 'em.