Yatseniuk seeks rapprochement with Russia

by Simon Pirani

Ukraine’s policy priorities must be to dampen the coming energy shock, stabilise trade relations with Russia, and raise competitiveness, says economics minister Arsenii Yatseniuk. “We haven’t yet faced the shock from raised gas import prices in terms of GDP growth and inflation”, Yatseniuk told Emerging Markets in an interview.

The current price, $110 per thousand cubic metres (tcm), is “something our economy can manage, albeit with very sharply increased prices for households”. But the $230/tcm proposed by Russia for the second half of this year is “absolutely unacceptable”, he said: it would mean “GDP growth of minus 7% and 25-30% inflation”.

Is he confident that agreement will be reached with Russia? “It could be, after the G8 [summit in St Petersburg]. It depends on the G8 countries, too.” He is confident that “everyone” there will urge Russia to reach a compromise.

The gas price stand-off has concentrated the attention of all Ukrainian serious policymakers, Yatseniuk included, on energy efficiency. And yesterday Yatseniuk discussed with EBRD president Jean Lemierre a $100-million-plus series of energy efficiency projects to be cofinanced by the bank and the Ukrainian government.

The programme will be announced soon, Yatseniuk says, and will be the start of an expanding effort. “Ukraine holds the world record for energy consumption per dollar of GDP,” he said. “That’s so stupid: we have to reduce this substantially.”

In addition, Yatseniuk urges Russian ratification of the energy charter – which would give central Asian and independent Russian gas producers equitable access to pipelines.

On competitiveness, Ukraine, “which has many, many clever people”, must develop its high-tech export sector. And WTO accession is crucial there, he says. “Yesterday we signed the last bilateral agreement on which we had major problems, with Australia,” he smiles. “Now only Taipei and Kyrgyzstan are left.”

On trade with Russia, “trade relations are correlated with geopolitics. Let’s separate the two.” WTO accession by both countries will improve bilateral relations, he adds. Yatseniuk believes that WTO membership for both Russia and Ukraine will help solve many of the frictions between the two countries on trade.

Yatseniuk points out that some of Ukraine’s economic fundamentals are strong. “We will have 2.6% GDP growth this year, despite the energy shock, and we are projecting 4.2% next year. Inflation is extremely low. And in the first quarter, we attracted $1 billion of FDI into Ukraine.”

There are negative numbers too: in the first quarter, a $700 million negative trade balance, and $3 billion of capital outflow. “Most of this sum is not cash moving out of the country, but an old Ukrainian problem: undervaluing imports as a means of evading taxes. This is something we have to deal with.”

But Yatseniuk disputes that the cash outflow reflects a need to devalue the currency. He disagrees with arguments made by the International Institute of Finance in a confidential report last month that the hryvna rate will need a downward correction of between 20% and 40% by the end of next year.

“First we were told the hryvna was undervalued. Now they say it is overvalued. What we need is a flexible exchange rate.”

Yatseniuk warns that the economy will suffer if the political stalemate following the election is not resolved. “If this goes on for more than two months, it will be harmful. I wish they would just form a coalition so that we could get down to business.”

The IIF’s report argued that a “grand coalition” between the president Yushchenko’s Nasha Ukraina block and the Party of Regions, based in Russian-speaking eastern Ukraine and led by 2004 presidential candidate Viktor Yanukovich, would be “more likely” to act on fiscal deterioration. Such a government could limit investment and non-wage current spending, and keep the hryvna correction to 20-25%, the IIF says.

But an “orange” coalition led by former prime minister Yulia Timoshenko could bring further increases in social spending and declines in capital inflows, which, combined with big energy import bills, could make a 40%-plus devaluation “difficult to avoid”.

The IIF’s Regional Overview on eastern Europe, published tomorrow, forecasts Ukrainian GDP growth of only 1.7% this year and 2% next year. Jeff Anderson, director of the IIF’s European department, said: “The economy was buoyed by steel prices and steel demand from China in 2004, but has suffered subsequently. Like Russia, Ukraine urgently needs to undertake structural reforms. Unlike Russia, high oil prices are not an advantage but a burden.”

A version of this article appeared in Emerging Markets, 21 May 2006.
Posted June 2006; © 2006 Simon Pirani

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