On top of the Russian threat and the perhaps more serious problem of endemic corruption, Ukraine faces an imminent financial disaster. There simply is not enough federal money to go around for much longer, and in the not-too-long term, that will devalue the hryvnia and erode Kiev’s credibility such that it will be unable to secure foreign loans. Anders Aslund, who is one of the most informed economic writers on the subject, warns in a recent blog post for PIIC:
The three critical factors at play in the country today are shrinking international reserves, a falling exchange rate, and a collapsing banking system. These factors would unleash high inflation and plunging output, which would devastate the economy and standards of living.The crucial concern is the level of international reserves. A critical moment occurred in October, when reserves plummeted from $16.4 billion to $12.6 billion. The cause of the fall was that Naftogaz paid back a bond of $1.67 billion and was compelled by the European Union to pay $1.45 billion of arrears to Gazprom, although Naftogaz is disputing this debt in the Stockholm Arbitration court. Ukraine also repaid the IMF $233 million.
According to Aslund, Ukraine should be more worried about its currency reserves than its behavior implies that it is. Ukraine has been paying out large sums of reserve cash to failing banks, including banks that are either truly insolvent or almost completely corrupt:
The [National Bank of Ukraine] and related state banks financed by the NBU already hold 60 percent of Ukraine’s public debt. The exchange rate of the hryvnia falls with every announcement of further bank recapitalization. An additional issue is that related lending is standard in large parts of the Ukrainian banking system. It even happens that more than 80 percent of the lending one particular bank has gone to enterprises belonging to its main owner.
This is not just a matter of good governance, it is an existential issue that the new government will have to face if the country is to survive on its meager resources. Aslund recommends:
First, Ukraine should close the truly insolvent banks rather than recapitalize them. The new government must not allow its reserves to just run out. It should call on its creditors to agree to a standstill on its foreign payments.
In fact, Aslund goes so far as to recommend that Kiev prioritize the issue of its currency reserves over even securing natural gas.
In particular, [Kiev] must not pay the remaining $1.65 billion to Gazprom for disputed arrears. For Ukraine, money is in far more short supply than natural gas. The government needs to cut public expenditures by 10 percent of GDP—as the Baltic governments did in 2009—to save the country and convince foreign creditors that it can manage the nation’s finances.
Ukraine has a lot of pressing needs, and a lot of forces trying to make sure that they aren’t met. But Aslund is right to maintain that the one thing that Kiev simply can’t afford to lose is its ability to receive Western help, which in many ways may be its best hope for weathering this perfect storm.