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Ukraine: eating the elephant

It has come a long way since 2014, but policymakers must keep going.


It is hard to overstate the scale of the challenge Ukraine has faced since the collapse of its government and economy in the spring of 2014

‘Eating an elephant’ is the metaphor of choice for the country’s reform-minded policymakers. Given the legacy of corruption and larceny left by decades of mismanagement, a mammoth might be more like it. 

Yet, bite by bite, steady inroads have been made into Ukraine’s massive meal over the past two years. 

The country’s sovereign debt has been restructured, as have a slew of corporate bonds. The currency, the hryvnia, has been floated. Inflation, which jumped to over 40% in 2015 following the move to a flexible exchange-rate regime, had been reduced to within a whisker of the central bank’s target of 12% by the end of last year. Capital controls have been relaxed, allowing foreign firms to repatriate dividends. 

In the energy sector, gas tariffs have been brought in line with market rates, while state-owned oil and gas giant Naftogaz – formerly a cesspit of waste and bad governance – has been overhauled and restructured. 

Technology has been used to bring transparency to government procurement, as well as to give Ukrainians a unique insight into the lifestyles of the public-sector elite. An electronic asset declaration last autumn revealed that, in addition to millions of euros and dollars in cash, the country’s politicians run to large collections of luxury watches and even, in one case, a ticket for a Virgin Galactic space flight.

Perhaps the most impressive achievement has been the cleanup of Ukraine’s banking sector, which in 2014 was on the verge of collapse. Since then the central bank has systematically reviewed and stress tested all but a handful of the country’s lenders. Eighty-five have been shut down, while the remainder have been forced to fully provision large portfolios of bad debts and start rebuilding their capital bases.  

There is even talk of Ukraine returning to the capital markets as early as the first quarter of this year. Bankers say Eurobond investors are keen to buy into what is increasingly seen as a recovery story

The final stage in the process came in December with the nationalization of the country’s largest lender, Privatbank. The move had been widely anticipated, given the bank’s notoriously high levels of related party lending (95% of the total, according to the central bank) and depleted capital base, but it was nevertheless a big step. Privatbank holds around 36% of all private-sector deposits in Ukraine.

These measures have already produced results. After shrinking by more than 16% in 2014 and 2015, Ukraine’s economy returned to growth last year. A $17.5 billion IMF aid programme, which appeared to have stalled after policymakers failed to meet reform targets, is back on track. A third $1 billon tranche of funding was released in September and a further instalment is expected to arrive this month.

Indeed, the situation is so much improved that there is even talk of Ukraine returning to the capital markets as early as the first quarter of this year. Bankers say Eurobond investors are keen to buy into what is increasingly seen as a recovery story – in return for a juicy yield, of course. 

Come to nothing

Despite these signs of progress, however, substantial parts of Ukraine’s elephant remain uneaten. Promises of large-scale privatizations have so far come to nothing. An attempt to sell a chemical plant in Odessa, billed as the forerunner of a new wave of asset disposals, had to be abandoned last year after the firm was found to have ties to one of Ukraine’s least reputable businessmen.

Promised reforms to the tax and pension systems may prove equally tough to push through, given the likelihood of popular resistance, while the task of turning Privatbank into a commercially viable lender will be a severe test of policymakers’ patience and ingenuity. 

Above all, Ukraine’s authorities have so far only nibbled at what many see as the country’s biggest problem. Despite many fine words on the necessity of tackling corruption, not to mention ample evidence of unprecedented larceny dating back at least two decades, no senior politician or public servant has yet been prosecuted, let alone convicted. 

What is more, powerful vested interests have been using their extensive resources to fight back against the western-backed reformers. Politicians and journalists with ties to Ukraine’s all-powerful oligarchs are doing their best to discredit the reform agenda, as evidenced by a recent smear campaign against the central bank. 

Ukraine’s chances of eating its own elephant may also be compromised by the presence of two other pachyderms in the room – presidents Trump and Putin. The Russian-backed conflict in the Donbass continues to rumble on, and locals hold out little hope for the success of the Minsk peace process. Meanwhile, the pro-Russian stance of some members of the new US administration has raised fears of a lessening of support for Ukraine’s restructuring and rehabilitation. 

One way or another, this year will be critical in determining whether Ukraine moves forward or backward. By 2018, the country will be into the next electoral cycle, taking the edge off politicians’ enthusiasm for unpopular measures. Large external debt repayments will also start to come due in 2019, limiting the room for fiscal manoeuvre. 

Much has been achieved in Ukraine since the Maidan revolution, but there is much still to do. If the country is to succeed, policymakers must maintain their appetite for reform. 

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