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Crisis in Ukraine’s economy

Ukraine has proved exceptionally vulnerable to the economic crisis, says Grigory Gritsenko. Dependent on its exports, it is hampered both by its dependence on its Russian neighbour for gas and the poverty of its internal market.
Grigory Gritsenko
3 November 2009

 

Although the Russian economy is often said to show the largest decline among the main industrial powers of the world, we could be the envy of some. We should compare our falling production statistics not only with the most developed economies of the world, but with economies whose level of development is close to ours. For example, our neighbour Ukraine: with a technological potential no worse than Russia's, and some elements of the economy that are actually better, their rates of decline have been much greater.  Russian GDP fell by 10% during the crisis, whereas in Ukraine the drop was 22% in the 1st, and 18% in the second quarter of this year. If this isn't collapse, then what is it? It's not only to do with the price of gas either.

To start with, the Ukrainian economy, like the Russian, is largely focused on export.  For this reason it is very dependent on the state of the world economy, even more so than Russia.   Russian companies mainly export raw materials and commodities resulting from their processing. They have to do this because the volumes produced would be too great for the Russian domestic market, and the prices much lower.  Some of the revenues accruing from the high export prices are spent inside the country, thus stimulating domestic demand and investment. Increased Russian export prices mean increased domestic revenues, savings, investments and reserves. On the contrary, if prices and revenues fall, then domestic demand drops, along with reserves and investments, and the economy drops to a level which is determined only by domestic demand. This is clearly not as powerful as external demand, but still provides for a life of relative ease.

In Ukraine the situation is more complicated. Its only export industry is iron and steel. Despite the size of this industry, and its attractiveness to foreign investors, it is in fierce competition with other world manufacturers, including Russia. As it is the main export industry, its decline hits the entire economy of the country hard and, unlike the Russian economy, it has no means of insuring against currency risks. For example, Russian exports, and accordingly production, of metals and natural gas may have declined, but oil exports and production have remained almost the same as before.  This has ensured that currency revenues have remained at an acceptable level. And that's without taking into consideration increases in the production and export of gold. Ukraine doesn't have the same possibilities, so the external crisis affects it much more seriously.

On the domestic market, conditions for selling iron and steel are even worse than they are for Russian companies, which precludes switching deliveries from the foreign market to the domestic.

Another problem is the dependence on Russian energy resources, both gas and oil. This is so great that Ukraine is forced to spend the lion's share of its currency earnings buying expensive gas. So far, this does not apply to oil, because the main Ukrainian refineries belong to Russian oil companies. They simply deliver Russian oil to these refineries for processing, so as to sell the resulting oil products on the local market, or to re-export them. It's a profitable business, but not a very convenient one, because Ukrainian contractors constantly want to grab a bigger piece of the pie: either to take an entire factory, which was the case with the Kremenchuk oil refinery owned by Tatneft, or to force a company to pay more to pump oil through Ukrainian pipes, as was the case with the Odessa oil refinery owned by LUKOIL.

In spite of this, oil supply, processing and payments run reasonably smoothly.  As always, the problems are with the supply of gas. Russian gas prices are no longer rising, and may even fall, but the conditions of the supply contract force the Ukrainian side to pay for stipulated volumes of gas in full, although demand has fallen off considerably because of the crisis. This payment for unconsumed gas will be a severe burden on Ukraine's  meagre currency resources and, if  enforced, will exacerbate the effects of the crisis on the country's economy.

The third difficulty is the poverty of the domestic market, which means that large volumes of consumer goods, mainly foodstuffs, have to be sold abroad. This tactic works in prosperous times, when growth in the nominal incomes of neighbouring countries results in increased demand.  For this reason those countries have to reconcile themselves to the presence in their marketplace of imported products similar to those they produce themselves.  But it's another matter when there's a crisis and all the countries in the world begin protecting their markets with prohibitive measures. In this situation, exporters of consumer products like Ukraine have a very difficult time.

Finally, the fourth difficulty of the Ukrainian economy is that it still has an engineering industry. This obviously dates from the Soviet period, when the market was not just the USSR, but the whole of Eastern Europe, and even some third-world countries.  Now the political and economic map of the world has changed considerably and Ukrainian engineering is of little use to anyone. There is not enough demand domestically for investment in the infrastructure to get the industry working at full capacity. While individual orders kept the industry ticking over in more prosperous times, now, when no one is investing, the industry is having a very hard time indeed.

The decline in both production and incomes in the iron and steel and engineering industries has led to a drop in demand for consumer products.  This industry too must wind down, although a significant proportion of its products could be sold on the internal market. But there is no domestic demand, so the depression has engulfed the whole of Ukrainian manufacturing, both non-competitive and competitive sectors, and at the moment no one can see a way forward.

 

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