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1. Swedbank Baltic Sea Analysis No. 23 10 January 2010
Ukraine
After the Orange Revolution – political stability
necessary for economic recovery
• Ukraine’s presidential election on 7 February appears to have
been a democratic success. Viktor Yanukovich, who was
removed as president during the Orange Revolution, is the
apparent winner. There is a big risk that political turbulence
will persist, however, since Yulia Tymoshenko, the other
candidate, continues to have support in parliament.
• Ukraine’s economy bottomed out last fall and significant
challenges still remain. The real economy has benefitted from
a rise in global demand for commodities, while inflation and
the exchange rate have stabilised. Huge imbalances persist,
however. The budget deficit continues to grow and the natural
gas sector is struggling with significant losses and increasing
liabilities. Households have been hurt by rising
unemployment, real wage decreases and an increase in real
debt burdens. The necessary economic reforms will continue
to hurt households in the short term.
• Political co-operation will be critical to macroeconomic
recovery. But the risks are great. One possibility is that early
parliamentary elections are called, which would mean another
election campaign. Greater turbulence remains a possibility.
An alliance between the candidates would be the best way to
agree on a difficult and unpopular economic stabilisation
program to mitigate the crisis. In the medium term extensive
reforms and liberalisations are needed to produce a higher
and sustainable economic growth.
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 1028
e-mail: ek.sekr@swedbank.se Internet: www.swedbank.se Responsible publishers: Cecilia Hermansson +46 (0)8-5859 1588
Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 1478 ISSN 1103-4897

2. New president but political uncertainty
prevails
Ukraine appears to have conducted a largely free and fair Historic election
election1, and voted the sitting president voted out of office and produces new
brought in his replacement during a period of substantial president
economic turbulence and global pressures. If the power shift is
orderly, it would be a huge success for democracy in Ukraine,
especially compared with many other former Soviet states. At
the same time, however, politics in Ukraine are still
overshadowed by the involvement of strong economic interests
and by increasing scepticism about the political elite. Voter
turnout is estimated by the election commission at 69%, against
77% in 2004. The key to increasing confidence in the political
system is to strengthen the fight against corruption, while at the
same time improving efficiency in the public sector.
Former opposition leader Viktor Yanukovich appears to have Ukraine goes back to
won the second round of the presidential election and returned the future for a
to the centre of Ukrainian politics.2 He had been forced out of president
the same post in 2004 by the Orange Revolution after winning a
tainted election. Yanukovich’s political career began as a party
functionary during the Soviet era, and he rose after Ukraine's
independence to become prime minister under president Leonid
Kuchma. Yanukovich’s principal support comes from the
Russian-speaking eastern parts of the country, which are
dominated by heavy industry. During the election campaign he
increasingly distanced himself from Russia and expressed his
support for economic stability policies.
Yulia Tymoshenko was unsuccessful in convincing enough Conflicts within Orange
voters who in the first round preferred one of the other coalition doomed
candidates, and could not mobilising eligible voters that Tymoshenko
abstained from voting. As the sitting prime minister and
dominant political figure in recent years, Tymoshenko, together
with outgoing president Viktor Yushchenko, has dropped in
opinion polls as the economy has worsened. At the same time
she has retreated from her previous West- and Europe-leaning
policies. Her efforts to appease Russia through the natural gas
agreement in December and diminished support for NATO
membership appears to be an attempt to attract more Russian-
speaking voters. The growing conflict between the former allies
in the Orange Revolution, Tymoshenko and Yushchenko,
undermined any opportunity either had to become president,
however.
1
According to election observers from OSCE.
2
Results showed Yanukovich receiving 49.0% of the votes, against 45.5% for
Tymoshenko. According to news reports, Tymoshenko is considering whether to
demand a recount in certain districts.
2 Swedbank Baltic Sea Analysis No. 23 • 10 January 2010

3. Opinion polls and the first round outcome of the presidential election
(Percent of voters)
45
40
35
30
25
20
15
10
5
0 09
09
08
9
9
9
nd
9
9
9
9
/0
-0
-0
r/0
/0
/0
/0
g/
n/
p/
ou
ug
ov
ov
ec
ct
ct
ap
/j u
se
au
-O
-O
tr
/a
/n
/n
/d
9/
12
8/
4/
1s
14
01
31
25
29
13
Viktor Yanukovych Yulia Tymoshenko Serhiy Tihipko Viktor Yushchenko
Source: Various opinion polls and election results from the first round
Despite Yanukovich’s long, and not always flattering, history in New president but
Ukrainian politics, there are hopes that his election will break uncertainty on new
the paralysis in recent years caused by differences between political direction
Tymoshenko and Yushchenko. Yanukovich has gathered a
group of advisers who are considered competent and goal-
oriented, and he has changed his position with regard to Russia
and the rest of the world. In addition, Yanukovich has signalled
that he will aim to restore negotiations with the IMF on the
macroeconomic stabilisation program. At the same time he has
stated that Ukraine should remain neutral between Russia and
NATO. He also does not support membership in the EU, but
has pushed for direct contacts in the form of bilateral
agreements on natural gas deliveries, for example.
The parliamentary situation remains complicated. Tymoshenko Political paralysis
is prime minister and her bloc of three parties3 has had support could persist
since the end of 2008 from the Lytvyn bloc, consisting of two
parties4, as well as from Our Ukraine, the party of the current
president Yushchenko. There have been a number of political
manoeuvrings in recent years. In October 2008 Yushchenko
dissolved parliament, but a new election could not be held after
parliament ruled that it was a violation of the constitution and
refused to grant the necessary financing. Yanukovich, as the
newly elected president, can try to induce members of
parliament to switch sides and support a new government loyal
to him. If Tymoshenko retains her support, there is a significant
risk that the country's leadership will remain bifurcated.
Yanukovich could then call a new election to build a majority for
his policies (provided that parliament accepts this), but this
would mean another election campaign and more political
indecisiveness.
Ukraine faces considerable challenges both political and New political situation,
economic. Corruption in politics and the public sector is but the seriousness of
extensive, and oligarchs, the powerful business owners who in the economic situation
many cases built their fortunes during the years following requires courage and
independence, have considerable influence. The country also compromise
faces decisive choices economically. Despite the high political
3
All-Ukrainian United Fatherland, Social Democratic and Reforms and Order parties.
4
People’s Party and Labour Party.
Swedbank Baltic Sea Analysis No. 23 • 10 January 2010 3

4. cost, reforms are needed to achieve a turnaround and create
sustainable, dynamic development. This will require a
willingness to compromise on the part of both the newly elected
president and the opposition. Judging by the political climate in
recent years, the likelihood of quick, effective decision-making
is not especially high.
Real economy has bottomed out, but it’s a
long way back
The severe economic slowdown eased at the end of last year. Hints of growing
Preliminary data indicate that GDP fell by about 14%. This is exports at the end of a
slightly better than expected, but at the same time was one of dark year
the largest declines among major economies during the global
downturn. Its dependence on steel exports and heavy industry
made Ukraine vulnerable to the decline in global demand, at the
same time that the financial system faced huge imbalances
after years of rapid credit growth, especially with respect to
loans in foreign currency. The recession bottomed out in the
second half of 2009 and industrial production climbed as
demand from Asia grew. The agricultural sector and food
production have held up better and contribute to a stabilisation
of the domestic economy. Still, the Ukrainian economy is
significantly below its capacity ceiling and major imbalances
remain.
Real sector developments, 2006-2009
15 120
10
Index=100, same period
110
5
previous year
100
0
Percent
-5 90
-10
80
-15
70
-20
-25 60
06-K3 07-K3 08-K3 09-K3
GDP (ann. change) Industrial production (real, r.s.)
Agricultural production (real, r.s.)
Source: Ukraine’s national bureau of statistics
The domestic economy continues to struggle. While the export The domestic
sector strengthened in late 2009, retail sales fell by over 20% in economy has been
December 2009 and by an average of 19% for the year. The hard hit and is unlikely
low level in 2009 would suggest positive growth numbers in to generate growth
2010, but at the same time many households face a difficult
situation, and it will take time to recover to the levels before the
crisis. Unemployment is rising and is expected to hit 9% in
2009, an increase of more than 3.5 percentage points
compared with the previous year. Real wages have eroded and
are estimated to have shrunk by nearly 10% in 2009. Add to
that a growing debt burden, in no small part due to the large
share of loans in foreign currency that many households and
businesses have.
4 Swedbank Baltic Sea Analysis No. 23 • 10 January 2010

5. At the same time that the current accounts deficit continues to Despite an improved
decline, capital outflows are rising and a new balance of current account
payments crisis remains a possibility. The majority of outflows balance, there is still a
consist of debt service by companies and banks, and since risk of an external
borrowing costs are increasing, it will be costly to refinance payment crisis
loans. As a result, the country's currency reserves are
shrinking. Currently there is enough reserves to cover
payments, but the huge outflows are creating uncertainty about
Ukraine’s solvency.
Current account and the exchange rate, 2005-2009
10 9.0
8
8.0
6
Percent of GDP
4
7.0
2
0 6.0
-2
5.0
-4
-6
4.0
-8
-10 3.0
05-K1 05-K3 06-K1 06-K3 07-K1 07-K3 08-K1 08-K3 09-K1 09-K3
Current account USD/Hryvnia (r.s.)
Source: Central bank of Ukraine
Despite the turbulence in the financial markets, the Ukrainian The hryvnia has
currency, the hryvnia, has remained remarkably stable after stabilised after a sharp
falling substantially in late 2008 and early 2009. The significant depreciation, but is
inflow of capital from the IMF and other public lenders has dependent on external
added to the central bank’s reserves and can be used to support
support the hryvnia, while at the same time growing exports and
falling imports have reduced demand for foreign currency. Of
course this also means that the hryvnia could again come under
pressure without further international support and an
improvement in foreign trade.
Inflation has retreated from an annual level of over 30% in mid- Falling inflation and
2008 to just over 10% in late 2009. The major depreciation of low wage increases
the hryvnia, which is giving inflation impulses, is outweighed by are making Ukraine
weak domestic demand. The central bank has tightened its more competitive
monetary policy as well. The money supply (M2) fell by 5% in internationally
2009 at the same time that the credit expansion slowed,
primarily led by the decrease in lending in foreign currency.
Falling inflation, coupled with lower nominal wage increases, is
making Ukraine more competitive.
Swedbank Baltic Sea Analysis No. 23 • 10 January 2010 5

6. Inflation and wages, 2006-2009
(Annual change in percent)
50
40
30
20
10
0
-10
-20
jan/06 maj/06 sep/06 jan/07 maj/07 sep/07 jan/08 maj/08 sep/08 jan/09 maj/09 sep/09
Real w ages Wages (nominal) Inflation
Source: Ukraine’s national bureau of statistics
Transit trade in natural gas, a key sector of the Ukrainian Financial deficits and a
economy, has stabilised this winter, but fundamental problems growing debt burden
persist. Imported gas is the primary energy source in Ukraine are making the natural
and significant revenue is generated from the transit trade. Last gas sector a ticking
year's natural gas crisis, when Russia shut off deliveries to time bomb
Ukraine, as a result of which large parts of Europe were left
without energy supplies, has not been repeated this year. In
December Prime Minister Tymoshenko signed an agreement
with Russia stretching over 10 years that makes the natural gas
and transit trade more predictable. Naftogaz, the state-owned
energy company, continues to have serious profitability
problems and a considerable debt burden. Last fall the
government, in connection with the election campaign, refrained
from raising energy prices at the consumer level despite that
they represent only about a third of the import cost. As a result,
Naftogaz’s cash flow is insufficient and the state has had to step
in to help it pay its bills.5 Normalising Naftogaz would require
substantially higher energy prices as well as a large capital
infusion to reduce its debt burden. Both measures would be
politically controversial.
The growing budget deficit will be the biggest challenge to meet The budget deficit is
following the election. During the campaign, spending was the biggest threat to
allowed to grow. Promises made to large groups such as macroeconomic
pensioners will be difficult to meet without sacrificing stability
macroeconomic stability. Moreover, the government did not
manage to get a 2010 budget passed by parliament. When it
became obvious that the spending increases announced last
fall could not be combined with the economic stability program,
the IMF suspended payments in November 2009. Other
international financiers are following suit and restrain their
support, and uncertainty among many private actors is
increasing.
5
In December of last year the IMF modified the economic stability programme and
reduced the minimum level for the central bank’s international reserves to allow
foreign payments for natural gas deliveries, among other things, to continue.
6 Swedbank Baltic Sea Analysis No. 23 • 10 January 2010

7. Our macroeconomic forecast is cautious. Despite a slight Slow economic
improvement late last year, the risks are significant. The political recovery forecast for
uncertainty is already evident and the global economy shows Ukraine
no signs of a rapid turnaround. We anticipate positive GDP
growth in Ukraine of 2-3% in 2010 and 2011, while
unemployment is expected to rise above 10% in 2010 before
falling in the latter half of 2011. Uncertainty in the financial
markets will increase pressure on the hryvnia, which is
expected to depreciate slightly. Weak domestic demand will
hold inflation in check, at the same time that higher energy
prices and the weaker currency will create inflation impulses.
Inflation is not expected to drop below 10% until 2011.
Political developments are critical to
economic stabilisation efforts
The political process this spring will be decisive to whether Three scenarios
Ukraine manages to reverse its stagnation and get its economy
to recover and grow again. There are three plausible scenarios:
(i) Political cooperation between president and prime An alliance could lead
minister: Yanukovich and Tymoshenko agree to work to rapid stabilisation of
together on economic stabilisation policies and succeed in the economy
introducing major reforms to reduce the budget deficit and
reform the energy sector. In this scenario the IMF starts
reissuing payments at the same time that the private sector
regains confidence in Ukraine and increases its investments.
A relatively quick recovery begins and economic growth
reaches 5-6% with a stable currency, and falling inflation and
unemployment. Considering the political culture in Ukraine,
this scenario has to be considered relatively unlikely.
(ii) Political tensions persist and parliamentary election is A new parliamentary
called: This is our main scenario and is considered the most election would prolong
likely. An election campaign makes it hard to restart political uncertainty
negotiations with the IMF, whose most important demands
are fiscal reform and raising energy prices to market levels.
International organisations are also cautious in increasing
economic support beyond what has already been promised.
Until the parliamentary election is held, probably sometime in
May, there are no significant reforms and an economic
recovery has to wait. Economic growth is expected to be
slightly positive, while unemployment and inflation slowly
ease, as in our macro forecast above.
(iii) The political divide deepens. Protests spread among the
New street protests
population. An open, extra-parliamentary conflict results in a
would lead to political
situation similar to 2004, but with less legitimacy. Political
chaos
decision-making is paralysed and market actors within and
outside Ukraine react by reducing investments and
increasing capital outflows. It would be impossible for the
IMF to restart negotiations on support measures and
confidence in the hryvnia would erode. Inflation accelerates
due to an increasing budget deficit and Ukraine finds it hard
Swedbank Baltic Sea Analysis No. 23 • 10 January 2010 7

8. to meet its foreign payments. Confidence is undermined and
the economy falls into a new recession.
Even though the actions of the government and president are Global developments
important to the stabilisation and reform process, Ukraine is are important to
also highly dependent on global developments. A robust Ukraine, but
recovery in global demand, together with stable financial sustainable growth
markets, is critical to whether the Ukrainian economy will also requires reforms
recover. This is not sufficient in the longer term, however, to and liberalisation
achieve sustainable economic growth and thus improve the
standard of living for a majority of the population. That would
require genuine reforms in the public sector and extensive
liberalisation of economy.
Magnus Alvesson
Economic Research
Department
SE-105 34 Stockholm Swedbank Baltic Sea Analysis is published as a service to our customers.
Telephone +46-08-5859 1031 We believe that we have used reliable sources and methods in the
ek.sekr@swedbank.se
www.swedbank.se
preparation of the analyses reported in this publication. However, we cannot
guarantee the accuracy or completeness of the report and cannot be held
Legally responsible publishers responsible for any error or omission in the underlying material or its use.
Cecilia Hermansson,
Readers are encouraged to base any (investment) decisions on other
+46-8-5859 1588
material as well. Neither Swedbank nor its employees may be held
responsible for losses or damages, direct or indirect, owing to any errors or
Magnus Alvesson, +46-8-5859 3341 omissions in Swedbank Baltic Sea Analysis.
Jörgen Kennemar, +46-8-5859 1478
ISSN 1103-4897
8 Swedbank Baltic Sea Analysis No. 23 • 10 January 2010