Nick Mason (pictured), Emerging Markets Equities Fund Manager at Invesco Perpetual, comments on the developments and potential obstacles for Ukraine…
With markets currently focused on potential fallout from Russia’s recent decision to annex Crimea, we are keeping a keen eye on the latest tit-for-tat sanctions developments and the potential for confrontation to escalate. However, it is also worth looking beyond immediate developments to consider what role Ukraine should be playing in the world. Rather than being a flashpoint pitting old Cold War foes against each other, my opinion is that the best possible outcome would be for Ukraine to function as a bridge that over time improves links between Russia and the West
Unfortunately, Ukraine has found it difficult to fulfil such a role over the past two decades as its economic and institutional development has badly lagged other post-communist transition states, not just those to its west but also Russia to its east. This is particularly disappointing considering the considerable advantages that Ukraine had with a well-educated workforce and rich natural resources.
During the Soviet days, Ukraine was commonly known as the “bread basket of Europe” because of its highly developed agricultural sector and vast, fertile lands. A big focus on heavy industry also ensured it was one of the most industrialised economies of Europe. However, since the implosion of the Soviet Union in the early 1990s, the country has been poorly managed and has failed to develop robust institutions, resulting in falling productivity and higher inflation. Despite more recent efforts from the IMF for Ukraine to implement reform, economic restructuring has been held up by resistance of diverse factions within its legislature.
A move towards a more open and competitive economy in Ukraine will encounter many obstacles. With a large current account deficit close to 9% of GDP and depleted foreign currency reserves, the IMF aid package announced on Thursday 27th March was urgently needed1. Obviously, any rescue package comes with conditions attached, but if Ukraine wants to prosper, it needs to implement a strong reform programme. This should include robust measures to clamp down on corruption, improve the legislative framework, and develop its capital markets.
Other countries in the region have taken difficult decisions and made tremendous progress over recent years. Figure 1 below shows GDP per capita in Ukraine, Russia, Poland and Czech Republic. Around the time of the Soviet Union’s collapse, living standards in Ukraine and Poland were about the same. The performance of each country since then has diverged significantly. If Poland can do it with the appropriate economic and political framework, why can’t Ukraine? Since the Russian crisis in 1998, the gap between Russia and Ukraine has also widened. Russia has introduced reform in many key areas of the economy, bringing benefit to workers as well as pensioners.
Given the strong trade links between Ukraine and Russia (24% of Ukraine’s exports went to Russia and 30% of its imports arrived from there in the 12-month period to October 20132), stabilising the Ukrainian economy will be achieved much more smoothly with Russian cooperation. A move towards a more stable and prosperous Ukraine would be beneficial to the whole region, potentially even pulling Russia in a more positive, market-friendly direction.
We believe there is no reason why Ukraine cannot rise again to be the region’s “bread winner”.