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Ukraine approaches its economic moment of truth

Confirmation that Russia's claim for repayment of its $3 billion debt goes for trial in January increases pressure on Ukraine amidst mood of deepening depression and malaise.

Claims that Ukraine would be able to keep the case Russia is bringing against it in the Commercial Court in London for repayment of its $3 billion debt to Russia going indefinitely, appear to have been proved wrong.

The Russian Finance Ministry is now saying that the case will go for trial on 17th January 2017.  The trial will last 3 days, and is due to conclude on 20th January 2017. 

It is unlikely the Commercial Court will hand down Judgment on 20th January 2017, the last day of the trial.  More probably the Judgment will be handed down a few weeks later.

If the Judgment goes against Ukraine then the entire IMF package negotiated by Ukraine last year, including the agreement Ukraine negotiated with its private creditors, will collapse.  The IMF has accepted that the $3 billion debt Ukraine owes Russia is public debt – which is to say debt Ukraine owes to the Russian state – which is a member of the Paris Club.  That means that under IMF rules Ukraine’s IMF bailout cannot proceed, notwithstanding certain rules changes which the IMF made last year.

What that will mean is that Ukraine will be in default on its foreign debt, putting a major obstacle in the way of the Ukrainian economy’s ability to obtain foreign funding, either through the Ukrainian state directly, or via Ukraine’s banks.

As I have discussed previously, the highly political basis upon which Ukraine is defending the Russian claim is unprecedented and in normal circumstances would be certain to fail.  Personally I still expect to fail in a case in the Commercial Court, despite the immense political support Ukraine has received in the West.

That the IMF also expects Russia to win the case is shown first by its decision to admit that the debt Ukraine owes Russia is public debt, and second by its failure to advance further payments to Ukraine since the beginning of the year.

I would add that if Russia wins the case in the Commercial Court, though Ukraine has a right of appeal, it would still be treated as being in default from the moment of the Commercial Court’s Judgment.  Only if it were to win the appeal would that change.

The stakes for Ukraine are very high.  Though it is many months since Ukraine has received funding from the IMF, it continues to include IMF funding it has not actually received in its budget, and continues to pay amounts out of its budget on that basis.  If there were to be a formal confirmation from the IMF that this funding will not be provided, and if Ukraine were formally placed in default, it is not at all clear how Ukraine could fill this gap in its budget. 

Further budget cuts to close this gap at a time of continuously higher military spending would inevitably put severe further pressure on the population at a time when the government is already becoming increasingly unpopular.  The alternative of simply printing money to pay the difference, in Ukrainian conditions would risk a big spike in inflation, which would of course also increase the pressure on the population though in another way.

The other option would be to try to come to some sort of terms with Russia to pay the debt.  That however has been ruled out, and it seems that for the present Ukrainian government it is politically unacceptable.

Dr. Nikolai Petro has written for the National Interest a vivid account of the state of Ukraine in the third year since the Maidan coup.  It makes for deeply depressing reading.  It shows a continuously deteriorating picture, with economic pressures on the population increasing steadily amidst endemic corruption, political paralysis, war fever, and falling national morale.

Over and above the help Ukraine has had from the West – which has always been only just enough to keep Ukraine from collapsing but never anywhere near enough to turn it round – Ukraine has had a huge unexpected windfall in the form of the collapse in oil prices which took place in 2014. 

That collapse significantly relieved the pressure on the Ukrainian economy, enabling it to buy oil and gas at a much cheaper price than the one it was paying before the Maidan coup.  That in turn gave Ukraine economically a renewed lease of life, which it could and should have used to turn itself round.

As Dr. Petro’s piece shows, that windfall has been squandered.  Ukraine if possible is now in an even worse condition than the one it was in before the windfall came.

Though oil prices are still less than half where they were in the first half of 2014, they have been slowly and fitfully edging up this year.  Predictions of a second oil price crash this summer failed to come true.  It is now highly possible – though obviously not certain – that oil prices will continue to rise in 2017.

If so, and if the court case in January goes against Ukraine, it could find itself economically in deep trouble next year.  Unless of course its Western backers are prepared to step up their economic help far beyond anything they have been prepared to do to date, it is not clear how it will cope with it.

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Alexander Mercouris
Editor-in-Chief atThe Duran.

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