Ukraine Edging Closer to Civil War?
Subject: Ukraine Edging Closer to Civil War?
Date: Thu, 20 Feb 2014
From: Vlad Signorelli <vlad@brettonwoodsresearch.com>
Ukraine Edging Closer to Civil War?
Protests in the capital of Ukraine turned deadly Tuesday with at least 25 dead and more than 240 injured. Bloody street fighting is transpiring between government police forces and the Western-leaning opposition. As the political crisis of the Yanukovich government deepens, panic has been settling into Ukrainian financial markets.
Since February 14, the Ukrainian stock exchange has lost more than 9% in U.S. dollar terms. Meanwhile, CDS prices have edged higher. According to CDS markets, there is now a 71% probability of the government defaulting during the next five years. The Ukrainian 10-Year trades at 10.9% versus 8.89% one month ago. And since December 31, the Ukrainian hyrvnia has lost nearly 9% against the U.S. dollar. (The Russian ruble has lost almost the same amount against the dollar during the same period.)
Part of the danger facing the Ukrainian economy is that Yanukovich could abandon his plans for pro-growth tax reduction – which we highlighted in December – for austerity. Yanukovich already started the year on the wrong foot, in our opinion, by postponing planned reductions to the VAT and corporate income tax. (The IMF had counseled postponement.) A shift toward austerity by Yanukovich would simply deplete whatever political capital he has left with the half of the country that remains mostly loyal to Russia.
On the European side, leaders such as France’s Francois Hollande are calling for economic sanctions on Ukraine given the violence occurring in the capital. Sweden’s Foreign Minister Carl Bildt blamed Yanukovich saying he has “blood on his hands.” For his part, Yanukovich has fired the head of the Army, replacing him with the head of the Navy.
The irony in the opposition’s call for joining the EU would likely mean the adoption of economic austerity by Ukraine. No doubt, austerity would be on the menu if Ukraine surrendered its economic sovereignty to the IMF, which is what Treasury Secretary Jack Lew suggested on Wednesday. Of course, such prescriptions could easily be more than the electorate is willing to tolerate. Remember, former central banker turned Orange Revolution Star, President Yushchenko, neglected the economy and tax reform during his 2005-2009 tenure and was summarily voted out of office by the electorate in 2010, failing to get the 5% threshold necessary to run on a second ballot.
Certainly, among foreign policy circles in the West, there are those that would like nothing better than for Ukraine, the old Soviet satellite, to join NATO and the EU or even simply break apart, similar to Yugoslavia. This would be consistent with rolling up Russia’s sphere of influence in post-Cold War Eastern Europe. In that regard, a ‘shock therapy’ economic approach might be better in splitting Ukraine apart than 100 cluster bombs. Not that we see that as a near-term likelihood, but civil wars often begin with bad economics. We think that’s the big danger behind the political unrest in Ukraine.
Vlad Signorelli
Bretton Woods Research, LLC
http://brettonwoodsresearch.com