Ukraine ducks EU 'surgery', economy still in pain

KIEV/MOSCOW Thu Nov 28, 2013 10:14am EST

KIEV/MOSCOW Nov 28 (Reuters) - When Ukrainian President Viktor Yanukovich rejected a trade pact with the European Union and turned to Moscow, he put off painful, EU-prescribed economic surgery that could have hurt his re-election prospects.

But he disappointed entrepreneurs who had hoped the EU deal would bring long-term growth by giving them easier access to rich markets and pushing Kiev harder to pursue policies - from cutting red tape and graft to tightening state budgets - that the IMF says would make post-Soviet Ukraine more competitive.

"When a person is seriously ill, they need surgery. They suffer a little, but then get well," said Yuri Kryvosheev, 53, owner of international trucking company Magnetik in Poltava.

"And our economy needs surgical treatment, but they are scared," he said of the government, which argued the EU deal would put heavy costs on the economy by imposing new standards in areas from policing to accounting, justice to pollution.

A possible customs union with Russia, which had threatened to cut off gas if Kiev looked west, might bring Yanukovich aid from Moscow to help with a growing budget deficit, shrinking foreign reserves and a spike in debt repayments. And that might spare him accepting tough conditions to borrow from the IMF.

For Kryvosheev, who had hoped his trucks would have easier passage through customs into Poland and the rest of the 28-nation EU, turning back to Russia will mean more of the same - a Ukraine that is the most corrupt state in Europe, performing poorly in competitiveness rankings and stuck in recession.

"We will lag further behind. We will stand still, waste time," Kryvosheev said. "I thought if we moved to the business rules and conditions in Europe, then we wouldn't have to drive 15- or 20-year-old vehicles. But since the signing has been put off, I have no hope of improvements. It will get even worse."

Yanukovich, who is attending a two-day EU summit in Vilnius despite walking away from the bloc's trade pact, has said it would have cost Ukraine $20 billion a year, an eighth of GDP and outweighing some $800 million of EU aid on offer.

As he prepares to seek re-election in just over a year, he must also have been concerned that signing the EU deal would trigger Russia's threat to cut off gas supplies and might also mean an increase in EU pressure to cut household gas subsidies, which are popular with voters but not with IMF officials.

RUSSIAN QUESTIONS

Possible easier access to the Russian market, Ukraine's second biggest trading partner after the EU, is little consolation to many small businesses, said Mykhailo Chermerys, manager of the Kalina underwear factory in the western city of Lviv. With no EU tariff deal, he remains at a disadvantage to rival EU producers in Poland, Romania, Lithuania and Latvia.

And Chermerys, who imports all his raw material from the EU and sells 90 percent of his output there, was doubtful that a customs union with Moscow would boost exports to the east:

"I am not sure ... that it will be easier to work with Russia if we don't sign with Europe," he said.

Ukrainian labour costs are below fellow ex-communist states in eastern Europe but have less advantage over those in Russia.

Not all businesses are likely to be disappointed, however. Yanukovich is close to wealthy "oligarchs" who control steel and other heavy industries in his native eastern Ukraine. Their success has seemed little troubled by high financing costs and bureaucracy that many smaller entrepreneurs find crushing.

An open trade deal with Brussels would be welcome, said Oleksander Yaroslavsky, ranked Ukraine's 11th richest man by Forbes magazine with a fortune of $980 million. But business would persevere without it, as it had done up to now.

"We have to be close to everyone. For business that is very positive. Not only with Russia or the European Union, but with the United States - with the whole world around us," said Yaroslavsky, president of DCH Group, which owns an airport, hotel and shopping malls among other assets.

"But I don't sit there and wait for them sign documents so I can get to work tomorrow. I am working today."

Barbara Nestor, a strategist with Commerzbank in London, said Ukraine's leadership seemed unwilling to introduce some of the economic changes sought by the EU in return for better trading terms - changes that could favour newer businesses.

"In central Europe in the 1990s, there was no hesitation in meeting EU requirements to get membership status," she said of the likes of Poland and Hungary, which joined the EU in 2004.

"But Ukraine's position seems like: We want it but we don't want to deliver on some of the things the EU is asking for."

CASH CRUNCH

In the immediate future, Ukraine faces a cash crunch. And while little has been confirmed publicly, many assume President Vladimir Putin may have offered Yanukovich Russian financial help on easier political terms than that from the EU and IMF.

"Otherwise, the turn to Russia would not make sense as the upcoming external needs for Ukraine are more or less given," said Gunter Deuber, head of central and eastern Europe research at Raifffeisen Bank in Vienna.

The finance ministry says Ukraine must next year repay more than $8 billion, including $3.7 billion to the IMF for an earlier $15-billion facility frozen in 2011 over Kiev's refusal to cut budget-draining energy subsidies. Some analysts put the 2014 repayment figure higher, at up to $11 billion.

It also faces a monthly gas bill of about $1 billion.

Foreign reserves, sapped by propping up the hryvnia, have nearly halved in the last two and half years, to less than $21 billion from over $38 billion. GDP shrank 1.5 percent year-on-year in the third quarter, despite a record grain harvest.

For businesses, a record of survival through more than two decades of post-Soviet difficulties provides some reassurance for the future, whatever tack the government takes.

"We have lived through the creation of the country, crises, the removal of farm subsidies and many others," said Anastasia Sobotyuk, head of investor relations at leading poultry and grain producer Mironivsky Hliboproduct.

"We didn't build the company in stable times, and so we always have a Plan B - and a Plan C."

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