Europe’s Crimean Crevice Canvassing
Russia’s Crimea incursion met with immediate US and EU sanctions as troops massed elsewhere in Ukraine, as its 15 percent weighting in the CEMBI rattled that resistant asset class as stocks and the ruble also fell along with other mainstay regional markets with intertwined energy, financial and trade links. Early investor reaction revolved around the belief that the peninsula’s succession alone could be managed economically and geopolitically, but that wider fractures in Ukraine’s East could be “catastrophic” both for it and neighbors and future global banking and capital market relationships. An indicative IIF analysis illustrated the plight of the interim Kiev government before scheduled May elections under major recession and almost 10 percent of GDP budget and current account gaps with reserves down to two months’ imports and external private borrowing impossible. Energy payment arrears to Gazprom come to several billion dollars and the currency is off 20 percent since the start of the year as bank deposits have likewise shrunk 10 percent. Sovereign and quasi-sovereign debt obligations coming to near $10 billion in the coming months are pressed by accelerating capital flight despite the imposition of controls under the ousted Yakunovych regime. The IMF program which may restart will likely encounter standard negotiating and political transition delays and entail previously attempted conditions including further utility price hikes and bank recapitalization with the NPL ratio at 40 percent. Crimea’s transfer itself would have marginal impact with its low industrial base and net drain on the central budget, but contribute to estimated near-term 10 percent national income decline and 20 percent inflation. A 2-year needed official financing package, mostly from the Fund with the EU and EBRD as partners, would be on the order of $20 billion, assuming private debt is rolled over with any restructuring focused on maturity extension rather than interest and principal reduction.
However spillover to other Eastern areas at the heart of agriculture and mining would invite depression-like output contraction and associated collapse in economic and financial system indicators. Russia’s fiscal burden and hydrocarbon export and capital flow vulnerability would increase under the scenario with a 25 percent voluntary and boycott- related drop in foreign direct and portfolio investment as domestic outflows at $30 billion in January alone further spike. As in the 2008 crisis, the central bank may preserve its ample reserve stash through modest ruble depreciation but big company and bank external borrowers could be left with a $100 billion hole. Elsewhere in Emerging Europe energy import dependence is the overriding factor under either scenario, with alternatives limited for Hungary and Bulgaria in particular. The Czech Republic and Poland can access pipelines through Germany and Belarus, respectively, and Turkey may go through the Black Sea although visitors from Russia and Ukraine comprise one-quarter of tourism earnings. Poland’s other trade connections are greatest while Hungary’s OTP has a cross-border bank presence. However domestic demand weakness will help foster 5 percent magnitude lower GDP for the region and risk aversion would soar, notwithstanding the additional prospect of large scale Ukrainian immigration again cracking Europe’s post-communist edifice as with Yugoslavia’s breakup.
