Ukraine – the dangers of neglecting Europe’s other debt crisis
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Politicians and policy makers can only focus on one problem at a time. With all attention concentrated on Greece for the past month there is a real danger that an even greater problem is developing, almost unnoticed, in Ukraine. The economy there is in deep trouble. A further collapse, perhaps triggered by a debt default, could lead to an outflow of refugees that would make the problem of migrants crossing the Mediterranean look trivial. Energy is at the heart of the crisis but could just possibly be part of the solution.
The basic story is well known. Since the Maidan demonstrations in November 2013, the Ukrainian economy has shrunk. A 5 per cent fall last year is variously forecast to be followed by a contraction of between 5 and 10 per cent in 2015. Investment has ground to a halt and in the energy sector big potential projects such as the shale gas developments planned by Shell and Chevron have been halted. The fighting in the east has cut off coal supplies to the rest of the country from the 300 mines in theDonbass region. The Russian annexation of Crimea has cut off gas supplies from the developments managed by Chernomorneftegaz in the Black Sea. Ukraine, as a result, has become even more dependent on imports of coal and gas from South Africa, Australia, other parts of Europe and even ironically from Russia. These supplies do not come cheap and in many cases suppliers will only do business if they are paid in advance and in hard currency.
All this has produced a growing national debt burden that by common consent is now unsustainable. Ukraine cannot afford to service the debts it already has and every monthly repayment is turning into a moment of trauma. The Government in Kiev is reported to be close to defaulting on some or all of the debts – a step that would halt both further lending and the desperately needed flow of new industrial investment that offers the only prospect of halting economic decline. The risk is not just that a default would alienate lenders and investors. It could also push thousands of Ukrainians to migrate across the country’s long and porous borders with Poland, Romania, Hungary and Slovakia. If Europe cannot cope with the limited flow of people crossing the Mediterranean one can only imagine the panic and chaos that would follow an exodus from Ukraine.
Can anything be done? A big conference is being held in Washington this week to encourage new investment in Ukraine. The effort is admirable and a further demonstration of the fact that the US government is taking the situation in Ukraine more seriously than anyone in Europe. But the effort will fail unless the debt issue is resolved and a default prevented.
The IMF and a group of private creditors, mostly US based, have been in intensive discussions around a rescheduling package but to be acceptable all round such a deal needs to be linked to investments that offer a real prospect of financial returns from which the debts can eventually be repaid.
Energy should be at the heart of this. Ukraine has resources that can and should be developed. Even if those situated close to the fighting in the east (such as Shell’s prospective shale gas development around Yuzivska) are still beyond reach because of the physical risks involved other projects are viable. Gas – conventional and unconventional, hydro and biomass are all identified as priorities in a report recently published by the International Energy Agency.
The existing nuclear stations are ageing and need refurbishment and in some cases complete renewal. The electricity grid needs to be modernised and there is enormous potential for investments in energy efficiency. All these projects would create jobs and provide secure supplies to local users (including other industries) while reducing the burden of imports. Over time there is even the possibility of Ukraine becoming a supplier of electricity to other parts of the region. Each of the potential projects would generate revenue and it cannot be beyond the intelligence of investors and the international institutions to design a package in which a share of the revenue is allocated to creditors in return for a rescheduling of the current debt and some limited and focused new lending. Some debt could for instance be swapped for an energy bond. Ukraine badly needs a new business model for its economy and energy has to be at the heart of the answer.
None of this, of course, solves the problems created by the continuing separatist conflict in the east. The political situation can only be resolved when Russia gets tired of funding a conflict that it is not winning and tired too of the relative isolation that sanctions bring. The west is clearly not ready to fight for eastern Ukraine. But we do need to act to stop the country entering a downward spiral that could end up with a failed state of 45m people less than 350 miles from Budapest and only 250 from Warsaw.
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