Ukraine: Nation on the brink of bankruptcy

Ukraine is so broke the nation is expecting to be cut off this week for failing to pay the gas bill, reports Mary Dejevsky from Kiev

When the United States sneezed, Old Europe's banks caught a heavy cold, and New Europe's mini-tiger economies have succumbed, one by one, to a nasty bout of flu. But in the so-called neighbourhood states immediately to the east, chief among them Ukraine, pneumonia threatens – and the experts' prognosis is not good.

International financiers will say, without wanting to be quoted, that Ukraine is already, for all practical purposes, bankrupt. They do not like the D-word, default, though that is clearly on their mind. Ukrainian officials like the word still less, smacking as it does of national humiliation. But the taboo was broken in recent days, when a senior IMF official, Marek Belka, director of the fund's European department, was quoted in the Ukrainian press as rejecting that idea. Which, in many Ukrainian minds, only made the prospect more real.

D-day – in almost every sense – could come as early as next Saturday when Ukraine has to pay its next instalment for Russian gas deliveries under the agreement painfully negotiated in January. It is grimly forecast that Kiev will not be able to pay, so triggering a new cut-off. Even if this particular Armageddon is averted, there is still April – when the warmer days of spring will still be only on the horizon.

So far, however, Ukraine's capital, Kiev, has worn impending doom lightly. High finance is not something that has impinged greatly on the average citizen – yet. Shops and restaurants may not be busy, but they are not deserted either. The city's elegant facades look better maintained than they did when I was last there a little more than two years ago, and any potential fuel problem clearly does not extend to petrol. The traffic is denser and the cars more expensive; shiny 4x4s are king.

Kiev has seen small, sporadic protests but nothing reminiscent of the waves of pent-up discontent that shook the country in 2004. Nothing, either, that would seriously threaten the fractious government – no more than the warring leaders threaten it themselves.

Half a dozen well-insulated tents – the temperature still plunges to -8C at night – are pitched beside the winter skating rink at the edge of Independence Square. Bathed in the floodlighting from the vast Ukraina monument, they are daubed with slogans that say "Everyone out!" A banner slung between them reads "No to corruption and abuse of power".

The camp, such as it is, presents but a poor relic of the glory days four years ago. Popular anger, it would seem, has some way to go before it reaches boiling point. Kievans, unlike some of their less fortunate provincial kin, are still living off borrowed money from the good times.

Borrowing, though, is where Ukraine, like so many of its near-neighbours, has come unstuck. Yet it is hard not to be just a little sympathetic. As in "new Europe", the bulk of the credits (80 per cent) were taken out not by the state, but by individuals and advanced by enthusiastic foreign banks that saw only high growth rates and low risk. And they covered themselves, as they thought, by loaning in their own money, rather than fast appreciating local currency. How the climate has changed.

The exposure of Austrian banks, in particular, to what was once seen as Eastern promise, is such – some fear – as to destabilise that country's hitherto rock-solid financial sector. In Ukraine, smaller, private banks have been in little-reported trouble since last December. I was in Kiev for the third annual Europe-Ukraine Forum, which brought together officials, politicians, industrialists and others from across the region and the EU. Inevitably, the economic crisis dominated every discussion. But, as always, it was the unscripted moments that were most telling.

After a succession of speakers, including the chairman of the National Bank's supervisory board, had insisted that, while dire, the banking system was absolutely stable, the deputy head of a scientific and technical centre in the Western city of Lviv – a city known for fancying itself more cultivated in every respect than Kiev – stood up to complain about frozen deposits, confiscated ATM cards and vanishing transfers at his branch of the Nadra bank, the country's sixth-largest.

What had he done about it? He had petitioned local dignitaries; he had extracted undertakings from the bank; he had used his remaining cash card to make withdrawals so he could pay his staff. And, when all else failed, it transpired, a sort of barter-economy was reappearing to fill the gap. Ivan Kulchytskyy, it seems, is unusual only in his readiness to expose the dubious protestations of officials, and of having a public forum where he could do so.

Ukraine's precarious financial position is compounded by its uncertain relations with the IMF. Kiev is still waiting for the second tranche of an agreed IMF credit, postponed for guarantees about how it will be used, after a significant proportion of the first tranche vanished – so it is said – in record time from the accounts where it had been deposited.

Corruption at almost every level is identified as Ukraine's number one problem. It is an affliction that has grown in the four years since the pro-democracy street protests that escalated into the Orange Revolution and propelled the pro-Western and pro-market pairing of Viktor Yushchenko and Yulia Timoshenko to power.

Their perpetual quarrelling is blamed by many Ukrainians for blighting their country's development – hence the "Everyone out" slogans on the tents. Television talk-shows denounce the political bickering as the slide in the grivnya against world currencies is scrolled in real-time beneath. Then the Prime Minister comes on to accuse her opponents (the President and his men) of talking down the currency to justify declaring an emergency. The Ukrainian media is among the freest in the emerging market countries – which may explain why the cameras at Ms Timoshenko's press conference homed in on her gleaming hair, cleavage, waistline, and high heels.

Not everyone agrees that the government discord is terminal. A new, self-justifying myth has grown up in official circles that says Ukraine was never a country distinguished by strong leadership, still less autocracy – a snipe at Russia – and that this is to its credit. And it is true that the economy grew apace after 2000 despite successive political upheavals. Italy was sometimes cited as an encouraging example of how economic growth and unstable government could live side by side.

While EU officials and politicians berate Ukraine for backsliding – on privatisation, modernising the infrastructure and, of course, corruption – the buccaneers of US business give a fine impression of remaining bullish.

From Citibank to Kraft Foods via Shell, area managers took the floor at the Europe-Ukraine Forum to congratulate themselves on investment decisions that had paid off, sometimes in spectacular fashion. One company's economic hardship, they chorused, was another's opportunity; they were looking to expand. Even as they spoke, Coca-Cola was announcing the acquisition of an elderly Ukrainian plant producing kvas, a traditional beer-like drink. Could Ukraine still be Europe's "best-kept secret", or were they simply picking over the entrails of an "emerging" market about to fail?

Such deep industrial and financial penetration from the West, and especially from the United States, reflects the euphoria abroad that greeted, first, Ukraine's independence, following the collapse of communism, and then the Orange revolution of 2004. If Ukraine is forced to default – a prospect that may not yet be inevitable – billions in dollars and euros will be lost, and with them many extravagant hopes for Ukraine.

Before EU leaders met in Brussels at the weekend, the President of the World Bank, Robert Zoellick, issued an appeal for Europe to "come together to ensure that the achievements of the last 20 years are not lost because of an economic crisis that is rapidly turning into a human crisis". Whether the EU can, or should, reach over its borders in an effort to rescue Ukraine from a fate that partly reflects the improvidence of foreign banks, and is partly at least of its own making, can be disputed. But there can be no doubt that Ukraine is next in the crisis line of fire.

Ukraine: At a glance

* Population 46 million

* Capital Kiev

* Currency grivnya (fallen to 9.7 to US$1 from 5 in Jan 2008)

* Per capita GDP US$7,800 (2008)

* GDP growth rate 5.3 per cent in 2008; projected (2009) -5 to -10 per cent

* Inflation rate (2008) 23 per cent

* Main exports Steel, machine-tools, grain

* Leaders Viktor Yushchenko (President); Yulia Timoshenko (Prime Minister)

* Next presidential election Nov/Dec of this year (but could be postponed)