Ukraine: Cyprus Ripples Not Negligible

KIEV, Ukraine -- News headlines about a Cyprus-crisis contagion have so far focused largely on Slovenia, Malta, Italy and Spain. But Ukraine could also take a hit. While Ukrainian businesses are said to have possibly just $1-3bn in Cyprus – much less than the $30bn that has been estimated for Russia – if this money gets confiscated by the bailout levy or tied up by financial transaction limitations, it could be enough to tip the country’s troubled economy deeper into crisis. As London-based Capital Economics points out in a report this week, the Cyprus bailout deal “may pose much bigger risks for Ukraine, which is already on the brink of a balance of payments crisis.” Russian and Ukrainian businesses, it said, “appear to be using Cyprus for their financial transactions to pay for imports and to receive payments for exports for tax optimisation reasons. When the money comes back to Russia/Ukraine, it shows up as FDI inflows on the capital account, rather than as export earnings on the current account.” This would explain why “tiny Cyprus” is Ukraine’s main source of investment, accounting for some 30 per cent of FDI. From Capital Economics: The introduction of capital controls in Cyprus risks disrupting these flows, which may ultimately affect business activity and hit vital capital inflows. In marked contrast to Russia, Ukraine’s economy is already on the brink of a balance of payments crisis. The current account deficit is currently at a record high of 8% of GDP, and on top of this Ukraine is facing an onerous external debt repayment schedule, with a total of over $55bn due to be repaid this year. We estimate that Ukraine’s total external financing requirement over the next 12 months stands at close to 40% of GDP. At the same time, Ukraine’s FX reserves have dropped below three months of import cover, which is the minimum recommended reserve coverage by the IMF. To make matters worse, the economy slipped back into recession towards the end of last year. And despite all this, there has been little progress in negotiations with the IMF over a new financing package. Summing up, Capital Economics said: The upshot of all this is that although the direct impact from the levy on deposits in Cyprus on the Ukrainian economy is likely to be limited, wider vulnerabilities mean that the Cypriot crisis may still be enough to tip Ukraine into a financial crisis of its own. Without an IMF deal in place, Ukraine is extremely exposed if the Cypriot bailout triggers a fresh spike in financial market tensions. On the ground in Kiev, the Cyprus crisis ripples are not sparking panic just yet, but they are being felt. Auditing and accounting giants such as PwC have held seminars advising businesses how to adjust. Adam Mycyk, partner at the Kiev law offices of Chadbourne & Parke LLP, said that Ukrainian business using “Cyprus as a ‘cash collection’ centre for transactions with their related Ukrainian entities may indeed face an issue, whether because of a shortage of available cash and/or any capital controls that Cyprus puts into place.” Tomas Fiala, CEO of Kiev-based investment bank Dragon Capital, said “the impact is not too big, but not negligible.” He added: “A lot of investment, loans and trade flows are structured through Cyprus. It takes time to set up accounts at other banks in other jurisdictions. Several billion US dollars got frozen there but should be available within a couple weeks. Several hundred million will be lost at Laiki and the Bank of Cyprus.” In talks with an IMF mission that arrived this week for discussions on a potential $15bn bailout, government officials have talked down the effects of the Cyprus situation. Meanwhile, locals say the Cyprus contagion could increase the cost of borrowing on the Eurobond market for Ukraine’s cash-strapped government. This in turn could force it to accept the tough IMF bailout conditions. Fiala said: “There is a bit of contagion, which together with large Eurobond supply from Ukraine caused prices to move down over the last two weeks. For instance, the long sovereign went down 4 points. If it should drop further, Ukraine would have a harder time accessing the market. And this could push Ukraine towards an IMF deal.”