Central bank's reserves have fallen to critical levels as Russia threatens to call in its loans

The economic situation in Ukraine continues to deteriorate.

Incensed that Ukraine’s proposed budget makes no provision to repay the $3 billion loan Russia made Ukraine last year the Russians are now threatening to call it in.

In the meantime the Ukrainian central bank’s reserves have fallen to just $7.5 billion - enough to cover just 5 weeks’ imports.

As the Financial Times is reporting (see below), there is no agreement on providing Ukraine with the extra $15 billion the IMF says it needs to get through the next few months.

The risk of a sovereign default is increasing by the day and unless Ukraine’s western supporters decide soon to put up far more money than they have shown any willingness to do up to now a sovereign default looks like a case of when not if.

Ukraine’s economic position was already bad before the Maidan coup but contrary to what Timothy Ash of Standard Bank says (see the Financial Times piece below) the Ukrainians are very much the authors of their problems.

Immediately prior to the coup Ukraine’s former President Yanukovych had negotiated a $15 billion loan from Russia on very favourable terms and had secured Russia’s agreement to a very substantial discount on the gas Ukraine was importing from Russia.

This was a far more generous package than the one the West offered. It would have stabilised Ukraine’s economic situation in 2014, putting Ukraine in a good position to profit from the fall in oil prices in 2015.

The benefits of the agreement with Russia were thrown away because the government that negotiated it was overthrown in an unconstitutional coup and the new government that took its place chose to treat Russia as Ukraine’s enemy rather than as its key economic partner.

Western commentators of course blame Russian hostility to Ukraine for Ukraine's economic problems. The opposite is true. The reason for the Maidan coup was precisely that Ukraine’s previous government seemed to be realigning Ukraine economically with Russia.

Much has been written about Yanukovych’s corruption and supposed authoritarian tendencies. However these were not what caused the protests against him which led to the coup.

The trigger for the protests was Yanukovych’s decision to postpone signing the association agreement with the EU to allow time to sort out economic issues with Russia. Such a realignment with Russia was unacceptable to Yanukovych's intensely Russophobic opponents, which is why they overthrew him.

Following the coup Ukraine’s new government has also made matters much worse by refusing to negotiate with its opponents (as it committed itself to do on 21st February 2014, 17th April 2014 and 5th September 2014) but by instead waging war on them. The result has been physical devastation, huge loss of life and the loss of key industrial and coal mining regions in the Donbass.

Unfortunately there is no sign of the Ukrainian government changing course. On the contrary all the evidence suggests that it continues to give its confrontation with Russia and with its internal opponents priority over solving the country’s economic problems.

How else to explain Yatsenyuk’s crass comment in Berlin portraying Russia as the aggressor in the Second World War and Germany as its victim or news of a further massive call up of reservists or Poroshenko’s almost certainly untrue boasts that the combat capability of Ukraine’s military has been fully “restored”?

Given that this is so, it is no surprise Ukraine’s situation goes from bad to worse.

From the Financial Times:

Ukraine's central bank reserves have sunk to a new record low of just $7.5bn after a steeper than expected decline in December, casting further doubts over the country's solvency.

The International Monetary Fund, the EU and the US are wrangling over who will foot the bill for the extra $15bn the IMF reckons Kiev needs to avert a full financial crisis and default.

Time is running out, with an estimated $10bn of government bond repayments due this year – on top of the recapitalisation needs of local banks and state-owned companies – and the central bank's reserves down to just about five weeks of imports.

Reserves stood at just under $10bn at the end of November, and while economists had expected a sharp drop, the median of three analysts polled by Bloomberg had expected reserves to only fall to $8bn.

Timothy Ash of Standard Bank wrote: