Ukrainian Economy Collapses in August, IMF Bailout in Doubt

Industrial production fell by 21.4% in August down from July's 2.2% contraction throwing into question the IMF's bailout of Ukraine.

The decline was led by a 60% collapse in the production of coal and there are few prospects of production bouncing back any time soon. The Energy Minister described the situation as "catastrophic" and that Ukraine will now have to "import coal to make up for the short-fall" as there is a major shortage of input for thermoelectric power plants.

Ukraine consequently faces a shortage of both coal and gas this winter. 

This came just after the ERBD lowered Ukraine's GDP forecast to minus 9% for 2014 and minus 3% in 2015; figures which already in light of this new data seem optimistic. Originally the 17 billion dollar bailout envisaged a 5% fall in GDP in 2014, which they recently altered to 6.5% and a return to growth in 2015.

Clearly, the IMF will need to severely revise it's data and restructure its bailout - which will undoubtedly need to rise in value. All of the above figures also assume that Donetsk and Lugansk remain part of Ukraine. 

The continually collapsing level of GDP is also critical because it risks pushing Debt to GDP level above 60%; which would require a miracle and a huge amount of manipulation to avoid.

Under the very probably scenario that debt to GDP breaches 60%, Ukraine must pay back its 3 billion dollar debt to Russia or be forced to default on its debt which would trigger a full scale banking crisis in the country. As of early September Debt to GDP was seen at 58% and thus given today's data it seems Ukraine has most likely breached the level this month. 

Regardless of a national default, a full-scale banking crisis is almost a certainty now and it will force the Ukrainian government to bail-out the banks with money it does not have. In short, the cost of the IMF bailout will rise further.

At the beginning of August the Ukrainian Central Bank had 15 billion dollars in reserves, down from the 38 billion in August 2011, which covers 2 and half months of imports using July's trade balance data - Russia by contrast has 460 billion dollars of reserves or 16 months' worth of imports. Three months is considered the bare minimum a central bank should have. 

Currently the central bank is fighting to maintain the currency at around 12.5 hryvina to the dollar but ultimately it is a losing battle and another imminent devaluation is likely - the hryvina was already devalued by more than 50% from 8 to 12.5. The issue, however, with devaluation is that Ukraine's debt is in dollars and euros - devaluation creates more issues than it solves.

It seems increasingly likely that Ukraine will have to default on all of its obligations, restructure its currency - in effect create a new one and ask the IMF to bail-out the banking system as well as the central government and bank.

Even then, Ukraine is still in a dire position - currently there is virtually no industry and no economy, yet it somehow has to produce something to pay for the gas it needs for simple subsistence.

The IMF will be on the hook in Ukraine for years and years and it will cost probably multiple times more than the original 17 billion dollars pledged, or, Ukraine will be forced to give in to Russia's demands.