Ukraine Quarterly Digest: January – March 2017

Experts from Ukraine’s Institute for Social and Economics Research (ISER) contributed to this Digest. Please scroll to the bottom of the piece to see the names of all contributors.

Table of Contents

1. FOREIGN AFFAIRS PULSE
   1. Top Foreign Policy Vectors
   2. Credit Tranch of the IMF
   3. Russian Debt in Court
   4. Naftogaz and Gazprom
   5. Gas Integration with the EU
   6. Electric Vehicles
2. INTERNAL PULSE
   1. Macro Results
   2. Cleaning up the Banking System
   3. Investment Climate Change
   4. Communities Becoming Stronger
3. #PROGRESS
   1. Ukrainian Wings for Saudi Arabia
4. DONBAS PULSE
   1. Emergency State in Ukrainian Energy 
   2. Deliveries from Occupied Territories
   3. Expropriation of Ukrainian Enterprises by Separatists

Ukraine’s TOP foreign policy vectors in the first quarter of 2017 were the following: 

• Enhancing cooperation with NATO
• Strengthening foreign support for Ukraine in the conflict in Donbas; and
• Woring through the process of abolishing visa requirements for Ukrainians making short trips to destinations in the EU and Schengen zone;
• Estabilishing contact with the new U.S. Administration;

February

Some improvements and clarity in relations between Ukraine and the U.S. took place in February. At the Munich Security Conference, the U.S. vice president Mike Pence declared that the United States, under President Donald Trump, would “hold Russia accountable” and would require Russia to honor the Minsk II agreement, which calls for restoring Ukrainian control over the eastern border regions. At a meeting with President Petro Poroshenko, Pence said that Ukraine is among the top priorities for President Trump’s cabinet.

With the aggravation of the military situation in the east of Ukraine and the shelling of Avdiivka in February and March, Ukraine again came under the spotlight of the world community and international organizations, including NATO. A meeting of NATO defense ministers on February 15–16 demonstrated support for Ukraine in the Russian-Ukrainian conflict. The U.S. secretary of state Rex Tillerson said that the U.S. sanctions against Russia remain in force until Moscow fulfills all Minsk II conditions and returns Crimea to Ukraine.

March

In early March, the Ukrainian minister of foreign affairs Pavlo Klimkin visited the United States. Among the main topics of the conversation were the situation in eastern Ukraine and nonfulfillment of the Minsk II agreements by Russia. According to comments Klimkin made outside the State Department immediately after the March 7 meeting, Rex Tillerson promised that the United States. would continue supporting Ukraine and that the U.S. policy of conflict resolution would not allow any trade-offs at the expense of Ukraine. The possibility of an official meeting between the Ukrainian and U.S. presidents is under consideration.

In March, Ukraine held meetings with the foreign affairs ministers of the UK, Germany, and Poland. The main subjects were the prospect of negotiations in the “Normandy format” to resolve issues in eastern Ukraine, implementation of the Minsk agreements, unification of compliance with the sanctions regime against Russia among various European states, and securing a visa-free regime for Ukraine with the EU. The Normandy contact group consists of senior diplomatic leaders from Germany, Russia, Ukraine, and France. The meetings afforded reason to believe that European governments generally regard the Normandy format as ineffective, owing to Russia’s unwillingness to fulfill its obligations under the Minsk agreements. While the idea of expanding the group by inviting the United States was broached at the Munich Security Conference, the possibility of inviting Poland and the United Kingdom to participate as well should not be ruled out. At the very least, the agenda of the foreign affairs ministers’ meeting included finding an alternative to replace the Normandy format talks or devising a means to strengthen the format.

On March 22, the Verkhovna Rada (Ukraine’s parliament) adopted a draft resolution to ask the U.S. Congress to conclude a defense agreement with Ukraine and to grant Ukraine major non-NATO ally status.

NATO-Ukraine cooperation is very active and promising. Currently it is being conducted under the Comprehensive Assistance Package for Ukraine and the Annual National Program of NATO-Ukraine cooperation for 2017. The main task is for the Ukrainian security and defense agencies to adopt NATO standards. For the first time, civil society will be involved in monitoring the implementation of the plans for 2017. In addition, the annual plan for next year will be developed together with the public.

Ukrainian civil society seems keenly interested in an association with NATO. According to the results of a poll conducted by the Ilya Kucheriv Democratic Initiatives Fund and the sociological service of the Razumkov Center, the best way to guarantee the country’s security is to join NATO (44.1% of respondents agreed). Some 62.2% of those polled said they would vote for NATO membership on a referendum if it were held in the near future. Some 22.7% said they would abstain. The poll was conducted between December 16 and December 20, 2016, in all regions of Ukraine except Crimea and the occupied territories of Donetsk and Luhansk regions; 2,018 respondents aged 18 years or older were interviewed. The theoretical margin of sampling error does not exceed 2.3 percentage points.

Seizing on these results, Ukrainian politicians could not refrain from taking some rather opportunistic and hasty steps. Amid escalating conflict in the Donbas, in an interview with the German newspaper Berliner Morgenpost, President Poroshenko said he was ready to hold a referendum on Ukraine’s membership in NATO, though such a referendum would not be of any practical value.

The first three months of 2017 were also marked by several other achievements in Ukraine’s foreign policy. On March 14 the Ukrainian parliament ratified the Canada-Ukraine Free Trade Agreement (CUFTA). Parliamentary ratification of this agreement, which had been signed by the respective governments in July 2016, marked a step forward in the development of cooperative relations between the two countries in such potential areas as aviation, IT, light industry, and agricultural products, including eco-production

On March 27, at the initiative of Ukraine, a meeting of the heads of states that are members of the Organization for Democracy and Economic Development–GUAM (Georgia, Ukraine, Azerbaijan, and Moldova) took place in Kyiv. Because of the blockade of Ukrainian goods transiting Russian territory, Kyiv is looking for alternative transport routes. The current activities of GUAM should lead to a strengthening of economic and trade relations among the member states. Another unifying feature is that even though the countries have very different political orientations, all have experienced separatist movements and military conflicts.

April

During a session in Strasbourg on April 6, the European Parliament voted to liberalize visa requirements for Ukraine, the latest stage in granting Ukrainians the ability to visit most EU countries without having to apply for visas. Only a few more formalities remain, and it is expected that Ukrainian citizens will be able to travel to the EU without visas as early as July 2017. Visa liberalization with the EU is of great importance for Ukraine because it opens up avenues for social and cultural exchanges.

FOREIGN AFFAIRS PULSE

Credit tranche of the IMF

The Ukrainian government took on a number of commitments and obligations to the IMF, listed in the Memorandum (dated March 2, 2017). This will be one more factor pushing the Ukrainian government to carry out effective reforms. However, undertaking reforms is not the primary aim of IMF agreements but only a step, one that can bring Ukraine closer to achieving the country’s main strategic goals and fulfilling its commitments to the IMF. In April, Kyiv received a loan of SDR 734,05 million (about U.S. $1.00 bln) under the EFF (Extended Fund Facility) program despite failing to achieve seven of the 11 structural benchmarks established by the IMF’s previous Memorandum of Understanding (dated September 16, 2017). Progress was also made in achieving fiscal sustainability and financial stability.

The new memorandum agreed to with the IMF focuses on further strengthening the banking sector (and the financial sector in general). In particular, attention is directed to completing a diagnostic survey of banks and improving the quality of their work, strengthening prudential supervision, protecting the rights of creditors, creating a credit register for determining the solvency of borrowers, forming a strategy for a successful development of state banks, forming new supervisory boards, and related matters. An important step will be the creation of a regulatory and legal framework for the securities markets and nonbank financial institutions.

The government’s commitments regarding reforms in the labor market, in particular the modernization of the vocational education system, which should increase the flexibility of the labor market, are promising. Relatedly, the government will refrain from raising the minimum wage again in 2017 (it was raised at the start of the year). The planned acceleration of transparent privatization of small state-owned enterprises and other small assets can contribute to economic growth. This is likely to promote the development of local small and microbusinesses.

Meanwhile, a number of provisions of the Memorandum of Understanding (dated March 2, 2017) have provoked harsh public debate, as was expected. Among them are the intent to unblock agricultural land sales in 2018, tighten the rules for the provision of social assistance, including subsidies for households’ utilities payments, and the adoption of comprehensive pension reform (expected to take effect on January 1, 2018, but the provisions are still unknown by the public)

Experts are reasonably concerned about the very weak regulatory support for the planned structural reforms, which are to be implemented in a very short time frame. Lack of regulatory support has repeatedly caused failure to achieve several structural benchmarks, which therefore keep being repeated from MoU to MoU.

It can be assumed that implementation of the memorandum in the future will continue to concentrate on certain macroeconomic parameters, in particular inflation targeting and containing the budget deficit. The latest memorandum retains a previously defined inflation target of 6–10%. The likely negative impact caused by the ongoing devaluation of the hryvnia is to be compensated by a tight monetary policy, which is expected to hinder the growth of the national economy. Therefore, it will be impossible to achieve a tangible expansion of credit this year, which may temper the growth trend in investment activity.

The “Russian debt” decision 

On March 29, 2017, the High Court of London promulgated a decision on the case of the so-called “Russian debt”. The High Court of London did not support Ukraine’s position on the so-called Russian debt matter but allowed Ukraine to appeal the decision. Also, it has granted the request of Ukraine to suspend the implementation of the decision. In addition, the judge acknowledged Russia’s economic and military aggression against Ukraine and took it into account as a factor likely to reduce Ukraine’s ability to fulfill its obligations. However, because the formal rules of English law were followed (in particular, English legal doctrine, directly related to the competence of English courts to make decisions in matters of high international policy, prohibits judges from considering Russia’s illegal actions and coercion as part of Ukraine’s objections), the decision went against Ukraine.

At the same time, however, the opportunity to appeal allows payment of this debt to be postponed once again, in the hope of positive decisions for Ukraine in other international cases.
The alleged debt arose in this fashion. At the end of 2013 (the period of Viktor Yanukovych’s cabinet), Ukraine issued bonds for a $3 billion external public loan at a rate of 5% per annum. The maturity date of these bonds was reached on December 20, 2015, but Ukraine declared a moratorium on repayment of the debt. The buyer of these bonds was the Russian National Prosperity Fund, which is considered part of the state budget of Russia. This arrangement gave the Russian Federation a logical opportunity to interpret the loan to Ukraine as an interstate (or sovereign) debt. At the same time, Ukraine classifies the debt as a private loan, and also believes that these funds were, in fact, a “bribe” at the time to encourage Ukrainian authorities to refuse European integration. Ukraine tried to restructure this $3 billion debt along with other debts in 2015, but Russia did not agree.

While the case was being litigated in the UK’s High Court, one of Ukraine’s expectations (of course, no official said as much, but the idea was expressed by experts) was that the deadline for payment of the debt would be postponed (with certain expectations in regard to both a political settlement of the situation and economic development on the assumption that it would be easier to pay the debt at a later date, with less harm for Ukrainian state budget and economy in general)

Litigation between Ukraine’s Naftogaz and Russia’s Gazprom

Arbitration between Naftogaz and Gazprom is on track in Stockholm Chamber of Commerce.Arbitration between Ukraine’s state-owned oil and gas company Naftogaz and Russia’s Gazprom is on track in the Stockholm Chamber of Commerce. Naftogaz claimeda “take or pay” requirement (set by a gas trading agreement between Naftogaz and Gazprom) was noncompetitive and thereafter refused to pay for unconsumed gas. In addition, Naftogaz claimed to have raised the price for transmitting Russian gas through Ukrainian territory to EU states. Currently, the total amount of the claims is about $80 billion (by comparison, Naftogaz’s profit in 2016 was only UAH 26.5 billion, or less than U.S. $1 billion). If Naftogaz loses, it will declare bankruptcy. A final decision on the case is expected in the second quarter of 2017. But the most likely scenario is an amicable agreement between the parties. The decision in the case will be of particular importance for future trilateral gas trading relations involving the EU, Russia, and Ukraine.

Integration of Ukrainian and EU Gas Markets

At the end of 2016 an agreement between the Ukrainian state-owned gas transport operator Ukrtransgaz and the French multinational utility company Engie was signed that allows the French company to store its gas in Ukrainian underground storage facilities. Ukraine has the largest underground gas storage capacity in Europe: 12 storage facilities with a total capacity of 32 billion cubic meters (bcm) are available. In addition, in April 2017, a Memorandum of Understanding between Ukrainian and European gas distributors (the Italian Snam and the Slovakian Eustream) regarding joint use of Ukrainian gas transport systems was signed. During the winter of 2015–2016 Ukraine bought gas only from the EU, which was supplied by 15 European gas trading companies (for reference, before 2013 all gas was supplied to Ukraine from Russia, and diversification was considered almost impossible). The existing network of gas storage facilities and pipelines, which is integrated with the European gas supply system, is an opportunity for both parties, Ukraine and the EU, to strengthen their mutual energy security. Most experts are confident that such agreements can become the first step toward establishing Ukraine as a regional international gas trading hub.

Ukraine is in top-5 countries with the largest share of registered electric vehicles

Ukraine placed fourth in the global ranking of countries by share of electric vehicles registered in 2016 (the percentage of electric cars among the total number of all cars registered in the country). Last year, sales of e-vehicles in Ukraine increased by 160% over 2015 sales, and the number of electric cars in Ukraine increased four times. Only Norway, the Netherlands, and Spain surpassed Ukraine in this ranking. The trend toward electric vehicle ownership mostly reflects the desire of consumers to cut down on patrol costs rather than a concern for protecting the environment or coping with climate change.

INTERNAL PULSE

Macroeconomic results

After two years of economic depression (2012–2013) and two years of deep economic and political crisis (2014–2015), bookended by the Euromaidan and Russia’s annexation of Crimea, Ukraine’s economy begins to show cautious signs of recovery. According to the State Statistics Service of Ukraine, the country’s GDP grew by 2.3% in 2016, although in general, such a revival of the economy cannot be considered significant. It was vastly outstripped by the growth in gross fixed capital formation, which for the year was 20.1% and suggests grounds for optimism. Gross domestic demand had a very weak stimulating impact on economic growth: the final household spending figure increased by only 1.4%. An increase in imports is natural in the initial stage of economic growth recovery: it was 8.4%, whereas exports fell by 1.6%. An expected deterioration in the trade balance contributed to turbulence in the foreign exchange market and accelerated the devaluation of the Ukrainian hryvnia in the last quarter of 2016.

Current trends (a comprehensive assessment of the macroeconomic situation in the first quarter is difficult owing to the lack of complete data) allow one to make some assumptions about a range of factors affecting economic growth

• The growth of investments continues: the construction industry grew by 21.0% in January–February. Investment demand is appropriately extrapolated to industrial production: the growth in machine building for two months was 6.2%
• Consumer demand, as a factor of economic growth, is becoming more prominent. In January–February the average monthly salary increased in real terms by about 20%
• External demand for Ukrainian products picked up. In terms of value, exports of goods increased by 34.5% (according to National Bank of Ukraine data) in January-February, with an improvement in the trade balance (imports increased by 23.5%). Export demand supported the positive dynamics in machinery fabrication, half of which goes to the foreign market; in the metallurgical sector (an increase of 1.9% for two months); and most of the increase in the food industry, which increased by 3.5%, largely from the export of vegetable oil.
• A remarkable revival of cargo transportation (up by 16.6% over the first two months of the year) was an artifact of these other factors

The improvement in the trade balance contributed to a gradual decrease in the currency exchange rate turbulence and a moderate strengthening of the hryvnia at the end of the first quarter of 2017. That made it possible for the National Bank to undertake another series of measures to weaken the exchange rate regulation, increasingly allowing market mechanisms to replace administrative oversight.

At the same time, inflationary dynamics remained prominent, influenced by the negative exchange rate expectations of previous periods and the inflationary risks caused by a sharp increase in the minimum wage from the beginning of the year. As of March, the consumer price index was 15.1% year over year, with a target of 6–10% determined by the National Bank for 2017. This pushed the National Bank to conduct a tight monetary policy, and specifically to maintain a high discount rate. The logical consequence was continued stagnation in the credit sphere. Loans granted in the national currency increased by 15.5% in the first two months of the year compared to the same period last year, which is similar to the inflation rate path.

Thus, in the first quarter of the year, Ukraine did not experience breakthrough changes in the trajectory of accelerating economic dynamics. The increasing number of growth indicators in the economy provides a basis for believing this trend will be sustained and for increasing the attractiveness of Ukraine for investment.

Ukrainian banking system: Cleaning up

The National Bank of Ukraine successfully mobilized all its resources to fulfill the main goal defined by the Basic Principles of Monetary Policy for 2016, namely, adherence to the inflation rate within certain limits (12.4%). In the first quarter of 2017, the National Bank of Ukraine (NBU) slightly lowered its own macroeconomic forecasts for the year as a result of the blockade of the occupied territories in Donetsk and Luhansk regions. The bank published a decrease in the level of economic growth expected from 2.8% to 1.9%, but without a significant impact on the inflation rate (9.1%).

At present, Ukraine’s international reserves have grown to $16.7 billion, sufficient to cover 3.6 months of future imports and, according to information from the NBU, to fulfill Ukraine’s obligations and fund current operations of the government and the NBU. The growth in international reserves was also due to the receipt in April of funds: the IMF lent U.S. $1 billion (equivalent) and the European Commission provided € 600 million of macro financial aid (for comparison, at the end of March those loans amounted U.S. $15.1 billion)

Key events in the banking sector of Ukraine in the 1st quarter of 2017:

At the end of the first quarter of 2017, solvent Ukrainian banks declared UAH 5.09 billion(about U.S. $189 million) in net profit, while the banking system as a whole showed a profit in each of the three months. For comparison, the banking system registered a record loss in 2016 of UAH 160.1 billion ($5.8 billion), along with the insolvency of some banks. PrivatBank was the loss-making leader, at UAH 135.3 billion ($4.9 billion) (however, this loss was mainly generated by the need to increase bank reserves).

The decision late last year by Ukraine’s central bank to “immediately” nationalize Ukraine’s largest bank, PrivatBank, which faced a multibillion-dollar shortfall, was finally realized in the first quarter of 2017 when a new management group was appointed and the newly formed board began to work full-time. The nationalization was appreciated by world financial experts. In general, UAH 116.9 billion ($4.2 billion) were allocated for the capitalization of PrivatBank. Today the share of the public sector in the economy of Ukraine is 51.8% (calculated according to asset size). So the government of Ukraine again must make decisions about the functioning of state-owned and state-capitalized banks (for example, of the six currently state-owned or partly state-owned banks, four are among the ten largest Ukrainian banks); that is, it must devise and implement a development strategy for state-owned banks. This strategy may include a time frame and proposals for the privatization of state-owned shares in those banks, perhaps even the participation of international financial organizations (the European Bank for Reconstruction and Development and the International Finance Corporation, the latter a member of the World Bank Group, discussed possibly buying shares of Ukrainian banks)

Talks on the resignation of the governor of the National Bank, Valeria Gontareva, who was tough and effective but attracted strong opposition, intensified in February, but Gontareva announced her decision to resign only on April 10. It should be noted that according to the banking laws, the decision to accept the resignation of the head of the NBU is made by the Verkhovna Rada on the submission of a request from the president of Ukraine. However, Gontareva will remain in office until a new governor is appointed by the Verkhovna Rada

Investment climate change

The dynamics of statistical data for 2016 on attracting investment in the Ukrainian economy indicate an improvement in the investment climate. Statistical data indicate an improvement in the investment climate in Ukraine last year. This trend, according to government forecasts, will continue in 2017. In particular, the government projected a probable increase in foreign investments in 2017 of about $700 million, bringing the total foreign investments figure to $4.5 billion.

The improvement can be explained by both objective factors—the market requires investments for retooling production facilities and refreshing fixed assets; a long recession ended and investors’ expectations turned positive—and by the efforts of the authorities around norm-setting activities aimed at creating an attractive business climate. UkraineInvest, the office for promoting investment in Ukraine, began work in December 2016, and certain legislative changes have been made to encourage investment. Those changes are primarily aimed at simplifying tax administration mechanisms.

One indicator of Ukraine’s improving business climate is Ryanair’s decision to access the Ukrainian market by launching new routes into and out of Kyiv and Lviv. The first flights are expected to take place in September 2017. The arrival of Ryanair opens up new opportunities for Ukrainians to travel to many of the other countries served by this company. According to experts’ opinions, better air transportation helps energize investment, human capital formation, and the economic growth of the country.

Local Communities Becoming Stronger

In the first quarter of 2017, new impetus was given to the administration’s decentralization reform, which began in 2014 and was broadly supported by Ukraine’s Western partners.

A number of bills were adopted that facilitated the simplification and acceleration of turning territorial communities into more self-organized, independent and capable. This reform is one of the key ones, since it is expected that the transfer of authority and resources to the local level will contribute to democratization of the country and reduction of separatism. The main goal is to formate capable territorial communities that will ensure the country’s bottom-up transformation .

By the results of the first quarter of 2017 decentralization demonstrated positive financial dynamics: all local budgets grew by 38 % or by 11.4 billion UAH compared to the same period in 2016.

In particular:

• The total amount of personal income tax amounted to 22.7 billion UAH (an increase of 43%, or UAH 7 billion, over the first quarter of 2016)
• Land taxes and charges amounted to 6 billion UAH (an increase of 21%, or 1 billion UAH)
• Single tax amounted to 5.5 billion UAH (an increase of 55%, or 2 billion UAH)
• Real estate taxes amounted to 400 million UAH (an increase of 57%)

Ukrainian wings for Saudi Arabia

In March, a test flight of the first prototype of the multipurpose transport aircraft AN-132D, manufactured by the Ukrainian Antonov State Enterprise and developed jointly by Ukraine and Taqnia Aeronautics, a Saudi Arabian company, took place

Fewer than a dozen aircraft manufacturing countries in the world command a complete cycle of development and production. Ukraine is one of them.

This is the first aircraft that Antonov has produced without Russian components. Components from a cluster of the best companies in the world’s aviation industry were brought together on a single platform to construct this aircraft. Components of both Ukrainian and foreign origin (supplied by Pratt & Whitney, General Electric, Honeywell, Liebherr, and Hamilton Sundstrand) were used. The engines were purchased from Canada, the avionics were supplied by the United States, and the screw system came from the UK. Many parts were bought from France, in particular the steering wheels and air conditioning systems. Some equipment was supplied from Germany. The control system, fuel systems, and the video surveillance system of the AN-132D were developed and manufactured entirely in Ukraine.

The AN-132D was built over a year and a half. The cost of the demonstration model is about $50 million. The intellectual property rights pertaining to the aircraft are to be divided between Ukraine and Saudi Arabia, thus enabling transfer of technology to the latter country. The aircraft is designed for flights of near and medium-range distances. It will be able to lift up to 9 tons of cargo into the sky. Its different possible military and civilian uses include transporting troops, cargo, and light vehicles, and it is able to land on unprepared runways. Part of the production of the AN-132 series will take place in Saudi Arabia. The production contract decisions will be made after the delivery of the first unit. According to estimates, the market demand for this model is expected to be 260 to 290 units by 2035, including Saudi Arabia’s planned purchase of 80 aircraft. Another 200 aircraft are expected to be sold in the Middle East, Latin America, and India.

This economic sector is of particular importance for Ukraine because of the high level of innovation, which promotes development in several related fields, among them scientific equipment, specific electrical and mechanical equipment, instrument and tool manufacturing, and high-quality metallurgical production. Besides these domino effects, innovation leads to the creation of thousands of jobs and provides foreign currency incomes through exports. Aircraft construction and related industries’ products together account for 46% of global high-tech exports. Therefore, the development of this sector should become a priority for state policy based on pragmatic principles.

DONBAS PULSE

Emergency state in Ukrainian energy

The critical dependence on coal supplies from the occupied territories of Donbas led to a state of emergency in Ukrainian energy. In January, activists and individual members of the Ukrainian parliament started blocking traffic in the uncontrolled areas of Donbas to prevent smuggling and trading with separatists. The main argument for establishing the blockade was that the state could not trade with those who fomented and carried out the war. The blockade interrupted the supply of anthracite from the region. Anthracite is a variety of coal with few impurities and a high energy content that burns without soot. More than 50% of all Ukrainian coal mines are located in uncontrolled areas of Donbas, which amount t

o only 25% of Ukrainian territory—but 100% of Ukrainian anthracite is extracted from these coalfields. Some 45% of all Ukrainian thermal power station capacities are engineered to use just anthracite; these stations are responsible for 12% of all electricity generation. The annual anthracite demand in Ukraine is about 8 million tons. The suspension of anthracite deliveries from the uncontrolled areas of Donbas led to an emergency state in Ukrainian energy, exacerbated because the government maintains control over energy supplies inside the country. Over the last three years, from the moment the state lost control of those areas, steps have been taken to decrease anthracite dependency, but most experts agree th

at progress in this area is slow. Moreover, a range of experts believe that three years constituted a long enough period to dismantle anthracite dependency and prevent the occurrence of a state of energy emergency.

Consequences of the termination of deliveries from the occupied territories

The consequences of the termination of deliveries have been costly.The stalled delivery of goods from the uncontrolled territories of Lugansk and Donetsk regions contributed to the political turbulence in Ukraine, with almost immediate effects on economic processes. Previously, legal reregistration of enterprises in the territory controlled by Ukraine that are located within the occupied territory allowed them to remain engaged in the national production of metallurgy and energy. The blocked transport of materials necessary for production processes stopped these enterprises’ operation, and they fell under the control of the ʺlaw enforcement authoritiesʺ of the self-proclaimed republics. As a consequence, on March 15, by a decision of the National Security and Defense Council of Ukraine, any transit of goods across the demarcation line was terminated.

The National Bank of Ukraine estimated that the macroeconomic cost of these impacts will cause a 0.9% decrease in GDP growth in 2017 from the expected 2.8%, with about $500 million lost from a previously planned increase in the gold and foreign exchange reserves. At the same time, the total effect as the national economy adapts to the loss in production capacity will take a variety of forms:

• An additional increase in energy tariffs will be needed to cover the costs of modernizing energy-generation capacities and the subsequent drop in effective demand

• The Ukrainian currency is expected to weaken as the result of a “double hit” on the trade balance from the decrease in export incomes and the need to increase coal imports

• The domestic market is likely to weaken with a decrease in revenues from the metallurgical enterprises. The depressive impact will show up in a decrease in consumer demand by the workers employed by those enterprises and in a decrease in demand for other goods that are complementary to, or part of the supply chains of, the heavy engineering industry.

Expropriation of Ukrainian enterprises by illegal armed units backed by Russia’s military forces in the occupied areas of Donbas

In response to the blockade of routes into and out of the uncontrolled areas in the east of the country, separatist leaders announced the expropriation of coal mines and enterprises located within the uncontrolled areas (which means usurping control of those enterprises and running them in a manner deemed reasonable by the separatists). The owners of the biggest share of those enterprises are DTEK (the largest Ukrainian energy holding; it lost control of eight companies, four coal extracting, three energy distributing, and one energy generating, which enterprises combined employed 36,000 people), the Industrial Union of Donbas (ISD), and separate state-owned enterprises. Officials fruitlessly tried to stop the blockade in different ways, but, on realizing the lack of a workable solution, the National Security and Defense Council of Ukraine, chaired by President Poroshenko, made the decision to halt trade and deliveries from the uncontrolled areas of Donbas. Returning control over the expropriated enterprises to the real owners was stated as a precondition for renewing trade and supplies. However, it is clear that substitution of the coal previously sourced from occupied Donbas with coal supplied by other states will mean higher prices (Donbas coal was cheaper than imported coal), the need to spend foreign currency, and consequently a worsening of the national balance of payments, which will likely increase energy prices for final consumers and so increase state expenditures on subsidies for households’ energy consumption.

Authors and Contributors:

Andrian Prokip,Kennan Institute, Ukraine, Senior Associate
Antonina Deshko, ISER Financial Policy Expert
Kristina Avramchenko, ISER Macroeconomics Expert
Olena Snihyr, ISER International Affairs Expert, Analyst, PhD in Politics
Mykola Kapitonenko, ISER International Affairs Expert, Conflictologist, PhD in Politics
Yulia Kurnyshova, ISER International Affairs Expert, PhD in History
Svitlana Kovalivska, ISER Investments Expert
Yaroslav Zhalilo, Chief of Economic Programs of ISER, Dr. Sc. (Econ.), Honoured Economist of Ukraine
Maryna Dadinova, ISER Communications Advisor
Olga Pavlenko, ISER Digital art director