Yanukovych Risks Losing Support Base

The political upheaval in Ukraine has intensified, with protests in Kiev showing few signs of losing momentum over the near term. Police attempts to disperse the protests with violence have been ineffectual, and so far only served to galvanize the demonstrators' resolve. The domestic opposition to closer Russian integration is particularly problematic for President Viktor Yanukovych, who now faces several potential choices, none of which are especially palatable. Continuing to muddle along is not an option for Ukraine. The economy is mired in recession, and external imbalances will drive the economy straight into a crisis unless it receives some form of external assistance in the form of cheaper financing or imports. With international reserves dropping to barely two months import cover, the looming currency crisis could potentially trigger a deeper economic crisis as external debt servicing costs increase.

While newsflow out of Ukraine remains extremely erratic, the fundamental difficulty in calling the outcome of the current quagmire is that in the current scenario, outcomes that are beneficial to Yanukovych's political career and outcomes that are positive for Ukraine's economic and political stability appear mutually exclusive. Signing the Association Agreement with the EU is undesirable for President Viktor Yanukovych, as this would be a major victory for the opposition in the short term while the economic damage from Russia's retaliatory trade embargo would cripple the country economically. Even if the EU/IMF were to come up with sufficient financing (at least US$10bn or more), Yanukovych has no real desire to push through economic and social reforms that would ultimately weaken his hold on the country. On the other hand, striking a deal with Russia in exchange for cheap gas or credit would be preferable for Yanukovych, allowing him to avert a crisis without taking any hard decisions. However, this would risk triggering further protests which could see the government ousted.

While there have been suggestions that the resignation of Prime Minister Mykola Azarov could allow both the EU and Ukraine to save face while resuming negotiations, we believe that this is unrealistic given Yanukovych's political dominance domestically. However, perhaps the most striking development since the protests began has been indications that Yanukovych has started to lose the support of the domestic oligarchs. Tycoon Dmitry Firtash's TV station has been airing footage counteracting government claims that protestors were the first to incite violence, while former economy minister and confectionary magnate minister Petro Poroshenko sided with demonstrators in a recent speech. Oligarchs are becoming increasing concerned about the possibility of EU sanctions in response to government-led violence against protestors, as well as the potential intrusion of Russian oligarchs on their territory should Kiev strike a deal with Moscow. We believe that the loss of the oligarch support base for Yanukovych would prove fatal for his political career, paving the way towards an ousting of the current government and potentially re-opening the door to EU integration. However, we emphasize that even in this scenario, any deal with the EU would still need to be accompanied by a comprehensive financing package for Ukraine to avert economic disaster.

No Easy Options Ahead
Ukraine - 5 Year CDS, basis points

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This article is tagged to:
Sector: Country Risk
Geography: Ukraine, Russia

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