Ukraine: 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 forcefully disperse the demonstrators have been ineffectual, and so far only served to galvanise their resolve. The domestic opposition to closer integration with Russia is particularly problematic for President Viktor Yanukovych, who now faces several potential choices, none of which are especially palatable.

The 'muddle through' approach is not an option for Ukraine. The economy is mired in recession, and with international reserves dropping to barely two months of import cover, the looming currency crisis could potentially trigger a deeper economic shock as external debt servicing costs increase.

The fundamental difficulty in calling the outcome of the current deadlock is that as things stand, developments that are beneficial to Yanukovych's political career and developments that are positive for Ukraine's economic and political stability appear mutually exclusive. Signing the Association Agreement with the EU (which is what protestors want) is undesirable for 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 Ukraine economically.

Even if the EU and 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. For Yanukovych, striking a deal with Russia in exchange for cheap gas or credit would be preferable, allowing him to avert a financial crisis without taking any hard decisions. However, this would risk triggering further protests, which could eventually result in his fall from power.

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. However, perhaps the most striking development since the protests began has been indications that Yanukovych has started to lose the support of domestic oligarchs. Tycoon Dmitry Firtash's TV station has been airing footage contradicting government claims that protestors were the first to incite violence, while former economy minister and confectionary magnate Petro Poroshenko sided with the demonstrators in a recent speech.

Ukraine's oligarchs are becoming increasing concerned about the possibility of EU sanctions in response to the government crackdown on protestors, as well as the potential intrusion of Russian oligarchs on their territory should Kiev strike a new deal with Moscow. We believe that Yanukovych's loss of support from the oligarchs would prove fatal for his political career, paving the way for his remobal, and thereby potentially re-opening the door to EU integration. However, we emphasise that even under this scenario, any deal with the EU would still need to be accompanied by a comprehensive financing package for Ukraine to avert economic disaster.