Crisis in Ukraine: Political Outlook and Its Implications for the Global Grain Markets
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April 2014
Crisis in Ukraine: Political Outlook and
Its Implications for the Global Grain Markets
Alex Brideau Key Points:
Senior Analyst, Eurasia Practice
Eurasia Group
long with the rest of the Black Sea countries, Ukraine is a major supplier of
A
corn and wheat to the global grain markets.
Divya Reddy rain shipments from Ukraine or other Black Sea countries do not yet appear
G
Director, Global Energy & Natural to have been disrupted; but as the crisis continues, risks for disruptions owing
Resources Practice to reducing planting, port bottlenecks, and sanctions will grow.
Eurasia Group
Ukraine remains mired in a geopolitical crisis that began in November 2013
and shows no signs of resolution until next year, at the earliest.
he Ukraine government’s stability should improve with the presidential
T
Inside this Issue…
election on May 25, paving the way for movement on the political and
Introduction ................................... 1 economic reforms needed to secure promised financing from the IMF.
Political Outlook ............................. 2 The security threat from Russia remains a major concern, and the risk of
further incursions into Ukrainian territory will be substantial in the near term.
Security Outlook.............................. 3
An invasion of eastern and southern Ukraine is unlikely, but the central
Economic Outlook........................... 4 government will face continued dissent from eastern regions which feel
excluded from the political process.
Implications for Grain Markets......... 5
Introduction
Ukraine remains mired in a political crisis that began in November, when then-
President Viktor Yanukovych pulled out of a deal that would have strengthened
economic ties with the EU. The ensuing, at times violent street protests eventually
led to Yanukovych’s ouster in February, with parliament naming speaker
Olexander Turchynov as interim president. In response, Russia deployed forces
to the autonomous Ukrainian region of Crimea. (See map.) In a March 16
referendum, Crimeans voted in favor of joining Russia, and Moscow moved swiftly
to annex the region, triggering a round of EU and U.S. sanctions.
The political crisis will likely remain a source of instability for the remainder of
2014. The government’s stability should improve with the presidential election
on May 25, paving the way for movement on the political and economic reforms
needed to secure tranches of an expected $14 billion-$18 billion loan from
the IMF. At the same time, the security threat from Russia will remain a major
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concern, and the risk of further incursions into
Ukrainian territory will be substantial in the
near term. An invasion of eastern and southern
Ukraine is on balance unlikely, but the central
government will face continued dissent from
eastern regions that feel like they are outside of
the political process. Furthermore, the public and
civil society groups who led the protests against
Yanukovych will likely apply increased pressure on
Russia
the government to tackle issues like corruption and
the influence of oligarchs on the political process.
Early parliamentary elections are likely in the next
6 to 12 months; and depending on the results,
they could lead to the installation of a cabinet with
differing political priorities and sensitivities.
Ukraine
The Black Sea region is an important supplier
of grains to the global market, and Ukraine in
particular is a major exporter of corn and wheat. Crimea
Grain shipments do not yet appear to have been
disrupted; but as the crisis continues, risks for
disruptions owing to reduced planting, port
bottlenecks, and sanctions will grow, with important
implications for global supplies and prices.
Political Outlook
The central government that replaced the
Yanukovych administration in late February is
weak. It should strengthen somewhat in the coming Moreover, the backing from western Ukraine is not without
months but will be subject to strong domestic political limits. The civil society groups and protesters who led the
pressures and an ongoing security threat from Russia. movement against Yanukovych could turn their ire onto
Overall, though, the government can be expected to the new government if they feel it is not representing their
remain stable enough to proceed with the reforms that interests. Right-wing groups, some of which include armed
the IMF and Western creditors will require in return for militias, also pose a threat to stability.
billions of dollars in financial assistance to avert default. The country is led by two figures who were leading
The new Ukrainian leadership gets most of its support opposition politicians during the Yanukovych
from the western and central regions of the country. administration. Turchynov will remain the interim
Support in the east and south, with greater concentrations president until the May 25 election, whose date
of ethnic Russians and Russian speakers, is far more was set by parliament (the Rada). Prime Minister
mixed. In fact, antipathy toward the new government was Arseniy Yatsenyuk, whose appointment was approved
an enabling factor for the invasion of Crimea by Russian overwhelmingly by the Rada on February 27, will
forces in late February, and it is an ongoing concern for remain in office after the presidential election. The Rada
the central authorities in these other regions. is dominated by the three opposition parties under
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Yanukovych, which, along with independents, have been The third change is probable early parliamentary
able to cobble together a 226-vote majority for a number elections. Lawmakers’ terms expire in 2017, but snap
of critical pieces of legislation since taking over the elections before then are likely. Both eastern and western
single-chamber legislature on February 20. voters, for different reasons, have a mutual interest in
demanding early elections. If that happens, it could lead
Significant political changes should be anticipated, and
to the removal of Yatsenyuk as prime minister, as he
some may well be destabilizing in the short term, even
would have to be reapproved by the new parliament. It
though they may bring long-term benefits. The first
may, however, also serve to increase the buy-in of eastern
change will occur following the presidential election.
constituencies to back the national government.
The candidates with the best chance of winning,
including frontrunner Petro Poroshenko, come from the
anti-Yanukovych camp and are likely to be more pro- Security Outlook
West than pro-Russia. This political orientation will risk Security issues represent the biggest single risk to the
aggravating the relationship between Kiev and politicians government in the near term. In the wake of the Russian
in southern and eastern Ukraine. It also would heighten annexation of Crimea, there are concerns about an
tension with Russia. However, the election will be incursion into eastern and southern Ukraine as well. This
important to further establish the legitimacy of the new threat remains substantial but on balance is unlikely.
political order. Russian President Vladimir Putin will likely use other
The second change is expected to be constitutional means to achieve his broader political goals in Ukraine.
reform. The Rada in February voted to revert to the mixed The decision about whether to take further military steps
parliamentary-presidential system outlined in the 2004 resides with Putin. Russia has deployed a significant
constitution, which divides power more evenly among military force along Ukraine’s borders, and Moscow has
the president, the prime minister, and the Rada. This declared that it has the right to protect ethnic Russians
has the potential to help keep different political forces and Russian speakers from alleged repression. Pro-Russia
in check, but additional reform is needed, especially in demonstrations in eastern and southern Ukrainian cities
two areas. One is trying to improve the rules governing have been relatively small but have sparked violence that
the political balance between institutions. The division of the Kremlin could use as an excuse for action.
power when the 2004 constitution was last in force led
to highly ineffective governance. Then-President Viktor While territorial acquisition appears to be one of Putin’s
Yushchenko and then-Prime Minister Yulia Tymoshenko, goals, the more important objective has been to push the
who had gone from allies in the 2004 Orange Revolution new Ukrainian government away from alignment with the
to adversaries, used vague rules about division of U.S. and the EU and back toward Russia. For historical,
power to overrule each others’ decisions, resulting in a cultural, and practical reasons, Putin views Ukraine as an
breakdown in policymaking and execution. The other integral part of Russia’s sphere of influence. The desire to
issue will be decentralization of power, which would give keep Ukraine within that sphere has led him to act as he
regional governments more control over their budgets has and ignore Western threats of sanctions and isolation.
and some policymaking. Moves toward decentralization Putin can achieve his objectives in a couple of ways.
will be part of Kiev’s effort to prevent the eastern and Most likely, he will opt to play a “long game.” This would
southern regions from attempting to break away in the not involve any additional territorial claims but would
same way that Crimea did. Although this reform has mean continued destabilization of the country’s eastern
the potential to improve relations between Kiev and and southern regions. Moscow would push Kiev to
the regions, success is hardly guaranteed, especially if adopt a more radical decentralization of power to give it
Russian pressure continues or the east and south see the more influence in the east and south. Russia would also
devolution of powers as inadequate. seek to steer Ukraine away from the EU and the IMF in
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© CoBank ACB, 2014 Prepared by CoBank’s Knowledge Exchange Division • April 2014www.cobank.com
the hope that this would eventually lead the country to Economic Outlook
pursue political and financial support from Russia as it
did under Yanukovych. This approach has a reasonable The new government inherited notable economic
chance of success. problems that will require major external assistance to
overcome. Early signs are promising for Western financial
The “short game” would involve further military incursions. aid, including the proposed two-year IMF standby
Putin would opt for this strategy only if he felt that the long agreement that is likely to be approved in April, and the
game would not accomplish his goals, and that taking default risk is decreasing slightly. Nevertheless, domestic
this step was worth the potential costs. These costs would political risks and the security threat from Russia present
include those directly associated with a war that likely dangers to the efforts toward economic recovery.
would not be as short as the 2008 conflict with Georgia, as
well as significant economic sanctions that the U.S. and For the past year, the government had attempted to
the EU would apply in response to military action. (Such tackle massive sovereign external debt obligations
sanctions, referred to as “Level 3,” would likely target a (estimated to be about $12 billion-$13 billion in 2014)
range of Russian companies and financial institutions, and and lower a current account deficit that hovers near
would be akin to Western sanctions against Iran.) 8 percent of GDP, widened in part by high natural gas
import prices from Russia. It did so while continuing
Such a course by Russia would jeopardize the stability of to run budget deficits considered unsustainable by
the Ukrainian government and territorial integrity. It would international financial institutions. After Yanukovych’s
likewise throw into doubt pledged Western financial ouster, the government indicated it would need $35
assistance, thereby greatly increasing the sovereign billion in external financial support over the next two
default risk and the danger of serious economic decline. years. Meanwhile, public worry caused by the so-called
But the long game also would be destabilizing, as Euromaidan protests and the Crimean invasion, along
eastern regions would continue to agitate for much with a decision by the National Bank of Ukraine (NBU)
more autonomy from the central government. Bilateral to stop supporting the hryvnia, have caused the currency
trade would suffer in response to economic pressure to fall 37 percent from the official rate of eight hryvnia to
from Russia, including periodic closures of the border, the U.S. dollar, which was in place at the end of 2013.
blocking Ukrainian exports, or disruptions of the natural The new NBU leadership in February reported currency
gas supply. (Russia would also likely disrupt its gas reserves of just $15 billion, enough to cover only about
supply to Europe.) two months of imports. Meanwhile, the government saw
The U.S. and the EU will continue to show support a $15 billion financial support package from Russia put
for the Ukrainian government, but there are limits to on hold after only $3 billion in disbursements.
what they will do to stop Russian interference. Military The situation has improved somewhat since the
intervention by NATO is highly unlikely. The harshest formation of the new cabinet. The likely approval of the
sanctions would be reserved for a Russian invasion of IMF loan program is the biggest story, especially as it
the east and south, though this would be unlikely in the unlocks additional billions of dollars in support from
long-game scenario. The EU will press ahead with its the U.S., the EU, and other countries and international
recently signed association agreement with Ukraine and financial institutions. Currency controls implemented by
has offered considerable short- and long-term financial the NBU also seem to have slowed the hryvnia’s decline.
support. But these pledges are predicated on Ukraine’s Authorities in late March also announced a series of
government continuing with a reform agenda, which austerity measures designed to bring the budget deficit to
would become more difficult if Russia applies strong sustainable levels. These steps will be unpopular with the
pressure or invades. public but are widely seen as necessary to both secure
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external aid and improve the economic and business scaling back of its implementation. That would endanger
environment over the long term. the fulfillment of the IMF program, which has happened
twice in the past six years.
The government should be able to secure IMF funding
for the rest of the year, predicated on its commitment Another major risk for the Ukrainian economy involves
to enact required reforms. The IMF wants sweeping changes to gas supply terms with Russia. On April 1, state-
fiscal and monetary policy reforms that would cut owned gas supplier Gazprom announced that it would
fiscal spending, liberalize the exchange rate, reduce raise the price of gas bound for Ukraine by more than 40
corruption, and improve the business environment. percent, effectively ending a discount to which the two
However, Kiev faces significant risks to the fulfillment countries had agreed in December. Ukraine already lacked
of the IMF program and, in turn, risks to the rest of the the means to pay even the heavily discounted price, and it
external support, which is dependent on cooperation will certainly be unable to afford a significantly higher price
between the government and the IMF. without Western financial help. If IMF funds expected in
late April fail to adequately address the challenges of rising
One concern is the risk of a Russian invasion. though this
debt and high monthly gas bills, the chance of a cutoff of
probably will not happen, it would raise serious questions
gas supply to Ukraine will increase in May.
about the viability of the IMF program. Another concern
stems from domestic politics and the prospect of early
parliamentary elections. The public is unlikely to stand Implications for Grain Markets
immediately in the way of the austerity program. But if
The Black Sea region, comprising Russia, Ukraine, and
opinion turns against the program later in 2014, it will
Kazakhstan, accounts for about 20 percent of global
increase the chance that Yatsenyuk’s government will be
wheat exports, mostly destined for markets in the Middle
removed by the next parliament following snap elections.
East and North Africa. Ukraine alone makes up about
His replacement probably would be more sensitive to the
5 percent of the global wheat market, while Crimea
political fallout from austerity, which could then lead to a
represents a relatively small portion (about 7 percent)
of Ukrainian wheat production. (See Exhibit 1.)
Since the crisis escalated in late February, wheat
Exhibit 1: World Wheat, Flour, and Products Exports prices for May delivery jumped about 17 percent,
World
(July wheat,2013)
2012-June flour, and products exports (July 2012–June from $6 per bushel 2013)
in January to nearly $7 in late
March. Reports are emerging about reluctance
on the part of Middle Eastern customers to sign
Australia
contracts with Ukrainian suppliers because of
14% Canada concerns about disruptions to supply, to the
26% benefit of European exporters. Nonetheless, no
EU reports have surfaced of an actual slowdown of
13% grain export shipments from the region. Instead,
Russia the instability is creating uncertainty in the market
Ukraine that has prompted extra buying in anticipation
15% of such a slowdown. Moreover, the events in the
19%
US region come at a time when the wheat market
8% is facing multiple weather-related challenges:
5% Others
drought in the Black Sea region, as well as in
Europe and Australia, coupled with unseasonably
Source:USDA
Source: USDA
cold temperatures in the U.S.
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Exhibit 2: World Corn Exports
World
(July corn2013)
2012-June exports (July 2012–June 2013)
The second possible implication for grain
markets is growing pressure on the hryvnia.
US
The major devaluation it has already seen,
13% 18% Argentina coupled with the added pressure that political
and economic challenges could create, will
Brazil result in higher costs for farmers heading
13%
into this year’s planting season. Although
India
Ukrainian farmers have already secured seeds
2% 23%
5% Russia for this spring’s planting, the cost of fertilizer,
pesticides, and fuel will all likely rise, as will
Ukraine the price of seeds required later in the year.
26%
In particular, Ukraine’s heavy dependence on
Others
fuel from Russia, which has already decided
to end one of two discounts on natural gas
Source:
Source: USDAUSDA prices, will likely result in higher input costs for
farmers that could set back planting volumes.
Meanwhile, the dire state of Ukraine’s
Ukraine is also a major exporter of corn, the third largest finances will make it more difficult for farmers to line up
in the world after the U.S. and Brazil. (See Exhibit 2.) The credit for financing their operations.
country accounts for roughly 15 percent of global exports
Another potential outcome from the crisis is a shifting of
and is expected to reach 18.5 million tons in the 2013/14
trade patterns and ensuing price differentials globally.
marketing year. Since late February, global corn prices
Specifically, if Ukraine moves to send more wheat to
have climbed about 11 percent to $5 per bushel as of
Europe in an effort to reduce Russia’s market share,
late March, partly driven by concerns about disruptions
Russia might respond by offering more favorable
stemming from the crisis in Ukraine. The smaller price
pricing to secure customers elsewhere. For other global
increase for corn than for wheat was likely due to more
suppliers of grains, such moves would have notable
favorable supply conditions, especially given abundant
price-distorting effects.
corn production in the U.S. this year. Any setbacks to
Ukrainian corn exports would benefit U.S. exporters. Finally, the threat of economic sanctions against Russia
could target some of its larger exports, including grains
The ongoing standoff between Ukraine and Russia
and in particular wheat. Although sanctions on grain
will affect grain markets in several ways. The first is
exports are not likely unless Russia escalates its military
disruptions to port access that could impair Ukrainian
incursion into a broader swath of Ukraine, the risk of
exports or alter trade flows for grains. In particular, the
such an escalation remains real. Sanctions that limit grain
Crimean annexation is already problematic for Ukrainian
exports from Russia would serve to drive up global prices,
exporters, as they at least temporarily have lost access to
similar to when Russia restricted its own wheat exports in
the port at Sevastopol. In addition, exports through the
2010 because of a weak harvest and ensuing concerns
port at Mariupol in the east risk problems in the Azov Sea
about whether supply could meet domestic demand.
and the Kerch Strait. These waters link the ports to the
Black Sea, and that access is under de facto Russian It probably will be some time before the Ukrainian
control. But the ports in Odessa and the surrounding government’s policy agenda for the agricultural sector
area, which ship the bulk of Ukraine’s agricultural becomes clearer. Like other sectors, it will no doubt
exports, are still under Ukrainian control and have open benefit from Kiev’s intention to battle corruption in
access to the Black Sea. the business environment. The government in 2012
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extended a moratorium on the sale of agricultural land have used the issue against the governing party. Their
to January 2016, but it established criteria for sales objection usually stems from distrust and a view that the
that would underpin eventual liberalization. The current sitting government would enact the reform in a way that
governing parties have generally been supportive of the does not benefit the opposition. In that vein, the current
effort to lift the moratorium, and such liberalization is governing parties will likely want to revise the laws that
seen as important for the growth of agricultural output. the Yanukovych administration put into place to facilitate
But implementation will likely take considerable time. the end of the moratorium, having argued previously that
it would be likely to fuel corruption and benefit only his
Lifting the moratorium remains controversial and is often
allies. The Party of Regions, Yanukovych’s former party
exploited by politicians playing to nationalist sentiments.
that is now in the opposition, will probably attempt to
The Communist Party faction in the Rada is a constant
block a lifting of the moratorium.
opponent of the idea, mainly for ideological reasons.
Other Rada factions, when they are in the opposition,
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