Switching to rubles in gas payments may undermine favorable trade agreements and pose currency risks
Gazprom and Naftogaz signed an addendum to the current gas deal under which Ukraine can pay in rubles for imported natural gas. The agreement was negotiated by Gazprom CEO Aleksey Miller and Ukrainian Energy Minister Yuriy Boiko in Moscow. Ukraine may switch from US dollars to rubles to pay for imported Russian gas as soon as December 2011. Prime Ministers Mykola Azarov and Vladimir Putin discussed this topic at a meeting in Saint Petersburg after which NBU Chief Serhiy Arbuzov and acting Finance Minister Anton Siluanov worked out the details. The initiative was said to have come from the Kremlin and rationalized as a desire to diminish the pressure of Ukraine’s foreign trade imbalance on its currency rate. According to Arbuzov, the new scheme will translate into $8 billion in saved gold and currency reserves. However, this argument seems quite suspect.
It is a known fact that Naftogaz periodically buys huge sums of dollars, sometimes as much as $700-800 million per month, on the interbank market to pay for Russian gas, which puts the hryvnia rate under pressure. In January-September 2011, the cumulative deficit of Ukraine’s trade balance reached $5.5 billion compared to $0.5 billion over the same period in 2010. Since August 2011, we have seen a significant drop in the prices of exported metal products as foreign demand for them has weakened. The export growth rate fell by 9.3% to 26.8% in September alone, while the global outlook is gloomy. So far it is unclear whether the Ukrainian government will be able to secure another hard-currency injection from the IMF. But none of this explains why Ukraine has to abandon the dollar in its payments to Gazprom. Switching to the ruble by itself does not solve the problem of either the trade deficit or balancing payments. Naftogaz, a state-owned company, by the way, will have to buy rubles somewhere. And here quite real risks far exceed imaginary macroeconomic advantages.
Risk No. 1 – structural. From a purely theoretical standpoint switching to the ruble would benefit Naftogaz only if ruble payments for gas transit to the EU were equal or higher than what it spends to buy natural gas. But this is nowhere near the case. Moreover, since 2006, Ukrtransgaz, a subsidiary of Naftogaz, has seen its revenue grow at a much smaller pace than the price of gas on the Ukraine-Russia border. Ukraine must spend around 7 billion cu. m. of gas per year to pump Russian gas to Europe – at least this is how much gas-compressor stations consumed before the crisis. The price of technical gas rose by $40 to $130 in 2007 and by another $49.5 in 2008, while the transit tariff increased only in 2008, and by a small margin at that – from $1.6 to $1.7 per 1,000 cu. m. per 100 km. The same trend continued in subsequent years: transit tariffs lagged behind ever-increasing gas prices. In 2011, the transit tariff is set at $2.89, while the average annual gas price is at least $332.5. In January-October 2011, Ukraine paid $9.876 billion for Russian gas, which is many times more than it earned on gas transit to Europe.
In these conditions, switching to the ruble would seem logical if Ukrainian industrial gas consumers, primarily metallurgical and chemical plants, were buying it from Naftogaz also with rubles. But this scenario is improbable. The total exports of the metallurgical industry to CIS countries barely exceeded $100.1 million in 2010. We need to also consider the lack of discipline in payments on the domestic gas market. As of September 2011, at least 17.3 billion cu. m. of gas delivered by Naftogaz was not paid for by public utility companies (UAH 2.6 million), the population (UAH 790 million) and government-financed organizations (UAH 35 million).
Risk No. 2 – currency. This risk is a derivative of the structural one. Russian gas is a critical raw material for Ukraine’s economy. The Russian currency is not freely convertible. Ukraine’s national bank does not keep it in its reserves (or keeps just a tiny amount), which makes Russia the only source of supply. A switch to ruble payments is unjustified in times of global instability, as it shifts all currency exchange and inflation risks onto Naftogaz. This is an unprecedented event in Ukraine’s foreign trade which can only be somehow justified if the Russians officially commit to sell certain amounts of rubles in exchange for hryvnias or pay for some Ukrainian products with rubles. However, these currency and trade swaps are an illusion. If they are not, shouldn’t it be fixed that Russian gas will be purchased with hryvnias? For the sake of an experiment, so to speak.
“The UAH/RUB rate hinges on the USD/UAH and USD/RUB rates,” says Oleksandr Okhrimenko, President of the Ukrainian Analytical Center. “Devaluation of the ruble against the US dollar would make the hryvnia stronger and vice versa. The fact that [the Russian currency] is not freely convertible makes any trade games with it very dangerous.” Oleh Ustenko, Executive Director of the International Bleyzer Foundation in Ukraine, is convinced that even if we suppose that Ukraine’s National Bank does make reserves in rubles, this will not rule out risks: the Russian currency is now weaker than the hard currencies, which means that the NBU’s reserves are sure to lose value if the ruble further weakens in relation to the US dollar or the euro. A rise in the price of gold and inflation in Russia would also depreciate ruble reserves. All of this will work not only against Naftogaz but also against the rest of Ukrainian industries, particularly exporters. Ihor Umansky, ex-Finance Minister of Ukraine, is convinced that Ukraine’s projected entry in the ruble zone spells gradual abandonment of the national currency. “Even if we manage to convert export flows into rubles, this will mean losing at least $2.5 billion in dollar receipts,” he says. And then he poses a question: Will the NBU be able to somehow manage the domestic financial market under this scenario?
Risk No. 3 – geoeconomic.The Ukrainian Week has written about the advantages and losses Ukraine will face if it joins a free trade zone with Russia and other CIS countries. But this is a slow process that will involve additional negotiations, agreements and their ratification. By switching to rubles in gas payments, which is much easier to do – as is often the case – on the level of businesses (Gazprom and Naftogaz in this case), the Russians get everything at once, and it is an open question whether they will make any trade concessions. The free trade zone will be, by and large, unnecessary to them. In January-September 2011, Ukraine exported $14.7 billion worth of goods to Russia and imported $21.6 billion. It is reasonable to assume that Moscow is quite satisfied with this trade balance. If anyone in Kyiv is eager to step up eastward economic integration, joining the ruble zone would make sense only after the free trade zone has been tried and tested. Otherwise Ukraine is clearly at a loss. It is naïve and amiss to hope the Russians will be altruistic. Merited Economist of Ukraine Viktor Suslov points out that in order to pay for gas in October, Naftogaz was forced to borrow $550 million from Gazprombank at 8.5%. Meanwhile, the IMF rate was 3.5%. It is unlikely that our government and business tycoons fail to understand the above currency risks. If realized in practice, this initiative can mean that Ukraine’s economic condition is worse that could even be imagined.