Bucharest 2008: a promise without a date, and what it cost to price

The NATO summit in Bucharest concluded on 4 April with a communiqué stating that Ukraine and Georgia will become members of the alliance, while declining to grant either country a Membership Action Plan — the technical process that precedes accession.

Diplomatically the formula was a compromise between allies who wanted to proceed and allies who did not. Analytically it produced something worse than either alternative, and this entry sets out why in commercial rather than strategic terms.

Why the formula is unstable

Consider the three positions that were available. A clear no would have established that Ukraine's security arrangements are its own problem, unpleasant for Kyiv but unambiguous — and unambiguity can be priced. A Membership Action Plan would have created a defined process with reciprocal obligations and, importantly, allied investment in the outcome.

What was chosen instead was a declaration of eventual membership with no process, no timetable and no obligations on either side. This gives Ukraine all of the political salience of a commitment — it is now formally on a path that other parties oppose — and none of the institutional substance that would make the commitment credible.

Risk analysts do not price intentions; they price mechanisms. A country that is declared to be heading somewhere without a mechanism for getting there occupies the least stable position on the map.

What happened to the numbers

The market response was not immediate but it was measurable within months. Ukrainian sovereign spreads widened through the spring. Several planned eurobond placements by Ukrainian banks and corporates were postponed. Political risk insurance premiums for Ukrainian projects moved.

The August war in Georgia converted an abstraction into a demonstration. Whatever one's view of the causes, the effect on how Ukrainian risk was assessed in London, Frankfurt and New York was immediate: a country in the same category, with the same summit language applied to it, had just seen conflict. Ukrainian spreads widened again, in September, before the global credit crisis arrived — and then the two compounded.

The lesson for Ukrainian policy

The general point is about the cost of ambiguous security arrangements to an economy that depends on external capital.

Ukraine's growth model since 2004 has been financed by foreign borrowing intermediated through the banking system. That model requires foreign lenders to be comfortable with Ukrainian risk over five- to ten-year horizons. Security ambiguity is precisely the kind of risk that lenders cannot model and therefore price conservatively or refuse.

The practical implication is that Ukraine's cost of capital contains a permanent component that no domestic reform can remove. Improving the courts, the tax system and the banking supervision will narrow the spread; it will not close it while the security question is open.

What businesses should do differently

Three adjustments are worth making now.

First, extend the tenor assumption in any Ukrainian investment case. If your model assumed refinancing available at similar terms in three years, test it at a two-hundred-basis-point widening and see whether the project survives.

Second, look carefully at where your Ukrainian counterparties borrow. Companies funded by foreign parent banks are exposed to a decision made abroad about country risk, not about their own creditworthiness. That decision can be made quickly and applied indiscriminately.

Third, note that geography now matters within Ukraine in a way it did not before. Assets in the west of the country and assets in the east carry different risk profiles for the first time since 1991, and insurers will discover this before analysts write about it.

None of this is a prediction of conflict. It is a statement about pricing under ambiguity, which is what April established as Ukraine's permanent condition until the ambiguity is resolved one way or the other.

Related in this archive

• Eight months: why the 2005 coalition collapsed, and what it cost
• The Orange Revolution: what seventeen days on a square changed for business
• Elections and investment: what actually changes and what does not
• Ukraine Annual Review 2008: two economies in one year

A promise without a date is harder for an investor than no promise at all: you cannot tell what to plan against. It works the same way in commerce — a customer who says they will buy but names no date makes it impossible to reserve a production slot. Without entering the politics of it, that is what I can say: an open-ended promise is an unpriceable risk.