Ukraine Market Report — Q3 2008
Steel prices fell by more than half, international credit markets closed, and the three exposures assembled over the previous three years began moving at the same time.
Overview
The external condition changed. Global steel prices fell by more than half between their summer peak and the end of the quarter, and international wholesale funding markets effectively closed to emerging market borrowers in September.
The economy that had been assembled over the previous three years was built for neither of these.
The transmission
The sequence is worth setting out because it is the clearest illustration in this archive of how a single price becomes a systemic crisis.
Steel prices fall. Export earnings collapse, taking the country's largest source of foreign exchange with them. The current account deficit, previously financed by external borrowing, now has no financing because those markets have closed. Pressure on the currency becomes acute. Households and companies with foreign-currency debt face a rising local-currency obligation. Bank asset quality deteriorates as those borrowers stop performing. Depositors, watching this, withdraw. Banks that funded long-term lending with short-term wholesale borrowing cannot roll over their liabilities.
Every step in that chain was predictable from the structure described in the 2007 reports. What could not be predicted was the timing, which came from outside.
Macro position
Industrial output began falling sharply in September, concentrated in metals and chemicals. Construction stopped almost entirely.
Deposit outflows began in earnest. Several banks required intervention. The central bank spent reserves defending the currency and eventually could not hold the rate.
Sectors
Metals — output cut drastically as export orders evaporated. Plants idled.
Construction — projects abandoned mid-build, a visible feature of Kyiv for years afterwards.
Banking — the sector at the centre of the crisis.
Agriculture — a record harvest, sold into falling world prices, but the sector was the least damaged because its debt was smaller and its product still had buyers.
What the quarter settled
That the vulnerabilities identified in the published data of 2006 and 2007 were real, that they moved together as predicted, and that the interval between the warning being visible and the event arriving was approximately two years.
That interval is the useful number. Structural warnings in an economy of this kind do not resolve quickly, which is precisely why they get ignored.
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