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Putin gambles on Ukraine bailout

People take pictures of wooden bars, bearing names of Ukrainian cities and settlements which are hometowns of demonstrators, as Pro-European
People take pictures of wooden bars, bearing names of Ukrainian cities and settlements which are hometowns of demonstrators, as Pro-European

By Lidia Kelly

MOSCOW (Reuters) - President Vladimir Putin has taken a gamble with Russia's own fragile economy by bailing out Ukraine for the sake of keeping it in Moscow's orbit and out of the European Union's embrace.

His finance minister, Anton Siluanov, defended Tuesday's deal in the Kremlin with Ukrainian President Viktor Yanukovich, which offered Kiev $15 billion in credits and slashed a third off the price it pays for vital Russian gas supplies.

"I believe that Russia only won," Siluanov told Reuters on Wednesday, dismissing as baseless concerns the accord might damage Moscow's own credibility with investors.

The deal has boosted demand for Ukrainian government debt and its currency, the hryvnia.

But Russia has had to tap into a rainy-day fund to afford the bailout at a time when its own economy, driven by energy exports, is in trouble. And it is not clear what it gets in return bar influence over the second most populous ex-Soviet state, whose 46-million population is a third that of Russia but whose ailing economy is less than a tenth the size.

Ukraine's leaders also face risks. Although Ukraine's prime minister hailed as historic a deal which offers his indebted nation at least temporary economic respite, it could swell numbers at anti-government, pro-EU protests in the capital.

About 3,000 protesters were camped behind high barricades in a central Kiev square after opposition leaders called for mass rallies to bring down Yanukovich for "selling out" Ukraine's national interests and independence to its historic overlord Moscow - and spurning a free trade pact with the EU.

The $15 billion, to be spent on purchasing Ukrainian government debt, may seem like small change for a vast, resource-rich country that sits on half a trillion dollars in foreign exchange reserves and has a strong ability to borrow.

But with Putin himself acknowledging that Russia's more than $2-trillion economy is too dependent on oil and gas and is heading for short-term stagnation, there could soon be economic and political costs: "It is a drop in the ocean," a Russian government source said. "But it could become a painful drop."

The latest official economic forecasts envisage Russia's gross domestic product growing at an average annual rate of 2.5 percent over the next two decades, less than the global average and much slower than some of its emerging-market peers.

Not everyone at the Finance Ministry, which manages the National Welfare Fund from which money will be taken to buy Ukrainian Eurobonds, is happy that cash supposed to be kept for helping Russia's growing population of pensioners will be used to aid an impoverished neighbor, government sources said.

The Finance Ministry is having to change the rules to let the Welfare Fund invest in Ukrainian debt because Kiev's credit rating is lower than the Fund's charter permitted.

IT'S GEOPOLITICS, NOT THE ECONOMY

Putin is widely seen as having put geopolitical interests ahead of financial concerns as he tries to woo Ukraine into a political and economic union of former Soviet republics which he wants to stretch from the Pacific to the EU's borders.

Christopher Granville, managing director of Trusted Sources, an emerging markets research group in London, said the Russian taxpayer and economic stability were "being put at risk in the interest of the geopolitical quest".

Putin regards Ukraine, with its large population, mineral resources and ability to act as a bridge to the EU market, as vital to the success of a Eurasian Union he wants to create to match the economic might of the United States and China.

But two decades after the collapse of communism broke a centuries-old link between Kiev and Moscow, Ukraine's GDP per head is not just well below that of Russia but is only half that of Bulgaria, the poorest country in the European Union.

Ukraine's needs are great - it has to cover an external funding gap of $17 billion next year - almost the level of the Ukrainians central bank's depleted currency reserves.

"At some point investors will realize that Russia is increasing its credit exposure to Ukraine, which is a much lower credit-quality sovereign," said Stanislav Petrov, a strategist at BNP Paribas in London.

Standard and Poor's rates Russia's long-term debt BBB and Ukraine's B-, several notches below.

Russia's economic gain from Tuesday's deal is hard to see, prompting speculation that Putin may have won more than what has been made public or that talks are still under way.

Although unannounced deals might include, for example, agreement for Russia to control pipelines in Ukraine that carry Russian gas to Europe, the uncertainty in unsettling for some investors.

"We have not yet seen what Russia will be getting out of this and for me that is the worrying part," said Sergei Strigo, head of emerging debt at asset managers Amundi in London.

"Either it's something they are not revealing or it's still up in the air."

RUSSIA CONFIDENT

Siluanov said it was the right decision to help Kiev out: "Ukraine's assets certainly do not have such high ratings as other paper in which we now invest our reserves," he said.

"However, we understand the need to support our neighbor, as we have very tight trade and economic connections."

He shrugged off worries that the $15 billion makes up almost one-fifth of the money in the National Welfare Fund and that using the money would hit Russia's credibility with investors. "There is no basis for that," Siluanov said.

As the world's biggest oil producer, Russia has sizeable cash reserves. However, the Russian economy is running at the slowest pace in four years - the World Bank forecasts GDP growth of 1.3 percent in 2013 and 2.2 percent in 2014 - and has little chance of topping up its reserve funds as in the boom years of Putin's first presidential terms from 2000 until 2008.

Ukrainian Prime Minister Mykola Azarov hailed the Kremlin pact as "historic" and said it would revive economic growth.

But many Ukrainians are far from grateful to either Putin or Yanukovich and are suspicious of Moscow's intentions and feel more drawn to the freedom and prosperity of the West.

"He has given up Ukraine's national interests, given up independence," Vitaly Klitschko, an opposition leader and heavyweight boxing champion, told protesters on Tuesday.

"I think the people will eventually have it their way. We will sign up to Europe. That's why I'm here," said Snezhana, a factory worker who spent the night on Kiev's snowy main square.

Businesswoman Irina Litvinianko said: "It's hard to imagine it could end up in anything else but a change of power."

Russia, in turn, accuses European Union leaders of trying to browbeat Ukraine into a closer association. Foreign Minister Sergei Lavrov told parliament in Moscow on Wednesday that "overt pressure" had continued despite the Kremlin deal.

He denied that Russia, which threatened Ukraine with trade sanctions if it signed up to an EU pact, had forced Kiev into signing the accord with Moscow and accused the West of trying to deny Ukraine its sovereign right to choose its own course.

(Additional reporting by Richard Balmforth, Natalia Zinets, Gabriela Baczynska and Pavel Polityuk in Kiev and Maya Nikolaeva in Moscow, Writing by Timothy Heritage in Moscow; Editing by Alastair Macdonald)

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