The Washington Post reports on Ukraine's Worsening Economic Crisis.

(emphasis mine) [my comment]

Ukraine, the Real Crisis on Russia's Doorstep

Last month NATO allies met in Bucharest and talked about the membership applications from Ukraine and Georgia. It was the latest episode in an 11-year-old courtship between the Western military alliance and the two former Soviet republics that Russia still sees as part of its orbit.

But NATO would have done more for Ukraine's - and Europe's - security if it had insisted that Ukraine reform its energy sector. Just one month after the Bucharest meeting, Ukraine is mired in its third annual natural gas contract dispute with Russia's state gas company, Gazprom, and the dispute is threatening supplies for much of western Europe because Russia's main pipeline to Europe transits Ukraine.

Reports from Europe today say that gas deliveries to Europe may have come to a complete halt; Russia and Ukraine are blaming each other for the disruption. This will undoubtedly bring a wry smile to the faces of conservatives who in the 1980s warned Europe against relying too heavily on Russia for natural gas supplies. President Reagan tried to stop the pipeline project back then. Back in 1982, an American Enterprise Institute report warned that the Soviet pipeline would be a "steel noose" that would create the potential for "economic blackmail."

Whether the current showdown is a contract dispute or economic blackmail isn't clear. It might be the former.

Nonetheless, if ever there were an example of how security cannot depend on military might alone, this is it. Ukraine's economy has been closed to outside investors eager to get into the natural gas supply and distribution business. Its dealings with Gazprom have been complicated by the role of RosUkrEnergo, a middleman company which appears to have little purpose other than siphoning off some of the money paid for natural gas.

Ukraine's energy-inefficient industries increase the need for supplies from abroad. And the country has done nothing to diversify supplies, preferring to rely on purchases from Russia at prices that remain below world market levels. [just like the US has done nothing to diversify its reliance on imported foreign goods, preferring to rely on purchases from China at artificially cheap prices.]

A December report by the International Monetary Fund said, "Consumers in Ukraine now pay only 10-40 percent of the international price of gas. This subsidization encourages overuse (Ukraine is among the world's least energy-efficient countries), expands the need for very costly imports, and through the required budget subsidy (or unpaid taxes) distorts spending and taxation." Ukraine uses more energy per unit of GDP than almost any other nation in the world and more than two and a half times as much as the average of the OECD nations. Now Ukraine has promised to bring domestic energy prices in line with international costs, but that will fuel inflation and will only be phased in over three years or so.

This energy mess couldn't come at a worse time for Ukraine's economy or the economies of Eastern Europe. In November, with the international financial crisis hammering Ukraine, the IMF extended a $16.4 billion line of credit to help restore stability. But a recent note by Erik Berglof, Chief Economist of the European Bank for Reconstruction and Development, warns that the IMF package might not be enough. "Ukraine is heading toward a twin currency and banking sector crisis that could well bring down most of the economies of Eastern Europe," he writes. Rapid currency depreciation is threatening the banking system because many firms borrowed in dollars. A few Western banks, mostly from the European Union, have major exposure in Ukraine, he notes, and that could spread the ill effects around the region.

Moreover, Ukraine faces massive debt rollover perils in 2009. As much as $41.5 billion (roughly 35 percent of GDP) external amortization payments are falling due,and refinancing in the current financial climate will be difficult, or at least costly.

Finally, Ukraine's GDP is expected to drop between 3 percent and 10 percent in 2009, Berglof says in the memo. And that could roil Ukraine's domestic politics in ways that might not be favorable to democracy and rapprochement with the West. "Securing a stable and democratic Ukraine, a country of 46 million people in the heart of Europe, is squarely in the interests of the United States and Ukraine's European neighbors," he wrote. "The progress in political and economic transition since the Orange Revolution in 2004 is being put at risk."

So this week's spat with Russia over natural gas supplies and prices may simply be the opening act in a year of pain and drama in Ukraine. And NATO membership would be no cure.

My reaction: Ukraine's hryvnia has joined the list of failed currency along with Zimbabwe's dollar, Iceland's Krona and the Seychelles's Rupee. Ukraine's economy is in a terrible economic position.

Ukraine's energy inefficiency

Ukraine is among the world's least energy-efficient countries. Ukraine uses more energy per unit of GDP than almost any other nation in the world and more than two and a half times as much as the average of the OECD nations.

Reliance on artificially cheap foreign imports

Consumers in Ukraine now pay only 10-40 percent of the international price of gas. Russia has been subsidizing Ukraine with artificially cheap gas the same way China has been subsidizing the US with artificially cheap consumer goods. I believe the China is getting ready to back out of this relationship, like Russia is doing with Ukraine.

Ukraine's troubles will have spillover effects

As the article says above, "Ukraine is heading toward a twin currency and banking sector crisis that could well bring down most of the economies of Eastern Europe," I am inclined to agree with this statement. The Ukraine crisis has many interesting global and dollar implications that I will be looking into in more detail later.