DAVOS, Switzerland — During the Jan. 22-26 World Economic Forum in Davos, Switzerland, assessments varied of the state of the global economy.
International Monetary Fund managing partner Christine Lagarde kicked off the forum with an upbeat picture of the global economy in the near term, but cautioned that there were a number of risks over the longer term.
Certainly the global economy is witnessing a cyclical upturn: it is expected that 2017 global economic growth with reach 3 percent, up from 2.4 percent the year before. This growth has been driven mostly by increased investment, supported by incredibly low interest rates for a sustained period and vast asset purchases by the world’s largest central banks, which have accumulated $21.4 trillion in assets, or as much as a quarter of all bonds in issuance.
With the resulting demand for money so low and a constant search for higher yields, it is no surprise that equity valuations have climbed as investors take on more risk.
The Standard & Poor’s 500 has doubled in five years (compound annual growth of 15 percent) and emerging narket bond yields are beginning to look dubiously low with investor behavior showing signs of questionable exuberance (look at Argentina, a serial defaulter, successfully issuing a century bond last summer).
Ukraine has tapped into some of this exuberance by pulling off an impressive 15-year, $3 billion bond issuance in September.
Perhaps the strongest indicator that risk appetite among investors is getting out of hand is the meteoric rise of Bitcoin, an asset class backed by nothing but anonymity and a vast waste of energy through “mining.” The cryptocurrency bubble is now firmly on the radar of the world’s regulators and economists as shown by the air time it got this year at the World Economic Forum.
It is striking that markets with such an inflated risk appetite are unwilling to invest meaningfully into Ukraine.
The issuance of September’s Eurobond, essentially a bet on the West’s support for Ukraine, was perhaps the apex of enthusiasm for “Invest in Ukraine.” Speaking to international investors in Davos, I felt the growing Ukraine optimism of 2017 was on the wane.
Three things were at the front of the minds of investors and economic commentators with regards to Ukraine:
Corruption
Few seemed convinced that reforms had yet led to a structural transformation of Ukraine’s national institutions. Embarrassing feuds between law enforcement agencies and persistent miscarriages of justice have led the country’s backers to call for the creation of an anti-corruption court.
President Petro Poroshenko claimed consensus was found with the IMF and Venice Commission in relation to this court. The problem, he went on, was that lawmakers were blocking progress, but that this would soon be overcome. How the parliament will be brought onside is unclear, especially given that the opponents have a credible argument that foreign influence in the selection of judges represents an erosion of sovereignty. Sadly this argument is mostly used as a convenient block and a meaningful debate on the matter is unlikely.
Privatization
Monopolies conventionally make what is termed in economics as a “monopoly profit. By charging for goods at a rate considerably higher than marginal cost they make excess profits that would not be found in competitive markets (at the expense of the consumer). Many Ukrainian state-owned enterprises enjoy such market conditions and yet manage to make meager profits or even losses. A privatization program needs to be finalized and implemented after years of talk. Some pricing manipulation in the process is inevitable, but as long as international observation ensures private monopolies are not created out of public ones, then any losses from undervaluation will be made back quickly as competition purges rent-seeking.
Land reform
From the investors’ perspective, creating a private agricultural land market is a no-brainer. The World Bank estimates it could boost gross domestic product by $15 billion. However, discussions in Davos with lawmakers and political consultants suggested support among the public for such reform is fairly contested.
Key to investment
Implementing these three priorities will be key to attracting investment into Ukraine. However, there is a sense that global investment risk appetite is at a cyclical high and this appetite is likely to be hit by inflationary pressures. If global financial markets take a tumble, even the implementation of an anti-corruption fight, privatization and land reform will not be enough to attract capital to Ukraine.
I fear the timing of the March 2019 Ukrainian presidential election could not be worse as election campaigns tend to be rhetoric-heavy and policy-light. A failure to conduct meaningful reform in the first half of this year could mean Ukraine has to wait a number of years for the next surge in emerging market investment.
