Over the first four months of this year, Ukraine lost $0.5 billion in exports of ferrous metals. Export sales in monetary terms thinned out by 15% A cut in prices is not the only reason for this situation. In actual fact, the market situation is worse than a year before. Prices for flat products in January–April fell by an average of 6–7% y-o-y, rebar — by 10%, semi-finished products — by 10–12%. But there is also a decrease in physical volumes of 300 thousand tons, or 5.4%. Here we see an interesting trend: exports of semi-finished products grew by about 7.5%, while exports of rolled products declined by almost 16%. This is one of the consequences of the growing global protectionism.

The use of various protectionism measures sharply increased in 2018–2019. At the same time, developed economies set trends in this area. The very word ‘protectionism’ is abusive among economists, although these tools are being used more and more intensively every year. And this is not a passing ‘fashion’, where some things are suitable today, and tomorrow brings something totally different. We are talking about evolutionary development of these ideas that have been maturing for many years.

The development of protectionism is a logical consequence of global processes in society and in economy:

  1. The growing popularity of nationalist sentiments, the greater influence of the right-wing forces on both political and economic processes. This impedes globalization and trade openness.
  2. The world has reached the peak of globalization, there is no room for development, openness has ceased to be economically viable, thus the reverse compression process has begun.
  3. The WTO crisis was caused by the weak discipline of compliance with the terms of agreements by some countries, the suspension of the Appellate Body, conflicting views of key stakeholders on the reform of the organization.
  4. The approaches to industrial policy have changed amid pressure on employment due to technological shifts and the expansion of Asian countries.

That is why in the coming years we should not expect the abolition or mitigation of protectionist measures. On the contrary, their enhancement is more likely.

What does this mean for Ukraine? If we analyze the structure of Ukraine’s metals exports, we can see that any changes that have occurred in the past five years are caused only by the introduction of various restrictive measures against domestic products. 36 such measures were imposed in 13 countries. To put things simply, we were just driven away from the CIS. Then they forced us out from the U.S. and the EU to the MENA countries. Now our presence in the MENA region is at stake. We have nowhere to run anymore.

This is how it looks in figures:

The whole world bristled and closed. And the economic crisis due to COVID-19 only strengthens protectionist sentiment:

The rules have changed. Protectionism is a new norm. You may deny or ignore it. Or proudly raise your nose and claim it’s ‘no good’. You can poke your finger at our trading partners, trying to prove to someone that is unfair. Though, this will change nothing. You need to adapt, learn to live with it, neutralize the consequences, if possible benefit, since this phenomenon will not disappear in the near future.

Initially published on Liga

Lockdown measures taken by countries erode national economies. However, no one has yet figured out how to minimize the effects of the current pandemic on the economy. Ukraine and the world have faced such a huge challenge for the first time ever.

Quarantine

A decline in the U.S. gross domestic product is currently estimated on average at 35% in Q2 and 3.3% on a y-o-y basis. Developed economies can flood the economy with money without fear of inflation risks. In contrast, Ukraine cannot afford that.

In our country, GDP is expected to fall by 20–25% in Q2 and by 6–10% on a y-o-y basis. This means Ukraine has a chance to suffer less losses in Q2 than other countries, but more losses at the year end. It turns out that the country cannot afford an ongoing and strict quarantine, since our economy will not be able to recover after it.

The quarantine in its current form is causing enormous damage to the economy and to every Ukrainian. It would seem that nothing is impeding the operation of industrial companies. However, indirect effects should be taken into account. Specifically, companies are experiencing tremendous difficulties in bringing workers to and from work, transporting raw materials and goods.

What if the number of cases of disease does not decline in May? If the quarantine lasts for two months and fails to produce results, this would mean it was not properly organized. Do we need tougher measures, including suspension of industrial production?

In case of a strict quarantine, we could lose 16–20% of GDP, i.e. the share produced by processing and mining industries. A slowdown in the industry will affect other sectors. As a result, scenarios of a crisis looming on a catastrophic scale are not improbable.

It should be understood that some industries cannot be halted. And if they are, their restart would require colossal costs. I am now talking about steel works, coke plants, coal mines. The specifics of operation of coal mines, for instance, does not allow suspension of pits until they are completely exhausted, otherwise mining pressure may eventually crash equipment.

The same is true for the agro-industrial complex as well. Its uninterrupted operation is a matter of food security. Stable operation of the chemical industry is a basis for rhythmic operation of the agro-industrial complex.

Everything is interrelated in the economy. The strictness of quarantine measures in one production segment will inevitably lead to interruptions in other sectors of the economy.

So, it is necessary to think right away how to change an approach to combating the epidemic. I would recommend taking selective measures targeting both the public and the economy.

Anti-crisis measures

There is no need for sector-specific measures to support and develop the industry. Support measures should be in place for the entire industry and exporters: agro-industrial complex, mining&metals sector, energy, mechanical engineering, transport infrastructure, chemical industry and others.

The list of the most important, in my opinion, measures ranked in order of priority is given below:

  1. Ensure movement of employees to and from work (unimpeded access to workplaces).
  2. Ensure uninterrupted operation of logistics infrastructure (Ukrzaliznytsia (Ukrainian Railways), ports, river infrastructure) prioritizing domestic transport over transit.
  3. Reduce tax pressure on business: ensure real automatic VAT refunds without artificial delays for document checks; support producers by allowing deferral of single social security tax, land tax, environmental taxes. This will enable companies to retain liquidity and save jobs.
  4. Cut tariffs and ban a further increase in tariffs of state monopolies: set reasonable tariffs at ports; decrease tariffs of Ukrzaliznytsia, as the producer price index dropped by 7.4% last year.

To rebound the economy, it is necessary to create a domestic market and encourage investment. This needs to be done through the following steps:

  1. Implement the state target program of infrastructure project development (Ukrzaliznytsia, ports, river infrastructure, road fleet, energy).
  2. Step up the reform of Ukrzaliznytsia providing for its division into three operators.
  3. Launch a home loan program.
  4. Expand lending to purchase domestic machine engineering products.
  5. Increase government orders for Ukraine-made products of the military-industrial complex.

The crisis is a catalyst for reforms. Therefore, efforts should be focused on improving the investment climate to make it a key performance indicator (KPI) of the Cabinet of Ministers in the long term.

Even hints of default are not allowed in this context. The government and the population are interested in business development and investment. And the business is interested in borrowing at low rates. This is possible only given a high sovereign rating and a good investment climate in the country. Default will derail everything and deepen the economic crisis.

I am confident that laws needed to renew the cooperation program with the International Monetary Fund will be adopted despite some difficulties. Cooperation with the IMF will minimize the risk of sovereign default both this and next year.

Governments of advanced and emerging economies support the industry seeking to save and create jobs. According to the IMF, government loan guarantees have become an important tool of business support.

Besides, it is necessary to protect the domestic market against unfair competition and growing imports, because competition in foreign markets is becoming fairly intense. To protect business today means protect the employment.

Areas of focus are clear. Some of them do not require an increase in budget spending. These include reform-related and regulatory measures. It is necessary to set priorities for the rest, because the budget is limited. However, time is also a limited resource in this situation. The fight against the crisis requires prompt and decisive action.

Initially published by Іnterfax-Ukraine

About every 5 years, the steel industry experiences a sharp slump in financial results due to cyclical recessions in the market. The industry is capital intensive. In other words, to carry out modernization projects or to maintain operating capacity, one needs to take a risk and to raise large amounts of money in the debt market. Those companies, which at the time of cyclical crises are in the middle of investment cycle or have a high debt burden, often become insolvent.

The debt burden in the industry is critically high. According to Ernst & Young, an accounting and consulting firm, Net Debt/EBITDA ratio of steelmaking companies was 4.5 in 2016. To date, the situation in the industry has not globally improved. What does it mean? During a market slowdown, this indicator increases to 5–6, thus indicating a high likelihood of debt service problems. And since it is an average value, the indicator is much larger for some companies.

Access to capital is particularly important in these circumstances. Companies from countries with developed financial markets attract long-term debt. In this way, they reduce the risk that a period of debt repayment will be unfavorable. Companies from developed economies also have more chances to refinance debt.

This thesis is confirmed by the almost complete absence of companies from developed economies on the bankruptcy list (with few exceptions usually associated with government interventions). For instance, British Steel was strongly influenced by Brexit. Some cases are linked to a ban imposed on companies whose operations cause significant environmental damage, such as Ilva, ERP Iron Ore. Funding costs also makes a difference: from 1–2% in the EU (Thyssenkrupp-2023 — 1.875%) to 10.25% in Ukraine (Interpipe-2024).

Companies from emerging economies are more vulnerable to defaults. This typically happens after cyclical recessions in the market: India — 5 defaults in 2017, Turkey — 3 defaults in 2019, China — 5 defaults in 2016–2018, Brazil — 2 defaults in 2016–2017, Ukraine — 5 defaults in 2009–2015.

Defaults are often caused by bad M&A deals where the buyer takes on a debt load, whereas the results do not meet expectations. A striking example is Mechel, Russia’s vertically integrated mining and metals company that closed a number of major deals before and after the 2008–2009 crisis when it faced problems. For instance, in 2011, Mechel bought Donetsk Electrometallurgical Plant (DEMP) for $537 million. Yet back in 2012 it made unsuccessful attempts to sell it. There is also much talk about problems allegedly caused by activities of Sanjeev Gupta’s Liberty House in the M&A market. Specifically, Infrabuild, an Australian steel unit, could not place bonds in full in the autumn of 2019 despite a 12% coupon. In 2017–2019, Liberty House completed some deals with troubled companies that needed capital injections to work effectively.

The situation is aggravated by excess capacity in the industry. Although the situation improved and the industry’s capacity utilization rate increased to 81% in 2017–2018, there are 400–450 million tons of unutilized capacities in the market. This creates a constant pressure of the supply even when the demand is high. Hence, manufacturers’ margin is insufficient for substantial investment and reduction of the debt burden. An average EBITDA margin in the industry over the past few years is 10%.

The importance of the process of forecasting prices and market slowdowns is increasing. For instance, iron ore prices fell by 50% from January to December 2014 and by another 20% by September 2015. Rebar prices in 2019 dropped by 15% in 4 months, from July to October. The current situation with coronavirus epidemic also increases the uncertainty and threatens a sharp fall in both China’s economy and commodity prices. Given poor predictability of the situation, companies are very cautious about investment projects and M&A transactions. Their important task is to ensure sustainability and right balance between the development pace and mitigation of risks.

Absence of hedging instruments in the sector adversely affects the ability of companies to withstand crises. The relevance of these instruments increases with increasing volatility in the market. The futures market (ore, rebar) currently operates only in China. According to the World Steel Dynamics, the 2019 crisis will prompt the development of the steel derivatives market outside China, as the need to hedge price risk is greater than ever.

Almost all major players in the steel market in Ukraine have gone through a technical default procedure. The reason is the same for all. Companies borrowed large amounts of money, including from foreign sources, to carry out key investment projects:

Yet in the periods of crises of 2008–2009 and 2014–2015, companies experienced difficulties in servicing these debts. The conflict in Donbas and the loss of assets dealt a serious blow to the industry. As a result, ISD and Donetskstal actually ceased to exist.

Global trends that cannot be prevented are challenging the industry. On the one hand, problems in the global economy, deindustrialization, and excess capacity in the industry make the market weak in a long-term perspective. On the other hand, the need for decarbonization and digitization increases the industry’s demand for investment. In these circumstances, steelmakers are nevertheless forced to take risks and invest so as to remain competitive.

Capital-intensive business in a cyclical industry poses high risks in developing economies. For domestic manufacturers, the situation could change due to:

Initially published on Liga.Net

* Default means the debtor’s inability to pay in full its outstanding liabilities to the creditor.

Bankruptcy means the recognized by a competent public authority inability of the debtor to pay in full its outstanding liabilities to the creditor.

Technical default means the situation when the debtor fails to comply with loan conditions, but demonstrates readiness to comply in the future. Technical default may end in an agreement with the creditors on debt restructuring (changes in the terms of repayment) or on adjudication of the bankruptcy of the debtor.