Ukraine’s Rust Belt Fears Ruin as Putin Threatens Imports

 For Pavel Cesnek the future of his sprawling locomotive maker in eastern Ukraine lies in the balance and its fate will be sealed across the Russian border.

The head of Luganskteplovoz in the city of Luhansk rules over a communist-era factory and workforce of 6,500 that builds trains primarily for state-run OAO Russian Railways. Like many local businessmen, he fears the pro-European government in Kiev will antagonize the Kremlin into unleashing trade restrictions that could wipe out industry across Ukraine’s rust belt.

prorussianactivist_small Ukraine's Rust Belt Fears Ruin as Putin Threatens Imports

“Trade ties with Russia are an existential question — to be or not to be,” said the 40-year-old Czech. “Without Russia, there’d be a total collapse for me, my workers and my owner.”

President Vladimir Putin is threatening to halt Ukrainian imports as he tries to cool his neighbor’s plans to integrate trade with Europe after the ouster of its Russian-backed leader in February. Ukraine’s east, whose metals and machinery plants rely on demand over the border, has been rocked by pro-Russian separatists who’ve seized official buildings and taken hostages.

While the eastern regions of Luhansk, Donetsk, Kharkiv and Dnipropetrovsk are home to 28 percent of Ukraine’s 45 million people, they accounted for almost half of industrial output in January-February, statistics service data show. Luhansk sends 70 percent of its exports to Russia, according to the service.

Eastern Reliance

“Our markets are in the east,” said Eduard Lozovskyy, who was first deputy governor of Luhansk until the new administration in Kiev replaced him last month. “Right or wrong, that’s a fact. It’s no coincidence western Ukraine is pro-Europe because they don’t produce anything.”

The Donetsk region is home to Metinvest, Ukraine’s largest steelmaker, owned by Rinat Akhmetov, the country’s richest man with an $11.8 billion fortune, according to Bloomberg’s Billionaires Index. The nation’s western provinces grow crops — such as wheat and corn — and also rely on service industries including tourism and information technology.

Ukraine’s economy, which has endured two slumps since 2008, is already facing a recession the government says will erase 3 percent of gross domestic product this year. Ukraine is awaiting approval for an International Monetary Fund loan to unlock $27 billion in financing in the next two years, with the hryvnia stuck at a record low.

Enduring Recession

“If they can’t export east, you could see a recession for east Ukraine that lasts many years,” Chris Weafer, a partner at Moscow-based Macro Advisory, said by phone. “The best option for Ukraine would be to mend fences with Russia in the short term while working toward developing a market in the EU.”

Russia has imposed bans or delayed shipments of Ukrainian goods several times during the last year as Ukraine’s government pushed ahead with plans to sign a European Union trade accord. Ukraine later changed its mind, sealing a $15 billion bailout from Russia that Putin withdrew after the ouster of his ally, President Viktor Yanukovych.

Russia has seized a confectionery factory belonging to billionaire Petro Poroshenko, a pro-European candidate in May 25 presidential elections, and halted most cheese imports this week, according to Ukraine’s Agriculture Ministry. Putin ordered the government yesterday to draw up a plan to replace Ukrainian imports in full.

Ukraine accounted for 5.6 percent of imports to Russia last year, compared with China’s 16 percent, data compiled by Bloomberg show. Ukrainian imports to Russia fell 12 percent to $15.8 billion, according to Russia’s Federal Customs Service.

Yachts, Palaces

“If Putin closes the border like he did last year, only for longer, many plants around here will lay off nine out of 10 workers,” said Andrei Nedoves, head of ZAO Avtomotozapchast, which makes automotive valves and employs 550 people.

The Luhansk’s region’s factories employ 40 percent of workers, who earn about a third more than average, according to the local administration.

Ukraine must overhaul its Soviet-era industrial base because it can’t rely forever on selling uncompetitive goods to Russia, according to Oleksandr Kendyukhov, head of the economic management department at Donetsk National Technical University.

“For 20 years, Ukrainian industry bought yachts and palaces rather than modernizing,” Kendyukhov said. “Dependence on the Russian market is futile because it’s based on politics rather than economics. The risk of a closed border isn’t conducive to investment.”

In rejecting the EU trade pact last November, the previous government cited the long period of adjustment Ukraine would need to retool its factories for European competition. That prospect alone scares some.

Job Peril

“Ukraine’s future may be in Europe, but what can I tell my workers if they lose their jobs now?” said 46-year-old Nedoves, Avtomotozapchast’s chairman. “They can’t wait five years for new investors if they need to feed their children tonight.”

His company sells 95 percent of its output to clients in Russia and Belarus, the biggest of which is Kazan, Russia-based truck maker OAO Kamaz. At present, Ukraine sends about a quarter of its exports to Russia and the same amount to the EU.

Back at the locomotive plant, part of Russia’s Transmashholding, which is quarter-owned by France’s Alstom SA (ALO), Cesnek is similarly downbeat on the prospects of reorienting Ukraine’s exports westward.

He estimates that only 5 percent to 10 percent of Luhansk’s factories produce goods that would find a market in Europe.

“The goal of selling to Europe isn’t realistic,” Cesnek said. “Our market is the former Soviet Union.”