Ri Insights

Betting on Ukraine

Betting on Ukraine by Andrés Velasco







By: Andrés Velasco *

Exclusively published in Kuwait by: Rai Institute

Betting on Ukraine by Andrés Velasco


KYIV – A year ago, young Ukrainians were risking their lives on Kyiv’s Independence Square to defend an agreement that would bring their country closer to the European Union. That uprising ended a corrupt regime and brought to power – after a free and fair election – what appears to be Ukraine’s most reform-minded government ever.

One might have expected the heroic commitment of Ukrainians to Europe’s democratic ideals to trigger a rush of Western support for the country in its battle against Russian aggression and economic instability. But that has not been the case. Indeed, though the last EU leadership summit of 2014 brought the courageous decision to “stay the course” on Russian sanctions, it produced little movement on aid to Ukraine.

Donald Tusk, the former Polish prime minister who was chairing his first summit as President of the European Council, supports additional financing for Ukraine. But, as the Financial Times reports, several EU countries’ willingness to come up with the money remains “lukewarm at best.”

When confronted with a debt crisis in the eurozone, European leaders repeatedly kicked the can down the road. The result was an unnecessarily deep and protracted recession. Now, they are about to make the same mistake in Ukraine, with even more devastating potential consequences.

Ukraine is facing a steady drain on bank deposits, large fiscal and current-account deficits, and sizeable external debt payments in the next few years. With its international reserves dwindling, the country cannot finance these gaps with its own dollar resources. The International Monetary Fund has estimated that Ukraine will need $15 billion in outside help in 2015, in addition to the $17 billion bailout that it received last year. The funding gap extends into 2016 and beyond.

Stabilizing Ukraine’s economy will, of course, require deep domestic reforms. The government will have to cut energy subsidies to reduce the yawning deficit of Naftogaz, the state-owned oil and gas company. At the same time, the central bank must continue to clean up and close insolvent banks and ensure the recapitalization of viable financial institutions. And, with Transparency International’s corruption perceptions index ranking Ukraine 142nd out of 175 countries, drastic measures to improve and professionalize governance are imperative.

But these reforms can succeed only in an environment of financial stability. With the fiscal deficit being financed through money creation, inflation is high and the hryvnia, Ukraine’s currency, has depreciated (though nowhere near as much as the Russian ruble). An external aid package that is large enough to restore confidence and assuage financing doubts is a precondition for successful structural reform.

The other prerequisite is political legitimacy. After all, reform demands tremendous sacrifices from citizens. Elsewhere in Central and Eastern Europe, citizens readily accepted such sacrifices, because generous financial assistance from the West and the prospect of EU membership lent credibility to the promise of democracy and future prosperity.

Ukrainians must perceive that the pain of adjustment is being shared fairly, which means that the country’s oligarchs must become subject, at long last, to the rule of law. But, given that a free, stable, and prosperous Ukraine is very much in Europe’s strategic interest, the EU’s member governments should also share the burden of financing reform. The funding that Ukraine will need to stabilize its economy over the next four years looks paltry when compared to the more than $300 billion, from different sources, devoted to bailing out Greece – a country where there is far less at stake strategically.

During previous financial crises, from Mexico in 1994 to southern Europe recently, the international community has proved that it can be very creative when it comes to finding mechanisms to channel emergency funds. This suggests that the problem today is not insufficient money or institutional constraints, but a lack of political will.

Skeptics in the EU and the German government acknowledge the urgency of Ukraine’s plight; but they fear that the money will go to waste in the absence of comprehensive reforms. Cynics privately add that hyperinflation may not be such a bad thing after all, because it would force local politicians to reform. But that ignores history: Ukraine suffered hyperinflation in the 1990s, only to elect governments headed by President Leonid Kuchma, whose misrule incited the Orange Revolution in 2004, and President Viktor Yanukovych, who was overthrown in February 2014.

Clearly, such complacent views are both wrongheaded and terribly dangerous. The success of reform efforts can never be assured in advance. But one factor that can guarantee failure – and lead to political and economic dislocation – is financial instability.

The current government in Ukraine has an unprecedented electoral mandate for change. It has also drawn into public service some of the country’s best and brightest (including from the Ukrainian diaspora) to fight a war and stave off an economic meltdown simultaneously.

One hesitates to consider what might happen if they fail. Plan B in Ukraine is surely not more reform, but less of it – and probably the kind of reckless economic populism that Latin America has witnessed in recent years, from Hugo Chávez’s Venezuela to Néstor and Cristina Kirchner’s neo-Peronist Argentina.

That possibility alone should be sufficient to spur the IMF, the United States, and, above all, the EU to act. In the grey and depressing days of the Soviet Union, an independent and democratic Ukraine seemed unimaginable. Yet it happened. Today, economic and political reform seems similarly daunting; but it remains just as attainable. For Western governments, coming to the aid of Ukraine is a gamble, but one that is surely worth taking.

© Project Syndicate

*Andrés Velasco, a former finance minister of Chile, is Professor of Professional Practice in International Development at Columbia University.

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