Global Economics

The Prognosis for Ukraine


The economic numbers look terrible, but some argue Ukraine is better off than it appears. The bigger problem remains divisive politics

Following events in Ukraine is like listening to the tale of the boy who cried "wolf": people have been shouting "crisis" for so long that it is hard to tell whether or not a terminal crisis has finally arrived.

The situation does look pretty bad. Ukraine's chronic political stalemate has run into the buzz saw of a global economic recession. Then add to the mix an obstreperous Russia, eager to flex its muscles – as shown by its willingness to cut gas supplies for an unprecedented two weeks this January.

First, the grim economic numbers. The hryvnya has lost 60 percent of its value against the dollar over the past year – despite the government spending $11 billion of its reserves in an effort to shore up the currency. The global slump saw demand collapse for Ukraine's export commodities like steel and chemicals. By January, industrial production had fallen by 34 percent year on year. Inflation is running at 22 percent, while real wages have fallen 12 percent. This is by far the worst performance of any of the Commonwealth of Independent States economies. The International Monetary Fund is predicting that GDP will fall 6 percent in 2009.

Sixty percent of Ukraine's loans and mortgages are held in dollars, and in October fears of a bank run and currency collapse led the Ukrainian government to negotiate a $16.4 billion loan from the IMF. The first $4.5 billion tranche was paid out, but the IMF suspended the second payment, due in February, because the government failed to make politically unpopular spending cuts (including cuts in utility subsidies) and the parliament passed a budget based on over-optimistic assumptions about revenue and hence spending for 2009.

The mounting economic crisis was exacerbated by the feuding between President Viktor Yushchenko and his archrival, Prime Minister Yulia Tymoshenko, whose backers maintain an unsteady majority in the parliament, the Verkhovna Rada. In October, Yushchenko tried to disband the Rada and hold fresh elections but backed off after complaints from Western allies. In November, he suspended talks on the 2009 gas contract with Moscow, helping to trigger the January gas crisis. More recently, on 4 March he sent the National Security Service to raid the headquarters of the gas company Naftogaz Ukrainy, seen as loyal to Tymoshenko.

The Rada in turn succeeded in ousting Foreign Minister Volodymyr Ohryzko, who was accused of mounting an anti-Tymoshenko publicity campaign, although legislators called a cease-fire in February in their attempts to fire the head of the central bank. The finance minister, Viktor Pynzenyk, resigned on 12 February; six weeks later the post remains unfilled. This is not the most auspicious time for the state treasury to be without a head.

The politicians are maneuvering in preparation for the presidential elections scheduled for January 2010. Yushchenko himself has no chance of prevailing (polls put him at 3 percent support). It will likely be a three-way race among Tymoshenko, Party of Regions leader Viktor Yanukovych, and a new contender, the 34-year-old former parliamentary speaker, Arseniy Yatsenyuk.

Some observers insist that the fundamentals of the Ukrainian economy are sound. Anders Aslund of the Peterson Institute in Washington, D.C., the best-informed specialist on the Ukrainian economy, insists that a default is unlikely and argues that Ukraine has met the IMF's key conditions. On one condition, balancing the budget, the fund has lightened up and now appears willing to accept a modest deficit. By March Ukraine still had $26 billion in reserves, enough to cover eight months of imports. In 2008 the government's fiscal deficit was a modest 1.5 percent of GDP, and the external trade deficit was about 7 percent of GDP. The state's foreign debts amount to about $24 billion, or some 20 percent of GDP, well below the levels usually seen in pre-default economies. Corporate debts are higher, estimated at $40 billion or more, but the fall in world oil and gas prices will ease pressure on an economy that is highly dependent on imported energy.

WHAT'S THE WEST TO DO?

The European Union itself has a great deal at stake, given its dependence on Russian gas pumped across Ukraine, and given the exposure of Austrian banks in Ukraine. But the EU lacks a common approach and has delegated the job of handling Ukraine's financial problems to the IMF.

Meanwhile, back in Washington think tanks have been issuing reports urging the Obama administration to act – to encourage the feuding Ukrainian leaders to cooperate in implementing the IMF program. They argue that Ukraine is too big – and too strategically located – to be allowed to fail. While they no longer call for an immediate pre-membership plan for NATO entry, recognizing that this step is opposed by many NATO partners, they still advocate helping prepare Ukraine to join the alliance. In the Brookings Institution report "Engaging Ukraine in 2009," authors Steven Pifer, Aslund, and Jonathan Elkind baldly state that "the primary reasons for engaging Ukraine remain geopolitical," that is, to "encourage Moscow to pursue a more cooperative, integrative foreign policy and give up any thought of seeking to restore the Russian empire." Such policies would probably serve to redouble Moscow's determination to push back against the American presence in the region. So it is not at all clear that Ukraine would benefit from efforts to talk up and politicize the economic crisis.

Ukraine's dilemma is that pressure to speed up external integration with Western institutions is opening up rifts within Ukrainian society that threaten internal disintegration, given the ideological distance between western Ukraine and the east and south of the country. These divisions are of course being exploited by a rogue's gallery of Russian political actors. But Western pressure, diplomatic or economic, is only likely to exacerbate the problem.


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