from Macro and Markets

A Roadmap for Ukraine

June 28, 2015

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U.S. and European efforts to resolve the Ukraine crisis seem to be finding their stride in recent days. U.S. Secretary of Defense Ash Carter ended months of “will they won’t they?” by announcing earlier this week that the U.S. would be sending heavy weaponry into Eastern Europe, and late last week EU leaders declared that EU sanctions against Russia would remain in place through the end of 2016, quelling months of anxiety around whether EU resolve on sanctions would hold.

But surely if, as Carter put it, the real test is whether the U.S. and its NATO partners deliver on commitments to “stand up to Russia’s actions and their attempts to reestablish a Soviet-era sphere of influence,” then among the strongest measures of success regarding Ukraine will be whether the country remains capable of steering its own fate economically.

As we have written elsewhere, transatlantic diplomacy suffers from a muscle imbalance when it comes to Ukraine. Far too much of the focus of U.S.-European attention has been on punishing Russia and deterring future aggression; the U.S., Europe, and allies need to do much more to support Ukraine’s economy, and they need to do so soon.

Further, of what little international attention has remained focused on the economic dimensions of this crisis, the overwhelming share has fixated narrowly on the negotiations now underway between the Ukrainian government and its private creditors, which remain deadlocked. This is understandable—it’s a high-profile negotiation, significant amounts are involved, and the outcome is central to the country’s fate. But without a larger U.S.-EU economic vision for Ukraine to anchor it, even the most successful outcome to the current debt negotiations will likely be forgotten to history, swallowed by an ending in which no one—neither Washington, Brussels, Kiev, nor Moscow— comes off well.

What, then, to do?

Clearing the fastest possible path for Ukraine to return to market access requires five basic ingredients: a credible reform plan; secure medium-term financing; a reduction of government debt to viable levels; leaders capable of delivering those reforms; and a public which is willing to go along. In the view of some analysts, the pricetag for all of this is in the range of $40–50 billion over the next three to four years—not a small sum, but hardly imposing when compared to the hundreds of billions expended on lesser strategic priorities (e.g. keeping Greece in the eurozone).

If Greece and other eurozone crises teach us anything, though, it is this: finding the right ratios of these five ingredients proves to be as or more important as securing a certain topline amount of short-term external financing. To their credit, Western leaders recognized almost immediately that, as willing partners in Kiev go, it won’t get better than the team currently in place. But what they fail to appreciate is that this is not a static point: it is true that Ukraine has its most serious reform-minded economic team since it gained independence twenty-four years ago. The current government has made meaningful downpayments on its reform commitments, passing anti-corruption legislation last October, standing up a new anti-corruption agency this past spring, and curbing jaw-dropping energy subsidies—one of the greatest sources of the country’s corruption— over recent months.

Yet, it’s not enough. Support at home is eroding. Local opinion polls point to sharp declines in support for the Kiev government over the past year. Whereas nearly half of Ukrainian respondents viewed the Kiev government as having a positive influence a year ago, that figure is now down to one-third. More striking, this shift is particularly strong in western Ukraine, where those who view the government as a bad influence has jumped from 28 to 54 percent.

This suggests that, in calibrating the right ratios—in determining how and how aggressively to push on the debt negotiations and on the broader reform agenda—Western policymakers would do well to see their task as defined, above all, by doing what is necessary to help the current Ukrainian government shore up support.

So far, the IMF appears to understand this. The Fund is hosting a rare trilateral meeting of Ukraine and private creditors’ representatives in Washington this week in a hands-on bid to bridge the gaps between the two sides. The Fund also helpfully bolstered Kiev’s negotiating position by signaling last week that it was prepared to release the next tranche of its bailout even if Kiev suspended debt servicing. And it reacted warmly to Ukraine’s offer to issue securities linked to future growth in return for private creditors accepting a writedown in debt, what IMF head Christine Lagarde softly applauded as Ukraine’s “continued efforts to reach a collaborative agreement with all creditors.” The next step is for the government itself to meet with creditors, without conditions, to move the negotiations forward.

Just as the Fund is doing its part to see that Ukraine emerges from the current creditor negotiations with a sustainable debt load, so too must the United States, EU, and other Western leaders do theirs: coming together around a common, detailed roadmap that does everything possible to support and hold the Ukrainian government to its own stated priorities. These include shrinking the bureaucracy, eliminating dozens of inspection agencies, improving the caliber of civil servants, and unifying all energy prices at the market level, which would eliminate the greatest cause of top-level corruption.

There is no single correct answer as to what such a roadmap must entail. We’ve compiled a few suggestions and ideas all sides might do well to consider (many of which build on recommendations contained in an excellent report by the Vienna Institute for International Economic Studies):

  • Prioritize energy efficiency reforms. The United States, the EU, and international financial institutions should triage energy efficiency and electricity sector reforms atop their various potential conditions for further assistance. Model legislation, drafted with the assistance of the European Energy Community, already exists for both reform areas (the European Energy Community had a similarly leading role in the drafting of Ukraine’s recently passed gas reforms); all these electricity and energy efficiency reforms need is the inducement of Western financing.
  • Provide secure, multi-year financing. There is clear evidence of an emerging financing gap in the current IMF program, which should be addressed quickly. The IMF is unlikely to want to significantly expand its financial commitment, but shifting money from one year to the other or covering up the gap with optimistic economic assumptions is not the answer. Substantial multi-year financing commitments from major governments, in support of a strong reform effort, is the best way to restore confidence and stabilize the exchange rate.
  • Do more to expose the beneficiaries of corruption and wasteful subsidies and leverage the government’s footprint in the economy for good. All sides seem to agree that financial and material assistance should be conditioned on progress in reforming the legal system, including requiring clear strategies for monitoring reform implementation. Western efforts should put more concerted focus on taxation of oligarchic assets and confiscation of illegally amassed wealth, though, as the rightful entry points for encouraging broader public tax compliance. Finally, given the Ukrainian government’s large presence in the economy, Kiev might harness its outsized procurement power to lead by example, setting new transparency and anti-corruption standards for all entities doing business with the Ukrainian government.
  • Use government land to establish special economic zones, which might be backed by Western trade and investment preferences. To be attractive to investment, any such government-sponsored economic zone or park must provide clear ownership rights, good transport connections, abundant and reliable energy and water supply. They must also enjoy the full support of local and regional government bodies. Ukraine’s many state owned enterprises possess underutilized industrial land, which could be quickly repurposed in this way. Western governments could sweeten the inducement by lending these zones special trade and investment preferences.
  • Revitalize the FDI agency InvestUkraine, preferably as an independent agency reporting to the prime minister. Several newer EU member states boast successful investment agencies (especially PAIiIZ in Poland and Czech Invest in the Czech Republic), which may serve as good sources of technical support to a similarly-revamped Ukrainian investment agency. Regional investment agencies in territorial-administrative units are necessary to direct investors to concrete leads and may also offer a vehicle for increasing the competence of oblasts and municipalities across the country.
  • Catalyze public sector reforms through a salary top-up fund. Ukrainian officials are quick to note that they are not lacking in Western advice. Rather, what they need is a cohort of reliable, capable civil servants who are up to the task of translating this advice into long-term change. Western assistance dollars should strongly consider a ‘top-up fund’ where, in exchange for acting on public sector restructuring plans, the Ukrainian government would receive outside funding to help it pay the competitive salaries necessary to recruit top domestic talent.

Jennifer M. Harris is a senior fellow at the Council on Foreign Relations.

 

More on:

Budget, Debt, and Deficits

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