December 19, 2014 | by Krassen Stanchev Print

Last March, before the Russian annexation of Crimea, a group of European economists and reformers, of which I am a member, tried its best to prevent the most damaging political, economic, and financial scenarios from befalling Ukraine. Now the economic and financial situations are much worse because of the annexation and support for separatists in eastern Ukraine. GDP is expected to contract by 9 percent by year’s end, central-bank reserves by more than 50 percent. Depreciation of the local currency this year is running at 50 percent, and inflation is around 20 percent. Two thirds of the banks are illiquid, and government debt is mounting.

Unfortunately, the most prominent reformer in our group, Kakha Bendukidze, who spent April and May in Kiev advising Ukraine’s government, died on Nov. 13. Nevertheless, we are working on an updated emergency response to the deteriorating situation.

In March, my responsibility was to outline opportunities in the context of EU-Ukraine relations; there is no other international actor to step forward and prevent Ukraine from free-falling into a hyperinflation abyss.

A year ago, there was illusory competition between Russia and the EU over Ukraine’s future. The EU proposed unconditional financing of about one third of the then-pending $3 billion debt payment. Its further stabilization program of €19 billion, however, was conditioned on sound central-bank operations and on cutting the fiscal deficit to 6 percent of GDP by eliminating energy subsidies (which stood at 12 percent of GDP for households, enterprises, and the state-owned gas monopoly, NAFTOGAS), stopping government-sector wage increases, and moving to targeted social aid and competitive government procurement.

Russia managed to convince then-president Viktor Yanukovich to back off from this program and sign on to its proposals worth about $21 billion — $3 billion in price reductions of natural gas and $18 billion in balance-of-payment support. It should be noted that in 2011–12 similar balance-of-payment support to Belarus was converted into Russian company ownership of that country’s economy.

At present, the Russian program is simply impossible, while the EU’s, though originally reasonable, is obsolete.

Foreseeing interruption of natural-gas supplies, the EU has no option but to “advise” Ukraine or NAFTOGAS to pay GAZPROM in full (it is due more than $3 billion in arrears and debts): the alternative could only mean that the EU would be left without natural gas; the EU average dependency on Russian natural gas is roughly 45 percent, and for some member states it’s above 90 percent. Like NAFTOGAS’s debt, the Ukrainian government debt cannot be resolved via ordinary market financing without further deterioration of the economy. In this situation the EU, with the consent of the newly elected government of Ukraine, can accomplish a Russia-style program, only transparent and beneficial. Its pillars might be the following:

NAFTOGAS may issue bonds convertible into equity that could be distributed to EU intermediaries in direct placement, with the prospect of refurbishing the company’s operations (when and if the government abolishes energy subsidies).

Balance-of-payments support should be conditioned on a broad range reforms, which, in addition to the original measures (some of which are halfway complete, others to be requested from or initiated by the EU), should include:

  • rationalization of central-bank operations via introduction of a currency board or inflation targeting managed by an international committee under the central bank’s governor (both options were proposed in March by monetary economist Warren Coats at the Emergency Economic Summit for Ukraine organized by the Atlas Network and its partners);
  • liquidation and/or privatization (the politically preferable way of liquidation) of ailing Ukrainian-owned banks;
  • Unilateral 100 percent EU liberalization of trade with Ukraine: Ukrainian exports to the EU are subject to a Generalised Scheme of Preferences granted by the EU in 1993; latest statistics show that at its peak GSP is applied to 72–73 percent of eligible Ukrainian products; in February then-European Commission President José Manuel Barosso announced a “revolutionary” €0.5 billion reduction of tariffs for Ukraine, managed as an annual allowance. Besides the obvious impracticality of the scheme, its volume is just 3.4 percent of imports from Ukraine and 5.4 percent of Ukraine’s trade deficit with the EU. Such liberalization may be initiated by either side. The EU granted it to the western Balkans after the Kosovo crisis.
  • A visa-free EU arrangement for Ukrainian citizens. Similar efforts, after years of hesitation were made, again, for the Balkans, and they motivated Balkan folks to ask their politicians to keep the EU membership dream alive (See “The Visa Roadmaps.”)
  • Elimination of foreign-trade regulations imposed by Ukrainian authorities on Ukrainian merchants and companies. According to the World Bank’s Doing Business indicators and independent observers, Ukraine performs worse than most ex-communist countries. Its private property system supports neither competition nor the free movement of capital, and is in fact semi-socialist, as Christopher Hartwell correctly notes. An improvement to the lead position, as we know from Georgia’s experience, is possible in the short term and would be beneficial for much longer.

All these and other measures could be bundled into EU’s Marshall Plan for Ukraine, supported with technical assistance by the staffs of the IMF and World Bank. (See also Anders Aslund, “Marshall’s Postwar Logic Holds True in Ukraine Today.”)

Such a program would demonstrate that Ukrainians are welcome in the EU. Moreover, it would give Ukrainian companies the incentive to adapt their investment and business strategies to trade with richer partners and to meet a more sophisticated demand than in the alternative Russian market. Eventually, as with all other transition countries, the program will bring prosperity. The most probable immediate effect for Ukrainian companies, citizens, and politicians will be the light at the end of the tunnel.

The opinions expressed in this commentary are solely those of the author.