A winning strategy

Sanctions, though necessary, are harmful not only to Russia but also to Europe’s economy. By contrast, enabling the Ukrainian economy to flourish would benefit both Ukraine and Europe.

Even more important, sanctions by themselves reinforce Putin’s narrative that Russia is the victim of a Western or Anglo-Saxon plot to deprive it of its rightful place as a great power equal to the United States. All of Russia’s economic and political difficulties, the Kremlin’s propaganda machine argues, have resulted from Western hostility.

The only way to counter this narrative is to combine sanctions with effective support for Ukraine. If Ukraine prospers while Russia declines, no amount of propaganda will be able to conceal that Putin’s policies are to blame.

Unfortunately, Europe’s leaders have chosen a different course. They treat Ukraine as another Greece: a country in financial difficulties – and one that is not even a European Union member state.

This is a mistake. Ukraine is undergoing a revolutionary transformation, and the current government is probably the one best able to deliver radical change.

There are indeed some significant similarities between the “old Ukraine” and Greece: both suffer from a corrupt bureaucracy and an economy dominated by oligarchs. But the new Ukraine is determined to be different. By keeping Ukraine on a short financial leash, Europe is jeopardising the country’s progress.

In a sense, Europe’s failure to recognise the birth of a new Ukraine is not surprising. Spontaneous uprisings occur frequently; the Arab Spring, for example, spread like a wave across North Africa and the Middle East.

But most revolts do not endure; their energy is exhausted quickly – as with Ukraine’s Orange Revolution a decade ago. Today’s Ukraine is one of the rare cases in which protest is transformed into a constructive, nation-building project. Although I participated in that transformation process, I confess that resilience.

Putin has made the same mistake, but on a much larger scale. He has been so successful in manipulating public opinion that he was unwilling to believe that people could act spontaneously. That has been his Achilles’ heel.

Twice he ordered former Ukrainian president Viktor Yanukovych to use force against the people protesting in the Maidan, Ukraine’s Independence Square. But, instead of fleeing the violence, people rushed to Maidan, willing to sacrifice their lives for their country. The second time, in March 2014, when the protesters faced live ammunition, they turned on the police, and it was the police who ran away. Such an event can become a nation-founding myth.

Putin knows that he is responsible for turning Ukraine from a pliable ally into an implacable opponent, and he has made it a top priority to destabilise the country ever since. Indeed, he has made considerable – though purely temporary – progress on this front. Given that Putin also recognizes that his regime may not survive two or three more years with oil substantially below $100 a barrel, his sense of urgency is understandable.

His progress – measurable by comparing the Minsk II ceasefire agreement with Minsk I – can be attributed partly to his skills as a tactician. More important, whereas he is willing to go to war, Ukraine’s allies have made it clear that they are incapable of responding quickly and unwilling to risk a direct military confrontation with Russia. This has given Putin the first-mover advantage, because he can switch at will from hybrid peace to hybrid war and back again. Ukraine’s allies cannot possibly outbid Russia by military escalation; but surely they can outbid Russia on the financial side.

European leaders, in particular, have failed to appreciate Ukraine’s importance. By defending itself, Ukraine is also defending the EU. If Putin succeeds in destabilising Ukraine, he may then apply the same tactics to divide the EU and win over some of its member states.

If Ukraine fails, the EU would have to defend itself. The cost, in financial and human terms, would be far greater than the cost of helping Ukraine. That is why, rather than dripfeeding Ukraine, the EU and its member states should treat assistance to Ukraine as a defense expenditure. Framed this way, the amounts currently being spent shrink into insignificance.

The problem is that the EU and its member states are too fiscally constrained to support Ukraine on the scale needed to enable it to survive and prosper. But that constraint could be removed, if the EU’s Macro-Financial Assistance (MFA)

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Ukraine’s facility were redesigned. The MFA already has been used to provide modest assistance to Ukraine; but it needs a new framework agreement to fulfill its potential.

The MFA is an attractive financing instrument because it requires no cash outlay from the EU budget. Instead, the EU borrows the funds from the markets (using its largely untapped triple-A credit rating) and lends these funds to nonmember governments. A cash outlay from the EU budget would materialise only if and when a borrowing country defaulted. Under prevailing rules, just 9% of the loan amount is charged to the current budget as a non-cash outlay to ensure against this risk.

A new framework agreement would allow the MFA to be used on a larger scale and in a more flexible manner. At present, the MFA can be used for budgetary support but not to provide political risk insurance and other investment incentives to the private sector. Moreover, each allocation must be approved by the European Commission, the European Council, the European Parliament, and every member state. The EU’s contribution to the International Monetary Fund’s rescue package in February took until May to process.

The strategy for Ukraine that I proposed at the start of the year has run into three roadblocks. First, the debt restructuring that was supposed to account for $15.3 billion of the $41 billion contained in the second IMF-led rescue package has made little progress. Second, the EU has not even started to construct a new MFA framework agreement. And, third, EU leaders have shown no sign that they are willing to do “whatever it takes” to help Ukraine.

German Chancellor Angela Merkel and French President François Hollande are eager to ensure that the Minsk II agreement, which carries their signatures, is successful. The trouble is that the agreement was negotiated by the Ukrainian side under duress, and was left deliberately ambiguous by Russia. It calls for negotiations between the Ukrainian government and representatives of the Donbas region, without specifying who those representatives are. The Ukrainian government wants to negotiate with representatives elected according to Ukrainian law; Putin wants Ukraine’s government to negotiate with the separatists, who took power by force.

The European authorities are eager to break the stalemate. By taking a neutral position on Minsk II’s ambiguity and keeping Ukraine on a tight leash, Europe’s leaders have been unwittingly helping Putin achieve his goal: financial and political crisis across all of Ukraine (as opposed to territorial gains in the east). Drip-feeding Ukraine has brought its economy to the brink of collapse. Precarious financial stability has been achieved at the price of accelerated economic contraction. Although political and economic reforms are still moving ahead, they are in danger of losing momentum.

On a recent visit, I found a troubling contrast between objective reality, which is clearly deteriorating, and the