Ukraine's other war: Bat­tling eco­nomic frailty

The Pak Banker - - OPINION - Mar­ton Eder and Natasha Doff

Ukraine is fight­ing two wars. One is its strug­gle to dis­lodge pro-Rus­sian sep­a­ratists from its east­ern­most prov­inces. The other is a bat­tle to re­shape an econ­omy that's buck­ling un­der the weight of cor­rup­tion, mis­man­age­ment and two decades of post-Soviet ne­glect. The shoot­ing war in­volves grap­pling with a big en­emy, Rus­sia. The eco­nomic one re­quires grap­pling with Rus­sia too, but also with big friends, in­clud­ing the U.S. and Euro­pean Union. They've ar­ranged for $40 bil­lion in aid that comes with taut strings at­tached. It's con­di­tioned on un­pop­u­lar mea­sures to curb sub­si­dies that cit­i­zens use to pay for heat, and re­lies on for­eign cred­i­tors to for­give some of Ukraine's debt.

Debt is the crux of Ukraine's short-term eco­nomic prob­lems. Af­ter five months of ne­go­ti­a­tions, it agreed on Aug. 27 to new terms with for­eign cred­i­tors hold­ing about $9 bil­lion of bonds in­clud­ing the fund gi­ant Franklin Tem­ple­ton. Now it has to con­vince lenders on another $9 bil­lion to ac­cept the deal, which in­cludes a 20 per­cent cut in the amount owed. Among them is Rus­sia, which bought a $3 bil­lion bond from Ukraine's for­mer pres­i­dent in 2013 and has threat­ened to go to court if pay­ments are late. The long-term chal­lenge is at least as thorny: con­vinc­ing for­eign com­pa­nies that Ukraine is a safe place to in­vest, de­spite the mil­i­tary stand­still in the east. Armed con­flict has dec­i­mated Ukraine's in­dus­trial heart­land, home to much of the na­tion's coal, steel and ma­chine-build­ing. The econ­omy shrank by al­most 7 per­cent in 2014, and Ukraine's Na­tional Bank pre­dicts that growth won't re­turn be­fore 2016. The slump has turned the cur­rency, the hryv­nia, into one of the world's worst per­form­ers, mak­ing it harder for the gov­ern­ment to re­pay its for­eign debt.

Torn be­tween Rus­sia and the rest of Europe, Ukraine's 44 mil­lion peo­ple have made lit­tle eco­nomic head­way since the Soviet Union's demise. Re­form­ers who came to power in the non­vi­o­lent 2004 protest move­ment dubbed the Or­ange Revo­lu­tion failed to de­liver on prom­ises to steer the coun­try to­ward the Euro­pean main­stream, leav­ing a clique of bil­lion­aire busi­ness­men in con­trol. These oli­garchs ran the na­tion's big­gest en­ter­prises and were rep­re­sented by con­flict­ing fac­tions in par­lia­ment. Cor­rup­tion is ram­pant: Ukraine ranks 142nd of 175 coun­tries in Trans­parency In­ter­na­tional's an­nual sur­vey of per­ceived free­dom from graft. Eco­nomic out­put per capita has lagged by com­par­i­son to the EU's eastern mem­bers. New lead­ers, led by a gen­er­a­tion of self-styled re­form­ers, rose in 2014 af­ter street protests de­posed the pro-Rus­sian pres­i­dent, Vik­tor Yanukovych. They've promised to mod­ern­ize Ukraine's energy and le­gal sys­tems and to en­force anti-graft mea­sures. In July, the IMF said that "signs of sta­bil­ity are emerg­ing."

Ukraine's route to eco­nomic in­de­pen­dence and growth is blocked by for­mi­da­ble ob­sta­cles. The gov­ern­ment's four-year trans­for­ma­tion plan in­cludes re­duc­ing sub­si­dies for house­hold energy spend­ing and pros­e­cut­ing cor­rupt of­fi­cials in tri­als broad­cast on live TV. It's ask­ing cit­i­zens to en­dure cuts in heat­ing sub­si­dies, in­fla­tion ac­cel­er­at­ing past 60 per­cent in April, and a freeze in pen­sions and wages. That's while try­ing to wean it­self from de­pen­dence on Rus­sian gas. Ukraine also wants to find a way to deepen eco­nomic and mil­i­tary co­op­er­a­tion with al­lies to move to­ward closer in­te­gra­tion with the EU, with­out up­set­ting a frag­ile cease-fire in the east. Mil­i­tary con­flict is help­ing main­tain public sup­port for the over­haul pro­gram, which faces daunt­ing risks, ac­cord­ing to the IMF. Suc­cess will mostly de­pend on Rus­sia. Pres­i­dent Vladimir Putin has shown lit­tle in­cli­na­tion to tol­er­ate los­ing a for­mer Soviet re­pub­lic from his sphere of in­flu­ence or to bend to U.S. and EU sanc­tions. Ukraini­ans say their abil­ity to over­come Rus­sian pres­sure de­pends on more help from for­eign com­pa­nies as well as gov­ern­ments. In­vestor Ge­orge Soros says Ukraine needs about $55 bil­lion of in­vest­ments to flour­ish. So far, money's been flow­ing in the other di­rec­tion: There was a $299 mil­lion net out­flow of for­eign di­rect in­vest­ments in 2014.

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