Ukraine's other war: Battling economic frailty

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.