Ukraine’s False Choice
Yanukovych can pick Russia or the European Union. Either way, the economic reforms are coming.
Ukraine president Viktor Yanukovych just unceremoniously rejected his country’s E.U. Association Agreement, a 1,000-plus page document, painstakingly negotiated over six years and intended to cement Ukraine’s political, economic, and trade ties with Europe. Now he’s slated to fly to Moscow on Tuesday, where the Kremlin is finalizing the terms of its counter-offer of financial support in return for political allegiance. With opposition to the Russian option gaining strength, Yanukovych faces a seemingly stark choice. He can bow to Moscow and its offer of cheap gas and easy money, or to the apparent will of Ukraine’s people by resurrecting its agreement with the European Union and re-engaging with the International Monetary Fund, which has suffered through two failed programs. Muddling through — as Yanukovych has done for so long — is no longer an option.
While this geo-economic choice seems stark, actually, it is not what it seems. Ukraine will almost certainly have to accept the need to reform its economy regardless of which political direction it chooses to pursue. Recent experience and economic reality mean that countries that offer the prospect of financial support in return for political fealty often end up pushing for IMF-style reforms in any case. The real choice then is not between painful economic reforms from the West and cheap gas and easy money from Russia. It is a choice between who imposes and enforces the necessary reforms and a balancing of political and economic costs and benefits.
Virtually all credible economic and trade analyses predict significant benefits, including long term GDP growth of up to 11.8 percent, if Ukraine goes ahead with the E.U. pact. And with dwindling reserves, a faltering currency, and a need to access the capital markets to pay its bills, the economic rationale for Yanukovych to sign onto deals with both the European Union and the IMF is compelling. He has hesitated in large part due to fears of political consequences that might hurt his chances for reelection in 2015. But with hundreds of thousands of protesters clamoring for the E.U./IMF option, Yanukovych is being presented with exactly the kind of political cover he so desperately seeks to pursue difficult, but necessary, reforms. These include devaluation of the Hryvnia, the Ukrainian currency, public sector spending cuts, and gas tariff increases — all of which are necessary to put Ukraine on a sustainable economic and political path.
Besides, Yanukovych’s hand in playing Russia off against Europe and the IMF may not be as strong as he had hoped. Increasingly, countries under economic stress are being presented with false choices as to options to determine the direction of their economic futures. In seeking to portray themselves as friendly alternatives to the so-called "Washington consensus," some cash-rich countries have sought to use their own financial resources to further their international political objectives. They offer the promise of financial support but without the sometimes-painful prescriptions required by the IMF, which seeks to impose reforms promoting prudent macroeconomic policies, open trade and investment, and free markets in pursuit of sustainable and balanced growth.
But promises of no strings attached financial support often end up requiring not just political sacrifices, but, ironically, pressure to adopt the same type of economic reforms generally proposed by the IMF.
For example, several times over the past three years, the IMF has come close to agreeing to a $4.8 billion program with Egypt that included tax, spending, monetary, and subsidy reforms. In each case, the short-term political costs were deemed to be too high by Egyptian political authorities and the deal was rejected. With reserves running dangerously low, Egypt has survived through the kindness of its neighbors. Initially, Qatar provided up to $8 billion in bilateral assistance to Egypt’s Morsy-led government, furthering its influence in the process. When the Muslim Brotherhood was ousted and replaced by the current government, Qatar asked for its money back. Egypt rejected the IMF again and Qatari money was replaced by financial support from the GCC-3 — a combination of Saudi Arabia, Kuwait, and the United Arab Emirates, which are potentially pledging up to $23 billion through the end of 2014.
The politically-motivated financial support provided no link to any real economic reforms. Egypt’s economy, predictably, suffered. Since 2011, growth deteriorated, fiscal deficits widened, energy and food subsidy challenges were exacerbated, reserves declined dramatically, and overall and youth unemployment skyrocketed. And the economy remains largely unreformed and challenged by the same structural impediments as before.
But recently, reports have circulated that the same GCC-3 providing Egypt’s financial lifeline are now pressuring Egypt to reengage with the IMF and implement IMF-style reforms, so as to prevent their short term financial support from leading to never-ending dependence.
Closer to home for Ukraine is the example of Belarus. In embracing a Russian-led alliance in 2011 as an alternative to the IMF, Belarus found that the terms of its three-year, $10-billion bailout from Russia contained familiar-sounding painful macroeconomic medicine, including cuts to subsidies, exchange rate liberalization, privatization, and structural reforms. In his own words, Sergei Shatalov, the Russian official who negotiated the deal at the time, said, "If you look at the financial terms of this loan to Belarus, more than anything this is like an International Monetary Fund program."
Reforms being proposed for Ukraine by the IMF and the European Union will undoubtedly involve short-term economic costs. The main areas pushed by the IMF include increased exchange rate flexibility, financial sector reform, fiscal consolidation, increases in domestic energy prices, and structural reforms. The proposed E.U. agreement exceeded 1,000 pages and included potentially sensitive reforms to trade, transparency, competition, and financial flows.
Russia’s promise to Ukraine of bilateral assistance will almost certainly include not only its own self-serving trade-based reforms (as part of its proposed customs union) but also, ultimately, pressure for macroeconomic reforms similar to those sought by the IMF. So the choice for Ukraine will undoubtedly include tough economic reforms, regardless of which way it turns. Only in one case, it includes the prospect of the loss of independence, domestic political discontent, and longer-term lost opportunity costs from turning away from Europe — the world’s largest economic bloc.
With calls for early elections and even for his impeachment increasing, President Yanukovych may have miscalculated in choosing to look to Russia as his best ticket to remaining in power. He would be well served to look past the chimera of short-term financial offers from politically motivated neighbors and use current popular support for the European Union and IMF to embrace the path to a sustainable economic future for Ukraine.