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Will the IMF Lose Ukraine?

BOSTON – An incumbent trying to win an election in a stagnating economy must stimulate growth. This is one the most basic principles of modern politics. And yet the West, which wants to help its allies in Ukraine’s interim government win the general election on May 25, seems to have forgotten it.

Instead, plans are underway to impose on Ukraine the biggest austerity package Eastern Europe has ever seen. This is no way to win votes. After the Russian-imposed chaos, the International Monetary Fund is planning to inflict its own chaos on Ukraine. It is time to remind the IMF that political stability, not a controversial raft of emergency reforms, must be the top priority.

The IMF has long sought to impose a range of economic “reforms” on Ukraine. Some are reasonable; others are not – and the IMF’s track record in Ukraine is weak. Some of the reforms the IMF previously tried to get Ukraine to adopt, like pension privatization, were tried in other countries and ditched. The IMF does not always get it right. Today, its main blind spot in Ukraine has concerned consumer subsidies and transfer payments.

It is true that Ukrainian households need to be weaned off absurdly large energy subsidies, which amounted to 7.5% of GDP in 2012. But, in a cold country where most of the population needs heating subsidies to survive and massive investments are required to increase energy efficiency, abruptly withdrawing support to households is politically unfeasible. No government that cuts heating subsidies suddenly will survive. The subsidies must be phased out and compensated by targeted cash benefits – the Ukrainian government estimates that it will cost €100 billion ($139 billion) to fix its energy policy – and these reforms need to be enacted after the upcoming election.

In addition, one-third of official income in Ukraine comes from government “transfer” payments of various sorts, but mainly pensions paid to elderly women, given that the country’s men rarely live much beyond the official retirement age. These women often use their pensions to subsidize their children and grandchildren. As a result, a majority of the country benefits from government transfer payments, and many households cannot do without them.

Yet cutting them ahead of the election – or announcing sharp cuts – is exactly what the IMF wants and what the interim Ukrainian government plans to do; in the words of Prime Minister Arseniy Yatsenyuk, “We don’t have any other options.” Yatsenyuk may be willing to sign away his political future, but the West should not let him do it. Not now.

The IMF and Western governments need to give Ukraine some breathing room. Ukraine’s economy was growing rapidly in the years before the global financial crisis, driven by exports of basic industrial goods, such as steel. Any emergency financial package must enable the government to survive through the May election and signal a commitment to reviving economic growth.

The international financial institutions should then turn their attention to crafting an aid package that does not require the budget to be balanced on the backs of the poor. Instead of cutting consumer subsidies, the IMF could help Ukraine to improve tax collection. More than half of the economy is unofficial and untaxed. Oligarchs can be asked to contribute to any program as a condition of support for their regions or industries. And the IMF can come up with clever ways to encourage energy efficiency, for example, by designing a tax credit for households that purchase high-quality heaters.

No successful Eastern European government has been asked to impose a dramatic austerity and reform program prior to democratic elections; it would be utter folly to start now. In Poland, the region’s star reformer, and elsewhere in post-communist Europe, citizens were asked to make the sacrifices that economic reform requires only after the government had gained a popular mandate.

Ukraine is still a step away from this politically. If the IMF insists that the interim Ukrainian government impose austerity immediately, the country will be forced to break uncertain new ground at a particularly dangerous time.

In short, the Western strategy for Ukraine should be to stimulate the Ukrainian economy until the May election and then negotiate a package of reforms with the government that emerges. Emergency economic reforms can wait two months; Ukraine’s unity and stability cannot.

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