KYIV – Ukraine’s immediate economic crisis has been resolved, but its economy remains fragile and still needs international support. If the new Ukrainian government becomes complacent, the country’s gains could be lost.
Ukraine has come a long way since the 2013-2014 “Euromaidan” uprising. When former President Viktor Yanukovych fled to Russia in February 2014, the Ukrainian economy was in free-fall, contracting by 17% in just two years. Ukraine’s budget and external deficits had already become unsustainable and needed radical restructuring, so Russian aggression was enough to push the economy over the edge.
By the end of 2015, former Ukrainian Prime Minister Arseniy Yatsenyuk had made remarkable progress in sorting out the country’s finances, but only in the areas where he and his technocratic reformers were in charge.
One of the most important areas was the energy sector. Since the early 1990s, Ukrainian oligarchs had profited immensely from buying subsidized gas at low prices and selling it at a marked-up rate. In the last two years, however, the Ukrainian government has standardized energy pricing and eliminated subsidies (which had amounted to 10% of GDP and fueled illicit financial flows).
These measures have proved effective: Ukraine reduced gas consumption by over 20% last year and is continuing to save even more on energy. The government cut its budget deficit from 10.5% of GDP in 2014 to just 2.5% of GDP in 2015, and it is maintaining budget discipline going into the next fiscal year.
Ukraine has been climbing out of an economic hole that Yanukovych helped dig. For starters, he created an unsustainable current-account deficit by insisting on an unrealistically high exchange rate for the Ukrainian currency, the hryvnia. After the Yanukovych government was forced to float the exchange rate in November 2013, the hryvnia plunged to one-third of its previous value against the dollar, energy prices increased, and inflation skyrocketed, peaking at an annualized rate of 61% by April 2015.
Almost three years later, Ukraine is keeping up on its foreign payments. The National Bank of Ukraine (NBU) is buying foreign currency to maintain exchange-rate stability, and it has reduced inflation to just 8% (as of August) by gradually cutting interest rates and easing currency regulations.
During Yanukovych’s administration, corruption was rampant throughout the Ukrainian banking system. Bank owners were issuing 80-90% of loans to themselves and using the money to buy more banks. Since then, NBU Chairwoman Valeriya Hontareva has made significant progress in cleaning up the industry, closing 80 of 180 Ukrainian banks, with a few small banks still to be shut down.
Ukraine could not have come this far on its own. In February 2015, the country was on the brink of a financial meltdown because its international currency reserves had slumped to a mere $5 billion, and its plummeting exchange rate was sending buyers into a panic. The International Monetary Fund rescued the economy with a $5 billion disbursement, and Ukraine’s international reserves have now increased to $14 billion. Moreover, because Ukraine voluntarily restructured its private debt last year, payments to service it will remain low until 2020.
Despite these considerable macroeconomic achievements, however, Ukraine’s microeconomic progress has been modest. The government has improved corporate governance at state-owned energy companies, and established public databases to track companies’ ownership and procurement. But the economy is still too heavily regulated, and more of the country’s 1,800 state-owned enterprises need to be privatized.
More important, Ukraine needs to strengthen the rule of law. The government has proposed judicial reforms to make it easier to prosecute corruption, but it is encountering heavy resistance from the old establishment. In August, a dispute between staff members from the prosecutor-general’s office and members of the new Anti-Corruption Bureau resulted escalated into a fistfight.
In April, President Petro Poroshenko ousted Yatsenyuk, with whom he had clashed, and replaced him with an ally, former Speaker of Parliament Volodymyr Groysman. Poroshenko claimed that Groysman would be more effective at managing Parliament, but the opposite has happened – Parliament has adopted only 11 of the Groysman government’s 177 bills.
In recent months, new legislation and reform efforts have come to a standstill, and the exchange rate has begun falling again. The IMF has not disbursed any funds since August 2015, but last month it approved a $1 billion loan, which could stabilize the exchange rate. The United States is expected to match the IMF tranche with a $1 billion loan guarantee, and the European Union will offer $673 million in macroeconomic-finance assistance.
The West is offering new financing because Ukraine established a public database for government officials’ assets and incomes. The West’s next demand will likely be that Ukraine appoint an independent energy regulator. But much more will be needed to generate economic growth, which the IMF estimates will reach a meager rate of 1.5% this year.
Meanwhile, many Ukrainians are impoverished. The official dollar wage, on average, has fallen 60% since 2013, to a paltry $200 a month, one-eighth the level in neighboring Poland. At this point, many young Ukrainians see better prospects in emigrating or in the shadow economy.
Worse still, Ukrainians know that corruption remains endemic, and little progress has been made in breaking the old elite’s power structure. As people continue to tire of poverty and war, the appeal of populism will grow, as we’ve seen throughout the West this year.
With fresh financing coming through, the new government has a window of opportunity to push through radical reforms and kick-start economic recovery. Otherwise, it risks an early parliamentary election – which it might not survive – next spring.