Ukraine is heading for a total economic collapse

Christine Lagarde speaks about the situation in Ukraine.
Christine Lagarde speaks about the situation in Ukraine.
Image: Reuters/Yves Herman
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When Christine Lagarde, managing director of the International Monetary Fund (IMF), announced Ukraine’s new, $17.5 billion bailout package Thursday morning (Feb. 12), she suggested it would be a “turning point for Ukraine,” which stands to receive $40 billion in relief funding from various sources over the next four years. “This new four-year arrangement would support immediate economic stabilization in Ukraine as well as a set of bold policy reforms aimed at restoring robust growth over the medium term and improving living standards for the Ukrainian people,” Lagarde said from Brussels.

But it will take a lot more than IMF billions to dig Ukraine out of economic crisis, and to implement the reforms Lagarde’s IMF team has has demanded. In order to survive, Ukraine will need to fashion a new social contract with its citizens, one that sheds hundreds of social services left over from the Soviet era, which Ukraine’s nomenklatura, its upper-middle class civil servants, still enjoy. ”The IMF is not the solution for the grave problems Ukraine has. Ukraine has a too big of an expanded state–big chunks of the state are really privatized by invested interests, and those interests do not work for the public good,” said Vladimir Fedorin, the former editor of Forbes Ukraine.”The problem lies not on the side of oligarchs, but on the side of the government—the government has no credible strategy, parts of government are corrupt.”

Under financial pressure from the war in eastern Ukraine and from its debtors, Ukraine’s social contract has begun to unravel, leaving the poorest Ukrainians in the lurch. The tenuous state of affairs was all too evident on Monday afternoon, when masked men set fire to a small pyramid of tires outside Kyiv’s city hall. They hoped the smoke would waft all the way up to the office of Mayor Vitaliy Klitschko, who announced a hike in public transportation fares last week. The scene—men in balaclavas shoving their way into city hall—was reminiscent of more visibly turbulent times in Kyiv last year, when the building was occupied by self-styled “self-defense forces.” “This is a kind of Ukrainian tradition we have,” Vitaliy Chernyokhovskiy, a local politician who helped organize the protest, told me. “We are not against raising metro prices, just stop stealing!” Militia still swarmed the premises, detaining four protesters before the gathering petered out. Chernyokhovskiy and a few others were left pacing around, as if trying to walk off the anticlimactic effect of their efforts. “How are we supposed to live on 50 hryvnias [about $1.90] a day?” one man in their group muttered.

The city government’s fare hike, which doubled fares for bus and metro rides to 3 hryvnias and 4 hryvnias respectively, had the unfortunate fate of coinciding with the worst devaluation in Ukrainian history. On Feb. 6, the hryvnia fell a full 50 percent, to 25 to the dollar, and has continued to fall since then. Chernyokhovskiy and company were protesting the equivalent of an $0.08 increase in public transportation fares, but as Ukrainians saw their savings halve virtually overnight, even that small increase became a much more drastic imposition. And thanks to persistent, rampant corruption, Ukrainians have no reason to believe that the increased prices will go to good use: When it comes to the metro, for example, Klitschko’s administration has decided to honor a questionable contract from the era of former president Viktor Yanukovych with a private, Kharkiv-based transportation firm that will make millions of dollars off of the fare hikes.

Even with the new IMF bailout, the Ukrainian government is still scrambling for new sources of revenue, currently through a creative mix of tax cuts and hikes in the proposed budget for 2015, at the precise moment when Ukrainians are least inclined to pay up. Corruption is just as bad, if not worse, than it was in the Yanukovych era, and with a significant chunk of international aid going to pay off Ukraine’s debts to Russia, civilians are less than inclined to contribute to state funds.

Unlike what happened after the ruble’s recent collapse, Ukrainians aren’t rushing to buy up expensive appliances to salvage what’s left of their savings—retail is down, and clearance sales are ubiquitous. “Now, business is not so good,” Dmytro Myroshychenko, the owner of a small ski outfitting shop, told me. Most of his goods are imported, and prices have risen three times since last week.

The government itself is doing little to assure Ukrainians that the situation will improve anytime soon. The draft 2015 budget depends on increased tax revenue from businesses, imports, and oil and gas, among other sources; rather than cutting down on the country’s bloated bureaucratic expenditures, the proposed budget would actually increase government spending. “The budget they proposed is totally crazy, because it builds on a huge deficit and requires printing more than 200 billion hryvnias, which promises much stronger devaluation,” said Dmytro Boyarchuk, Executive Director of CASE Ukraine.

His firm analyzed how the government could cut 50 billion hryvnias from the budget, and concluded that “It is possible. Many institutions have so-called ‘social infrastructure’— the prosecutors’ office has their own kindergartens, the National Bank of Ukraine also has some kind of sports center,” Boyarchuk told me. “A large part of social protections go to people who don’t need them. This is related to our Soviet past, when privileges and benefits were granted to nomenklatura—people in the Communist Party, or who work for the government. It translated to Ukrainian society, so prosecutors, policemen, judges, MPs, have privileges… Changing [the budget] means total destruction, reshuffling all social agreements, relations—it’s very risky.” And there are plenty of people in power who aren’t interested in seeing that change. ”I think there will be impressive layoffs of civil servants. It will be very painful,” Boyarchuk said.

“This is war, between the old system and the new system. This war is not so evident as the war in the east. There, there is open war, with fire and soldiers, but this second war is a soft war, we cannot see it. But it is absolutely clear who is fighting against whom,” Valerii Pekar, a Ukrainian entrepreneur with the Gosh Strategy center, told me. “All economic indicators show that collapse will be soon.” Last year, Pekar’s company identified 800 regulations that could be cut to save state funding. So far, only six of those deregulations have been implemented.

‘Last month I travelled over all Ukraine, and more and more often I hear the idea that, “during this war I have to pay more money to my country, but not to my state. So I will stop paying taxes, and I will pay even more than I have to pay [in] taxes to those volunteers who help soldiers, and to help those people who flew from the east and have no houses, no job, no nothing,’” Pekar said.

“Time is lost. I think, in a month or two, we’ll have statistics that will show that tax revenues are far from government estimates,” Fedorin told me. “To pay all Ukrainian taxes is to be a suicide bomber.”

“It’s not possible that everyone likes the new budget,” Natalie Jaresko, president Poroshenko’s newly appointed finance minister, told the Kyiv Post. “In the 2015 budget the stabilization of balance of payments is essential, temporary additional taxes are therefore implemented to address this issue.”

Back in September, Fedorin warned of an impending “Financial Chernobyl,” in which “the Ukrainian budget suffers a total collapse and the IMF aid program breaks down.” His forecast appeared likely to come true five months ago, but the new $17.5 billion package may have arrived just in time to bring Ukraine back from the edge of default. Then again, “Default is a stance where you cannot borrow money from anyone except the IMF. So we’ve already been in default for more than a year,” Boyarchuk said.

Just as volunteers are working around the clock to support the Ukrainian army in the east, they’re also fighting the “soft war” in Kyiv to save the country’s economy. “The ‘Financial Chernobyl’ scenario has been unrolling in front of our eyes, the reserves have ended,” Pavel Kukhta, an economist from the Reanimation Package of Reforms Initiative, told a group of colleagues on Feb. 6. At an outpost of the Russian-owned Shokoladnitsa chain of cafés in Kyiv’s historic Podil neighborhood, he had called an open meeting of local economists and economic journalists together to help draft amendments to the state budget, which he hopes to present to Jaresko next week.

“State spending is the main source of the problem…It’s a crisis of the whole economic model. The BOP [balance of payments] used to be propped by Soviet heavy industries,” he told the economists crammed around the table. They ran down the list of candidates for budget cuts: education, pensions, payroll taxes, oil subsidies, and more. “Ukraine is the most unsuccessful country in Europe in the last ten years,” Kukhta said. “What about Belarus?” someone interjected from across the table. “Let’s leave Belarus alone. Every unhappy country is unhappy in its own way.”

But if things keep going on this track, even with the new billions Lagarde will send over the next four years, Ukraine will still be unhappy in its own, very special way. The IMF has rightly asked for budget amendments and reforms as a pre-condition for the delivery of this next financial package, and the Ukrainians are hustling to meet those requests—the parliament will approve or reject amendments to the budget by the end of the month, and the government has promised to cut expenditures by a couple GDP percentage points. But as Pekar put it, “Half of the government is eager to keep the old system, and half of the government is eager to break it. And then you understand why reform is so slow.” Ukraine’s “turning point” is within arm’s reach, but it’s not here yet.