I have spent the last couple of days in Kyiv, helping with the launch of our Chatham House report, The Struggle for Ukraine which was published back in October.
The trip enabled some interesting interaction with policy makers, politicians, academics, representives of civil society, journalists, diplomats and IFIs.
My own chapter from the Chatham House report sends a message that:
a) The status quo maintained over the period 1991-2013 was not working for the bulk of Ukrainians, and EuroMaidan was the breaking point that things needed to change. Growth and development needed to be more inclusive, and not just for the benefit of a narrow section of Ukrainian society: its oligarchic and politically connected elite. Ukrainians had the choice in 2013/14 between a Western, European orientation, moving towards the European Union, or an eastern orientation thorough deeper integration with the Russian dominated Eurasian Union. In the end, and despite foreign annexation (of Crimea) and invasion of Eastern Ukraine by Russia and its proxies, the bulk of Ukrainians chose the former.
b) Experience with reform over the past four years since EuroMaidan suggests that Ukraine is absolutely reformable. Indeed, some remarkable reform achievements have been delivered, including energy sector reform, fiscal and balance of payments adjustment, introduction of Prozorro, e-Declarations, banking sector reform, NABU, NBU reform, et al. So despite the huge challenges facing Ukraine – and perhaps because of them – Ukraine has proven able to push on and deliver radical reform. And Ukraine has a vibrant, dedicated, technically competent (international standard) group of reform technocrats who have proven able to devise innovative solutions and deliver these.
c) But reform is incomplete, and we are now approaching a critical juncture, perhaps make or break. Basic macro stability had been restored, and the foundation for growth is there but the key determinant of whether Ukraine grows at 2 percent, as at present, or 5 percent plus, as really needed, is whether the business environment can be improved to the point where domestic and foreign investment flows, and therein I think the critical issue now is addressing corruption. And sadly but the reality is that nearly a quarter of a century of warped development on an oligarchic dominated rent seeking, State captured model, has meant that corruption became endemic and almost an industry in its own right. But if Ukraine wants to move on, and move to a Western, European model of development, corruption and rent seeking behaviour has to be reined in. Now this is not saying that Western Europe is squeakly clean, it is far from it, but the challenges faced by business because of corruption and rent seeking behaviour are still multiples worse than in Western countries. To enable domestic and foreign business to do better, and to bring more inclusive growth, corruption has to be moderated, and reduced. No one is saying it has to be eradicated overnight – albeit that would be nice. But there has to be some noticeable improvement, which if delivered I think would deliver more investment, growth, jobs and higher living standards for a greater cross section of society. And in Ukraine it is not that just per capita GDP is low, around $3000 per capita, but the distribution is warped so that a few hundred oligarchic families/groups/clans take the bulk of this wealth to the neglect of the vast majority of the rest of the population.
In Europe and the US, Post Brexit and Trump, all the talk is about the need to deliver inclusive growth. Such discussion should be centre stage in Ukraine, or else the risks of a more populist agenda emerging are clear. And in this latter scenario the existing oligarchic groups might not all prosper so well, so as a group they should also surely have an interest in also delivering growth, and inclusive growth at that. They should also have an interest in also cleaning up the business environment.
Ok, so the above perhaps reflects a rather academic perspective, but what do I currently see on the ground? Do I see/feel this appetite to address corruption and improve the business environment to deliver inclusive growth?
Unfortunately that was not my big take out from the recent visit. Indeed, it has been my understanding for some months now that Ukraine’s reform progress is being pulled off course (going backwards even) as politicians first focus on looming elections, and second worry I think what could be the end result of the successful implementation of an anti corruption agenda.
In terms of specifics, the IMF EFF has been off track now since the last review was completed in April 2017. Indeed, even the completion of the third review back in April was somewhat half hearted given that numerous prior actions were not completed, and waivers given essentially in acknowledgement of the brave, and in many respects landmark, decision to nationalise Privatbank. But even since April, there has been backtracking with failure to hike gas prices as agreed with the IMF as a condition for the third review. We can then add in pension reform which has still failed to meet IMF approval, slow progress in addressing the problems at Privatbank, failure to deliver on promises over land reform (moratorium on land sales extended again to 2019), threats now to the Prozorro system from the Buy Ukraine programme, risks to VAT reform, a myriad of tax break/changes in the 2018 budget which much raise big issues for the IMF in terms of its suitability and sustainability even, plus also the on-going battle over NABU which does raise real concerns over commitment to fighting corruption. And still 8 months after the resignation of Valeria Gontareva as governor of the NBU, the institution does not have a permanent governor appointed. The latter is just perverse, given the importance of the institution, and suggests that political horse trading is still underway, or simply Ukraine’s political leadership does not fully comprehend the importance of the NBU as an institution, and the import of cementing its credibility in markets and wider society. This actually undermines the great work done at the NBU over the past few years.
I am left asking myself why when the current administration seems to give ample lip service to the importance of staying the course on the current IMF programme, does it not do more to ensure compliance?
Indeed, I sat through the Ukrainian presentation at the IMF AGM in Washington in early October to hear then that there were no major problems with the IMF, and everything would be resolved in a matter of days. We are still waiting. But why has the fourth review still not been completed when as per the original schedule of the current EFF we should already be on the ninth review? The answer has to be that either the administration has its focus elsewhere, or other priorities, perhaps does not want the fiscal strait jacket of an IMF programme going into elections, perhaps thinks that it does not need the money (has access to market financing) or has some fundamental objections to key components of this IMF programme, and more particularly therein perhaps the anti corruption agenda.
But failure to meet IMF conditionality has broader costs, including a failure to secure the release of the final 600 million euros in EU MFA and, despite spin from the Poroshenko administration, still really no commitment from the EU to work up a new 1.8 billion euros MFA programme any time soon. It is as if Ukraine is flush with cash, and does not need the $10 billion plus IMF/EU money already on the table, while some talk up grandiose and completely unrealistic ideas of a Marshall Plan for Ukraine worth tens of billions of dollars. That sounds like pie in the sky when the administration is not drawing on existing concessionary financing on the table because it is unable or unwilling to deliver on the conditions therein. But staying on track with the IMF would offer the best chance of ratings upgrades, lower financing costs for government and business, kickstarting credit in the economy, and delivering investment, jobs, growth and improving living standards.
It is perhaps worth circling back to the anti corruption agenda, which is, as I have noted, so critical for Ukraine’s future development. I think it is fair to say that recent fights between the Prosecutor General’s Office and NABU, the removal of the chairman of the Rada’s anti-corruption committee, seemingly more official interest in investigating the financing of anti-corruption NGOs than pursuing allegations of serious and large scale corruption by government officials, or bringing anyone significant to account for corruption, suggests that the old and corrupt system is fighting back. Arguably the system and the elites therein have most to loose, at least from where they are sitting, to the successful and logical conclusion of the systems and institutions set up to counter corruption. Elites seem to think that they will be brought to account (jail time?), and hence seem to be doing their utmost to resist.
Questions could then be asked as to whether the system as is being created, which envisages, I think, examples being found and individuals brought to account for past misdemeanours, including prison terms, was too ambitious at the outset. I argued several years back that a more workable system, given the widespread and pervasive (inclusive even nature of corruption in Ukraine – could anyone survive in the old/existing rules of the game without breaking the rules in some way, I guess there was only a difference in scale) would have been to have a Truth and Reconciliation process for corruption, with windfall taxes imposed to address historical corruption, but then zero tolerance for future excesses. If that had been applied I think the country’s elites might have been more interested in supporting and facilitating reform of the judiciary, and legal system to ensure future corrupt practice is not tolerated.
But the battle over the Anti-corruption agenda has now become the logjam and seems to be risking broader political stability as seen in recent days the Saakashvili demonstrations, arrest and then release. Politically Kyiv seems to be in a state of flux. On the one part there seems to be centralisation around the party of power, and the Poroshenko administration, on the other opposition parties are responding to what they regard as undue and unfair pressure from the Poroshenko administration in using the old tried and tested levers of power, to forge new alliances amid shifting sands. Street demonstrations, while still relatively small in scale, have the potential in Ukraine, given the experience of the Orange Revolution, and EuroMaidan, to build in scale and quickly if mismanaged by officials in power.
But a pervasive view which came across on this trip was real uncertainty now where Ukraine is going, and real nervousness as to whether the pace and direction of reform will be maintained. Have the old oligarchic elites totally reimposed their control/authority, and is the current situation in Ukraine all that different from the period 2011-2013 in the lead up to the EuroMaidan? And I think there is a real fear of a populist backlash.
** Please note that any views expressed herein are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions. The views expressed do not reflect the opinions of all portfolio managers at BlueBay, or the views of the firm as a whole. In addition, these conclusions are speculative in nature, may not come to pass and are not intended to predict the future of any specific investment. No representation or warranty can be given with respect to the accuracy or completeness of the information. Charts and graphs provided herein are for illustrative purposes only.”
