Ukraine brought a large delegation to the spring meetings of the International Monetary Fund this year, headed by the newly confirmed governor of the National Bank of Ukraine, Yakiv Smoliy.
The size of the delegation I guess was meant to signal intent and a desire to iron out the various outstanding issues with the now long delayed fourth review of the $17.5 billion IMF lending program through 2019. It is now a whole year since the completion of the last review, less than half the planned IMF monies have been released to date, and Ukraine should now be on its 13th review, not its third.
It’s fair to say that Ukraine’s Western allies are frustrated. Indeed, the sense is that while huge reform strides were made in 2014-2016, the pace of reform has since stalled, even stopped, and that the old oligarchic elite order has been restored. What a disappointment after the euphoria of the EuroMaidan Revolution, which drove Kremlin-backed President Viktor Yanukovych into exile in 2014, when there was such hope that this time could be different.
As I understand it, Smoliy impressed, in terms of his businesslike and “can-do” approach, and has done much to help ease the considerable frustrations which have now built in Washington, D.C. around Ukraine’s lagging reform progress. Smoliy is seen as having much better relations with the Verkhovna Rada than his predecessor, Valeria Gontareva, and the hope is that he can break the logjam over key outstanding issues, and in particular official creditors’ demand that Ukraine passes the second reading of a bill creating a truly independent anti-corruption court. It does help that Smoliy has earned considerable respect from the international financial institutions for his capable and orthodox management of the NBU in his own year stint as acting governor. Indeed, not only did he maintain an orthodox monetary policy stance – even hiking policy rates in the 24 hours before his formal nomination in the job as governor by the Rada, but also fending off horse trading his appointment for political placements on the NBU board. Smoliy is trusted and respected in D.C., and also Kyiv, and the hope I guess from both sides is that he can use to finally kick-start the program again. He had strong support in D.C. from other reformers in the administration including Finance Minister Oleksandr Danylyuk, and Naftogas CEO Andrey Kobolyev. Indeed, it was very much the dream team in D.C.
In terms of the issues which are still outstanding with regard to the IMF program, the gas price issue remains unresolved. The Ukrainian side have been going round in circles for months trying to suggest new pricing formulae but which all in essence appear to have the intent of avoiding hiking gas prices.
The Volodymyr Groysman administration argues that raising gas prices at this stage is politically unpalatable – albeit the gas price increases now required are many multiples lower than already delivered since 2014 (without social unrest), and targeted assistance to almost 5 million households suggests that the poor will be significantly protected.
This raises obvious questions as to the real motives underlying the new found unwillingness to hike gas prices. Some might argue that this all reflects a return of rent-seeking behavior in the gas sector from Ukraine’s elites, others that this is just an attempt to play for leverage with the IMF, or to use the gas price issue as a cloak (to the domestic population) for unwillingness to implement other aspects of the IMF reform agenda (e.g. the anti-corruption court), and also perhaps it might reflect the political ambitions of Groysman, who might surmise that playing tough with the IMF over gas prices might help create a political base for him to launch his own bid for the presidency in 2019.
What is clear in my mind though is there is zero chance of compromise from the IMF on this issue of gas pricing. Groysman better not hold his breath for a compromise.
Indeed, gas price liberalization, and the move to an automatic gas pricing formula, is seen as one of the great reform achievements since the EuroMaidan Revolution. It has helped cut graft, cut energy consumption ensuring more efficient and environmentally friendly energy use, cutting the large Naftogaz and quasi fiscal deficit from gas subsidies (4-5 percent of gross domestic product only a few years back) and helped cut the gas import bill from $12 billion a decade ago to perhaps a couple of billion dollars currently. This has hence helped rebalance the current account, helped stabilise the hryvnia and build the National Bank of Ukraine’s foreign exchange reserves in the process.
On so many fronts this has been a win, a huge win, and transformational.
Why would the IMF tolerate going back on this great achievement?
Equally as significant and grating for the fund is the fact that Ukraine promised to hike gas prices as a condition for receiving the last credit tranche in April 2017. Not hiking as per that agreement showed considerable bad faith and arguably judgement from Ukraine’s political leadership, as it expended some considerable political capital in D.C. for no benefit. Some in the Ukrainan government thought that they could play the IMF. This strategy has backfired. I cannot see the IMF budging on this issue, nor should they.
A second issue which has emerged over the course of the year is weakening on the fiscal side. In December last year, in the second reading of the budget the government hiked spending by Hr 41 billion, up from what had been agreed with the IMF.
In order to keep the budget deficit flat at 2.5 percent of GDP, the budget assumed higher budget revenues would be forthcoming in 2018. The line there was that economic activity would be stronger and tax compliance more effective. In the event revenues have failed to meet the higher budgeted targets, and the revenue shortfall looks set to be as much as 1.5 percent of GDP. As a result the IMF is looking for additional fiscal measures to close this gap – likely politically challenging as we head into an election year.c
And finally, the IMF is still demanding that the Rada pass legislation enabling the creation of an independent anti-corruption court, in second reading.
This requirement is really the make-or-break condition (from the Ukrainian side at least, as the IMF will also demand the gas price issue resolved) in terms of whether this next review gets done anytime soon, and indeed, before elections scheduled for March 2019.
There were numerous issues raised by official creditors from the first draft of the bill passed already by the Rada, but my understanding is that most of these have now been resolved aside from perhaps the most important, which is the process for the selection of the judges – and therein having sufficient oversight from the international donor community to ensure that the judges are actually independent.
The hope is that as the bill goes through the committee stage over the next month or so, that the requirements of the IMF and the donor community with regard to the selection of independent judges are taken on board. There is also the matter of the hundreds of amendments tabled to the first reading, many, if not most, would also render the bill non-compliant with the IMF demands.
But the hope still is that an IMF-compliant version of the bill is tabled in the Rada on May 15 – assuming Rada deputies can be persuaded to return early from recess (hotels in the Maldives will be full) – and passed, to then allow an IMF review mission to visit Kyiv in the second half of May. This creates a best-case scenario of allowing disbursement of $1.9 billion in IMF monies, and a total of $4 billion in international financial institution credits by early July. “Manna from heaven” one might think.
It remains touch and go whether the anti-corruption court bill will be approved in second reading, or at least whether an IMF-compliant bill will win approval. I guess at the heart of the matter is whether President Petro Poroshenko’s administration is really serious about fighting corruption. The anti-corruption court is meant mainly to fight elite, high-level corruption, and therein to send a signal throughout Ukrainian society that behavior has to change, and it will be finally changed from the top. High-level political leaders, government officials and even oligarchs might actually go to jail (none have so far, four years after the EuroMaidan Revolution, and whichever way you look at it, is a sad indictment of this administration) if you follow the logical conclusion to the current process with regards to the anti-corruiption court – and I guess that is precisely why there is so much elite resistance. This law could actually transform Ukraine – positively, and for ordinary Ukrainians, rebalancing the system away from elites to ordinary people. Imagine that – the rules change that Ukraine can have higher and more inclusive growth and that the country won’t just be run for a narrow clique of greedy elites.
This isssue is so critical for Ukraine, as all the business and popular surveys suggest that the number one issue facing Ukraine is corruption, and recent years have seen disappointing progress herein, as least as reflected in slow, even glacial progress in Ukraine’s ascent up Transparency International’s Corruption Perception Index. And in the end, without progress in rooting out corruption and thereby improving the business environment, Ukraine will simply fail to succeed in attracting significant inflows of foreign direct investment, and spurring domestic investment, which is so crucial to raising the rate of real GDP growth in the country currently lagging its European peers and therein even from a very low base.
I have my doubts as to whether the Rada will back an IMF-compliant anti-corruption court, as likely many of the deputies in the Rada will view this legislation as being squarely aimed at them and their business groups and interests – ergh, yes, it is!
Poroshenko has to show leadership and drive in getting his faction, and its allies in the Rada, to back the bill. So far this support has been somewhat grudging – indeed, while Poroshenko had earlier seemed to promise delivery himself on the anti-corruption court, he seems to have since deferred the matter to the Rada. Some would say this is passing the buck, in the knowledge that turkeys never vote for Christmas, but that he can deflect blame for failure to meet international financial institutions demands to others.
Factors raising hope that the anti-corruption court will be passed, in an IMF-compliant format, include the allure of $4 billion in international financial institution credits which rest on the current 4th review, plus the hope that with the IMF programme back on track, that this will reduce Ukraine’s borrowing costs, and will underpin another successful and large foray into international capital markets.
It’s possible to imagine a scenario with the anti-corruption court bill passed, IMF money in the bank, and then further bolstered with Eurobond issuance, that the Poroshenko administration flush with cash is able to bankroll its election campaign into the March 2019 presidential elections.
And with opinion polls showing Poroshenko lagging badly behind ex-Prime Minister Yulia Tymoshenko, he likely will have to spend big sums to have any chance of beating Tymoshenko in March 2019. Getting an IMF signoff, and eurobond cash perhaps give him the best chance. And even on the issue of elites being worried as to the consequences of the anti-corruption court being allowed to run its course, and actually imprison corrupt individuals, I guess elites might take some solace from the fact that passing legislation facilitating the creation is one thing, but actually implementing the legislation is another – and is only likely now to be a condition for future IMF reviews (or programs), beyond the next election. Indeed, even with the bill passed in May, it is inconceivable that any judges will be operating before the presidential elections. They might assume that while the bill will be passed, it may actually never be implemented, so why resist its passage? Possibly, if anything likely makes Ukraine’s oligarchic elites wake up in a sweat at night, it is likely passage of the anti-corruption court any time soon.
But while you can perhaps make a case for Poroshenko trying to push the anti-corruption court through the Rada, it is less clear cut why a weight of the opposition in the Rada (Tymoshenko, Radical Party leader Oleh Lyashko and factions controlled by billionaire oligarch Igor Kolomoisky) and even Poroshenko’s rivals within the president’s bloc in the Rada would support such legislation which might hand the president a tool to eventually put them in jail, and also to give him the keys to a war chest to win the presidential election. Even Groysman might not be greatly enthused by the prospect of giving a gift to Poroshenko when he will undoubtedly have to take the rap for having to hike gas prices – given it was the prime minister who surprisingly announced that there would be no gas price hikes under his stint as prime minister last year. Indeed, a part of Groysman, might consider resigning over the gas price hike, and to use that to launch his own bid for the presidency.
A very likely scenario remains that a version of the anti-corruption court is passed at second reading but includes clauses which fail to ensure its independence. Poroshenko hails this nevertheless, and as he did with pension reform, as a triumph, suggesting that any remaining issues with the IMF will be ironed out in due course. And, on this basis – that the court is still a work in motion – Ukraine comes back to international capital markets, borrowing enough to fund a somewhat less generous election campaign.
An alternative but very possible scenario is that ,fearful of failing to win the presidential elections, Poroshenko pushes for constitutional reform, moving Ukraine back to a parliamentary democracy.
He could then bring parliamentary elections foreword to autumn 2018 and hope to use the current electoral system to cement a majority in parliament and then to lead the country as a prime minister with enhanced powers. Any such vote could also include referenda on NATO and European Union membership desired to get the vote out and boost his own popularity. I think within the Rada there would likely be strong support for such a reform, as it likely would entrench coalition government, and create lots of scope for political patronage which Ukrainian political elites just love. Likely the biggest loser from such a scenario would Tymoshenko, currently heading opinion polls for the presidential contest. It would also head off any chance of a challenge to Poroshenko from new fresh candidates – a Ukrainian Emmanuel Macron (Slava Vakarchuk).
But the upshot of the above is that this could delay the vote on the anti-corruption court, and also perhaps its eventual implementation. And that would very much be the point.
In conclusion, Ukraine is reaching decision point on so many areas, including the anti-corruption court, gas prices, the future of the IMF program, market access, constitutional reform and elections. It is going to be an interesting year for sure.
