Geoffrey Smith of Renaissance Capital -

As of today, it doesn't seem like an exaggeration to say that the next presidential election depends on how Prime Minister Yulia Tymoshenko's Oschadny Bank compensation scheme plays out over the rest of the year.

The plan, designed to compensate those whose savings in the former USSR savings bank were wiped out by hyperinflation in the early 1990s, has so far been an unquestioned political triumph for the prime minister, meeting with overwhelmingly popular approval across the country.

Its success has been down to two reasons: first and foremost, it has been free money. The vast majority of those who lost their savings cannot, after 14 years of more or less kleptocratic oligarchy, ever have expected to see them again. The maximum cash payout is more than the average monthly pension and over half the average monthly wage in Ukraine. Secondly, it is a rare example of a government delivering in full on an election campaign promise within a short time of winning the election. For an immature democracy, looking with envy and self-doubt at the boom in authoritarian Russia next door, this alone is a welcome development, helping to rebuild trust between rulers and ruled, proof that voting can and does change things.

The political logic is brutally simple: put enough cash in people's pockets, and they will know whom to thank when the presidential election campaign starts next year. And the more cash you give, the more intense the gratitude. The PM may only have penciled in $1.2bn in payouts into this year's budget, but her talk of $4bn as a desirable total payout is surely not accidental. It seems that whatever money there is to be spent, will be spent.

Inflationary risks

Money created from nowhere and simply distributed to the people: it's the stuff of nightmares for both economists and political opponents. The inflationary risk is obvious, and is arguably already coming true: January's CPI, up 2.9% month-on-month (the 12-month rate accelerated to 19.8% from 16.6% in December), was an acceleration from the previous two months that cannot simply be argued away as a seasonal start-of-the-year exception.

Consider: most of the Oschadbank beneficiaries are pensioners, people who, even if they have no urgent material needs, have no desire to defer consumption any longer. Of course, all of the Oschadbank bounty is going to go straight into consumption. What do pensioners spend most of their money on? Food and medicine. Hence in January, the price of bread went up by 3.9%, eggs 6.6%, sunflower oil 5.1% and healthcare goods 3.9%. The corresponding figures for January 2007, when there was no Oschadbank payout, were 0.1%, minus 1.4%, 0.1% and 1.0%, respectively.

And that was the effect of just the $398m disbursed in the first three weeks of January. Another $215m was paid out in the first half of February. At this rate, the full $1.2bn earmarked for this year will have hit the money supply (already growing at an annual clip of 50.8% through December) by the end of March.

One of the worrying things for economists, and the opposition, is that the inflation caused by the compensation is not half as bad - in the short run - as the inflation that caused the savings to be wiped out in the first place. A few kopeks on the price of a bottle of cooking oil will seem nothing compared to the trauma of watching 20 years of savings destroyed in a couple of weeks. Hence, Tymoshenko's risk of losing the votes that she is buying may prove manageable. Knowing this, Tymoshenko may calculate that the political gains of a bigger payout outweigh the risks of losing the support of non-Oschadbank beneficiaries due to a fresh surge in prices.

It would be nice to think that the payout can be financed entirely through better tax collection and suppression of the shadow economy, by stamping out customs fraud, grey-wage schemes, bogus VAT claims et al. Only this would legitimize Tymoshenko's efforts to redistribute wealth to the poor and defrauded. Alas, the risk is that such goals are too difficult to attain in the short run, and that the government will resort to selling the family silver instead, effectively robbing Peter to pay Paul. Ukrtelecom, Odessa Portside Plant, six electricity distribution companies, Turboatom, Luganskteplovoz (again) - the government has made clear that it would sell all of them if it could. And all of them together, according to our calculations, would generate the above-mentioned $4bn figure very neatly, assuming the government privatizes transparently and competitively.

Small wonder, then, that President Viktor Yushchenko is looking at Tymoshenko's privatization programme with alarm. The more sales, the more compensation to Oschadbank savers and the more votes to Tymoshenko in the first round of the presidential elections. The incentive to hobble her, while claiming (with justification) to be acting out of classic economic prudence, must be intense.

However, that would be an electoral gift to the PM, allowing her to cast not only her usual opponents in the Party of Regions, but also the president himself, as putting the interests of fat cats and big business before those of swindled savers. The Party of Regions head Viktor Yanukovych must be especially distraught - Tymoshenko is now wooing pensioners in his electoral stronghold, by delivering something that he didn't manage to do in his two separate premierships. The Oschadbank scheme may one day be viewed as the moment that Ukrainian politics went truly national.

Yanukovych's two consolations are that the public, especially those without Oschadbank savings accounts, will have enough time to see the consequences of the scheme, and realize that it was being bribed with its own money. Secondly, the whole affair has forced Tymoshenko into defending Oschadbank CEO Anatoly Guley just as a central bank investigation accuses him of abuse of office, with Yushchenko accusing him - irony of ironies - of financing the Party of Region's last election campaign with the bank's money. Protecting someone under such accusations just because he is loyally cooperating with the compensation scheme does nothing to burnish the PM's anti-corruption credentials, after all.

Tymoshenko has embarked on an extraordinarily bold and risky gambit. If she can contain the inflation that must ensue from it, then she will have taken a huge step toward the presidency and struck the kind of blow for social justice that most democratic left-wing politicians can only dream of. But if she fails, then she will discredit both herself, and the ideals she has claimed to be pursuing.

Geoffrey Smith is Head of Research at Renaissance Capital in Kyiv

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