COMMENT: Ukraine's bad start

By bne IntelliNews October 24, 2014

Ben Aris in Moscow -


This weekend's crucial parliamentary elections in Ukraine could mark the end of two decades of failure and the launch of the country's attempt to catch-up with the rest of the region. The trouble is that Ukraine is already off to a really bad start. 

There has been no real reform in Ukraine since the collapse of the former Soviet Union in 1991, irrespective of the colour of the government - orange or blue.  The Orange Revolution was a wasted opportunity. President Victor Yushchenko won a mandate from the people on the streets of Kyiv and ousted the kleptocratic government of Leonid Kuchma, but internecine fighting amongst his fellow revolutionaries and the machinations of Ukraine's leading oligarchs gutted any attempt at real reform. When ousted Ukrainian President Viktor Yanukovych took back control in 2010 in what were probably the country's first truly democratic elections, the stealing began in earnest. Leading to another revolution. 

Ukraine is a case study in failure. It is one of only two states in the former Soviet Union not yet to get back to the 1991 level of GDP (The other is Kyrgyzstan). Per capital income is a mere $3,000 - a fifth of that in Russia and well behind even Belarus. 

As Eurasia Group founder Ian Bremmer pointed out in his book "The J Curve", authoritarian rule brings stability but democracies, while more chaotic, offer a much higher standard of living. The difficulty is, to get from one to the other you have to pass through the bowl of the "J" and not everyone makes it. 

Ukraine has not been helped by the duplicity of the west. Happy to welcome Ukraine into the European club of "shared values" politically, it is not prepared to pay for Ukraine's transformation. And the country is in desperate need of cash. The widely touted IMF $17bn stand-by loan sounds like more than the $15bn Russia offered in 2013, until you realise it is paid out over two years and doesn't even cover this year's bills for the $5.4bn Ukraine owes Russia in overdue gas bills, the approximately $2bn more it will have to pay for this winter's gas and the $1.6bn Eurobond that state-owned gas company Naftogaz had to redeem earlier this month. 

Not paying the Russian bill is not an option so that leaves nothing left over for badly needed investments and recapitalisation of the banking sector, to name the most obvious pressing needs. Ukraine is in very real danger of total economic meltdown. 

Ukraine's Naftogaz said it has set aside $3.1bn in a special escrow account to pay Russia's natural gas supplier Gazprom on October 24, but without a new deal on gas prices this amount remains about half what Ukraine owes. 

The international financial institutions have not helped, reflecting the hubris of the tight-fisted European politicians who are long on rhetoric but short on loans. The economic prognosis of Ukraine's ills that formed the basis of the IMF's loan was "wildly optimistic", predicting, for example, a 3% contraction in GDP for 2014, when even at the start of this year other economists were predicting 10%, much closer to the current 9.5% economic fall. This year will mark the economy's worst performance since 2009, when GDP tumbled about 15% because of the global financial crisis.

"If the IMF thinks their programme is still on track, then they are living in cloud cuckoo land," commented Tim Ash, head of research at Standard Bank in a note. 

IMF Managing Director Christine Lagarde almost admitted as much on October 8, saying, "The situation in Ukraine is serious and more funding will be needed". However, she went on to say that the IMF will not put up much more and "other lenders" will need to participate, without specifying who those lenders will be. 

What next? 

Will these parliamentary elections break the cycle of mismanagement and revolution in Ukraine? Hopes are obviously high but what little the new government has done and said on the topic of reform so far is not encouraging. 

The parliamentary elections will complete the process of legitimising the new government after it unconstitutionally ejected a democratically elected government, which is a pre-requisite to making a fresh start. 

However, the government is clearly groping its way forward. The first problem is the wild assessments and spending promises the government has been making. The economic forecast that so badly underestimated the problems Ukraine would face is one example. President Petro Poroshenko's promise to up military spending to 5% of GDP is another; even Russia, which is actively rearming, only spends 3.8% of GDP on its military and Ukraine is going to struggle to spend an extra UAH5 on its military, let alone such a huge share of budget revenues. 


The government passed new anti-corruption laws on October 7 to tackle top-level government corruption, hoping to ease public discontent before the election. The laws oblige high-level officials in government, the judiciary and law-enforcement to declare their own and their families' assets and financial transactions. The declared income of civil servants will be measured against lifestyle and property holdings, and an independent agency will investigate discrepancies.

"Very good - except every Ukrainian government since independence has passed a raft of anti-corruption legislation and matters have got worse rather than better," wrote Nikolai Holmov, a well known blogger. 

Journalists and MPs have already claimed that the new "Maidan government" is guilty of abusing its power for the personal enrichment of deputies. And Ukraine's deputy prosecutor general has been linked in the media to suspicious deals,  in what is seen as a test case for Poroshenko's anti-corruption credentials. 

The hope that the Maidan protestors would usher in sweeping reforms and sweep out the old school graft was still born. 

Ukraine's most prominent anti-corruption campaigner and celebrity journalist, Tetiana Chornovol, quit her post as head of the government's National Anti-Corruption Committee in August after only a few months on the job, writing on the prominent Ukrainian news website, Ukrainska Pravda, that the "government is unprepared for an uncompromising, large-scale war against corruption". Chornovol is the personification of everything that Maidan was about. She received a brutal beating at the hands of the Yanukovych regime that nearly killed her and her husband died a few months later fighting against pro-Russian rebels in eastern Ukraine. 

The acid test will be if the new Rada votes to remove its own immunity from prosecution, as both the people and the president expect. The bulk of the corruption concerns the members of parliament, who use both their control over state spending and get out of jail free card status to line their own pockets on a colossal scale. Any anti-corruption measures that don't make deputies accountable will be (another) waste of time. 

"As the Ukrainian proverb goes, 'The fish rots from the head'. No corruption effort will succeed without the president and his entourage demonstrating honesty, more-or-less," said Zenon Zawada in a note. "Yet the Poroshenko Bloc electoral list for the early October 26 vote is loaded with politicians with allegedly corrupt histories, as determined by journalists and non-government organizations. And Poroshenko's own nepotism has led to numerous appointments of corrupt top ranking officials, as alleged by these sources."

Poroshenko's party is a ragtag bunch of old and new faces, but eyebrows were raised when Poroshenko's son declared he would stand for office in the upcoming elections. A "war hero" in the recent battle for the east, questions have also been raised as to if the younger Poroshenko was actually there - there doesn't seem to be any evidence that he actually took part in the fighting. 


The issue of corruption strikes to the heart of Ukraine's problem: it remains an oligarchy in the true sense as businessmen paid millions of dollars to gain parliamentary seats as that is how business has been done in Ukraine for two decades. 

Poroshenko has to smash this system and separate business from government. But he compromised from the start. In these desperate times the interim government has appointed several oligarchs as regional governors. More oligarchs are competing in the parliamentary race. And finally at the end of the day Poroshenko himself remains an oligarch. Tomas Fiala, founder of leading brokerage Dragon Capital, accused Poroshenko to his face at an investors meeting of selling parliamentary seats on his party lists for $3-4m.

"The political nepotism and clan structures pervading Ukrainian government can easily serve to undermine any of the investigations and criminal cases that emerge from the anti-corruption structures being created," says  Zawada. "It's entirely possible they will exist on a de jure basis, for international structures such as the IMF, but will have little de facto authority to address illegal activities. So we see no reason to get excited about the legislation until it's demonstrated that the highest ranking officials will abide by current laws, and new laws that emerge."

Economic policy 

The government needs to get a grip on the economy - and quickly. Not only is economic growth contracting, it is also rapidly scuttling off into the shadows: every third worker is now working off the books, according to Hryhoriy Osoviy, the head of the Trade Unions Federation of Ukraine, sapping the state of tax revenues and pension contributions. 

"The tax burden increasingly is shifted onto legal workers, the number of which declines every year and is already less than 10m [from a work force of 35m]," Osoviy said, as reported by the Ekonomichna Pravda news site. 

The president's reform programme has been criticised for being more rhetoric than reason, and hopelessly ambitious, something Poroshenko is aware of. "[The programme] involves a significant number of reforms and solving problems. It's hardly possible to conduct 62 reforms simultaneously, but we have no choice," Poroshenko told a meeting of foreign business representatives and investors in Kyiv in October. 

The growth of the shadow economy is expected to continue to grow as the state has already imposed punitive taxes on the companies with the largest sources of revenues, as it desperately hunts for a way to fund its budget obligations. 

"Kyiv's attempt at fiscal discipline to fund the war effort in the east and stave off an economic crisis is not working, and the end result is going to be economic suicide," Robert Bensh, majority shareholder of Cub Energy, Ukraine's fourth-largest independent gas producer, told from Kyiv.

Ukraine is on the brink of committing "economic suicide" after imposing a crippling 55% tax on private gas producers, say business people. 

"These statistics indicate that the Ukrainian economy is utterly dysfunctional and requires the 'tectonic changes' declared by Ukrainian President Petro Poroshenko, who is testing the patience of the public by claiming to be waiting until after the elections to pursue reforms," says  Zawada. 

At the same time Poroshenko's ambitious plan to attract $40bn in foreign investment and joining the European Union by 2020 is a "pipe dream for a country that is holding current investors hostage and making the atmosphere prohibitive for any new investors", says Bensh. 

Ukraine received an average of $7.2bn in foreign direct investment in 2010, 2011, and 2012, but investment fell to $3.8bn in 2013 and will plummet in 2014, according to the UN. 


The whole point of joining the EU is because Ukraine aspires to the those European democratic values, but on several scores the government has already balked at actually adopting them. 

Lustration is in effect a political pogrom against the old guard. While it can be seen as necessary, and maybe even desirable, it is still not democratic as it excludes people from office on the basis of their political beliefs which is against the spirit of democracy. 

Moreover, from the outset Poroshenko is ignoring the new law from almost its first day. He has appointed several members of Yanukovych's administration to run regions - Serhiy Kuzmenko as the head of the Kirovohrad, who held the same post under Yanukovych; and he supported the parliamentary candidacy of Yaroslav Moskalenko, a former Party of Regions MP, to name two examples - despite the fact they are clearly subject to lustration. 

Poroshenko promised to sell his assets on taking office, but then quickly backtracked saying he would not sell his Channel 5 TV station. Putin is heavily criticised for controlling most of Russia's leading TV stations via state structures, but he would be roasted alive by the international press if he personally owned one of the leading broadcasters in the country. 

And less than half a year on the job, Poroshenko is already embroiled in a media scandal. Ukraine's Defence Ministry and the state arms procurement company Ukroboronprom are suing the news site, after it published a document from the president's office showing the government had sold weapons to the pro-Kyiv militia fighting on its behalf. Poroshenko denied issuing any such order, calling it fake information. "That's nonsense! The opposite is true," he told journalists at an October 21 press conference.

"Poroshenko has demonstrated a habit of declaring politically correct and populist statements when they have no basis in reality," wrote Zawada scathingly in a note. "We doubt the scanned document published on the website of a reputable newspaper is a fake.The new authorities are still stuck in a post-Soviet mindset in its knee-jerk reaction of targeting a news site." Everyone is waiting now to see if a promised investigation into the affair happens.

Most worrying is the investigations in the snipergate shootings on Maidan in February, where nearly 100 people were shot and killed, allegedely some by the protesters themselves, and the investigation into the fire in Odessa that killed nearly 50 pro-Russian demonstrators has already been buried. Results will now not be released until next year and serious flaws in the investigation have already emerged. If the government fluffs the investigation into these key history-making events then the outlook for a change of ruling style look very poor indeed. 

People uncertain 

International commentators are focused on the positive change and confident that the adoption of democracy can only be a good thing for Ukraine. However, for the people this means gas bills that will quadruple, trade that will halve, centuries old ties with Russia will be  effectively broken and incomes will fall. The Ukrainians are much less certain of the benefits of those "European values" than the rest of Europe. 

A poll conducted in October by the Razumkov Centre found that almost half of Ukrainians (46.2%) doubt the government's ability to protect them, only 10% think the current policies are going to provide the country with adequate security.

Moreover, Ukrainian society is still deeply divided. The silver lining to come out of the civil war is that it has created for the first time a sense of Ukrainian statehood where none existed before: even the Russophiles in the east have largely decided would rather remain Ukrainian than secede and join Russia. 

And democracy is still very young and brutal in Ukraine.  Mark Gres, a candidate for parliament with the populist Radical party, was attacked, beaten and stabbed on October 18 in what party officials called an assassination attempt, the New York Times reports. Oleksandr Gorin, a candidate from the People's Front party, led by the prime minister, was also savagely beaten the same night after being ambushed in the foyer of his apartment building in Ukraine's southern Odessa region.

More insidiously many of the old faces from the old Rada will retain their seats, due simply to political inertia. This is bad news as the traditions of corruption and power plays will continue in the new Rada as a result. 

"It is very likely that many of the old faces standing in single mandate [first past the post] seats will be returned due to there being too many new faces standing against them that will dilute the vote against the old faces," writes Holmov. "The old faces have taken great care to insure they all run in different seats so as not to stand against each other and will gain votes through blind partisan loyalty, name recognition and more nefarious deeds."

Even before the first ballots are cast there are already at least three cases of election "irregularities" (mostly investigations into voter bribery) pending at the Odessa Primorsky Court. 

Ukraine is setting off on a bright new path and if Poroshenko successfully navigates the worst potholes then this election could start a decade-long boom as Urkaine finally embarks on the same "catch up" growth the rest of the region went through. This could be the last really big investment opportunity to make huge money really fast in eastern Europe as the rest of the region is approaching maturity and the more complicated "nurture business" phase of growth. However, if it goes wrong in Ukraine it could go horribly wrong.

"The entire country is hoping that Poroshenko leads the new government towards tectonic changes, as he had promised," says. Zawada. "However, his actions so far have demonstrated those are just words for mass consumption by television viewers and that he’s truly committed to maintaining the status quo in the corrupt Ukrainian oligopoly."


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