KYIV BLOG: What’s to be done about those who are to blame in Ukraine?

KYIV BLOG: What’s to be done about those who are to blame in Ukraine?
Ukrainian president Volodymyr Zelenskiy finds himself in a very similar position to Russian president Vladimir Putin when he took over in 2000
By Ben Aris in Berlin September 19, 2019

The burning of the former governor of the National Bank of Ukraine (NBU) Valeria Gontareva's dacha at the weekend is proving to be a watershed moment for the new Ukrainian President Volodymyr Zelenskiy. Attention has been dramatically refocused from the high hopes from Zelenskiy’s radically anti-corruption and reformist legislative agenda to a single question: what is his relationship with his oligarchic backer Ihor Kolomoisky? Is Zelenskiy merely a puppet?

A string of events have only added to the unease that accompanied Kolomoisky’s role in the Zelenskiy story. The president’s chief of staff is Kolomoisky’s former lawyer. The state is proposing to pay Kolomoisky’s Ukraine International Airlines (UIA) compensation for losses incurred due to the Russian sanctions and most recently has suggested it will also compensate him for nationalising his PrivatBank in 2016. The escalating string of attacks on Gontareva that prompted the NBU to tweet “STOP TERROR” this week. Not to mention the fact that Kolomoisky blatantly stole $7bn from PrivatBank, but remains at liberty and free from investigation.

While the “Kolomoisky question” is currently front and centre, the problem is bigger than just one oligarch who seems to have manoeuvred himself into the heart of Ukrainian politics and is now extracting his revenge on his enemies with impunity, before he helps himself to billions of state dollars.

Ironically Zelenskiy faces exactly the same set of challenges as Russian President Vladimir Putin did when he took over in 2000. The Russian economy was a smoking wreck following the 1998 crisis, but the biggest danger to economic recovery and Putin’s political power was the oligarchs had more or less captured the state and riddled the apparatus with their corrupt placemen. Putin himself had been hand chosen, not by the ailing Boris Yeltsin, but the “Family” members, oligarch Roman Abramovich and Yeltsin’s daughter Tatiana Yumasheva.

The two most famous phrases in the Former Soviet Union (FSU) are “What’s to be done?” (After a pamphlet Lenin wrote.) And “Who is to blame?” (The basis on which the planned economy was run.) Today this could be better phrased as “What’s to be done with those who are to blame?”

Kolomoisky is riding high but the oligarchs are a cancer that has pervaded the entire body politic. Like in Russia, the basic business model of most oligarchs is to seek rents from the state and then later from the population. Zelenskiy needs to halt the attacks on Gontareva and hold Kolomoisky to account (if it is shown he is responsible), but more importantly, like Putin, he needs to break up the oligarchs' control over the state. Worryingly from the impressive list of 500 legislative acts that Zelenskiy put on the docket for action before Christmas, anti-trust legislation is entirely missing.

Reading from Putin’s playbook

Much is made of Ukraine's turn to the west and EU aspirations, but the fact is that the situation Zelenskiy finds himself in today is very similar to what Putin had to cope with when he took over in 2000.

GDP crash: in 2000 Russia was just emerging from a debilitating crisis. The economy collapsed in 1998 suffering from a 7% contraction that destroyed the top tier of the banking sector. The Ukrainian economic contraction was worse: Ukraine’s economy contracted by 17% at is worst in 2015.

Devaluation: the ruble lost three quarters of its value on August 17, 1998. Ukraine’s hryvnia has devalued by about the same amount, falling from UAH8 to the dollar to UAH25.

Incomes and poverty: the crash cut Russian incomes in half and poverty levels soared. Unemployment in 1998 was 10% and almost a third (29%) of the population were living in poverty. Ukraine has been suffering from a similar fate with unemployment at 9.2% in the second quarter, but poverty levels have been reduced to 4% as of the end of 2018 partly thanks to a 22% pension increase and a doubling of the minimum wage put in place by former president Petro Poroshenko.

Gross international reserves (GIR): Russia’s gross international reserves were down to about $7bn in the summer of 1998, not enough to cover two months of imports, versus the $528bn Russia has today. Here Ukraine is actually ahead of the game as its reserves fell to a low of $18bn, which just enough to cover three months of imports, considered the minimum needed to keep the currency stable, but are up to $22bn now, a comfortable 3.4 months of import cover.

Putin is considered lucky as the economy was already on the mend when he took over. The beneficial effects of the devaluation quickly kicked in and the economy boomed, expanding by 10% in 2000 – a record that has never been beaten.

Both Poroshenko in 2014 and Yeltsin in 1996 inherited economies that were going into crisis. If anything Zelenskiy has been even luckier than Putin. Ukraine’s economy expanded by an unexpectedly strong 4.8% in the second quarter, even before he took office. In Putin’s case it was not clear until well into 2001 that the Russian economy was bouncing back. Ukraine may not have oil but it does have grain and brought in a record harvest this year and earned circa $25bn from grain exports – also worth circa 25% of GDP. If Russia’s post-1998 devaluation experience is anything to go by then the ambitious 7% a year growth target the Zelenskiy government has set itself should be achievable.

It's lost in the mists of time now, but Putin also launched a deep structural reform plan to finally deal with some of the problems that lay fallow under Yeltsin, dubbed the Gref plan after then-minister for economic development and now Sberbank CEO German Gref. This programme started with a radical overhaul of the tax regime with flat income and corporate taxes, a new labour code, the introduction of a federal treasury system to stop the regions stealing so much money and an assault on the legendary red tape. In the end Gref only managed to implement about a third of the plans, but even that was enough to lay the ground work for an eight year long boom that saw the country transformed and lifted into the UNDP “high income” bracket – the first of the major emerging markets to do so.

Zelenskiy has an even more ambitious plan with over 500 laws due to be drafted and presented to the Verkhovna Rada before the end of this year. And Zelenskiy has full control of parliament so these are likely to be rammed through one after the other. The number of major changes that have already been made in just the first few weeks, like lifting deputies' immunity and the launch of the anti-corruption court (ACC) after years of dithering under Poroshenko are already very impressive.

What is striking about the upcoming legislation is how detailed it is, including measures to collect taxes on amber mining and illicit gambling, to a transparent tax and regulation regime to boost transport by ships on the Dnieper. Although Zelenskiy said almost nothing about his plans during the two campaigns this year, clearly there was a lot of planning going on behind the scenes.

What’s to be done with those who are to blame

But then there are the oligarchs. The burning of Gontareva's home has underscored that the biggest threat to Ukraine's success are the oligarchs. The anti-corruption laws are welcome but it is not the traffic cop taking a few hundred hryvnia for traffic infringements that is the problem. Stopping state officials creaming off hundreds of millions of dollars from a state contract is a serious problem too, but the really insidious and destructive corruption is oligarchs cutting sweetheart deals where they can extract rents from the state or the people. The glaring hole in Zelenskiy's reform plan is there are no plans for tough anti-trust legislation or a beefing up of the existing Anti-monopolies Service.

Putin didn't bother with anti-trust legislation either. During the 1900s Russia’s oligarchs more or less captured the whole country. Boris Berezovsky famously said that he, and the six other preeminent oligarchs, collectively controlled half of Russia’s GDP. A World Bank study at the time found that the real number was closer to around 20%, but even that was significant. And as these “businessmen” controlled not only cash cows in raw materials and hydrocarbons, but also banks, newspapers and TV stations, they had significant political power – power they demonstrated when they lifted Boris Yeltsin’s ratings from low single digits in 1996 to get him re-elected that year in order to keep the gravy train on the tracks.

Ukraine is in an identical place today. If anything the wealth is concentrated amongst fewer oligarchs, who are proportionally even richer and much more deeply entrenched as they have had an extra decade to dig themselves in.

Putin's solution to his "oligarch problem" was to capture the state back. He rapidly jailed Vladimir Gusinsky, who was the biggest player in the TV business, and Berezovsky was driven into exile. Berezovsky was also a big player in media, controlling ORT, now the First Channel, the biggest, but nominally state-owned, broadcaster.

Putin invited the survivors to his famous oligarch meeting and offered the unspoken deal: “keep what you have but get out of politics.”

The final step in the process was to fire all the elected senators from the upper house of the Duma that represented the regions and change the rules so they became appointed by the president. The elections for the Federation Council were a sham as even Anatoly Chubais, a young reformer who ran the national power company United Energy Systems, admitted that it was common practise to “buy” a senator, who could then lobby for legislation that suited a business’ interests.

This system worked well and Putin later supplemented with the "ZAO Kremlin". Putin began having one on one meetings with the biggest oligarchs to make sure their investment plans dovetailed with those of the Kremlin. Putin acted more like an unofficial CEO of Russia's biggest business as the oligarchs followed his informal "suggestions".

Eventually the system started to break down as the oligarchs tried to go their own way. Yukos owner Mikhail Khodorkovsky tried to build a privately owned oil pipeline to China against the Kremlin's wishes and was jailed for it. Other oligarchs close to the Kremlin like Mikhail Prokhorov got into politics but then suffered delusions of independence and were quickly sidelined. Prokhorov is in the process of selling all his Russian assets. Putin has now retreated into an intimate circle of "stoligarchs" made up of his oldest friends to whom he gives the biggest private contracts.

The problem with ZAO Kremlin is that while Putin is the CEO and makes the biggest decisions, the concentration of commercial power in the Kremlin's hands and the failure to set up strong anti-trust laws and the strong property rights that go with them means that his underlings are playing the same game.

As Putin increasingly concerns himself with only the biggest projects, the heads of the biggest state owned enterprises are engaging in empire-building. State-owned Sberbank dominates the banking sector and in the crisis years was responsible for the entire sector's profits. Now it is snapping up technology companies and building e-commerce marketplaces that will dominate Russia's retail trade as well. Likewise, its sister bank VTB has taken over the Post Office bank that gives it access to a nationwide network of branches as well as the massive pension payments business. More recently it has targeted grain trading and bought up several players to make it the dominate player in this $25bn a year business. And Igor Sechin, CEO of Russian oil major Rosneft, has built his company up from a minor player into a global oil powerhouse.

The rapacious nature of the state owned companies means that private sector oligarchs are selling up, or at least not investing in the development of their companies, to the detriment of Russia's development. Fixed investment remains below par, locking Russia into a maximum of 2% growth for the foreseeable future. Equity investors are ecstatic as Russian stocks are currently paying the highest dividends in the world  more than twice the level of the benchmark MSCI EM average  but that is a bad thing: it means private sector oligarchs are simply taking their money out of their companies as cash instead of reinvesting it into their companies.

Zelenskiy faces the same set of problems and seems to be getting ready to make the same mistakes as Putin. The fight against “corruption” has been a top priority and progress has already been made, but no attention has been paid to the oligarchs' influence. Indeed, what is so unsettling is he has barely commented on Kolomoisky, who is left to walk about at liberty despite a growing number of scandals surrounding him and PrivatBank.

So far the issues with Kolomoisky involve his possible harassment of Gontareva and the state owned Privatbank. But so far no money has changed hands. No compensation has been paid. No real damage has been done. With the International Monetary Fund (IMF) breathing down Zelenskiy's neck it will be very hard for him to hand over hundreds of millions of dollars to Kolomoisky and not derail the new IMF programme that is currently under discussion.

However, the problem is bigger than that. Zelenskiy not only has to manage his relationship with his personal friend Kolomoisky, but the state's relationship with all the oligarchs. In the rough and tumble of Ukrainian politics Zelenskiy is doing what all new presidents in Eastern Europe do: consolidate power. Some of the constitutional changes on the table like moving more of the security agencies out from under parliament's control and putting them directly under the president's control will move Ukraine away from a parliamentary democracy and towards a presidential republic.

And maybe that is necessary. Ukraine's oligarchs have had an extra decade to entrench themselves compared to their Russian peers. Even Putin shied away from open warfare with the oligarchs in 2000, preferring to compromise and then work to build up his own power slowly. It's not clear if Zelenskiy is of the same political calibre as Putin. It's not clear if he is prepared to be as ruthless. It's not even clear that he is not simply a client of Kolomoiskiy's.

Since the Zelenskiy administration has not included it, it seems now that it is up to the country's international donors to start advancing a robust anti-trust agenda as part of the conditions its attaches to its loans, along with the laws and infrastructure to make them effective.