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Ukraine: In between a rock and an angry Russian bear

Now that the revolution is over, the opposition is facing the same economic crisis that helped drive Yanukovych from office

  • By Jamila Trindle and Keith Johnson
  • Published: 20:00 February 27, 2014
  • Gulf News

As Ukrainian leaders trade the barricades for bureaucracy, they’re faced with nearly empty government coffers, painful economic reforms and the looming threat that their success will provoke retaliation from Russia, whether economic or otherwise.

After a bloody week that brought the country to the brink of civil war, opposition leaders succeeded in ousting former president Viktor Yanukovych, who fled Kiev as his government dissolved. Their prize? Dealing with the same economic crisis that helped drive their predecessor from office.

The new Ukrainian government has indicated that it will need roughly $35 billion (Dh128.5 billion) to get through the next two years, much more than the original $15 billion bailout the government negotiated with Russia last fall.

In addition to putting a price tag on fixing its economy, this week the Ukrainian government moved to shore up the country’s financial future by picking a new central banker. Parliament voted for Stepan Kubiv, who is a former “commandant” from the protest movement, according to the Kyiv Post. Kubiv said one of the first things on his agenda would be inviting the International Monetary Fund (IMF) to Kiev to restart negotiations over a bailout package.

Over the past few days, western countries have again welcomed Ukraine to the European fold, and now stand ready to offer financial assistance once a new government is in place. In addition to making clear that Ukraine had a path back to financial solvency through the IMF, the United States proffered bilateral aid as well. European officials are also reaching out to Japan, China and Turkey to organise a Ukrainian bailout, according to Reuters. But the money won’t come easy. The IMF has previously outlined its demands, including cutting energy subsidies, slashing government spending and reining in corruption.

Those conditions are not expected to change — and will likely be unpopular among Ukrainians — but some analysts are optimistic that there is a way to fix the economic problems that have plagued the country for over two decades.

“This is a really opportune time to do things that are long overdue, and can be easily blamed on the outgoing administration,” Tim Ash, head of emerging markets research at Standard Bank Group, said in an email.

The new leaders were part of the opposition that revolted against President Viktor Yanukovych’s decision to accept Russia’s cash and reject closer trade ties with Europe. Now, they are free to put the country back on a European trajectory, and reconsider signing the trade and political agreement that Yanukovych rejected, but they may face the same fallout from Russia that he did. Ukraine relies on Russia, not just for trade, but also for natural gas imports.

If Ukraine’s short-term financial lifeline comes with the signing of the association agreement with the European Union, which will allow for a free-trade zone and lift visa restrictions, it will carry one big additional risk: the threat that an angry Russia could use its energy leverage to try to cow Kiev back into its orbit.

“If the Russians choose to make life difficult for Kiev, they have lots of tools. They could raise the price of gas back to pre-December levels, they could boycott Ukrainian goods, they could even go so far as to shut off shipments of natural gas,” said Steve Pifer, a Ukraine expert at the Brookings Institute and a former US ambassador to Ukraine.

While President Obama and European leaders have tried to convince Putin that a stable Ukraine is more in Russia’s interest than a failing state would be, the Russian leader’s geopolitical calculations are likely to be different — leading him to work against any sort of stabilisation of Ukraine.

“Putin is going to be tempted to use some of the pressure levers at his disposal to make life difficult for the new leaders. I suspect Russia will be part of the problem, not part of the solution,” Pifer said.

Russia holds sway over much of the Ukrainian economy, but Moscow’s dominance of natural gas supplies looms largest. Russia has cut off gas supplies to Ukraine several times in the past, and gas trade between the two countries has been at the heart of the tug-of-war for influence since late last year.

For now, though, the big questions facing Kiev are threefold. What happens to the preferential deal that ousted Ukrainian president Viktor Yanukovych signed with Russia in December that included $15 billion in aid and a 33 per cent discount on natural gas? How painful will the domestic economic and energy reforms needed to satisfy the IMF and the European Union really be? Finally, what will the turmoil do to Ukraine’s long-term plans to become a bigger gas producer in its own right and shake off the Russian energy yoke once and for all?

Russia does hold some powerful cards in the short term. Under the terms of the December deal, the price discount will have to be renewed by mutual agreement every quarter. Michael Levi of the Council on Foreign Relations warned at the time of the deal that deep discounts can give energy suppliers big leverage, too.

Ukraine’s acting energy minister said this week that he hoped the gas price would remain stable, Reuters reported. But Dmitri Medvedev, Russia’s Prime Minister and a deputy CEO at Gazprom, laid down his own marker this week when he said the gas discounts will run their term, and will then have to be renegotiated with the new Ukrainian government, “if one appears.”

Ukraine’s broader trade relationship with Russia could also hang in the balance. Yanukovych decided to spurn the European Union last fall after Russia threatened punishing trade sanctions if he signed the deal.

Russian Economic Development Minister Alexey Ulyukaev said this week in Washington that his government would have to consider what a new Ukrainian pact with Europe would mean for Russia. He said it was still an open question whether Ukraine could be part of both the Russian and the European free trade zones.

“We decided the three parts — Ukraine, European community, and us — will start to talk about if it’s really possible to have the two things together,” Ulyukaev said.

He also made clear that the rest of the $15 billion aid deal that it promised in the fall is not a sure thing. Ulyukaev said it would depend who Russia’s “partners” were in Ukraine.

A $2 billion bond deal that was supposed to be the latest instalment of the aid package fell through last week, after Russia indicated it was backing off because of political instability.

Another big question is how Ukraine balances the need to reform its economy, especially parts of its domestic energy sector, in order to satisfy Europe and the IMF. Under the terms of the association agreement that both sides initialled last November — but which Yanukovych suddenly ditched, sparking the whole protest movement in the first place — Ukraine must set market prices for natural-gas users in the domestic market, rather than offering discounts that act as a hidden subsidy. Additionally, Kiev has to ensure any energy it exports is priced at the same level as it charges at home.

All that adds up to a political headache for the new crop of policymakers in Ukraine: Any move to raise domestic prices could eventually shore up state finances, which is why the IMF has pushed for such reforms, but could also spark a popular backlash.

Finally, the months of protest, the formation of an interim government, and the prospect of another round of contentious elections raise the question of what will happen to Ukraine’s long-term prospects for domestic energy development. Last year, Ukraine signed huge deals with Chevron and Shell to develop shale-gas resources and try to replicate, if on a smaller scale, the kind of energy revolution that has turned the United States from an importer of natural gas to a prospective exporter in just a few years.

Earlier in February, Ukrainian officials said they hoped to finalise the shale deal with Chevron in March. But the turmoil has made it unclear just when those foreign companies can actually start exploration. Chevron said late last week that it was “monitoring” the situation in Ukraine, and still needed the Ukrainian parliament to pass additional energy legislation before it can start any exploration work on the $10 billion deal.

Though Ukraine’s list of economic challenges is long, the country has managed to tick off its biggest economic obstacle.

“The big problem with the economy was that Yanukovych and his family only had one objective: to enrich themselves,” said Anders Aslund, a senior fellow at the Peterson Institute for International Economics. Unfortunately, the Yanukovych family’s corruption may have already cost the country about $12 billion, Aslund said.

— Washington Post

Jamila Trindle and Keith Johnson are Foreign Policy senior reporters.

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