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Ukraine’s Economic Crisis is Deep; It Needs Loans Faster Than You May Think

Yuriy Gorodnichenko, associate professor of economics | February 10, 2015

The uncertainty around how much — and how soon — Ukraine might get help from international lenders is contributing to two real economic dangers facing the country: a default on its debts and a radical slashing of the budget. Ukraine’s friends — the United States and European governments — need to do a better job, along with the International Monetary Fund (IMF), of finding resources for loans to avoid these pitfalls.

For many casual observers, the notion of a radical austerity plan for Ukraine may seem to make sense. Such plans have been a therapy of choice for the IMF in helping cash-strapped states return to fiscal viability. And Ukraine’s historically endemic corruption makes it harder, politically, to sell the idea of lending the vast amounts — an estimated $15 billion on top of the $17 billion package assembled last year by the International Monetary Fund (IMF) — being discussed as Ukraine’s need.

But radical budget slashing would be a dangerous choice for Ukraine, courting economic, humanitarian and political disasters. The government in Kyiv is trying to avoid that option, and Ukraine’s supporters should help it to do so.

Ukraine’s Immediate Danger

Amid the drama of Ukraine’s war against Russia’s assault in the southeast, and the recent argument over whether the United States should help it with weapons, it’s too easy to lose focus on the depth of what is really a more immediate, existential threat — Ukraine’s economic crisis. Here are some reminders:

  • In the past year, the national currency, the hryvnia, lost more than two thirds of its value against the dollar.
  • Ukraine’s economy (its gross domestic product), shrank by 7 percent last year — a decline exceeded only by South Sudan and Libya.
  • Inflation roared at 25 percent last year and will remain in double digits throughout this year.
  • The country’s foreign currency reserves, for a nation as populous as France, have shrunk to a level that could cover only about five weeks of imports. (Economists say a healthy economy needs six months’ worth of reserves, and a level of three months signals a crisis.)

A Reuters report from Kyiv last week painted the alarming economic picture well: Ukraine’s crisis, it said, “is turning the clock back to the 1990s, when people kept dollars in their socks rather than at banks and smuggled cars to sell them on the black market.”

Economic Crisis Blocks Reforms

This crisis directly threatens Ukraine’s ability to fund its own defense (which Finance Minister Natalie Jaresko said last week is costing the government $5 million to $10 million per day). As dangerous, it is forcing the government to slow down the critical process of reforming what was measured again last year as Europe’s most corrupt economy. This is politically dangerous, for last year’s Maidan movement and two national elections underscored anti-corruption reform as the first demand of most Ukrainians. And it’s also the primary demand of Ukraine’s friends abroad.

But Ukraine’s allies need to realize that Ukraine’s barren treasury makes aggressive reforms impossible. That’s because reforms create winners and losers — and temporary shortages of tax revenue. Given Ukraine’s dire fiscal position, it can neither cover those temporary imbalances nor even partially compensate losers from reforms, a key step in keeping the reform process politically viable.

Indeed, the resources are so scarce that there is an open discussion about a looming default on public debt and the financial markets estimate the probability of Ukraine’s default at 20 percent. As a result, the private debt markets are largely closed for Ukraine and the current government cannot borrow to smooth the transition.

Austerity: The Poison Pill

Kyiv’s lack of financing leaves it the dangerous option of proceeding with reforms anyway and solving the budget deficit by radically slashing government spending. This would be a high political risk and would court economic disaster. Given the costs and the imperative of military defense potentially disastrous in economic terms. Ukraine can’t cut its defense costs while under invasion from Russia, and will spend 5 percent of Ukraine’s gross domestic product (GDP) this year, according to Jaresko. That is one of the highest defense burdens for any country in the world.

So an aggressive austerity plan would slash spending on health care, education and other socially sensitive programs. Under much less stressful conditions, a belt-tightening policy in Greece beginning in 2010 led to a depression-like contraction of the economy and then successive rounds of budget cuts. With that in mind, Jaresko and the government have chosen to try to broaden the tax base and revenues, rather than slashing budget spending for 2015. Still, their projected tax revenues are rather optimistic and soon the government will have to make a stark choice: reform the country regardless of the costs or become a failed state.

Ukraine can avoid this poison pill only if its allies can scrape together enough loans—and quickly. Several financial officials have posited that the minimum number is around $15 billion for the next few years, in addition to the $17 billion arranged last year. (Those numbers do not take into account the very real danger of a major escalation in the war.) As Jaresko has underscored, it’s critical for these funds to be “front-loaded” — that is, made available early to restore public confidence in the Ukrainian government’s fiscal viability.

Last month, the financier George Soros argued for a European “Marshall Plan” of as much as $50 billion dollars for Ukraine — a plea that appears to have fallen on deaf ears in the West. While this is a big sum, the cost of letting Ukraine fail is far higher.

Given the fast pace of developments in eastern Ukraine, a solution to this problem may need to be found in weeks. Ukraine’s lenders may choose to offer their aid under carefully crafted conditions, but those should not include the deep spending cuts of an aggressive austerity regime. Ultimately, the Western and Ukrainian leaders will have to take risks and trust each other. It is in the mutual interest of the West and Ukraine to develop a working plan to support Ukraine economically for the next few years, until Ukraine’s economy gets back on its feet.


Reposted from the Atlantic Council blog.

Comments to “Ukraine’s Economic Crisis is Deep; It Needs Loans Faster Than You May Think

  1. As for Dave Pacific, I’ve got a question to him. It relates the “validity of cultural anthropology” which, according to him, can bring peace to Ukraine.

    My grandpa married my grandma, they had 5 children, a house, a big piece of land. My grandpa was slaughtered by a Polish band for being “a conscious Ukrainian”, his wife was deported with children and father-in-law by train in standing position far away and forced to leave the estate and all their belongings. The soviets granted her a tiny half of a hut in a remote village. Three of the children did not survive diseases, famine or other calamities all together. My dad was one of the two survived. He had to fly with one wounded wing for the rest of his life. Spoke little. Hated Poles and the soviets, collectively, regardless of time and space. He spoke of Germans with pride, despite the fascism and holocaust.

    Now, my husband’s grandpa is 91. He is a convinced Ukrainian-speaking communist. He does not understand why Ukrainians have war with Russia. His idealistic worldview is incapable of encompassing the current reality. He says Stalin was a nice leader. He says the Ukrainian famine 1933 was made up by Stalin’s enemies etc. etc. He spent many years in Germany as ost-arbeiter. He hates Germans.

    The line of anthropological selection goes right between me and my husband, cutting our three children in two. Shall I draw it? Just for the sake of peace in Ukraine and that you, guys, over there, in your countries, would not be bothered anymore with the question of Ukraine…so disturbing…so inconvenient…just so out-of-hand. Really. Just for the sake of a “valid cultural anthropology”…but unfortunately, Hitler was applying cultural anthropology for drawing lines between unter- and uber-mensch.

    I am a Christian and the blood shed by Christ on the cross goes beyond the levels and limits of any human understanding and division. Be it not for this, I would not believe in peace at all.

    • Halyna, i have much empathy for all Eastern Europeans who have suffered so much brutality, and not just recently, but over centuries of war from all directions.

      My posted thought was my own. A search upon reading your question, though, points to an entire issue on this concept in the Journal of Cultural Anthropology, published by a section of the American Anthropological Association which has “11,000 members…including archaeologists, cultural anthropologists, biological (or physical) anthropologists, linguistic anthropologists, linguists, medical anthropologists and applied anthropologists in universities and colleges, research institutions, government agencies, museums, corporations and non-profits throughout the world.”*

      My additional thought is that for the “Ukraine Spring” to continue and flower and bear fruit, there needs to be a huge swelling of participation by young people and women.


  2. As for Relko Reanato, I would say the following. You have to read a lot about Putin before you understand the origin of his numerous funds. Read about the submarine Kursk, about the explosions of civil houses in Russia in 1999, about war in Chechnia, about Beslan, about Nord Ost, about Georgia in summer 2008, about Anna Politkovskaya, about Anatoliy Litvinenko, about Magnitskiy, about Nadiya Savchenko, about Boris Niemtsov.

    I must say you very under-informed. Therefore it seems to you that the problem of Ukraine has a very simple solution. I envy you because you lead a very easy and careless life. So, it’s interesting to learn that the country attacked by an aggressor even has debts before the aggressor. Maybe raped women also have debts before their rapers? It’s an amazing way of reasoning. Where did you graduate from?

  3. I live in Ukraine and know what is happening not from the news. I live in the news. There is no civil war in Ukraine. A big country ruled by a KGB criminal has surreptitiously attacked another country presenting it to the world as a will of easterners to separate.

    This war started long ago before the actual undisguised killing of people took place. It started when Yanukovych was put into the presidential chair as a vice-president of Russia ruling from Kyiv and being councilled on every tiny matter by Kremlin. The very statehood of Ukraine was being undermined and ruined already then. Of course officially everything looked very nice – independent state, legal president, joky-poky. Ukraine was slowly robbed by Yanukovych and his surrounding, gradually sold to Russia.

    If there had been no Maidan events in 2013-14, we would have been occupied by Russia anyway but with less visual means. The expression of free will from the side of Ukrainians – both western and eastern, however, spoiled his plans and he had to take radical measures of appropriating what he believes is his property.

    Take time and find in the internet pictures of Russian military bases created not far from the Ukr-Rus border in late 2013, taken by a German journalist. Yes, there are Russian-speaking Ukrainians who are willing to live in Russia (they are very much misinformed but that’s their choice). Nobody objects. They have free will to change their citizenship. What for to rape the country regions presenting it as civil war?

    Thank you very much for believing the lies of Putin. Thank you very much indeed. Never ever try to learn what is really happening in Ukraine. Do not help Ukraine, leave my country to bleed to death, save the money of your taxpayers for your daily cares. But remember: there is a price for everything. Be sure you are ready to pay it in future as you reveal the truth…

  4. It is a really bad idea to invest money in the economics of the former Ukraine where civil war in a progress. The former Ukraine will be disintegrated soon due to genocide of civilians in Donetsk and Lugansk area. Obama and Biden already look as war criminals supporting Ukrainian junta. As a taxpayer I hate the idea to invest in the bloody junta. It is spending taxpayer money in vain. It is a sort of trap for the USA. A new Vietnam. Do we need it?

  5. I don’t understand why the Ukraine doesn’t just sell some of their land if it is in so much debt! That would solve everybody’s problem! Putin has the funds, he can even reduce the deficite that the Ukraine has with Russia.

  6. Large parts of Donetsk and Luhansk regions appear to be ethnically Russian and appear to not want to be part of Ukraine.

    IMF lending more money to continue trying to force these resisting people against their will back into Ukraine is a political power play and bad economics.

    Putin is ‘The Neighbor from Hell’ … we’ve all had ‘neighbors from hell’ and over time we’ve learned that we have to accept deals that we don’t like.

    Cultural anthropology that’s politics-blind may conclude that the separatist regions should be released from Ukraine.

    Further IMF loans should not become money simply incinerated in further bloodshed.

    A peace based on valid cultural anthropology facts is needed and has the best chance of working.

  7. I don’t understand why the Ukraine doesn’t just sell some of their land if it is in so much debt! That would solve everybody’s problem! Putin has the funds, he can even reduce the deficite that the Ukraine has with Russia.

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