Reviving Ukraine’s Economy

Read Time:4 Minute, 39 Second, DC – Ukraine has suddenly arrived at a democratic breakthrough. After
former President Viktor Yanukovich incited major bloodshed, many of his MPs defected
to the opposition, creating a large majority. In order to consolidate its authority,
whatever new government emerges will need to act fast and resolutely – and receive
considerable international support – to overhaul the country’s crisis-ridden

Ukraine suffers from three large economic problems. First, its foreign payments are
unsustainable. Its current-account deficit last year was an estimated 8.3% of GDP,
and its foreign-currency reserves are quickly being depleted, covering just over two
months of imports. Second, public finances are also unsustainable, with the budget
deficit reaching almost 8% of GDP and government-bond yields skyrocketing. Third,
the economy has been in recession for five quarters since mid-2012.

These problems reflect Yanukovich’s economic policy, which had one aim: enriching
him, his family, and a few of his cronies. During the last four years, Ukraine has
experienced unprecedented embezzlement by its rulers, with estimates putting the
Yanukovich family’s wealth at $12 billion. Here, too, the new government will need
international assistance if it is to recover at least some of this loot.

With Yanukovich out of the way, official extortion of Ukrainian business should end,
enabling the economy to recover. In fact, Ukraine’s GDP actually grew by 3.3% in the
last quarter of 2013, because his cronyism was stifled by the protests. Yet much can
and must be done very quickly, because Ukraine is running out of money.

For starters, the new parliamentary majority needs to appoint a new government, so
that a fresh economic-policy agenda can be launched. A new central bank governor
also should be named, with the first order of business being to float the exchange
rate. This would lead to a substantial devaluation of perhaps 10%, thereby ending
the current run on the hryvnia, eliminating the current-account deficit, and
enabling a reduction in Ukraine’s extremely high interest rates, which would
stimulate investment.

As soon as a government has been appointed, the International Monetary Fund should
send a mission to Ukraine. Within two weeks, the IMF mission could conclude a new
financial stabilization program with the new administration. The IMF works fast and
could make a first large disbursement in late March.

The IMF could lend Ukraine $10-12 billion for a one-year stabilization program, with
the European Union using $3-5 billion from its balance-of-payments facility to
co-finance an IMF standby program. These two sources alone could cover much of the
$35 billion in external financing that Yuriy Kolobov, Ukraine’s acting finance
minister, has said the country could need over the next two years. Moreover, IMF
loans carry a lower interest rate and a longer maturity than the Russian loans on
which the Yanukovich government relied (and which are unlikely to continue).

The conditions that the IMF places on its loans can help Ukraine undo Yanukovich’s
venal policies. First and foremost, Ukraine will have to reduce its budget deficit
sharply, which, given large tax revenues, should be accomplished through expenditure
cuts and freezes. Large industrial subsidies – for example, to the coal industry –
amount to nothing but giveaways to Yanukovich’s supporters and should be eliminated
immediately. Likewise, gas prices should be liberalized to stop corrupt enrichment
from regulatory arbitrage. Needy consumers, not wealthy producers, should receive

Similarly, the IMF will insist on the reintroduction of competitive tenders. Since
2010, orderly public procurement has ceased, with Yanukovich simply doling out state
contracts to friends and acolytes at twice the market price. Naturally, sales of
state enterprises to loyalists – typically at rock-bottom prices – must end as

Another source of corruption has been refunds of value-added tax for exporters, for
which top tax officials charge a commission. Putting a stop to this would stimulate

In addition, Ukraine should reintroduce the simplified tax code for small businesses
that Yanukovich abolished. Two million small enterprises were wiped out by that
change; many of them could be revived if tax procedures were no longer prohibitive.

Ukraine also needs to work with the EU. Within a week, the new government can
fulfill the EU’s conditions for signing the long-concluded Association Agreement,
and doing so should be on the agenda at the EU-Ukraine summit in March. Parliament
has already scheduled new elections, and former Prime Minister Yuliya Tymoshenko has
been released from prison. The only remaining EU condition – legislation reforming
the prosecutor’s office – can be adopted quickly.

The EU-Ukraine Association Agreement will greatly benefit Ukraine. It amounts to a
comprehensive reform program for the Ukrainian state apparatus, including its
law-enforcement bodies. Sixty state agencies in various EU countries have already
concluded agreements with their Ukrainian counterparts concerning the necessary

The agreement also contains a Deep and Comprehensive Free Trade Area, which will
open the vast European market to Ukrainian exporters – and thus attract more foreign
direct investment to Ukraine. This will also help to safeguard the country against
possible Russian trade sanctions.

Here, diplomacy will play an important role as well. The United States and the EU
need to persuade Russian President Vladimir Putin to reach an understanding with
Ukraine’s new leaders, rather than follow through on his threat to impose sanctions.
Peaceful co-existence, not mounting bilateral tension, is in both countries’ best

Anders Åslund is a senior fellow at the Peterson Institute for International
Economics and a former economic adviser to the Ukrainian government.

Copyright: Project Syndicate

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