An Economic Overview of Ukraine at a Critical Juncture

Nationalism often has been a force of political deadlock and economic stagnation. In a place like Quebec, it is possible for voters to decide they are wearisome of separatism and it is time their elected officials focus on economic growth and job creation. In Ukraine, things are much more complicated. One third of Ukrainian exports go to Russia, and the country depends on Russian energy to produce most of its goods. Decades of dependence have nurtured a wasteful and tangled economy, and now Russia is doing everything in its power to undermine the new Ukrainian government.

Unnatural Natural Gas Wars

Ukraine’s energy infrastructure is inefficient and wasteful, making gas imports crucial to economic production. Half of these imports come from Russia. Ukraine’s economy has been built on subsidized gas, as Russia has been discounting sales by a third of market price. Putin claimed that “during the past four years, Russia has been subsidizing Ukraine’s economy by offering slashed natural gas prices worth 35.4 billion U.S. dollars.” Years of discounted gas prices have left its industry with a large and unquenchable thirst. In Ukraine’s current state, industrial production requires twice as much energy as an advanced industrial nation.
Furthermore, the subsidies have led to an energy sector riddled with debilitating corruption. Oligarchs have made billions as middlemen, buying up cheap gas intended for families and reselling it to industrial producers. The lack of industrial innovation, accountability and transparency has led to a ballooning energy debt, with no one willing to risk investment in a solution.
Problems in the energy sector have compounded, and the currency has spun downwards. Ukraine’s currency, the hryvnia, was pegged against the dollar until February to control the cost of imports. The Central Bank of Ukraine decided to float the currency, making its goods cheaper to other countries, in an effort to boost exports. The value of the currency has fallen 27 percent this year, making it the worst performer globally. Cheap currency makes Ukrainian agricultural and industrial products more appealing abroad, but it makes debt obligations hard to stomach.
Ukraine has $35 billion in sovereign debt that will become due over the next two years, one billion of which is due on June 4. As a part of the International Monetary Fund reform program, the international community will contribute $27 billion over the next two years. Of that amount, the IMF will put forward $14-18 billion, depending on the amounts of bilateral and multilateral support.
The main contingency of the IMF loan is to eliminate subsidies and corruption. The IMF stated in a press release that “the program will focus also on improving the transparency of Naftogaz’s [Ukrainian state-owned gas supplier] accounts and restructuring of the company to reduce its costs and raise efficiency.” If history is any indication, this will be much easier said than done. The IMF has helped Ukraine twice before with similar loans, but both programs resulted in failure. Eliminating subsidies requires raising the cost of gas for families, a very unpopular move politically.
Even with the IMF bailout, Russia has been making it all but impossible for the Ukrainian economy to survive. Ukrainian Naftogaz owes Russian Gazprom $2.2 billion, and last month Russia aggressively raised its price 80 percent. Additionally, Putin issued a letter to European leaders stating, “Gazprom is compelled to switch over to advance payment for gas deliveries.” He added that in order to deter Ukraine from syphoning off gas intended for Europe, Russia would require Ukraine to pay $5 billion up front for 11.5 billion cubic meters to hold in reserve. Putin is setting Ukraine up for financial failure at every opportunity.
After news of the IMF package to loan up to $18 billion to Ukraine, Russian Prime Minister Dmitry Medvedev announced a total energy debt of $16.6 billion. If Russian demands are not met, it may cut gas supplies to both Ukraine and Europe. Europe gets a quarter of its gas from Russia, half of which travels through pipes in the Ukraine. If Russia cuts off Ukraine, it would reduce the flow through Ukraine to ensure none goes missing along the way. It has been a mild spring, and gas reserves remain high, but Europe would face significant challenges if its energy supplies were suddenly cut.

On The Brink

Russia is demanding Ukrainian federalization. It wants Ukraine to adopt a new constitution that decentralizes the government, shifting power to each region. Each region would be able to choose its own economic policy, retain tax revenue and determine which foreign relations to strengthen. Federalization, assigning federal status to territories, could be successful, but it requires a strong central government to bind the regions together with political and economic purpose.
Federalization may sound like a small price to pay for peace, but granting more autonomy to regions would also exacerbate the already present instability and divisions. The government is in political shambles, the Ukrainian economy is on the verge of economic collapse, and Russian troops wait for an excuse to invade. Federalization would only encourage regions in Eastern Ukraine to gravitate to Russia’s larger and more stable economic body. Eastern Ukraine is already heavily dependent on Russia, and granting autonomy will only facilitate Russian annexation.
Kiev has scheduled presidential elections for May 25, and parliamentary elections will take place soon after. Participation by all regions in the elections is necessary to lend legitimacy to the fledgling government. Putin is expected to exert economic, military and political pressure to ensure failure for the Ukrainian government. Chaos will escalate during this next month leading up to the elections, but if a unified Ukraine stands under a central governing body, it could emerge from this crisis with a stronger national identity and the will to untangle economic dependencies.