Deadlier Than Putin? The IMF Pays Ukraine a Visit

The International Monetary Fund has worked its magic on Ukraine. The carrot is about $17-billion in bailout funding. The stick is the market price of natural gas (link is external) . Soon the democracy-loving Ukrainians will see their gas bills soar nearly threefold.

While Kiev will have to help poorer families pay for pricier gas, the cost of that assistance pales in comparison with what artificially cheap local gas cost the government. The IMF estimated (link is external) in 2012 that cheap gas cost Ukraine about 5 percent of its prewar GDP per year.

Bringing gas tariffs back to something resembling market prices will also curb energy consumption and provide more incentive for Ukraine to produce its own natural gas. Together, that promises to further reduce Ukraine’s reliance on imported Russian gas, potentially removing one of the sharpest arrows in Moscow’s geopolitical quiver.

Ukrainian gas consumption has fallen from 108 billion cubic meters (bcm) per year in 1993 to about 42 bcm today, thanks (link is external) in part to a dismal economy in the 1990s and the phaseout of Soviet-era heavy industry. With the reform package, Ukraine could further trim the amount of gas it needs to import from Russia, which last year fell (link is external) to the lowest level in 15 years.

What's unclear is how Ukraine's already wobbly economy will handle the energy shock. Josh Cohen, an ex-US State Department staffer who handled economic reform projects in the former Soviet Union thinks the IMF medicine Poroshenko has swallowed will be toxic for Ukraine.

We have seen this story before. During the 1990s, the U.S. Agency for International Development (USAID) in the office charged with managing economic reform projects in the former Soviet Union, I observed that the type of austerity now being required of Ukraine was the standard prescription for countries in economic crisis. The leading Washington financial institutions, such as the IMF, World Bank, and U.S. Treasury Department, were passing out this one-size-fits-all solution. And it almost never worked.

Russia was the classic case. In the midst of the political shock caused by the breakup of the Soviet Union, neoliberal reformers supported by the West instituted (link is external) a policy of so-called "shock therapy" involving an end to price controls and large cuts in government spending and subsidies. The result was a plunge in Russia’s GDP and inflation rates averaging (link is external) 20 percent per month. As the poverty rate climbed to a full 55 percent of the population, there was a widespread political backlash against austerity led by Russian Vice President Alexander Rutskoy, who termed the reforms "genocide" and led a failed attempt to overthrow President Boris Yeltsin in 1993.

...Kiev’s decision to implement similarly painful austerity measures during its own political turmoil is doomed to fail in the same way, leading to even more instability and crisis in a country that has had more than its share of both over the past year.

...Reforms that reduce corruption and cut government spending and subsidies are necessary if Ukraine is ever going to come close to reaching its economic potential. However, with a collapsing economy and an ongoing war, Kiev needs a semblance of stability far more than shock therapy.

Ukraine is currently in economic free-fall. After estimating that the economy would shrink 5 percent in 2014, the IMF now predicts (link is external) a 6.5 percent drop in the country’s GDP, while some analysts think (link is external) it could be as high as 10 percent.

...Despite the economic crisis, the IMF’s loan requires Kiev to enact a series of policy changes, all of which will accelerate the collapse of the economy and decrease the purchasing power of ordinary Ukrainians.

The IMF demands (link is external) that Ukraine make immediate cutbacks to reduce the fiscal deficit. To meet this requirement, Kiev has already enacted a series of laws raising (link is external) excise and property taxes, reduced (link is external) social income support expenditures for retirees and public employees, frozen Ukraine’s minimum wage, and cut public-sector wages.

Another target is the energy sector. Ukraine is required (link is external) to increase natural gas and heating tariffs for consumers by 56 percent and 40 percent in 2014, respectively, and by 20 to 40 percent annually from 2015 to 2017. At the same time, as gas prices increase sharply, gas subsidies to end users will be completely ended (link is external) over the next two years.

...This overall combination of increased taxes and energy costs, decreased wages and social expenditures, and growing inflation is more akin to a Kevorkian (link is external) prescription for Ukraine’s economy then a recipe for a return to economic growth. Given that a USAID-funded opinion survey released in April found (link is external) that a majority of Ukrainians already oppose higher energy tariffs and prices, the political consequences of austerity could be explosive.

The West could help Ukraine through this economic crisis. As a recent Bloomberg editorial noted (link is external) , "In Ukraine, the IMF will in essence be trying an economic solution to a geopolitical problem." Indeed, Kiev’s decision to implement austerity in the middle of a bitter civil war is foolhardy for both financial and political reasons: Wars cost money — lots of it — and unsurprisingly, Poroshenko has already announced (link is external) $3 billion in additional defense spending for this year. Given that the second tranche (link is external) of the IMF’s loan is $1.4 billion, the ongoing costs of the war make it extremely unlikely that Ukraine will be able to meet the IMF’s fiscal and financial targets.

But the political problems with shock therapy for Ukraine are even greater. The austerity program will further alienate the very citizens of Donbass, the restive eastern region currently hosting the worst fighting. If the country will ever be put back together, the people of the east must feel that Kiev takes their concerns into account. Unfortunately, by implementing austerity when industrial output has as of July declined by 29 percent year-on-year in Donetsk and a whopping 56 percent in Luhansk, the government in Kiev provides just the opposite message to the east.

Oh boy, another failed state to add to our ever growing list of interventions - Kosovo, Libya, Afghanistan and now Ukraine. Perhaps we should put our plans on shipping them weapons on hold until we get assurances they won't just sell them to Putin's side for pocket money.

How are food supplies holding out in Russia?