Ukraine - The Crouching Tiger

By: Sam Vaknin, Ph.D.

Also published by United Press International (UPI)

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Written January 2002

Updated March 2005

Reading the Western media, one would think that Ukraine's main products are grotesquely corrupt politicians, grey hued, drab, and polluted cities, and mysteriously deceased investigative journalists and erstwhile state functionaries.

When another journalist was found dead in Odessa on New Year's Eve 2002, both the Prosecutor General and the Ukrainian Parliamentary Committee for Fighting Organized Crime and Corruption have accused the entire Ukrainian Cabinet of Ministers of collusion in shady dealings with Kazakhoil, the Kazakh national oil monopoly.

The "Orange Revolution" in October-November 2004 the disorderly, though popular, transfer of power from one group within the "Dniepropetrovsk family", headed by Leonid Kuchma and his henchman to another faction, headed by the volatile and incompatible Viktor Yushchenko and Yulia Timoshenko led to more deaths in unexplained circumstances.

Both Yushchenko and Timoshenko had served in senior positions (as prime minister, for instance) in the ancien regime and, therefore, may have skeletons in their cupboards. The spate of "suicides" committed by former and knowledgeable functionaries came as no surprise - both parties, outgoing and incoming, have a vested interest in suppressing embarrassing revelations.

From December 2001 onwards, the Legsi (the Lehman Brothers Eurasia Group Stability Index) kept warning against a deterioration in Ukraine's social stability, owing to fiercely resisted austerity measures.

Until recently, things were not auspicious on the international front as well. During the Balkan hostilities between Macedonians and Albanians in 2001, Ukraine supplied Macedonia with attack helicopters and other weaponry over the strident objections of the State Department. Its strategy of ever closer union with Russia and China was in ruins following the sudden shift in Putin's geopolitical predilections after the September 11 attacks. And to spite the EU (which forced Poland to impose strict controls on its porous border with Ukraine) - "starting from 1 January 2002, Kyrgyz citizens, like the citizens of Azerbaijan, Armenia, Kazakhstan, Tajikistan and Uzbekistan, may enter, leave and pass through Ukraine without visas" as the Kyiv based UNIAN news agency jubilantly announced on January 4th, 2002.

Its parliament having failed to pass a government sponsored law against the unlicensed production of CD ROM's (piracy) - the Ukraine was subjected on January 2, 2002 to much postponed US imposed stiff trade sanctions (estimated to cost it $500 million per year). The employees of Ukraine's largest CD maker, Rostock Records, demonstrated opposite the US embassy against the sanctions, denouncing them as "economic terrorism". The International Federation of Phonographic Industry (IFPI) countered by saying that "Ukraine is the largest exporter of pirated CDs to Europe, with tens of millions of high quality illegal copies shipped each year to markets throughout Europe and as far away as South America."

At any rate, following its blatant intervention in the political machinations which led to the Orange Revolution in October-November 2004, anti-American sentiments are running higher than usual in the eastern, Russophile parts of the country.

Ukrainian discontent is further exacerbated by the American continued threat to slap tariffs on steel imports despite a last minute agreement signed in 2001 with the EU and other major steel manufacturing countries to curb worldwide production. Ukraine has agreed to cut its output by 11 million tons annually (out of a total reduction of 97.5 million tons). Depressed prices for gallium (used mainly in the recession-struck mobile phones industry) have gravely affected Ukraine's only alumina producer (Mykolaevsky Hlynozyomny Zavod) which has just quintupled its capacity to 10 tons.

Ukraine is optimally located between Central Europe and Russia. It is the largest polity in East Europe and the second largest country is Europe (almost the size of Texas). It is rich in natural endowments, though hopelessly polluted (Chernobyl is in the Ukraine) and deforested. In the former USSR, it provided 25% of all agricultural produce. The Soviet mining and oil industries relied on Ukrainian heavy industry for their equipment. The literacy rate in Ukraine is 100% and many are polyglot.

Yet, these Ukrainian riches were squandered in the decade following independence. Dependence on energy and a reform effort thwarted by entrenched Communist era stalwarts led to a 60% drop in GDP compared to 1991 (the year of its independence). Frenetic money printing resulted in hyperinflation in 1993. Inflation has still not been subdued and has topped 26% as late as 2000.

More than 50% of the population are under the official, starvation level, poverty line. Though only 5.3% are registered as unemployed, both underemployment and hidden unemployment are rampant. Mercurial and default prone Russia is still Ukraine's main trade partner (c. 30% of its international trade). Each of Ukraine's 49 million citizens owes $200 to foreign creditors - the equivalent of 30% of GDP per capita. Public debt has doubled to c. 50% of GDP in the four years to 2000. Worse still, Ukraine is increasingly used as a drug smuggling route and drugs growing area for the CIS. Synthetic drugs are manufactured in the Ukraine and smuggled to the countries of Western Europe.

Ukraine is a major target for Russian investors, especially from the energy sector. Putin appointed Victor Chernomyrdin, a political heavyweight - a former Prime Minister and, more importantly, a former chairman of Gazprom, the Russian energy behemoth - as Russia's ambassador in Kyiv. Ukrainians are not against Russian investment - but they are averse to the political strings it comes attached to. They also resent the bargain basement prices at which their most valued assets are "privatized" to these old-new "foreign" investors. Inevitably, they ask themselves "cui bono" - who benefits personally from these questionable transactions. The answer is not too hard to guess - but guessing has proven to be a dangerous occupation. At least one muck-raking journalist has been (literally) beheaded and a senior politician (now prime minister in the new regime) jailed for trying to reform the energy sector.

Inevitably, Ukraine is socially and politically strained. Its western parts are fiercely nationalistic and West oriented. Its eastern parts lean more towards Russia and are USSR-nostalgic. But this apparent schism is no bad thing. It provides Ukrainians with a secure foothold in both worlds - and no one seriously considers secession.

Unnoticed by many, Ukraine is undergoing a seismic shift which may result in an economic revival of Chinese proportions.

When Viktor Yushchenko, the popular Prime Minister and darling of the West was brutally ousted in May 2001 by the authoritarian President, Kuchma (himself hailed as a daring reformer by the IMF when elected in 1994), everyone predicted a calamity. Yet, Yushchenko moved since then to the centre in what appears to be an implicit reconciliation with the president.

His replacement, Anatoly Kinakh, surprised everyone by proving to be an efficient and modernizing technocrat. Ukrainian bonds returned to investors more than 60% net in 2001-2, making them the best emerging markets investment by far. Its capital markets are gradually being internationalized. The much maligned Kuchma introduced a sweeping anti-money laundering decree (later to become law). Ukraine (since its 1998-2000 series of de facto defaults following the financial meltdown in Russia) is now a model debtor. In August 2000 it has even re-paid the IMF $100 million.

Possibly emboldened by his re-election in 1999, Kuchma seemed to be making real efforts to streamline the government (which anyhow consumes a mere 18% of GDP), cut red tape, consolidate the government's fiscal stance (Ukraine had small budget deficits, excluding privatization receipts, in 1999-2001), become a WTO member, and create a legal environment conducive to private enterprise and entrepreneurship.

A new Land Code - passed by a surprising ad hoc parliamentary alliance and providing for the (limited) private ownership of land - took effect on January 2, 2002. Payment discipline in the critical energy sector was enforced, the agriculture sector was revamped, non cash revenue offsets and cronyist tax exemptions were entirely eliminated, government arrears (including pensions) were substantially reduced (though new arrears have again accumulated thereafter), a privatization law was finally introduced, and municipal finance was rationalized.

The government's contractionary fiscal rectitude (a new Budget Code was enacted and tax collection improved) was balanced by the central bank's (NBU) expansionary monetary policy aimed at increasing its dangerously dilapidated foreign exchange reserves (c. $2.4 billion in 2001) and spurring growth in the real sector. Rising demand for money and the propitious existence of a thriving informal (cash) economy prevented the resurgence of inflationary pressures - though inflation has picked up in December 2001, forcing the central bank to tighten in 2002 (it disputes the government's official figure of 6.1% inflation for 2001).

In 2000 the economy grew for the first time (by 6%). Growth was export driven and industrial output increased by 13%. The global recession has hurt Ukraine's export prospects but even so, it grew by 4-5% in 2001. It continued to expand by 2-4% each year in 2002-2004.

With a labour cost of 30 cents per hour, Ukraine attracts the interest of manufacturers in the US, in Central Europe, and even in Russia. Strong import growth may swing it back to a current account deficit (in a surplus of c. 5% of GDP in 2001, as it has been in the previous 2 years). Fiscal shenanigans ahead of the March 2002 and October 2004 elections (and the horse trading which inevitably followed) had ratcheted up the predicted inflation rate of 9-12% - but the appreciation of the hryvna is set to continue.

The economy is surprisingly modern. Only 24% are employed in agriculture (and they produce a mere 12% of GDP). More than double that is produced by industry (26% of GDP) and a whopping 62% of GDP is generated in services (in which only 44% of the labour force are employed).

On December 2001, S&P upgraded Ukraine's currency risk rating (both foreign and domestic) to "B" with a "Stable" long term outlook. On the pro side, S&P cited financial stability, partly the result of a rationalized and rescheduled foreign debt structure. On the con side, it cited the usual litany of corruption, weak legislature, problems with privatization and with structural reform and malignant oligarchs. These flaws being noted, it did upgrade Ukraine's rating - as did Fitch, Moody's and Japan's Rating and Investment Information Agency. The price of Ukraine's (mainly dollar denominated) Eurobonds appreciated dramatically on institutional buying immediately following the announcement.

Ukraine's image as bereft of Foreign Direct Investment is false. Moreover, c. 80% of all FDI in Ukraine is Western - not Russian. USA investors compete with Russian (cum "Cypriot") investors - each holding 17% of the total stock of FDI (c. $4.5 billion in early 2002).

Moreover, Ukraine is now in good standing with the IMF (after a difficult 2001 in which the IMF virtually suspended all communication with Ukraine due to falsified data provided by the NBU). It has signed in 1998 a $2.6 billion arrangement (of which $1.6 billion are used). Another tranche of c. $380 million was approved in September 2001. The IMF singled out the banking, energy, and agriculture sectors as in need of continued, pervasive, reforms.

The World Bank has committed close to $3 billion (and disbursed $2.2 billion) to projects in Ukraine (mostly in the energy, mining, agriculture, finance, and private sectors) since 1992. The latest Country Assistance Strategy documents for Ukraine (2001-2003 and 2004-6) are unusual in that they seek to circumvent the hopelessly venal and discredited administration and work directly with the public, business, and NGO's towards building a civil society and its attendant institutions. "The strategy seeks to move Ukraine closer to the European Union standards, fostering environmentally-sustainable development" - says the Bank. though it hastens to emphasize the success the government had in implementing its reforms.

As of June 2001, the EBRD (which has a mixed track record in Ukraine) has approved 45 projects in Ukraine (34 of which in the private sector) worth 1.2 billion euro. This excludes the construction of a highly controversial and politically inspired nuclear power plant.

Ukraine has gone so low in the world that its fortunes can only improve. It is poised for a modest economic comeback as its mediating geographic position between centre and east comes into play with EU enlargement. Kuchma was eased out by the very oligarchs he nurtured. They now constitute an element in a broad based coalition for reform. Having sated their appetite for loot they now seek respectability and access to capital markets and credits in the West. They want a functioning country and a larger cake. Kuchma is a figurehead of a disfigured past. In the long run, a Putin style robotic reformer is likely to succeed him. When it happens, Ukraine may yet become the region's first economic tiger.

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