Opinion: The IMF or Uncle Vlad – Ukraine makes its choice – beyondbrics - Blogs - FT.com:
Welcome to Ukraine. You’re running a rickety business, mainly cash-in-hand, that has a big gas bill and is losing money. Your shady Uncle Vlad says he will give you cheaper gas, lend you money on suspiciously favourable terms, and perhaps see his way to giving your workers an extra something in their pay packets. In return, all you have to do is back him up in family disputes in perpetuity. Meanwhile Christine, your steely-eyed bank manager, wants you to turn down the thermostat in your offices, lay off half your staff and stop fiddling the books.
It’s not hard to see that the first seems attractive but is basically going to get you nowhere and will land you with a debt you can never pay off. The second is not going to have the office buying you cupcakes on your birthday but might, in a few years’ time, get you legit and into profit. Or it might make you go bust. Your call.
Unsurprisingly, given the orientation of its current government, Kiev has gone withthe IMF-EU-US nexus rather than the Moscow solution. Uncle Vlad, his offer spurned, has taken over the east wing of the office building and is running things very much his own way. We have plenty of experience of this route. Ukraine follows a standard pattern for IMF problem countries back in the 1980s and 1990s, before pegged exchange rates were largely abandoned: a fixed currency, expensive energy subsidies, chronic budget and current account deficits. (Fund staff who worked on Argentina must be feeling particularly nostalgic.)
The bailout conditions are also familiar: unpeg the currency (already done), cut gas subsidies, squeeze domestic demand. Following the 1990s fashion for addressing “governance issues” (corruption), the fund has tacked on conditions about transparency in public procurement.
The problem with the IMF programme is not just the obvious one of the short-term pain arising from a combination of devaluation-induced inflation, rising gas prices and tax hikes clawing significant holes in household income. It is also the medium-term question: where is the growth going to come from? The contraction in domestic demand is intended to knock a hole in the economy through which manufacturing exports can surge. But you can hardly expect an export sector stunted through years of an overvalued exchange rate and sub-standard business climate to shoot hungrily out of the traps.
Ukraine’s problem since independence has been a chronic reliance on commodity exports and failure to go up the value chain into manufactures. There are rewards for being a low-cost manufacturing exporter on the fringes of Europe even if your chances of actually joining the EU are remote. Turkey’s EU membership drive seems indefinitely on hold, but has not stopped it happily increasing sales of car parts, clothes, fridges and washing machines to Europe.
Ukraine’s attempts to do similar have generally been based on secondary measures like restricting exports of steel and other raw materials to divert them cheaply to domestic manufacturers. This form of manufacturing export promotion has been tried elsewhere, as with China’s export quotas on rare earths, but it seems pretty clear it didn’t do much in Ukraine. In any case Kiev was forced (by the EU as it happens) to dismantle such policies before joining the World Trade Organisation in 2008 – a move which also unaccountably failed to ignite a dramatic burst of exports.
Structural transformations of economies take years, or indeed decades. Even if you credit IMF trade liberalisation and privatisation programmes in the 1980s and 1990s for turning round African economies, for example, the “African boom” in growth did not occur until the 2000s.
Having seen Ukraine fail to stick to promise after promise over the last five years, the fund does not want the country on a long drip-feed lending programme. It is all too possible that Ukraine will just about stabilise, and the IMF will leave, without having created the conditions for future growth or indeed left behind much goodwill. The EU could step in and provide longer-term funds for restructuring and investment, but it is unlikely to want to antagonise Russia or its own taxpayers by turning Ukraine into a semi-permanent dependent.
In this context, the appeal of Russia’s short-term populism is clear: cheap gas to keep households warm (in fact, overheated – Ukrainian households consume way more energy than most in Europe), cheap money to finance the current account deficit, and maybe a national version of the increase in pensions and civil service pay already pointedly implemented in Russia-dominated Crimea. With no pesky corruption investigators to deal with, it is a simple deal: cash-for-no-questions-asked.
Yet it’s evident from the performance of Russia’s vassal states like Belarus that coming under the Moscow umbrella is likely to keep Ukraine dependent on commodities indefinitely. If Russia knew anything about diversifying exports it would presumably have done so itself, and a Russia-dominated government in Kiev is unlikely to be keen on encouraging foreign direct investment by European companies. There are echoes here of the Soviets keeping Cuba’s economy afloat for decades by overpaying for its sugar. Only when that lifeline was cut off with the collapse of the Soviet Union did Cuba eventually (and successfully) expand its tourist industry to plug the hole in the balance of payments.
IMF programmes have a fairly good record in easing the adjustment of basically sound economies in currency or debt crises. They have a much less good record in increasing trend growth in dysfunctional economies within the timescale of their own lending programme. (Anyway, that’s the job of the World Bank, or its regional counterparts.) Going with Christine from the local bank rather than dodgy Uncle Vlad is still the right decision, but Ukraine should be aware of the long-term risks as well as the short-term pain involved.
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