17 January 2019

Ukraine’s Crumbling Economy

By Ekaterina Zolotova

The country’s persistent economic strife is veering toward crisis.

Ukraine is in internal disarray. Driving the disarray is its deteriorating economic situation. While poor economic conditions predate the 2014 revolution, the subsequent Russia-backed insurgencies and annexation of Crimea exacerbated the underlying economic problems and forced Ukraine to attempt a rapid reorientation toward the West. Ukraine staved off potential disaster in December when the International Monetary Fund, as part of its four-year assistance program, approved a new $3.9 billion standby loan, $1.4 billion of which has been disbursed. (Ukrainian government debt is now approaching 70 percent of gross domestic product.) But the program is just a Band-Aid. This year will be a serious test for Ukraine, as millions of citizens – already hurting from the current conditions – will feel the pinch of economic reforms mandated by Ukraine’s creditors.

Rising Prices, Plummeting Conditions

Although some official statistics paint an artificially rosy picture, by almost any metric the economic situation in Ukraine is in danger of becoming critical. According to the U.N. resident coordinator in Ukraine, while 4 percent of the Ukrainian population lives below the national poverty line (defined as 75 percent of the median income), some 60 percent live below the subsistence minimum. Ukraine’s social policy minister noted that between 2014 and 2017, poverty in Ukraine rose from 8 percent to 55 percent. Improvements in the economy can more often be traced back to bureaucratic siphoning of budget funds to prop up entrepreneurs than to any actual improvements among the general population.

Inflation is becoming a pernicious problem. While the official inflation rate has been around 10 percent since last June, Ukrainian research and media firms suggest it’s much higher. Vesti-UA reported the prices of 87 percent of consumer staples have increased. Info-Shuvar reported that the price of potatoes doubled since the beginning of November, and Obozrevatel said that such increases were not limited to potatoes. According to the State Statistics Service, the price of onions has increased by 115 percent, cabbage and carrots by 60 percent and beets by 30 percent (compared to the same time last year). Bread, flour, semolina and bacon have seen price hikes between 14 and 17 percent, while the prices of beef, fish and sausage have reportedly increased between 9 and 11 percent.

Other consumer goods and services are feeling the effects of inflation, too. Public transit fares have risen by 26 percent. Cigarette prices are up 16 percent, and antibiotics cost around 10 percent more than they did a year ago. Looming largest, however, are natural gas price increases. The IMF has mandated that Ukraine cut natural gas subsidies if it wants to remain in good standing. Ukraine has resisted; still, starting May 1 the price of natural gas is slated to increase by 15 percent, and beginning in 2020 it will be sold at market rates. (Due to previous price hikes, Ukrainians are now paying roughly 40 percent of the market price for gas. In 2015, they paid only 12 percent.) At the same time, the volume of natural gas in Ukraine’s underground storage facilities has fallen to 43 percent of capacity. Ukrainians should prepare to pay more for this key commodity or fall back on the coal industry.

Reports suggest that deepening poverty and fear of increasing military activity are prompting a new wave of migration as Ukrainians seek better economic conditions elsewhere. This is not a new phenomenon: According to the IMF, between 2 million and 3 million Ukrainians work abroad, while the government estimates that 3.2 million Ukrainian citizens are living abroad permanently. (The U.N. estimated that in 2017, roughly 6 million Ukrainians were living abroad in total.) The IMF has said the increase in the number of Ukrainian emigrants is becoming a domestic political issue. One opposition party leader said that “poverty makes Ukrainians [want] to work abroad, sometimes people have to work in terrible conditions and with old equipment.”

The increased migration has resulted in long queues at the Uspenka checkpoint, on the Ukraine-Russia border near occupied Donetsk. Eyewitnesses said there were more than 200 cars queued up to enter Russia – though apparently, it’s possible to purchase a better place in line for 2,000 Russian rubles ($30). Details on this specific outflow are sparse, and at least some of the increased traffic may be a result of people returning to Russia after Christmas, which the Orthodox world celebrated Jan. 7. It remains to be seen if the situation will stabilize in the coming days.

Government Inaction

It’s hard to know whether the Ukrainian government’s inability to tackle these problems is a symptom or cause. Either way, Kiev is increasingly unable to support its citizens. The government needs cash to pay off the foreign loans it took out in 2014-2015, valued at roughly $17 billion. (Coincidentally, that’s about the value of the country’s entire gold and foreign currency reserves, which total $17.7 billion.) The bulk of these repayments are due in the second half of 2019, just as natural gas subsidies are slashed, prices are climbing and elections are held.

Meanwhile, Kiev has increased military spending, a political necessity considering that the government has made the threat of Russian aggression a key campaign talking point. In December, Interfax reported that the government planned to increase spending on the army in 2019 by 16 percent – for a total of about $16 billion. Funding for the defense and security sectors will top 5 percent of GDP. (In 2017, only 5 countries spent a greater percentage of their GDP on the military.) Russia is a real threat to the government. But so are elections – and they go a long way to explaining why President Petro Poroshenko, who after 2014 promised to “live in a new way,” now touts the slogan, “Army, Language, Faith.”

What this boils down to is that Ukrainian authorities – whether pro- or anti-Russia – will need an infusion of cash in 2019. Oligarchs have money, but they’re not going to spend it on Poroshenko. (Instead, they may throw their own hats into the ring this election cycle.) The IMF remains a key option for the president. Decisions on the next tranches of the standby program will be made in May and November this year. They will hinge on Ukraine’s ability to slash its budget, reduce inflation while maintaining a flexible exchange rate, privatize state-owned businesses and increase natural gas prices. Ukrainian citizens won’t be happy with these reforms, and it won’t be easy for presidential candidates to appeal to the population while staying on good terms with the IMF. Pursuing one of these imperatives necessarily hinders the other, which puts Ukraine in the unenviable position of having to choose between choices that are all bad.

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