Ukrainian Chess

By Peter Boone and Simon Johnson:

U.S. Secretary of State John Kerry arrived in Kiev on Tuesday.  The Obama administration is feeling real pressure from across the political spectrum to “do something”, but the US has no military options and little by way of meaningful financial assistance it can offer to Ukraine.  The $1 billion in loan guaranteesoffered today by Mr. Kerry means very little.

Millions of people have a great deal to lose if the situation gets out of control, and the Russian leadership is behaving in an unpredictable manner.  The sharp drop in the Russian stock market index on Monday morning, alongside an emergency hike in interest rates by the Central Bank, demonstrates that Russia’s financial elite was also caught completely off guard.

Mr. Kerry can and has made threats, but it would be better to join the Europeans in helping to calm the situation.  There is a completely reasonable and peaceful path to a solution available, but only if everyone wants to avoid a major conflict.

The alternative to peace will be ugly.  Many Russians believe that the Maidan uprising will negatively the rights of ethnic Russians in Ukraine.  The fact that the new authorities in Kiev quickly sought to repeal Russian as an official second language inflamed these fears (the interim president, Oleksandr Turchynov,vetoed the proposed law on Sunday). Russian President Vladimir Putin will not stand by quietly if ethnic Russians protest and such protests lead to violence.  The borders of Ukraine may be redrawn, and the ensuing conflict would be painful for all involved.

Russia will pay a high cost for its unilateral intervention in Crimea.  Many in western Ukraine have been further alienated, while some Russian-speaking Ukrainians and ethnic Russians in Eastern Ukraine will not like the bullying tactics.  But the big Russian choice lies ahead: Putin can heed “calls” to bring his military further into Eastern Ukraine (a threat articulated in public by one of his aides in September), or he can work with the EU, the US, and all Ukrainians to seek out a more democratic outcome.

Which way this situation develops will depend on three factors.

First, Ukraine’s established politicians have spent the last two decades playing off the US and Russia, and extracting resources from both sides.  Corruption among this group is pervasive; in no sense have they managed Ukraine for its people.

The genuine Ukrainian street revolution is against the political elite most closely aligned with Yanukovych.  But do not get too starry eyed about new democrats already taking over – the people now holding the reins of power have been prominent before.

Second, the Russians have what they see as legitimate security concerns.  They are Ukraine’s largest trading partner, they transport a lot of natural gas across Ukraine through soviet-built pipelines, and their Black Sea Fleet – based in Crimea – is seen as a major strategic asset.  The Russians sell their gas cheaply to Ukraine.  They have repeatedly forgiven large arrears on payments and ignored gas gone missing in transit.  It is naïve to think Russian interests can now be ignored in a “winner take all” victory for the opposition.

Third, with the ouster of President Viktor Yanukovych, pro-Russian forces lost a big round.  But the current pro-western forces are unlikely to remain strong and undivided.  The pro-Western 2004 “Orange Revolution” rapidly collapsed with accusations of corruption and betrayal amongst partners – leading ultimately to Yanukovych’s election in 2010.

The appointment in recent days of three rich Ukrainian businessmen to the Ministry of the Interior and to key gubernatorial positions suggests the fight against corruption will be uphill.

Mr. Kerry should push for more representative government in Ukraine.  There need to be elections, including for the presidency (currently scheduled for May) and for parliament.  And there needs to be a negotiation – involving Europe, the U.S., and Russia, as well as Ukrainians – over how these elections will be managed so they are fair and can ensure all ethnic groups in Ukraine are represented in future government.  This could involve constitutional reform, to be approved by a national referendum.

Some Europeans and Ukrainian officials are suggesting the EU association agreement (EUAA) should be signed immediately.  Rapid accession prior to establishing a more representative political process would be a mistake.  Implementing the EUAA demands years of legislative work that will bring Ukraine’s laws closer to Europe’s legal framework.  Such long-term reforms can’t be managed or promised by a government lacking a broad mandate, and one that only recently toppled an elected President.

Mr. Kerry is not in a position to provide generous loans, and money will not be forthcoming from Europe, but large funds are not needed.  The International Monetary Fund can lend the amounts needed to refinance its own debts and to build some foreign exchange reserves as a way to build confidence.  Domestic bonds are largely held by domestic banks, and those can be rolled over and refinanced if the authorities work with the banks on a plan.

Most importantly, the Ukrainians should end their dependence on cheap Russian gas by agreeing to pay market prices going forward.  They need to pass these prices on to local customers, effectively ending subsidies and reducing the budget deficit. Ukraine needs to stop running budget deficits that can’t be safely financed at home. For now, that means balancing the budget.

All this is not enough to create a more dynamic and prosperous Ukraine, but at least the benefits to corrupt Ukrainian politicians from playing off East and West will have been reduced, and a new representative, elected regime will be in place.

This piece is cross-posted from The Baseline Scenario with permission.

One Response to "Ukrainian Chess"

  1. MC50   March 11, 2014 at 11:15 am

    I don't know where you get the idea that Ukraine has been buying cheap gas. They have been paying over $400 per cubic meter to Gazprom under the disastrous deal negotiated by Tymoshenko. In fact this deal was the grounds for her trial and imprisonment. Ukraine has been paying higher prices for natural gas then the European countries that lie farther west. It is true that Ukrainian consumers are paying subsidized prices. But these subsidies are the main reason the Ukrainian government's budget is so deep in the red. It is true that under the agreement reached last fall to prevent Ukraine from signing the EU Association deal, Russia agreed to cut the price to $268 per cubic meter, but that has collapsed along with the Yanukovich regime, so back to paying Gazprom exorbitant prices.