On 4 March 2015, the Central Bank of Ukraine raised its key benchmark rate from 19.5 per cent to 30 per cent. This is driven by the capital flight and the continued loss of value, which has dropped 70 per cent since the Russo-Ukrainian crisis started. This trouble has been exacerbated by a 2014 year-on-year GDP plunge of seven per cent. On 12 February, the IMF announced a $17.5 billion continued bailout to Ukraine. This was topped up by other actors including the EU and the United States to over $40 billion, replacing the previous year’s $17 billion bailout. According to the Ukrainian government on 5 March, the economy may shrink up to 11.9 per cent in a worst-case scenario with inflation accelerating to an eye watering 43.8 per cent by the end of 2015. These are a massive revision from the 0.3 per cent growth projection and inflation at 9.8 per cent projected in September 2014. As noted by our columnist, Kazakhstan a founding members of the Eurasian Economic Union are uncertain about the Russian Federation’s plans in Ukraine. Meanwhile, President Lukashenko of Belarus continues to press for peace between the two formerly fraternal states.
As Russian-backed forces advanced in February, a military solution looks out of reach while the second Minsk ceasefire looks simply as a way to catch the Ukrainian government’s troops on their back-foot. Nonetheless, the bailout may buy the Ukrainians time to make reforms to the economy. This is demonstrated by a somewhat stronger Hryvnia vs the USD. Still, following the spike in the key interest rate, credit will be even harder to receive and the business environment will remain ever-more difficult. The question remains though, whether the political will and the administrative capacity remains to implement deep and effective structural reforms. The crux of the problem is that while the government needs to maintain morale and recruit troops for the front-lines. This comes at cross-cutting motives with conducting difficult reforms.
The Ukrainian Central Bank has instituted capital controls. This includes a ban on foreign currency above 3,000 Hryvnia while accounts above 15,000 in foreign currency. Moreover, exporters are required to conducted above 75 per cent of their exports in Hryvnia. Much of this is driven the near-depletion of international reserves totaling $5.6 billion. While these efforts may marginally affect the outflow of capital and the usage of the Hryvnia, they are only temporary fixes. The government needs to rationalize much of its expenditure. It has already reduced the amount of subsidies, but many remain. These are highlighted by the World Bank’s Doing Business Report for 2015 where Ukraine remained at a lowly 96th.
While unpalatable to many including your correspondent, a political solution may be the most expedient way to avoid collapse. In order to excise Russian influence, the creation of new borders at the line of control may stymie further conflict. Additionally. contrary to Russian practice of creating gray areas of frozen conflict in which festers crime and nefarious interests, this would saddle the Russian Federation instead of the Ukrainian government with much of the legacy costs of the conflict. Moreover, such a seizing of the poisoned chalice would create new political realities within Ukraine, allowing an even more stable pro-western majority.
With the correct moves, such new ground-truths may spur reform, bolster de-corruption activities, as well as a friendlier investment situation for European near-shoring and foreign direct investment (FDI). While this is not the ideal solution, both the palatable political and military solutions have been spoilt by the Russian Federation and its “little green men”. Thus, creativity is needed in finding a solution, but realization of the dismemberment of the state must not be entirely ignored. As the economy teeters on collapse, hard choices must be made before Europe faces a failed state to its East.