A NEW Ukraine was born a year ago in the pro-European protests that helped to drive President Viktor F. Yanukovych from power. And today, the spirit that inspired hundreds of thousands to gather in the Maidan, Kiev’s Independence Square, is stronger than ever, even as it is under direct military assault from Russian forces supporting separatists in eastern Ukraine.
The new Ukraine seeks to become the opposite of the old Ukraine, which was demoralized and riddled with corruption. The transformation has been a rare experiment in participatory democracy; a noble adventure of a people who have rallied to open their nation to modernity, democracy and Europe. And this is just the beginning.
This experiment is remarkable for finding expression not only in defending Ukraine’s territorial integrity from the separatists, but also in constructive work. Maidan’s supporters have moved from opposition to nation building.
Many of those in government and Parliament are volunteers who have given up well-paying jobs to serve their country. Natalie Jaresko, a former investment banker, now works for a few hundred dollars a month as the new finance minister. Volunteers are helping Ukraine’s one million internally displaced people as well as working as advisers to ministers and in local government.
The new Ukraine, however, faces a potent challenge from the old Ukraine. The old Ukraine is solidly entrenched in a state bureaucracy that has worked hand in hand with a business oligarchy. And the reformers are also up against the manifest hostility of Russia’s president, Vladimir V. Putin, who wants at all costs to destabilize Ukraine.
One drawback is that the new Ukraine is a well-kept secret, not just from the rest of the world but also from the Ukrainian public. Radical reforms have been hatched but not yet implemented.
It is instructive to compare Ukraine today with Georgia in 2004. When he became president that year, Mikheil Saakashvili immediately replaced the hated traffic police and removed the roadblocks used to extort bribes from drivers. The public recognized straight away that things had changed for the better.
Unfortunately, Ukraine has not yet found a similar demonstration project. Kiev’s police force is to be restructured, but if you need a driver’s license, you must still pay the same bribe as before.
Mr. Saakashvili was a revolutionary leader who first stamped out corruption but eventually turned it into a state monopoly. By contrast, Ukraine is a participatory democracy that does not rely on a single leader but on checks and balances. Democracies move slowly, but that may prove an advantage in the long run.
The big question is, will there be a long run? Although Russia is in a deepening financial crisis, Mr. Putin appears to have decided that he can destroy the new Ukraine before it can fully establish itself and before an economic downturn destroys his own popularity.
The Russian president is stepping up the military and financial pressure on Ukraine. Over the weekend, the city of Mariupol came under attack from forces that NATO said were backed by Russian troops, undermining the pretense that the separatists are acting on their own.
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Ukraine will defend itself militarily, but it urgently needs financial assistance. The immediate need is for $15 billion. But to ensure Ukraine’s survival and encourage private investment, Western powers need to make a political commitment to provide additional sums, depending on the extent of the Russian assault and the success of Ukraine’s reforms.
The reformers, who want to avoid the leakages that were characteristic of the old Ukraine, have expressed their wish to be held accountable for all expenditures. They are passing extensive legislation but also want the International Monetary Fund to go on exercising oversight.
Unfortunately, just as democracies are slow to move, an association of democracies like the European Union is even slower. Mr. Putin is exploiting this.
It is not only the future of Ukraine that’s at stake, but that of the European Union itself. The loss of Ukraine would be an enormous blow; it would empower a Russian alternative to the European Union based on the rule of force rather than the rule of law. But if Europe delivered the financial assistance that Ukraine needs, Mr. Putin would eventually be forced to abandon his aggression. At the moment, he can argue that Russia’s economic troubles are caused by Western hostility, and the Russian public finds his argument convincing.
If, however, Europe is generous with its financial assistance, a stable and prosperous Ukraine will provide an example that makes clear that the blame for Russia’s financial troubles lies with Mr. Putin. The Russian public might then force him to emulate the new Ukraine. Europe’s reward would be a new Russia that has turned from a potent strategic threat into a potential strategic partner. Those are the stakes.
Bernard-Henri Lévy, a philosopher, is the author of “Left in Dark Times: A Stand Against the New Barbarism.” George Soros, an investor and philanthropist, is the chairman of the Open Society Foundations.A version of this op-ed appears in print on January 27, 2015, on page A21 of the New York edition with the headline: Save the New Ukraine. Order Reprints| Today’s Paper|Subscribe
Justyna MielnikiewiczMasha, a hairdresser from Luhansk who joined the pro-Ukrainian Donbas Battalion last spring, at a training camp near Dnipropetrovsk, held in an old summer camp still decorated with Soviet-era Young Pioneers, July 2014; photograph by Justyna Mielnikiewicz from her series ‘A Ukraine Runs Through It,’ which has just been awarded the Aftermath Project’s 2015 grant for photographic work documenting the aftermath of conflict. It will appear in War Is Only Half the Story, Volume 9, to be published by the Aftermath Project next year.
The sanctions imposed on Russia by the US and Europe for its interventions in Ukraine have worked much faster and inflicted much more damage on the Russian economy than anybody could have expected. The sanctions sought to deny Russian banks and companies access to the international capital markets. The increased damage is largely due to a sharp decline in the price of oil, without which the sanctions would have been much less effective. Russia needs oil prices to be around $100 a barrel in order to balance its budget. (It is now around $55 a barrel.) The combination of lower oil prices and sanctions has pushed Russia into a financial crisis that is by some measures already comparable to the one in 1998.
In 1998, Russia ended up running out of hard currency reserves and defaulting on its debt, causing turmoil in the global financial system. This time the ruble has dropped by more than 50 percent, inflation is accelerating, and interest rates have risen to levels that are pushing the Russian economy into recession. The big advantage Russia has today compared to 1998 is that it still has substantial foreign currency reserves. This has enabled the Russian Central Bank to engineer a 30 percent rebound in the ruble from its low point by spending about $100 billion and arranging a $24 billion swap line with the People’s Bank of China. But only about $200 billion of the remaining reserves are liquid and the crisis is still at an early stage.
In addition to continued capital flight, more than $120 billion of external debt is due for repayment in 2015. Although, in contrast to 1998, most of the Russian debt is in the private sector, it would not be surprising if, before it runs its course, this crisis ends up in a default by Russia. That would be more than what the US and European authorities bargained for. Coming on top of worldwide deflationary pressures that are particularly acute in the euro area and rising military conflicts such as the one with ISIS, a Russian default could cause considerable disruption in the global financial system, with the euro area being particularly vulnerable.
There is therefore an urgent need to reorient the current policies of the European Union toward Russia and Ukraine. I have been arguing for a two-pronged approach that balances the sanctions against Russia with assistance for Ukraine on a much larger scale. This rebalancing needs to be carried out in the first quarter of 2015 for reasons I shall try to explain.
Sanctions are a necessary evil. They are necessary because neither the EU nor the US is willing to risk war with Russia, and that leaves economic sanctions as the only way to resist Russian aggression. They are evil because they hurt not only the country on which they are imposed but also the countries that impose them. The harm has turned out to be much bigger than anybody anticipated. Russia is in the midst of a financial crisis, which is helping to turn the threat of deflation in the eurozone into a reality.
By contrast, all the consequences of helping Ukraine would be positive. By enabling Ukraine to defend itself, Europe would be indirectly also defending itself. Moreover, an injection of financial assistance to Ukraine would help stabilize its economy and indirectly also provide a much-needed stimulus to the European economy by encouraging exports and investment in Ukraine. Hopefully Russia’s troubles and Ukraine’s progress would persuade President Vladimir Putin to give up as a lost cause his attempts to destabilize Ukraine.
Unfortunately neither the European public nor the leadership seems to be moved by these considerations. Europe seems to be dangerously unaware of being indirectly under military attack from Russia and carries on business as usual. It treats Ukraine as just another country in need of financial assistance, and not even as one that is important to the stability of the euro, like Greece or Ireland.
According to prevailing perceptions, Ukraine is suffering from a more or less classical balance of payments crisis that morphed into a public debt and banking crisis. There are international financial institutions devoted to handling such crises but they are not well suited to deal with the political aspects of the Ukrainian situation. In order to help the Ukrainian economy, the European Union started preparing an Association Agreement with Ukraine in 2007 and completed it in 2012, when it had to deal with the Viktor Yanukovych government. The EU developed a detailed roadmap showing what steps the Ukrainian government had to take before it would extend assistance. Ukraine has undergone a revolutionary transformation since then. The roadmap ought to be adjusted accordingly, but the cumbersome bureaucratic processes of the European Commission do not allow for that.
Accordingly, Ukraine’s problems have been cast in conventional terms:
• Ukraine needs international assistance because it has experienced shocks that have produced a financial crisis. The shocks are transitory; once Ukraine recovers from the shocks it should be able to repay its creditors. This explains why the IMF was put in charge of providing financial assistance to Ukraine.
• Since Ukraine is not yet a member of the EU, European institutions (like the European Commission and the European Central Bank) played only a secondary part in providing assistance to it. The IMF welcomed the opportunity to avoid the complications associated with the supervision by a troika consisting of the EU, the European Central Bank, and the IMF that was used to deal with Greece and others. This new arrangement also explains why the IMF-led package was based on overly optimistic forecasts and why the IMF’s contribution of approximately $17 billion in cash to Ukraine is so much larger than the approximately $10 billion of various commitments associated with the EU, and even smaller amounts from the US.
• Since Ukraine has had a poor track record with previous IMF programs, the official lenders insisted that Ukraine should receive assistance only as a reward for clear evidence of deep structural reform, not as an inducement to undertake these reforms.
• From this conventional perspective, the successful resistance to the previous Yanokovych government on the Maidan and, later, the Russian annexation of Crimea and the establishment of separatist enclaves in eastern Ukraine are incidental. These events are seen as simply temporary external shocks.
This perspective needs to be altered. The birth of a new Ukraine and the Russian aggression are not merely temporary shocks but historic events. Instead of facing the remnants of a moribund Soviet Union, the European Union is confronted by a resurgent Russia that has turned from strategic partner into strategic rival. To replace communism, President Putin has developed a nationalist ideology based on ethnic grounds, social conservatism, and religious faith—the brotherhood of the Slavic race, homophobia, and holy Russia. He has cast what he calls Anglo-Saxon world domination as the enemy of Russia—and of the rest of the world. Putin has learned a lot from his war with President Mikheil Saakashvili’s Georgia in 2008. Russia won that war militarily but was less successful in its propaganda efforts. Putin has developed an entirely new strategy that relies heavily on using both special forces and propaganda.
Putin’s ambition to recreate a Russian empire has unintentionally helped bring into being a new Ukraine that is opposed to Russia and seeks to become the opposite of the old Ukraine with its endemic corruption and ineffective government. The new Ukraine is led by the cream of civil society: young people, many of whom studied abroad and refused to join either government or business on their return because they found both of them repugnant. Many of them found their place in academic institutions, think tanks, and nongovernmental organizations. A widespread volunteer movement, of unprecedented scope and power unseen in other countries, has helped Ukraine to stand strong against Russian aggression. Its members were willing to risk their lives on the Maidan for the sake of a better future and they are determined not to repeat the mistakes of the past, including the political infighting that undermined the Orange Revolution. A politically engaged civil society is the best assurance against a return of the old Ukraine: activists would return to the Maidan if the politicians engaged in the kind of petty squabbling and corruption that ruined the old Ukraine.
The reformists in the new Ukrainian government are advocating a radical “big bang” reform program that is intended to have a dramatic impact. This program aims to break the stranglehold of corruption by shrinking the bureaucracy while paying the remaining civil servants better and by breaking up Naftogaz, the gas monopoly that is the main source of corruption and budget deficits in Ukraine.
But the old Ukraine is far from dead. It dominates the civil service and the judiciary, and remains very present in the private (oligarchic and kleptocratic) sectors of the economy. Why should state employees work for practically no salary unless they can use their position as a license to extort bribes? And how can a business sector that was nurtured on corruption and kickbacks function without its sweeteners? These retrograde elements are locked in battle with the reformists.
The new government faces the difficult task of radically reducing the number of civil servants and increasing their pay. Advocates of radical reform claim that it would be both possible and desirable to shrink the ministries to a fraction of their current size, provided that the general population would not be subjected to severe cuts to their living standards. That would allow the discharged civil servants to find jobs in the private sector and the employees retained on the payroll to be paid higher salaries. Many obstacles to doing business would be removed, but that would require substantial financial and technical support from the EU. Without it, the “big bang” kind of radical reforms that Ukraine needs cannot succeed. Indeed, the prospect of failure may even prevent the government from proposing them.
The magnitude of European support and the reforming zeal of the new Ukraine are mutually self-reinforcing. Until now, the Europeans kept Ukraine on a short leash and the Arseniy Yatsenyuk government did not dare to embark on radical structural reforms. The former minister of the economy, Pavlo Sheremeta, a radical reformer, proposed reducing the size of his ministry from 1,200 to 300 but met such resistance from the bureaucracy that he resigned. No further attempts at administrative reform were made but the public is clamoring for it.
That is where the European authorities could play a decisive role. By offering financial and technical assistance commensurate with the magnitude of the reforms, they could exert influence on the Ukrainian government to embark on radical reforms and give them a chance to succeed. Unfortunately the European authorities are hampered by the budgetary rules that constrain the EU and its member states. That is why the bulk of international efforts have gone into sanctions against Russia, and financial assistance to Ukraine has been kept to a minimum.
Petro Poroshenko and Vladimir Putin; drawing by James Ferguson
In order to shift the emphasis to assisting Ukraine, the negotiations have to be moved from the bureaucratic to the political level. The European financial bureaucracies find it difficult to put together even the $15 billion that the IMF considers the absolute minimum. As it stands, the European Union could find only €2 billion in its Macro-Financial Assistance program, and individual member states are reluctant to contribute directly. This is what led Ukraine to pass on December 30 a stopgap budget for 2015 with unrealistic revenue projections and only modest reforms. This is an opening bid in the negotiations. The law allows for modifications until February 15, subject to their outcome.
European political leaders must tap into the large unused borrowing capacity of the EU itself and find other unorthodox sources to be able to offer Ukraine a larger financial package than the one currently contemplated. That would enable the Ukrainian government to embark on radical reform. I have identified several such sources, notably:
1. The Balance of Payments Assistance facility (used for Hungary and Romania) has unused funds of $47.5 billion and the European Financial Stability Mechanism (used for Portugal and Ireland) has about $15.8 billion of unused funds. Both mechanisms are currently limited to EU member states but could be used to support Ukraine by modifying their respective regulations by a qualified majority upon a proposal by the European Commission. Alternatively, the Commission could use and expand the Macro-Financial Assistance Facility, which has already been used in Ukraine. There is indeed a range of technical options and the European Commission President Jean-Claude Juncker should propose a way forward as soon as the Ukrainian government has presented a convincing set of priorities.
2. Larger matching funds from the European Union would enable the IMF to increase its lending to Ukraine by $13 billion and to convert the existing Stand-By Agreement into a longer-term Extended Fund Facility program. This would bring the total size of the IMF program to fifteen times Ukraine’s current IMF quota, an unusually large multiple but one that already has a precedent in the case of Ireland, for example.
3. European Investment Bank project bonds could yield €10 billion or more. These funds would be used to connect Ukraine to a unified European gas market and to break up Naftogaz, the Ukrainian gas monopoly. These changes would greatly improve Ukraine’s energy efficiency and produce very high returns on investment. It would help create a unified European gas market and reduce not only Ukraine’s but also Europe’s dependence on Russian gas. The breakup of Naftogaz is the centerpiece of Ukraine’s reform plans.
4. Long-term financing from the World Bank and the European Bank for Reconstruction and Development for restructuring the banking sector. This should yield about $5 billion. The 2009 Vienna Initiative for Eastern Europe, which proved to be highly successful in limiting capital flight and stabilizing the banking system, should be extended to Ukraine. The foundations for such an extension were already laid at the inaugural meeting of the Ukrainian Financial Forum in June 2014.
5. Restructuring Ukraine’s sovereign debt should free in excess of $4 billion scarce foreign exchange reserves. Ukraine has almost $8 billion in sovereign debt coming due in the private bond markets in the next three years. Instead of a default that would have disastrous consequences, Ukraine should negotiate with its bondholders (who happen to be relatively few) a voluntary, market-based exchange for new long-term debt instruments. In order to make the exchange successful, part of the new financial assistance should be used for credit enhancements for the new debt instruments. The foreign assistance needed for this purpose would depend on what bondholders require to participate in the exchange, but it could free at least twice as much foreign exchange over the next three years.
6. Ukraine must also deal with a $3 billion bond issued by the Russian government to Ukraine coming due in 2015. Russia may be willing to reschedule the payments by Ukraine on the bond voluntarily in order to earn favorable points for an eventual relaxation of the sanctions against it. Alternatively, the bond may be classified as government-to-government debt, restructured by the group of nations officially called the Paris Club, in order to insulate the rest of Ukrainian bonds from their cross-default provisions (which put the borrower in default if he fails to meet another obligation). The legal and technical details need to be elaborated.
Perhaps not all these sources could be mobilized in full but where there is a political will, there is a way. German Chancellor Angela Merkel, who has proved to be a true European leader with regard to Russia and Ukraine, holds the key. The additional sources of financing I have cited should be sufficient to produce a new financial package of $50 billion or more. Needless to say, the IMF would remain in charge of actual disbursements, so there would be no loss of control. But instead of scraping together the minimum, the official lenders would hold out the promise of the maximum. That would be a game-changer. Ukraine would embark on radical reforms and, instead of hovering on the edge of bankruptcy, it would turn into a land of promise that would attract private investment.
Europe needs to wake up and recognize that it is under attack from Russia. Assisting Ukraine should also be considered as a defense expenditure by the EU countries. Framed this way, the amounts currently contemplated shrink into insignificance. If the international authorities fail to come up with an impressive assistance program in response to an aggressive Ukrainian reform program, the new Ukraine will probably fail, Europe will be left on its own to defend itself against Russian aggression, and Europe will have abandoned the values and principles on which the European Union was founded. That would be an irreparable loss.
The sanctions on Russia ought to be maintained after they start expiring in April 2015 until President Putin stops destabilizing Ukraine and provides convincing evidence of his willingness to abide by the generally accepted rules of conduct. The financial crisis in Russia and the body bags from Ukraine have made President Putin politically vulnerable. The Ukrainian government has recently challenged him by renouncing its own obligations toward the separatist enclaves in eastern Ukraine, under the Minsk cease-fire agreement, on the grounds that Russia failed to abide by the agreement from its inception. After Ukraine’s challenge, Putin immediately caved in and imposed the cease-fire on the troops under his direct command. It can be expected that the troops will be withdrawn from Ukrainian territory and the cease-fire will be fully implemented in the near future. It would be a pity to allow the sanctions to expire prematurely when they are so close to success.
But it is essential that by April 2015 Ukraine should be engaged in a radical reform program that has a realistic chance of succeeding. Otherwise, President Putin could convincingly argue that Russia’s problems are due to the hostility of the Western powers. Even if he fell from power, an even more hardline leader like Igor Sechin or a nationalist demagogue would succeed him.
By contrast, if Europe rose to the challenge and helped Ukraine not only to defend itself but to become a land of promise, Putin could not blame Russia’s troubles on the Western powers. He would be clearly responsible and he would either have to change course or try to stay in power by brutal repression, cowing people into submission. If he fell from power, an economic and political reformer would be likely to succeed him. Either way, Putin’s Russia would cease to be a potent threat to Europe. Which alternative prevails will make all the difference not only to the future of Russia and its relationship with the European Union but also to the future of the European Union itself. By helping Ukraine, Europe may be able to recapture the values and principles on which the European Union was originally founded. That is why I am arguing so passionately that Europe needs to undergo a change of heart. The time to do it is right now. The Board of the IMF is scheduled to make its fateful decision on Ukraine on January 18.
—January 7, 2015
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