ODESA -- I have been in the lovely city of Odesa this week, at ICU’s Ukrainian Financial Forum, which really was a stellar event.
Great list of speakers, including a couple of my personal heroes: Lajos Bokros, the former minister of finance of Hungary, and Engin Akcakoca of the SDIF in Turkey. What both these men achieved in their respective countries was simply stunning. The durability and strength of these two economies is in no small part due to the reforms they both spearheaded. Ukraine can learn from both. I am glad that Engin is involved in the Privatbank rebuild.
Returning to Ukraine, I am leaving really downbeat and disheartened. The reform zeal that we saw a few years back is sadly dissipating, as the political leadership increasingly focus on elections in 2019.
I think the IMF program - which has been hugely successful to date - is at real risk of going off track for an extended period of time. Domestic ownership is now faltering.
Just to be clear: this IMF program has been staggeringly successful to date. It has way beaten expectations, if you think of what has been achieved in terms of macro stabilization, energy sector reform, fiscal adjustment, banking sector reform, and NBU reform.
But some of these achievements are now at risk, as politicians focus on their own survival in office. Credit to the IMF teams and to the reformers in Ukraine for what they have delivered so far, just shows what can be achieved, and that Ukraine is absolutely reformable -- no doubt, with focus, the right people in place, support and commitment. And sometimes well placed criticism.
IMF deputy MD, David Lipton, was in Kyiv last week. I assume he read the riot act over IMF concerns. But I understand he left less than assured.
From an IMF perspective, it is not about the delay to the next review, the fourth review under the EFF, delayed from May - July, but also backtracking from commitments and prior actions from the third review back in April.
There seem to be six areas of contention: energy price liberalization, energy subsidy reform, the supplementary budget revision, the post of the NBU governor, inflation, and Privatbank. (For this newly nationalized bank, this getting new management in place, and ensuring coordinated legal action to recover $5 billion in lost assets.
This is a pretty big list. It is hard to think of an IMF mission returning until a weight of these are resolved - and some are pretty weighty issues. (Privatbank and energy subsidies cannot be resolved just by a single signature). An IMF mission was supposed to have visited Sept. 12 to begin the next review. But Ukraine got the riot act instead from Lipton - which also was clear from an interview Lipton gave Ekonomichna Pravda. The man clearly was not pleased.
I am totally perplexed on the now long vacant position of NBU governorship -- six months after the resignation of former governor Valeria Gontareva. Where in the world does such an important position of governor of the central bank remain unfilled for six months? Simply incredible.
And this is Ukraine which is facing major challenges. It is not as though there is not a candidate that is well respected and had been evidently lined up for the job -- Volodymr Lavrenchuk. He was seemingly teed up for the job in April, got sign off and was on promise to the IFIs, but now clearly has been moved aside.
Why the delay? Well, presumably, in Ukraine style, the position is now a bargaining chip for the future, either with the IMF, or political factions in the Rada. This just looks so bad, and damages the country's credibility in the process.
In terms of the next review, policy makers naively think that by just passing pension reform, the IMF will give them a pass on other reform priorities -- including the anticorruption agenda and land reform. While that judgment is wrong, even on pension reform. The current version, revised with literally hundreds of amendments from the earlier version agreed with the IMF and World Bank, may not now be IMF compliant.
It likely will be passed with some euphoria in the Verkovna Rada as it implies big pension increases from October, so will be popular. But I don't think the IMF will give the green light without major review/revision.
Meanwhile, on the anti-corruption agenda, President Poroshenko appears to be going back on prior commitments to establish separate anticorruption courts and chamber. His officials have been very defensive recently on the issue, suggesting that commitment is lacking to seriously bring about change.
At the start of this process, I argued that an alternative approach - a Truth and Reconciliation Commission, Amnesty and Windfall Tax approach -- would be more effective. But it was ignored. In the end it is about changing behavior. Speed is of the essence there. We are seeing IFIs/NGOs trying to create institutions to prosecute and convict, but an elite doing all it can to delay and torpedo that process. They fear they are more than likely going to be main targets of this process.
An almighty battle is on-going. The good guys will lose as they face an elite that can always outspend on lawyers. In the end behavior is not changing fast enough to improve the business environment and bring meaningful, growth enhancing uptick in foreign direct investment.
I would pursue a dual approach: a Truth and Reconciliation Process to address past corruption, while in parallel building institutions to address wrong doing going forward. A clear line/date would be drawn in the sand defining when rules change and, with them, behavior. But the key has to be changing behavior to root out corruption, to help promote business and growth.
Don't get me going on the above subject.
On the IMF front, the strategy from the Poroshenko administration is to do as little as possible, assuming the IMF will inevitably back down - as they did with the 3rd review. Eight structural benchmarks were missed back then, but a pass was given as a result of the Privatbank nationalization.
The assumption is that, whatever the relationship with the IMF, global markets will remain open, and market financing can bankroll Poroshenko re-election. This in part reflects the success of the recent $3 billion Eurobond deal, which the administration put more on its policies than the flush state of global markets. But this has bolstered the government's cash reserve - probably now $4 to 5 billion.
This is a substantial war chest to take into 2018 and the run up to the March 2019 elections. I assume the administration is thinking of fiscal pump priming next year to get growth moving, and ensure its election. Freed from the IMF shackles, this clearly will be easier. And I would not be surprised to see another bond issue within the next six months, global markets willing.
I have argued in the past that the scenario now seemingly panning out was always likely, given past experience with the IMF and market access. The problem for the Fund, and it is well known, is that programs require market access eventually to ensure the IMF actually gets paid back.
But once countries regain market access, they no longer need IMF money, and then you really find out how much ownership of the program their really is. In the case of the Poroshenko administration, I have real doubts as to whether they are committed to the key problem of fighting corruption, addressing the problems at Privatbank, corporate governance more generally (see problems at Naftogas now), and land reform, et al.
All this is very sad in my mind. Ukraine now faces a unique opportunity and window for reform to change Ukraine's trajectory, and deliver on what those braving the cold during the Euromaidan protests really wanted - an end to elite capture/corruption. The current situation reminds me very much of the Yanukovych administration between 2011 and 2013. We all know how that ultimately ended. Poroshenko needs to be mindful.
The reformers and the IMF,need allies and friends of Ukraine to speak out. Previous US ambassadors were publically very vocal in this regard. The flux (I am being diplomatic) in the US administration under Trump is not helping.
Watching the Trump - Poroshenko meeting in New York this week I was somewhat flummoxed. The messaging from the US administration was clear, given that the line up included Trump, Mattis, Tillerson, Mcmasters, Volker, and I think even Fiona Hill. This was a strong vote of support for President Poroshenko.
Whatever you might think of the peace process in the East, the US administration needs to understand that there is an equally important battle for Ukraine at home for reform, and for what the Euromaidan was all about.
The messaging to the Poroshenko administration should be crystal clear: We will help bring peace in the East, but we will hold you to account for reforms at home. Currently you are off track with the IMF. You cannot expect our unbending support if you continue along this path. The US administration needs to be much more vocal. Where is the leadership?
Timothy Ash is senior sovereign strategist for emerging markets at BlueBay Asset Management in London.
Posted Sept. 22, 2017