20:49 PM Monday, July 16, 2018
Ukraine's 2018 Window: The Russian Bear Will be Distracted
Putin's reelection March 18, followed by World Cup June 14-July 15, will keep Kremlin on OK behavior
image/svg+xml Kyiv Lutsk Rivne Zhytomyr Lviv Ternopil Khmelnytskyi Uzhgorod Chernivtsi Vinnytsia Chernigiv Sumy Kharkiv Poltava Cherkasy Kirovohrad Lugansk Dnipropetrovsk Donetsk Zaporizhzhia Mykolaiv Odesa Kherson Simferopol Sevastopol Ivano- Frankivsk

I have been rethinking my Ukraine view. It’s always a complicated story, so for the ease of the reader and myself, it is simpler to revert to the Q&A format:

Q: What about Ukraine’s relationship with Russia?

Answer: Still important, this is the obvious point. Russia’s leverage over Ukraine is admittedly much reduced, as economic, trade, financing, banking and energy ties have been significantly scaled back since 2014. But Moscow can still cause plenty of problems for Ukraine, particularly in its ability to re-escalate militarily at a whim almost across its border with Ukraine – in Donbas, and indeed beyond. There are options for cyber-attacks, and manipulation of domestic politics in Ukraine via social media, et al, and more directly by various political “projects”.

Q: What is Moscow’s latest game plan?

Answer: Putin is currently focused more keenly at home on the presidential elections in Russia, in March 2018, and then the looming World Cup in Russia in June/July.

Taking the latter first, he wants World Cup to be well attended by international teams, as he wants the event to showcase Russia, as a place open for business. Hence, he does not want the risk of any Western boycotts. This suggests he does not want anything to particularly deteriorate the relationship with the West in the run up to the competition.

The hope of some in Russia will be that the World Cup will be another opportunity to thaw the relationship with the West. It provides an opportunity for inward investment into Russia, beginning to crack the Western sanctions regime.

So, on Ukraine, in the period to the World Cup at least, Moscow will be looking to not escalate/deteriorate the relationship. This means going through the motions at least with the Minsk peace process, and the new Volker-Surkov US/Russia channel. The recent Russian UN peacekeeper initiative was part of trying to be seen to be constructive, even if the offer was not particularly new and unacceptable to the Ukrainian and Western sides.

From a Russian perspective the current situation in Ukraine plays reasonably well at home. The economic and political situation in Ukraine is still challenging (albeit improved). Moscow will play the line in the upcoming elections that Russians are still better with Putin’s leadership rather than the Western orientation panning out in Ukraine.

There is a willingness to wait and see how domestic Ukrainian politics plays out – and the assumption that domestic Ukrainian politics, in the run up to the 2019 elections in Ukraine, could play to Moscow’s advantage: the Opposition Block doing well, populists willing to deal with Moscow, or even new Russian-inspired political projects, like the Ivanishvili victory in Georgia to oust former President Saakashvili.

Rada MP Iryna Lutsenko in action on Friday. Unlike the unanimous votes of Russia's Duma, Ukraine's Duma features real debate over votes. (UNIAN/Aleksandr Kosmach)

Q: And Russia’s presidential elections?

Answer: Putin is odds on to win, but Putin wants to win well. That would be 70:70 -- a 70% poll backing on a 70% turnout. Given the current apathy among the Russian public, as reflected in the low turnout in recent local elections, it is going to be hard getting a 70% turnout. More likely, it will be 55:55 win for Putin -- and even that will be with all the levers of the state being rolled out.

There is not much strategy from the Putin camp on how to deliver another strong mandate – few new ideas or vision. Stability – close to stagnation/isolation – seems to be the order of the day. Two percent growth and the fact that living standards have stopped falling seem to be the main selling points. It could be worse. But the Putin administration does not want to risk any major escalation in Ukraine. This would risk blood and treasure, if past experience is anything to go by.

The Putin administration thus seems to be limping to the presidential elections, perhaps even just happy to get over the line, then regroup afterwards. Perhaps the Kremlin strategy is to sell the idea to the Russian electorate, that at least the Putin administration is not Trump, weak Europe, Brexit UK, or Ukraine under Poroshenko. And that will be enough to win -- or that is the assumption. The longer term game plan is to bide Russia’s time, build defenses, until the inevitable collapse of Western liberal market democracy creates new opportunities for Russia, and perhaps its own Sovereign Democratic Model.

Q: What can go wrong with this?

Answer: Likely the biggest risk now to Putin is the extent of feeling of resentment, annoyance, and even embarrassment felt across the US Washington establishment at the fact that Russia seemingly successfully intervened in the US elections. This resentment was seen in the Congressional Approval of a Bill to Codify Sanctions on Russia, along with Iran, North Korea and other foes of the US earlier this year – against expectations.

This law will prove very damaging long term to US-Russia relations, and the investment environment around Russia. It will prove sticky and will deter Western business with, and investment in Russia. There is a strong undercurrent of views in DC that Russia cannot be allowed to get away with all this – and that further action needs to be taken against the Putin administration, which needs to be brought down to size. The US establishment is hurting. The Putin administration is a ready source of anger.

Importantly, as part of the Congressional Sanctions bill, section 241 also allows within 180 days for the US Treasury to report on oligarchic links to the Putin regime, sources of wealth/assets, and perhaps reveal vulnerabilities. Many will see this as a potential future sanctions list – a warning for those in business around Putin to step back from supporting his administration.

For some in the US establishment, the looming Russian presidential election represents an opportunity for some quid pro quo for Russian actions in the US elections. Concern over this prospect might reflect the lack of action by the Putin administration – it is waiting and expecting some US action to undermine/destabilize the Russian political scene, but is not as yet willing to provoke that. Putin has not yet even announced that he will run for another term as president.

Putin does appear vulnerable to general apathy at home – the lack of new vision/ideas. Meanwhile, Alexander Navalny continues to gather momentum. Many question why Putin still tolerates Navalny, given that other potential political opponents have always been quickly side-lined/undermined by the Kremlin machine. This might reflect the view that Navalny does not represent a significant political threat yet to Putin. It might also reflect Kremlin nervousness that moving to bar Navalny from running might provoke the US into further and more aggressive action to undermine Putin’s re-election bid. This could be publishing “kompromat” on those in/around the Kremlin, or threatening a boycott of the World Cup in Moscow later next year.

A further risk to escalation would come if the US follows through on recurring threats within the US administration to arm Ukraine with defensive military capability. In such a scenario, would Moscow feel able not to respond – or would re-election risk force Putin into no immediate response?

Ukraine's authoritarian temptation: activists of the National Corps protest a Rada vote on the Donbas on Thursday. (UNIAN/ Vyacheslav Ratynskiy)

Q: What does all this mean for Ukraine?

Answer: Russia looks set to stay on the side-lines at least until after the World Cup, and possibly even to the Ukrainian presidential elections, although that seems a long way off in terms of Russo-Ukraine relations. This presents a great opportunity for Ukraine to get on with reform, to improve the strength/durability of the Ukrainian economy, of the army, until the next Russian intervention, which seems inevitable given Putin’s obsession with Ukraine.

Q: Can Ukraine reform effort succeed, and will it?

Answer: The first bit is easy. Absolutely yes, it can, without a doubt. This is reflected in the remarkable reforms delivered, against expectations to date – covering energy sector reform, banking, NBU reform, fiscal adjustment, and debt restructuring. It shows that Ukraine is absolutely reformable -- where there is the political will.

Q: Then the next questions are: will it? and is there the political will?

Answer: Here I have my doubts. President Poroshenko now is focused on re-election, as we approach the March 2019 elections. There is less willingness to do less politically popular things, which are now crucial. True, pension reform was passed this week, but the bill was revised/watered down, and I am not sure it is IMF compliant as yet. Remember: this reform entailed large upfront pension hikes, with the pain only coming after elections. It was low hanging fruit for the Rada and Poroshenko.

We have seen backtracking on energy sector reform/price liberalization, the Privatbank “clean-up”, land reform, and really slow progress on the anti-corruption agenda. The danger now is that the administration goes off track on the IMF program, and we see fiscal pump priming over the next year. This would be helped by the fact that the fiscal position looks strong -- a fiscal surplus, cash in the Treasury single account, and access to markets to borrow.

Some might argue Ukraine no longer needs the IMF. Some locals say they know better, and it’s just a question of cutting taxes for business, spending on infrastructure, and putting money in people’s pockets.

That is really dangerous in the Ukrainian context, as the structural reforms the IMF now pushes are key to ensuring Ukraine gets on a higher growth plain and stays there.

If Ukraine goes off track, fiscal pump primes to the elections in 2019, it will likely end up in a place similar to where it was in late 2013/2014 -- twin deficits/imbalances, elite capture, and a disgruntled population with a track record of going to the streets. The risks of another revolutionary change are not insignificant. Ukraine has lived through this failed reform scenario from 1991 to 2014.

Q: So how can the Poroshenko administration be kept on the reform track?

Answer: Ukraine has a vocal/vibrant NGO/civil society movement now. The IFIs and Western governments need to be vocal in holding the Poroshenko administration to account and in supporting these local movements. The IMF, EBRD, World Bank and US government need to call out reform back-tracking – as seems to be happening now.

Will they? I have my doubts. A particular narrative is being sold by those close to the administration that Ukraine is not ready for reforms: the anti-corruption agenda (separate courts), further energy price liberalization, land reform. They say society is fragile, and that if the West pushes too hard, the Poroshenko administration will be brought down in favor of a populist/nationalist/pro-Russian administration. This line is being pushed: the Poroshenko administration has its faults, but is a staunch Western/US ally and important foil to Russian expansionism, and is as good as it gets in the Ukrainian context. And it needs to be cut some slack.

I would totally argue against that.

First: I am not sure that early elections would bring a Rada in that much different to the current one – given the warped election system where rotten boroughs prosper. Likely it will again be 60:40 EU:Western oriented. That is a reflection of Ukrainian society as a whole, with business interests pre-dominating. A pro-Russian agenda simply will not now sell in Ukraine, given over 10,000 deaths in the East. Ukrainian public opinion has decisively shifted there.

Second: In the presidential election, I would not rule out new/fresh, reform minded candidates, such as Styatoslav Vakarchuk. Poroshenko, Tymoshenko, et al are only polling at 10-12%, so the bar for a new fresh face is not that high. Momentum can build quickly behind a new candidate – remember Serhiy Tyhipko in the 2010 presidential election, or even Leonid Kuchma back in 1994. I am not selling them in any way as reform candidates, but just making the point that new/surprise candidates can quickly capture the imagination of voters, or enough to get into the second round of an election.

So foreign donors should not be fearful of elections in Ukraine – indeed, I thought that’s what Euromaidan reforms were about, and Western support.

Third: As proven before, Ukraine can do reforms. Remember all the opposition to energy sector reform and the fears of popular unrest, which never happened despite multiple increases in gas/energy prices. The anti-corruption agenda is not unpopular – well not amongst the mass of the population. Obviously it is unpopular among elites, as they are likely to be most at risk from this legislation.

Q: What about progress with the anti-corruption courts/chamber?

Answer: Poroshenko seems to have had a turnaround there. He is back to supporting anti-corruption courts, after his seeming “wobble” at the YES conference last month. This might reflect the looming decision by the Venice Commission, expected over the next week and likely in favor of special anti-corruption courts. It might also reflect the legal reform bill passed earlier this week which set time limits on prosecutions. As some anti-corruption campaigners argue, it could well end up making it more difficult to lodge anti-corruption prosecutions. In effect, it would be the equivalent of a grand “get out of jail free card” for some of the elite/oligarchic and political class. That’s assuming they end up in jail in the first place.

But the bottom line is that anti-corruption agenda is critical. It is now the number one priority now in Ukraine to improving the business environment, getting investment, growth and jobs, and IFIs need to completely hone in on pushing this agenda forward.

Q: What about the IMF: will lending resume?

Answer: The IMF needs to hold the administration to account – past programs have failed because the IMF was too soft/politically motivated by key shareholder geopolitical motivations. Now is not the time for these considerations.

Looking at the backtracking in commitments from the 3rd review and limited progress on 4th review benchmarks, I don’t see how the IMF can give the green light for resumption of lending any time soon. It is important that the IMF is vocal in its concerns – what has been achieved, and where progress has been lacking.

Some IMF shareholders might think that being overly critical of the Poroshenko administration, now an important Western ally, might be exploited by its foes. But for Ukraine to move forward, its friends need to be honest in terms of what can and should be achieved. This IMF program has achieve a lot so far. But more should be delivered to ensure the long term success of Ukraine. With Russia on the back-foot, as Putin focuses on his re-election and the World Cup, all in 2018, there is a narrow window of opportunity to reform.

Timothy Ash is senior sovereign strategist for emerging markets at BlueBay Asset Management in London.

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