After a stellar 2019, 2020 was for Ukraine a year of dashed hopes. 2021 will see the country return to a variation on the pre-2019 norm: balancing between reform and vested interests. Persistent financing difficulties should produce enough pressure to see at least some reform progress.
A year ago, the picture in Ukraine was rosy. After an unprecedented reform drive in the second half of 2019, after Volodymyr Zelensky clinched the presidency and a parliamentary majority, Ukraine seemed ready to embark on a path of sustainable growth, demolishing the oligarchic structures that have throttled the country’s development since independence in 1991.
Not so today, and not just because of Covid-19. Ukraine has in fact weathered that crisis well, compared to most developed economies, with a smaller workforce employed in lockdown-affected sectors. The combination of low energy prices and high commodity prices have created a current account surplus, a rare feat.
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But the reform drive has dissipated. Oligarchic power struggles crept back, forcing the sacking of both a technocratic government in March and the professional leadership of the National Bank of Ukraine (NBU) in July amid calls for lower interest rates, higher inflation, and a weaker hryvnia. In late September, underwhelming local election results put paid to the parliamentary majority of the governing party, Servant of the People (SOTP). Finally, in late October, the Constitutional Court derailed much of the past years’ anti-corruption progress, setting off a constitutional crisis.
This reform backpedalling soured relations with the International Monetary Fund (IMF), which had approved a stand-by facility in summer, followed by disbursement of a large tranche. The backsliding cast severe doubt over the programme’s future, threatening both fiscal and debt financing.
In 2021, Ukraine’s economy is likely to return to normal. That means rebound growth of around four per cent, after a five per cent contraction last year. It means a return of structural current account deficit, with a rise in energy prices and a slump in commodity prices. And it means rising inflation, due to a pick-up in consumer demand, energy tariff hikes, and a 20 per cent bump to the minimum wage introduced in January.
Continued cooperation with the IMF should support the economic rebound. Rapprochement began late last year, as it was clear that financing needs could not be met without added fuel from the Fund. If successful, an ongoing virtual mission will lead to a disbursement in the spring, putting the budget on track and allowing for timely debt repayments, which peak in September.
Persistent political risk
With macrofinancial fundamentals strengthened since the 2014-15 crisis – the banking sector is healthy, and the NBU’s reserves equal 4.8 months’ of imports – it is doubly true that the risks are primarily political.
Externally, Covid-19 and the conflict with Russia loom largest. With Ukraine in lockdown for next two weeks, the situation appears relatively calm for now. But with an upcoming vaccination programme expected to progress slowly, a new infection wave may lead to at least partial lockdowns until summer.
In the Donbas and the Crimea, while escalation is unlikely, it is a possibility, and could even be triggered by recent suggestions that Ukraine could cut off Crimea’s water supply. While the government will continue to avoid direct conflict, Ukraine’s pro-Western geopolitical alignment is only firm on the surface: an inch below, it remains shaky, with Russia-friendly political and media elements doing the groundwork for an eventual shift.
Internally, hopes that Zelensky’s powerful mandate might banish Ukraine’s chronic political instability, lasting since at least the 2004 Orange Revolution, have been dashed. Last September’s elections hastened the splintering of SOTP into various factions, making deals both within the party and with the opposition essential for policymaking this year. The party should manage to avoid a snap parliamentary election this year, however.
The most pressing policy matter is reforming the judiciary to clean out corrupt justices, a key IMF demand. The government appears committed to debating an ambitious bill in parliament, but the horsetrading and compromises that will follow may well leave the door an inch open to corruption.
With no quick fix to the constitutional court’s obstructionism available, the tug-of-war between the justices and the president will likely drag on, potentially into the medium term. The court may well move to reverse other key reforms, for instance a law that prevents the return of Privatbank to oligarch Ihor Kolomoisky. Until parliament appoints enough justices to tilt the balance in the constitutional court, it will continue to effectively keep the government hostage and paralyse decision-making.
Old reforms will also haunt the government this year. Tensions between the central government and local governments empowered by decentralisation will intensify – directly-elected local leaders have already refused to abide by lockdown restrictions. National policymaking will increasingly require painstaking negotiations with local authorities – slowing reforms in the short term, and pushing Ukraine towards regionalisation in the medium term.
At the NBU, the sidelining of former governor Yakiv Smoliy’s well-respected team has established the conditions for regression both on the monetary policy and the banking supervision front. Pressure from the IMF will keep the NBU from backsliding in the short term. But once fiscal financing and external debt pressures have eased somewhat, likely in the second half of the year, the bank may well step away from inflation targeting – a move to monetise government debt by refinancing state-owned banks buying up domestic bonds would be particularly concerning.
All these issues will again risk cancellation of the IMF programme – which would entail the end of EU and World Bank funding too, and a prohibitive rise in borrowing costs.
The Ukrainian risk landscape in 2021 is not all that different from that of 2018. The oligarchic structure’s notorious resistance to change forces leaders to balance between the demands of vested interests and those of the IMF, on which financial stability depends.
But as in the years before 2019, fiscal and debt financing pressures are heavy enough to force just enough movement towards reform to keep the IMF on board. Ukraine will neither break out, nor break down, but it will muddle through – just about.
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