Survival of the richest: How oligarchs block reform in Ukraine

The resignation of Ukrainian PM Arseniy Yatsenyuk and the elevation of Volodymyr Groisman demonstrates the failure of Kyiv’s reform process, and offers Europe an opportunity to push for deeper changes.

And while Ukraine suffers from many types of corruption, it is the penetration of its politics by the super-rich oligarchy that forms the main obstacle to reform.

Wealth is concentrated in few hands in Ukraine. Before the Euromaidan protests of 2013 the assets of Ukraine’s 50 richest individuals made up over 45 percent of GDP, almost five times as much as in the US. Politics in Ukraine is extraordinarily expensive, with campaign expenditures running at hundreds of millions of dollars. And oligarchical media ownership further strengthens the hold of the wealthy over Ukraine’s democracy.

The author highlights two key areas, the judiciary and Ukraine’s state-owned enterprises, where the nascent process of ‘de-oligarchisation’ has failed to take hold. Control over the courts means that there have been no high-profile leading figures from the Yanukovych era brought to trial. And Ukraine’s state-owned enterprises siphon off government funds to the pockets of oligarchs, providing further funds for them to control events in Kyiv.

The EU remains Ukraine’s only plausible ally and, as such, has the potential to wield a huge amount of influence over the reform process. Wilson highlights two main areas that European policy makers should focus on, both of which focus on decoupling the oligarchs from the political system, rather than attacking the oligarchy itself.

The first step should be to strengthen the pressure applied on the Ukrainian authorities from below, by local civil society. Engagement could take the form of encouraging the participation of Ukrainian NGOs in EU-Ukrainian government dialogue.

Ukraine can win the war against corruption

This week I spoke at the European Council for Foreign Relations on a platform with Andrew Wilson who delivered an excellent paper on corruption in Ukraine, entitled “Survival of the Richest: How oligarchs block reform in Ukraine.”

For a copy of the paper please contact www.ecfr.eu directly. Or click on [... pdf ...]

Wilson's paper is excellent in providing fine detail over the subject matter -- it is kind of all in the title, and well worth reading.

I played the role as the discussant at the session, and herein, I provide a summary of my own views on the matter.

At the outset I think it is important to recognise that opinion polls in Ukraine consistently suggest that an overwhelming majority of Ukrainians view corruption/graft, and the lack/failings of the rule of law, as the number one issue facing Ukraine at present -- this has taken over from the security situation in the eastern Donbas as the key concern, as the latter conflict has moderated in recent months with evidence of Russia taking a backseat.

Indeed, I would go further than that and I would argue that the EuroMaidan Revolution back in late-2013/early-2014 was actually more about this issue (fighting corruption/imposing rule of law) than demands for EU membership. I don’t think Ukrainians back then were stupid enough to think the EU would ever let them in, but what EuroMaidan was about was a (West) European orientation in terms of reform towards Western “values” taken as the honest/even application of the rule of law, respect for human rights, democracy, property rights, et al., kind of all the stuff in the original Copenhagen Treaty.

Criteria from the Copenhagen Treaty from 1994 which set in motion the first wave of eastwards enlargement of the EU a decade later. Ukrainians wanted, and want, to live in a normal European country where their rights are respected, and their elites don’t rip them off and are allowed (even expect) to operate by a different and far more advantageous and lucrative set of rules of the game, which they shape to their advantage through their near total capital of party politics and the political process in Ukraine.

Critical to Ukraine's future

So the fight against corruption is important, indeed, I would argue that it is critical to determining Ukraine’s longer-term pace of development and whether potential real gross domestic product growth is 2-3 percent or 4-5 percent.

Fighting graft and corruption is important as it is the key to improving the business environment to encourage foreign direct investment in Ukraine, and also to encourage Ukrainians to invest in their own economy, rather than to partake in capital flight at which they currently excel (unfortunately).

But with the application of (West/Central) European values, I see no reason why the Ukrainian economy should not be the next Poland in 10 years’ time -- it has the potential, skill base, strong sectors in agriculture, information technology, semi-finished production, some manufacturing and is a potentially big domestic market to allure foreign manufacturers and those willing to sell in Ukraine and beyond. Ukraine can/should be the next Poland, with the potential to grow at 4-5 percent, helped by the currently low base.

Now as Wilson so rightly argues, corruption is currently holding the Ukrainian economy down and unfortunately post-EuroMaidan, progress in fighting corruption has been disappointing, as reflected in recent resignations (ex-Deputy Prosecutor General Vitaly Kasko, ex-Economy Minister Abromavicius, et al.) from the government of former Ukrainian Prime Minister Arseniy Yatsenyuk.

Wilson argues that this is significant because oligarchs, and the politicians they promote, are standing in the way of action against corruption -- we can call this elite capture, or whatever. Again, I have little dispute with him here.

But Wilson goes on to argue that “Ukraine lacks a substantial reform elite,” a point to which I do take exception. And herein I think it is important to step back and recognize some of the remarkable achievements so far by post-EuroMaidan reform administrations, achieved against an incredibly difficult backdrop of war/conflict, annexation, and foreign intervention, trade/transit blockade:

Herein I would highlight:

Better balance of payments

-- A marked balance of payments adjustment, helped by the nominal and real depreciation of the hryvnia. Thus the current account deficit has gone from 9 percent of gross domestic product just a few years back to 1-2 percent of GDP now. The hrynvia has stabilized and the National Bank of Ukraine is now buying foreign currency, with import cover now standing at over three months of cover, from just a few weeks only a year or so ago. And this has been achieved without any International Monetary Fund/international financial institution disbursements to note for the past six months, so Ukraine has been sustaining itself;

Deficit cut

-- The fiscal and quasi-fiscal deficit has been cut from 8-9 percent of GDP just a year or so ago to perhaps 2-3 percent of GDP this year, with the state budget currently in surplus, and the single Treasury account also having a substantial positive balance, again despite no significant international financial institution disbursements.

Debt restructuring

-- The debt restructuring deal was achieved in November 2015, against the odds, and it has termed out Ukraine’s debt service pressures to for 2-3 years ahead, buying Ukraine time -- albeit I do think the deal could have been more generous to Ukraine.

Reducing energy dependency

-- The energy sector deficit has been reduced massively. The gas import bill, for example, has been reduced from 40 billion cubic meters or so in 2008/09 to perhaps 10 billion cubic meters last year, and holding the prospect of self-sufficiency in gas on a 4-5 year view. The cost of gas imports has, as a result, been reduced from $12-15 billion annually back in 2008/09 to perhaps $2 billion or so at present, creating big positives for the budget and balance of payments. Energy prices -- which many local politicians said could not be hiked for their social and political impact, have been increased (and again from May 1,2016) and this is ensuring energy conservation, and more can be done to push towards energy self-sufficiency which is now a realistic medium-term prospect for Ukraine. The latter is a remarkable achievement, which many people said was impossible. It is now a reality because of the ambition of the “reform” team at Naftogaz Ukraine.

Central bank transformation

-- The transformation of the National Bank of Ukraine has been nothing short of revolutionary -- administrative (11,000 head-count, down to 4-5,000, and on to sub-2,000), monetary policy, banking sector regulation/supervision brought into line with the best international practice. The NBU has gone from “worst in class” to near “best in class” in Emerging Europe in just two years. Governor Valeria Gontareva gets a lot of criticism for many things -- but she deserves credit for this.

-- And similarly, what has happened in the banking sector has been simply remarkable -- 60+ banks, one third of the total, have been closed over the past year or so, and closing banks (many conduits for money laundering and organised crime) in the post-Soviet space is potentially life threatening for regulators, let’s not forget the memory of Andrei Kozlov, the former deputy governor of the Central Bank of Russia, of Zoran Dzindjic, the former prime minister of Serbia, who dies trying to impart similar reforms in their countries. Those officials at the NBU rolling out the bank restructuring process are the real heroes of reform, and let’s give the due credit for that.

Effective hiring

-- The state-owned enterprise hiring process has finally been revamped -- as reflected in the appointment of a new Polish head of Ukrainian railways, hired in a transparent, competitive international process.

ProZorro

-- ProZorro -- the new transparent public procurement system has been introduced -- and realistically can reduce budget spending by as much as $2 billion (3 percent of GDP) a year.

Police reform

-- Police reform at the local level has been rolled out and feedback from the population has been good.

Transparent ownership

-- Laws on beneficial ownership and on the Registry of Property have passed which should help improve transparency.

Fighting corruption

-- And the creation of National Agency for Prevention of Corruption is a step in the right direction and should begin to make a difference in rooting out corruption and changing behavior.

Some of the above was admittedly low-hanging fruit, but much more, such as banking sector, energy reform, and fiscal adjustment has been politically, economically and personally for the reformer involved very painful to undertake. What the above suggests to me is that Ukraine does, in fact, have a substantial group of dedicated, motivated reform technocrats. They have the technocratic know-how to deliver a reform agenda (they don’t take it off the shelf from the International Monetary Fund, but they have taken ownership themselves), but the key bottlenecks are in politics, and therein I think oligarchic business interests do block development and indeed are now the key impediment to reform.

I would argue that the greatest battle is/will be the fight against corruption, to deliver to the population what they fought for on EuroMaidan and subsequently in the war in the east.

Anti-corruption fight disappointing so far

I think it is correct to think that so far delivery on the anti-corruption agenda has been disappointing, indeed very disappointing -- no-one has gone to jail, either in the former Yanukovych or beyond which is simply incomprehensible to ordinary people. But this failure in terms of delivery in the fight against corruption is not because Ukraine does not have the talent -- on the broader reform agenda, in terms of what has been already delivered, the message is they clearly have.

I also think there is a danger to write Ukraine off as unreformable because of failings on the anticorruption reform agenda -- and I think Ukraine’s enemies seek to do that. But that would be wrong, Ukraine is fixable, but it is about giving the reform technocrats the political support/capital to drive forward reform.

Corruption ingrained

But I also think that we have to accept that because after years of failure, corruption is ingrained, that the fight, and victory, against corruption, will be long-running and difficult. And herein the experience of Emerging Europe is pertinent. Note that Romania -- the IMF reform darling of the region, since 2008/09, only moved up 11 places in Transparency International’s Corruption Perception Index, since 2007, and that came with the twin reform anchors of EU accession and an IMF programme, and after two former prime ministers were imprisoned. Ukraine is currently only standing on one of these legs -- the IMF programme. The plus for Ukraine is that it has a strong civil society movement, and now a strong investigative journalistic tradition, plus Western IFI financial support and oversight, which can push reform forward, helping to anchor reform, but this will be a long run project.

Oligarchs stall anti-corruption fight

Looking at current impediments to efforts in the anti-corruption arena, I would share Wilson’s conclusions that oligarchs are stalling the process. They have captured a large part of the political class and process and are stalling the rolling out of the anti-corruption agenda because they fear that this will inevitably see penalty (prison) for any past misdemeanors.

Meanwhile, in the current no man’s land between East and West, they know and understand the rules, which seems like it is eat or be eaten -- you have to be on the offensive in business and politics, to prevent your oligarchic rival ultimately devouring you and your business.

They are nervous how they survive in the new rules of the game, the clean rules. It ends up as something of a prisoners’ dilemma, many oligarchs openly say they would rather like to operate by clean, Western rules of the game, but are nervous about making the transition unless their oligarchic competitors also agree and also play the game.

There has to be some brokered agreement or incentive for these oligarchs to truly embrace the new, clean rules of the game. Separately therein I have offered the suggestion of a EuroMaidan Truth and Reconciliation process where oligarchs declare ill-gotten, and otherwise, wealth, pay a windfall tax and then benefit from an amnesty with a zero tolerance for future misbehaviour -- maximum penalty for future bad actions. That for me is the only really way to encourage oligarchs to play by the rules of the game, and to step back from their current dominance and total distortion of the political process in Ukraine. Oligarchs need to get out of politics and move to a healthier and more hands-off approach to politics.

The role for the West?

Well, Ukraine would benefit greatly from a real EU accession perspective, as have the likes of Poland and Romania, which has provided a template and anchor for reform. The reality though is that the EU is currently in no fit shape to offer any real accession perspective, as with Brexit it is likely now fighting for its very survival.

But the West does have leverage over Ukraine via the $25 billion IMF-anchored financing programme agreed in April 2015.

Ukraine still needs this financing to stabilize the balance of payments, fund the budget and cover energy import needs.

The new Volodymyr Groysman administration also has a credibility gap at present, because of failures of the Poroshenko presidency as yet to fully address the anti-corruption agenda -- it needs the credibility which an IMF programme brings.

Hence, the international financial institutions should attach tight conditionality to future disbursements, linked to real and specific deliver on key performance indicators associated with improving the rule of law and fighting corruption.

Oligarchs must be persuaded to back out of politics -- maybe a Truth and Reconciliation process with a Windfall tax/Amnesty would be one solution. I would also suggest Ukraine returns to electoral reform, to move back to a proportional system, which will once and for all get rid of the in-effect “rotten boroughs” by which business interests capture influence in the Rada, i.e. through the current “constituency-based” electoral system.

Balcerowicz gives hope

In conclusion, I would argue that Ukraine has achieved a huge amount on the reform front, against enormous odds, over the past two years. Its reform technocrats have proven they can deliver real reforms, and Ukraine is reformable -- it is not a lost cause/case. But the next battle should be the fight against corruption, and the result of this battle will determine whether Ukraine is indeed the next success story in the region, the next Poland. Therein I thought it was very notable this week that the guru of the Polish reform model, Leszek Balcerowicz, has agreed to be President Petro Poroshenko’s main reform policy adviser. There is hope.