Kyiv Trip, February 4, 2013

Timothy Ash

Kyiv trip takes outs, part II

We continued our Kyiv visit today and herein are a few additional takeouts from our various meetings, plus impressions from a walk around Maidan.

Taking the last of these first, I was truly surprised at the shear scale, organization and determination of the Maidan protests. I think it is tempting to think that this is just concentrated in a very small part of Kyiv, and is relatively isolated. While much of the rest of Kyiv is continuing to function, the Maidan protesters occupy a vast swathe of central Kiev, down Kreshchatyk, up Hrushevsky to the cabinet of ministers, and parliament. This is now a vast encampment of perhaps hundreds of large, army style tents, with row after row of huge ice barricades, and catering facilities. It is very well organized, and patrolled by bat wielding Maidan patrols. Talking to some of these individuals they appeared very cheerful, and very motivated. Clearing these demonstrators would involve a very substantial security force operation, which would be far from easy, and would be unlikely to be without substantial risks for all sides. Simply put I do not think the authorities have the ability to clear the demonstrators by force – without risk of substantial loss of life, and likely resulting in the imposition of extensive regime sanctions by Western governments.

Given that the use of force is unlikely to work, the question is then what compromises could be offered and agreed which could encourage demonstrators to stand down. Herein, the problem is that the position of protesters seems to have hardened over recent weeks, and after what they see as brutality from the regime, after the use of lethal force, arrests, beatings and disappearances. They want to see meaningful regime change, extending beyond prime minister Azarov who resigned last week, but also perhaps extending up the hierarchy to those responsible for ordering the crackdown, and perhaps even to President Yanukovych himself. They also want early, and free elections – both presidential and parliamentary, and a reversion to the 2004 constitution, and a return to the pre-2010 electoral rules, which would imply a return to a fully PR based system. Even in a best case scenario, developing on this agenda could take a very long time, i.e. likely months, not weeks.

Our sense is that the Yanukovych regime is also entrenched, and determined to ride it out/play for time. Their line seems to be that they have already offered concessions, and anything further will be a sign of weakness, and they seem unwilling, unless pushed, to offer that much more.

In passing a new amnesty bill the Verkhovna Rada included a 15-day deadline for clearing public buildings, and we think that this is likely now a key event line to watch.

Note that the impression is that President Yanukovych extended a significant amount of political capital (warning of very significant sanctions on deputies) ensuring that Regions deputies in parliament held to the party whip and voted for the above mentioned Amnesty bill. Many of those we met though questioned why Yanukovych had made such a big thing of passing this bill, which was not supported by the opposition – hence it is not being viewed by the opposition as a concession.

The fact that a chasm still exists between the government and opposition was evident in discussions in parliament earlier today, where the Regions majority appeared to reject talk of constitutional reform as demanded by the opposition. The Rada session hence ended with no substantive votes.

The West has been pushing the idea of the formation of a technocratic government, perhaps a coalition between the opposition and the Regions’ majority. The government might be willing to accept that, but obviously the question then is who would head it. The post was offered to opposition leader, Yatseniuk, but he baulked at this, unless the opposition were given assurances that they would really control government – Yanukovych failed to provide adequate assurances. One potential name who was mentioned as filling the void would be Petro Poroshenko. One of the few oligarchs who quickly allied with the pro-EU opposition before Vilnius, he is an experienced politician, having served as head of the National security council, as foreign minister, and chairman of the board of the NBU, under President Yushchenko, and Yanukovych. He is one politician who can span both camps, and I sense he might just still be acceptable to the Regions’ majority. That said, I sense other leading figures in Regions are still eyeing the post of prime minister. In particular,  the names of Andrei Kluyev, the current head of the presidential administration, and Serhiy Arbuzov, have both been mentioned as possible contenders for the post of prime minister. However, Kluyev would be totally unacceptable to the opposition, as he is widely blamed for having a role in the crackdown on the Maidan at the end of November, during his stint as head of the National Security and Defence Council. Similarly, while some see Arbuzov as an economic reformer, he is generally seen as being too close to the Yanukovych family to be acceptable to the opposition. Important also for the opposition will be control of the ministries of justice, interior and the national defence and security council, i.e. the “power” ministries.

All roads tend to lead to Poroshenko. He might just be persuaded to head such a technocratic government, if he can be given a free rein to force though difficult economic reforms, perhaps underpinned by a new IMF programme. Indeed, in many ways Poroshenko has little to lose, and much to gain from taking a gamble on such a role. He can sell this as taking the job for the national interest, to keep the country united and heading off the risk of a Civil War. IMF financing would require a far reaching and painful economic reform programme. However, if he clearly sets out the reforms he aims to push through at the outset (fiscal consolidation, energy sector liberalization including gas price hikes, and exchange rate liberalization) as the price for getting back on the European integration path, and backed by an IMF programme it just might work. If he succeeds, his profile will be raised, and he will boost his chances as president in the March 2015 elections, assuming they are not held sooner. If he fails, well no one will likely blame him for taking on a near impossible task – and he will hardly damage his chances in the 2015 elections, as he already polls in third place amongst opposition leaders behind Klitschko and Yatseniuk.

The danger is likely that Yanukovych drags out talks over forming a new technocratic government, aiming still to shoehorn his own loyalists into position, while other opposition leaders might just block Poroshenko’s push to the top for pure selfish ambition. This could leave the government leaderless for months, with policy drifting, and leaving an ever present risk of violence flaring up as frustrations from both sides ebb and flow, and of economic meltdown.

In terms of prospects for a Western bailout, there has been much press speculation around a WSJ interview given by EU foreign affairs chief Catherine Ashton on the even of her latest visit to Kyiv. This was read by some as suggesting that a large scale Western aid package – to rival the $15-18bn Russian bail bond n’ gas deal – was in the offing. Somewhat remarkably, few diplomats and officials in Kyiv we met appeared to know very much about this – indeed they appeared totally in the dark. One of the problems is that neither the US or EU have readily available kitties of cash to disburse to countries such as Ukraine, outside of regular IFI lending programmes such as though the IMF. Pre-Vilnius the EU did agree EUR610m in budget support on condition of agreement over a new IMF programme. This might be increased to EU1bn with inclusion of spare funds from the Eastern Partnership Programme. Similarly, the US might conceivably be able to stump up as much as $1bn. And I can conceive of other Western bilateral donors throwing some small change in the tin, albeit in total I doubt these “new” Western commitments would add up to much more than several billion dollars. And, as is often the case this might end up being a case of smoke and mirrors  with the repackaging of funds already committed. It would likely be a case of the West trying to spin any support as being much more than actually available – the problem is simply the pot is pretty empty at present. And, Western countries are unlikely to want to throw any cash committed without significant oversight, and likely conditionality attached, e.g. through an IMF programme. An IMF programme of $10-15bn is possible, but again conditionality would be attached, and given numerous prior failed programmes with Ukraine, I still think that the IMF would be long on upfront conditionality, and short on upfront cash disbursements.

We did hear suggestions that some Western finance might be front loaded, but this would require political concessions/anchors – which we took as Ukraine signing up to the EU’s AA-DCFTA. However, the Ukrainian officials we spoke to were still talking of the need to balance any move to deeper European integration, with normalizing the relationship with Russia – and this still seems like a difficult circle to square.

One question we asked is would signing the AA-DCFTA now encourage Maidan demonstrators to leave the streets. The overwhelming answer from those we met was no, I.e. this is now more than European integration, but holding the Yanukovych regime accountable for their actions in office, and in particular in terms of the suppression of the demonstrators. The Maidan wants heads to roll, high up in the Yanukovych administration, extending perhaps even to the president himself, albeit it is clear he is not willing to budge, and as Yatseniuk recently warned, he will go down fighting. Something has to give, but the stakes all around are still very high.

At the core of the problems in Ukraine is a lack of credibility and trust all around, I.e. between the government and opposition, between opposition leaders and the Maidan, between the West/IMF and the Yanukovych government, and between the West and Russia. This makes cutting any deal extremely difficult.

In terms of the relationship with Russia there was widespread acceptance that the bail bond and gas deal agreed in December with Russia was unlikely to prove beneficial to Ukraine and likely had very significant conditionality (even if unwritten) attached. Lending via Eurobonds issued increased the future default risk, giving Russia increased leverage as a result. In any event the assumption is that Moscow would no longer fund an administration which moved back towards a European orientation, and that also meant a lifting of the gas price discount from April.

We heard increasing talk during our visit of potential sanctions to be imposed on the Yanukovych regime by the West, if they continued to threaten violence and refused to compromise with the opposition. Already the US has announced limited visa restrictions on regime members linked with the violence already used against the opposition, and is hinting that more could come. The EU had appeared reluctant to follow the US line, with some EU/EC officials indicating that the experience with the sanctions imposed on the Lukashenko regime in Belarus had been one of disappointment. However, there now seems to be recognition that the regimes in Belarus and Ukraine are quite different, and that government members and oligarchs (often the same people) have many more links and assets in/with the West. The opposition has also been very vocal in calling for sanctions to be imposed on the regime, in particular asset freezes. These calls seem to be gaining momentum now and press reports suggest that at least three EU member states are now pressing for a more strident EU stance on this issue, perhaps following the US line. We think such an approach could be effective.

Exchange rate management was a central theme during the visit, reflective of the fact that the UAH has weakened significantly over the past week or so – by around 6-7% – and suggestive that a very significant policy shift is underway. This move is very significant given that over the past 2-3 years, the NBU has maintained a very hard UAH policy. What has changed? First, I think the more credible officials at the NBU, and within the administration, always accepted that the hard UAH policy could not last, and the aim was to move to a more flexible regime, perhaps based on the Russian example and experience with a basket and corridor regime. Second, recent changes in the government have perhaps moved the balance of power within economic cadres towards a more reformist camp – former PM Azarov had been an ardent backer of the former hard UAH policy, and there seems to have been a shift now to Arbuzov. Third, a wide current account deficit, dwindling and limited FX reserves, and the stalling of the Russian bail bond programme, has perhaps reinforced the view in official circles the hard UAH policy was not sustainable. Fourth  recent extreme moves in EM peer currencies, particularly, the TRY and RUB, has just accentuated the over valuation of the UAH, and made the need for an FX correction much more urgent.

Hence I think on going UAH weakness reflects less support for the currency from the NBU, but also increased real and retail demand for UAH from the population, banks and economic agents. The NBU will still be mindful and concerned that a correction in the UAH could easily turn into a rout, and this would risk wider and more systemic problems. The NBU probably wants to manage the UAH 10% or so weaker  but as has often been the case in EM FX, currencies so often over adjust. The NBU will hope that administered restrictions already in place on FX transactions, and also still high rates paid by banks on UAH deposits (~15-20%) provide something of a floor for the UAH. This may be wishful thinking, and without the anchor of an external financing package making this move now is very risky.

One plus from on going FX weakness/adjustment is that this ticks one of the boxes of conditionality set by the IMF for a new programme. I.e. greater FX flexibility.

Finally and as we have noted in other recent filings, no one in Kyiv has any firm idea where the country is heading, and cannot attach any meaningful probabilities to any scenarios – everything is purely guess work at this stage, and nothing can be ruled in or out.

One parting, perhaps more positive note, the current crisis being faced by Ukraine is so serious, that it will likely force radical change, and the hope is that this is towards real and meaningful reform. Indeed, often countries with very deep, structurally engrained problems like Ukraine, need crisis situations to transform. That said, in Ukraine’s case there are still many destructive forces at work and pulling in different directions, which complicates the whole equation.

Reprinted with the permission of the author, who writes for the Standard Bank Group, the copyright holder to this article. Thanks to Taras Kuzio for his assistance in expediting the publication .



Distinguished University Professor, University of Alberta

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