Ukraine Is Ready For The Tough Love Of The International Monetary Fund

ODESSA, Ukraine -- Jaded by decades of mismanagement and corruption, Ukrainians greeted the announcement of the International Monetary Fund’s assistance package of up to $18 billion with the cautious expectation that it will get the country on the road to recovery. Like the often-disappointed relatives of a gravely ill patient, Ukrainians are placing their hopes on a painful treatment that promises a cure, even if it may mean the end of subsidies they have long relied on for basics such as heating.

With Ukraine’s territorial integrity sundered by the Russian annexation of Crimea and further threatened by the Russian troops massing on the eastern border, Ukrainians have little choice but to accept the tough love offered by the IMF. Their country is, after all, on the brink of financial collapse. The carefully worded statement issued by Nikolay Gueorguiev, the IMF’s mission chief for Ukraine, doesn’t gloss over the somber realities for Ukraine.

“Following the intense economic and political turbulence of recent months, Ukraine has achieved some stability, but faces difficult challenges … the economic outlook remains difficult, with the economy falling back into recession,” the statement said. “The financial support from the broader international community that the program will unlock amounts to US$27 billion over the next two years. Of this, assistance from the IMF will range between US$14-18 billion.”

The IMF’s program “will focus on reforms in the following key areas: monetary and exchange-rate policies; the financial sector; fiscal policies; the energy sector; and governance, transparency, and the business climate.” Of greatest concern for a weary public are energy-sector reforms that could drive their heating bills up in a country that relies on imports for more than 90 percent of its energy needs.

A major condition is that the government must cut energy subsidies, which are as high as 8 percent of Ukraine’s GDP. Russia also said it will raise the price of natural gas by April 1. Ukraine receives half of its gas supplies from Russia, and already owes Russian state-owned energy company OAO Gazprom (MCX:GAZP) more than $1 billion in past bills.

“One of the things that made me doubtful of the previous [Ukrainian] government was incompetence and very poor performance,” said Ted Truman, senior fellow at the Peterson Institute for International Economics. “So, politically the country is ready for a change, and it would appear that the people in charge have [embraced the IMF program].”

The IMF says that gradual reforms will “move retail gas and heating tariffs to full cost recovery, along with early action towards that goal.” In so many words, that means subsidies will be cut, even though provisions will be made for the poor, as these measures “will be accompanied by scaled up social protection to mitigate the impact on the most vulnerable.”

The cost of natural gas might seem a trifling concern given that Ukraine is steeling itself against the looming threat of war from the nuclear power and former Soviet master next door. And many Ukrainians see the costs of acquiescence as the only way to avoid financial collapse.

“My sense is that people want change, so I don’t think you are going to see a situation where a social upheaval is likely in the traditional sense,” Truman said, when asked if Ukrainians would balk at rising gas prices. If the interim government and then the newly-elected government can bring about meaningful economic change, the public will go along, he said. “The point is they really don’t have any choice, they are broke,” he added.

Eduard Dulapchy, a well-traveled, polyglot seaman in Odessa, believes the IMF package could be beneficial for Ukraine, though he is wary of the strings attached.

“They do not have to insist on blocking subsidies for the poor people,” Mr. Dulapchy, 42, said. “Subsidies in Ukraine surely need to be cut but this is surgical work that needs to be done with a scalpel, not an axe. How can you cut benefits for World War II veterans or pensioners and not go after groups that have benefited from entitlements for such a long time?” The latter, he said, was a reference to relatives of prominent citizens who he alleged receive stipends from the government.

As a taxpayer, Dulapchy feels natural gas prices in Ukraine are cheap, which means that for average people there is room for the expected increases. He just paid 2,400 hryvnia (approximately $240USD) in natural gas consumption by his household of four – including his wife and two children – from November 2013 through March 20. While he favors a scaled mechanism whereby low-income citizens should receive gas and heating at a discount, he believes a lot of the heating issues and natural gas problems would be addressed by promoting heating efficiency. “Soviet-time heaters are massively wasteful,” he said.

In the diplomatically crafted wording of the IMF statement, “the reform program will focus also on improving the transparency of Naftogaz’s [Ukraine’s state-owned gas agency] accounts and restructuring of the company to reduce its costs and raise efficiency.” Elsewhere in the statement, the IMF notes that the 2013 deficit of Naftogaz reached nearly 2 percent of GDP, driven by the sharp increase in sales at below-cost prices. “Without policy action, the combined budget/Naftogaz deficit would widen to over 10 percent of GDP in 2014,” the IMF said.

Most respondents in Kiev saw the IMF’s lifeline as vital for the country’s survival.

Borys, 58, a construction sector businessman in Kiev, who like most of the respondents in Kiev declined to give his surname, believes the IMF help is “positive,” as it would be “very difficult for Ukraine to get out of the crisis hole it is in now.”

Iryna, a 55-year-old realtor in Ukraine’s capital, sees the package in a positive light in terms of accountability to foreign institutions, which will demand more reforms in Ukraine.

“This is cheap money, and Ukraine can not survive without it,” said Alexander, 60, a retired supermarket manager in Kiev.

For Stanislav, a 22-year-old student, the IMF’s package is a “life injection for Ukraine at this point of time.” Farther from Ukraine’s epicenters of crisis -- Kiev and Crimea -- interviewees in Odessa, Ukraine’s biggest port on the Black Sea, were less enamored of the IMF package, often equating in their minds the international lender with the U.S.

“I prefer that the U.S. doesn’t give us any money,” said Vladimir, 28, a producer at Odessa TV who declined to give his last name. “They only claim to be helping us but when we needed military help to stop the Russians they were nowhere to be seen,” he said.

“We can live without that money,” said Kristina Trach, a 19-year-old design student. “I’m against this agreement.”

A retired teacher, 62, who refused to have even his first name quoted, said that Ukraine should turn down assistance from the West, which, in his view, had let the nation down. “Are they going to come if the Russians march further in?” he asked as he waited for a tram near Odessa’s train station.

According to PIIE’s Truman, “One advantage of this IMF program is in fact that there have been other programs of the IMF in Ukraine in the last 20 years.” Truman conceded that, “they haven’t been particularly successful, but the people of the IMF know more what’s going on in Ukraine and know more than let’s say just parachuting into Indonesia, where they had no particular programmatic involvement for decades.”

But Robert Kahn, senior fellow for international economics at the Council on Foreign Relations, is more guarded about the overall impact of the IMF assistance. “These types of crisis packages almost always bring about some social tensions,” he said. “They also exacerbate the social economic inequalities.”

Kahn believes “it is inevitable that when you are in an economic crisis and government programs are being cut and the IMF comes in, even though their financing is hopefully making the adjustments smoother, that you are going to have significant social tensions and your often going to exacerbate income equality.”

He stressed that with these austerity measures, there needs to be a strong safety net for the poor. “I think that there are very significant risks in Ukraine that as well-intentioned as this interim government is and as willing as they are to do very tough things, at the end of the day the measures that are being supported by the program can be quite destabilizing.”

In Kiev, Lubov, a 45-year-old office worker, hedged his view of the IMF’s aid package. “It will be positive for the economy but not very good for the people because prices will go up and social benefits costs as well,” he said. So, he continued, “there may be a decline in the demand for goods and services.”

That has happened with other IMF austerity packages, most recently in Greece, where there have been reports of resulting malnutrition, and of children fainting in school due to hunger.

(With additional reporting by Anna Pyatetska in Kiev and David Kashi in New York)