The Big Bluff

29 November 2013, 23:25

In 2010, Viktor Yanukovych became the head of a state where the middle class, economically independent and effective, constituted a small part of society. It was not represented in politics and unprepared to protect its own interests and those of the state. Given the lack of effective institutions of civil society, it had no instruments to efficiently control, let alone influence politicians. As a result, both the government and the opposition failed to act in the long-term interests of the nation.

Over the past three and a half years, these negative trends have intensified. The consolidation of power crushed the system of checks and balances and hampered the activities of the narrow circle of those involved in politics and big business. Disregard for economic laws, the discrediting of the judiciary and law enforcement, attacks on SMEs and business overall, as well as thriving corruption and raider attacks – all this had been in place before 2010, but Yanukovych has taken it to the next level.

For the first two years, those in power blamed anything they were criticized for on their predecessors. Then, a steep devaluation of hryvnia in 2008 eased the impact of trade and foreign currency deficit and boosted the competitiveness of Ukrainian producers. All of this was accompanied by cash inflow from foreign and domestic investors seeking high yields on government borrowings undertaken to cover the budget deficit. This drove the national debt from UAH 318bn in 2010 to UAH 550bn in 2013. The post-crisis recovery of foreign markets further contributed to this.

However, the impact of these factors was quickly exhausted. This became palpable by the 2012 parliamentary election and particularly afterwards. It became ever more difficult for the government to meet its budget obligations; local budgets frequently saw their accounts frozen, and unfixed budget categories were underfinanced. Businesses experienced growing tax pressure; state-owned and private banks were forced to buy government bonds to help it patch holes in the budget. For political purposes and a wide-scale bribing of voters before the parliamentary election, tax authorities forced businesses to pay taxes in advance. The election is long over, but the practice continues. According to The Ukrainian Week’s sources, the tax administration is now demanding that businesses pay advance income tax for January-February 2014.

The trust of Western investors and creditors was short-lived. It was lost as soon as they realized that nobody was going to implement the reforms widely advertised in 2010, and the government and the central bank (National Bank of Ukraine, NBU) ignored economic laws while opting for brutal administrative pressure instead. Ukraine lost options to attract foreign funding other than FDI. Lately, the latter have only grown because of investment from offshore areas (see Scarecrow for investors).

The government and the NBU may have covered the deficit by printing money covertly. This is actually happening, to a certain extent. However, with the overvalued hryvnia, which is manually maintained, this has been leading to a steep decline in the balance of payments. This, in turn, has been aggravating the foreign currency deficit while Ukraine’s international reserves have almost halved since April 2011, from USD 38.4 to 20.6bn. Ukraine is virtually in default.

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Don’t blame it all on exports

Yanukovych has two options to solve this. One is to implement radical reforms. The other is to transfer the funding of the deficit to foreign partners. The prospect of a geopolitical choice between the EU and the Customs Union seemed to be the perfect opportunity. The troubles were blamed on the trade war with Russia and the “disastrous effect” of the Association Agreement with those in power demanding “compensation for the loss of the Russian market” from the EU.

“The billion euro which the Ukrainian President and Premier have submitted as financial assistance from the EU for the signing of the document cannot be viewed as compensation for the loss of the Russian market,” ex-Polish President Aleksander Kwasniewski tried to clarify the money controversy on the day before the Vilnius Summit. “The billion euro offered under the framework of the Agreement is aimed at general projects, not for the support of the Ukrainian economy. What Yanukovych said is a false argument,” he concluded.

The scale of Ukraine’s dependence on exports to Russia and vulnerability to its pressure is greatly overstated. An analysis of Ukrainian exports to Russia before and after the trade war to disrupt the Association Agreement reveals that Ukraine has lost less from it in the last few months compared to the last few years. According to the State Statistics Committee, Ukrainian exports to Russia shrank by 11.6% from USD 4.3 to 3.8bn in Q3 2013 compared to Q3 2012. This decline was two times lower than the one seen in Q3 2012 compared to Q3 2011.

This negative dynamic evolved as the CIS free trade zone agreement came into effect. This was before the start of the trade war with Russia, caused largely by three factors. The first was the economic slowdown in Russia that made its market shrink. The second was the Kremlin’s long-term policy whereby Ukrainian producers were ousted from the Russian market in favour of domestic ones. This long-term consistent protectionism has had a negative impact on Russia’s partners in the Customs Union, Belarus and Kazakhstan (see Tug ‘O’ War at The third factor is the politically motivated restriction on the import of Ukrainian goods. These have long been in place in an effort to force Kyiv to fully integrate into the Customs Union, not just reject association with the EU. Without this, Ukrainian exports to Russia will not see any long-term improvements.


From the very beginning, the only thing that mattered to Yanukovych was to find someone to pay for the failures of his first term as president and provide a financial impetus that will help his reelection.

EUR 150-165bn was the amount that the Ukrainian government wanted. “The Ukrainian government has not provided any arguments to support this data,” UK Ambassador Simon Smith said in his interview for the Kommersant publication. “The EU is not an institution that covers budget deficits.” 

Once it became obvious that the EU would only give money if Ukraine implemented a number of reforms, some of them painful and unpopular in view of the upcoming 2015 presidential election, Yanukovych no longer saw any point in the association. Premier Mykola Azarov said in parliament that the “last straw (urging the Cabinet to suspend preparations for the signing – Ed.) was the stance of the IMF outlined in the letter received by the government on November 20”. It said that the IMF was prepared to refinance Ukraine’s debt of USD 4bn to it, not issue new loans in the amount of USD 15bn that Kyiv was asking for.

As a result, Yanukovych continued his “consultations” with the Russian regime, albeit secretly. The ongoing negotiations to set up a gas transportation consortium that intensified last week are one element of this process. While the nation is out on the streets rallying for association with the EU, Energy Minister Eduard Stavytskyi admits to journalists that he is in the process of negotiating a bilateral consortium to exploit the Ukrainian gas pipe.


While Yanukovych turned down association with the EU, he doesn’t seem to have any guarantees from the Kremlin. Off-record, Russian officials deny alleged deals on a gas discount for Ukraine and say that loans for Ukraine are only possible if it joins the Customs Union.

Still, there are factors preventing Yanukovych from fully rejecting association with the EU during his presidency. One is the fear that Putin may let him down, and his regime will not last long without external support. Even if Russia grants the gas discount, Ukraine will only save USD 1-1.5bn. Meanwhile, the IMF will not help Ukraine refinance its debt after the failed association. The European factor in the 2015 election is another weighty reason.

Whatever the result of the Vilnius Summit, Yanukovych will no longer be seen as a European integrator. He will be blamed for ruining the possibility of accession to the EU at the finish line.

This once again gives the opposition a monopoly for European integration. The fact that Yanukovych failed it, coupled with attempts to surrender strategic objects of Ukraine’s economy to Russia in exchange for some mitigation from it will serve as a mobilizing factor for society. Therefore, people will vote for the opposition candidate (and, more importantly, take to the streets to protect their choice) as someone who expresses their European choice rather than as an individual candidate in the presidential election. In contrast, Yanukovych will be associated with dragging Ukraine into the Customs Union or self-isolation in a grey area between the European and Eurasian unions. Today, after a shift of generations, the share of supporters of Ukraine’s European vector is far higher than that of opponents – even higher compared to 2004 when the Orange Revolution took place.

Europeans, who seem to rely too many expectations on the ability of Ukrainian society to elect a president in 2015 who will lead Ukraine to Europe should take a closer look at what’s going on. They should not underestimate specific problems of the authoritarian post-Soviet state where the election can be simply rigged – or falsified with all kinds of more sophisticated mechanisms. This will be easier to do this time since, in contrast to 2004, Ukraine has no clear and single alternative to Yanukovych. In an open clash for power which the current president values more than the EU or Russia, the problem of divided opposition will make it more vulnerable and less effective.

Meanwhile, the failed association opens new doors for a more proactive play on the Ukrainian field for the EU. The latter should realize that it is not possible or reasonable to deal with the current president. Thus, it should focus its efforts on proactive support of an alternative to the current government in three major areas.

One is Ukrainian opposition. Europe should help it organize more effectively and resume the European integration focus. Another one is support to the institutions of civil society that could exert pressure both on the government and the opposition, thus forcing them to act in the interests of democratization and European integration. The third area is various groups of influence within the government, particularly big business. The EU and US have tools to urge them oppose the scenario whereby Yanukovych can stay in power at any cost. This could be reinforced with an ongoing warning of personal sanctions against Yanukovych and his closest circle.


Scarecrow for investors

While the amount of attracted FDI declines annually, the share of investment from Cyprus and British Virgin Islands has constituted 2/3 of all investment growth over the years of Yanukovych’s rule

DFI to Ukraine, USD bn

As of 01.04.2010

As of 01.10.2013


British Virgin Islands

Other countries

EU Enlargement Commissioner Stefan Füle: “Our offer has never been meant as a beauty contest with anyone or about who puts more on the table”

Poland’s President Bronisław Komorowski: “Ever since Ukraine gained independence, it has always been maneuvering between integration into Western Europe and the East. It can now miss its historic chance.”

Premier Mykola Azarov: “Russian leadership has stated clearly that the signing of the Agreement means that it makes no sense to further discuss trade and economic regimes. We were told clearly: we are ready to discuss the problems in a tripartite format but you should postpone the signing of the Agreement, then we’ll sit at the table for negotiations, and then sign it.”

Co-Chair of the European Parliament Monitoring Mission, Aleksander Kwasniewski: “The EU negotiates with candidate-states as sovereign entities provided that they decide that they want to hold these negotiations… I can’t imagine that the EU can come to terms with Russia which wants to have Ukraine in the Customs Union, and the Eurasian Union in the future.”

Yanukovych had two possible solutions: radical reforms or getting foreign partners to cover Ukraine’s financial deficit


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