Article by: Olexandr Savchenko
Who benefits from a default in Ukraine, and why Russia is sticking to the ‘law of predation’
Whether economic reform is possible in times of war is too narrow of an issue for Ukraine. A more correct one would be: is reform possible in Ukraine at all? Our 22-year-old history, including the 6-month-long history of the ‘new’ government, shows that Ukraine and reforms are absolutely incompatible. Why so? The answer seems to be simple: the Ukrainian ‘elite’ makes only populist decisions, and openly steals while making them. Up until today the people have been against corruption, but never against populism.
Real economic reforms are incompatible with both populism and corruption. They always result in increase of salaries, income, revenue of those who work a lot, productively, creatively and in innovative ways, including by means of decreasing the incomes of corrupt officials, social parasites, black businesses and just those who work little and unproductively.
I will express a paradoxical but indisputable truth. War began in Ukraine because there had been no reforms, Ukraine had become the poorest, and therefore the weakest country in Europe. The proletarization of the east of the country, on the one hand, and the militarization in Russia, on the other, became the basis for Putin’s unfolding of war against Ukraine. In a natural setting, the predator always chooses the weakest prey to attack, and in our case, a country, which is unreformed Ukraine. Would even the most unpredictable President, such as Putin, have dared attack a 45-million country where there is order in the economy and the army, where justice rules, where salaries and pensions increase, where corruption has been eliminated, and therefore there are many foreign investments and interests? I think even Putin would regard such a country with respect. I will express an even more paradoxical thought: only confident and radical reforms will be able to stop the war in Ukraine. Not pacifism and conformity, not peace plans and talks (even though they are useful in the appropriate format), but only reforms.
The thing is that Vladimir Putin aims to destroy Ukraine not only by means of military action, but economic, political, information action as well. His economists, by the way, with the help of the Ukrainian Science Academy, calculated the optimistic and realistic scenarios of the development of the Ukrainian economy for 2014-2015. The essence of these calculations is to prove to the West that it will be unable to feed (give sufficient loans) to Ukraine. The predict a payment balance default in 2015 with almost $100 billion following a realistic scenario, which would mean a default. The thing is that the IMF and the EU think that Ukraine needs only $18-20 billion for the current and next year to escape the crisis. These funds would really be sufficient if reforms are carried out. It is also important to understand that Putin will do everything in his power to execute Ukraine’s bankruptcy plan: the destruction of Ukrainian factories with the infrastructure, the import ban on key Ukrainian goods to Russia, blocking of economic reform with the help of FSB agents in Ukraine.
As such, Putin’s plan aims to cause a default in Ukraine by 2015. It also implies turning the EU association into a fiasco. What is more, Ukraine’s bankruptcy will show that it cannot exist in the Western civilization, its place is in the Moscow-patriarchal civilization under Russia’s patronage! The Ukrainian people are mistaken…
In the previous article, War of Civilization, we included calculations, how much time is left until Russia’s bankruptcy: under the conditions that sanctions and Putin’s policies don’t change, about two and a half years. So, following this scenario, Russia’s default will only happen in the beginning of 2017. Putin will only be able to avoid this and beat the West under the following circumstances: in 2015 (15-20 UAH/$, GDP fall of 7-8%, the fall of Ukrainians’ incomes by 10-15%, the deficit of the payment balance of $40-50 billion). In 2016 Putin suspends both military action and the crudest means of influencing Ukraine and the EU. U.S. and EU sanctions are abolished. Russia prevents default and Putin achieves his goal.
Why am I convinced that Putin will act in such a way? Because he has no other game, and this game involves his new Ukrainian friends. Isn’t the 15 UAH/$ exchange rate not part of this game? If we take Russia’s financial system, it seems quite strong: the central bank’s gold reserves are 15% of the GDP, the communal reserves of sovereign funds are 9,1% of the GDP. Meanwhile army expenses are 3,2% and national security expenses are 3,1% of the GDP.
However, the Russian economy is in recession, oil and gas prices are falling, the budget has a 1% GDP deficit. The Russian economic government block advised the President quite openly to not militarize the economy and not make populist decisions to increase social expenditures in the 2015 budget. However, Putin decided to increase military expenditures and populism by 1,5 trillion rubles in 2015, which will lead to a budget deficit of 2% of the GDP. Which means the people will support Putin next year, but in 2016 he will no longer have such opportunities for populism any more… As such, next year will be deciding both for Ukraine and Putin. Ukraine will either reform itself or go bankrupt both in the economic and civilizational sense.
It so happened that the government in 2014-2015 will being to Poroshenko-Yatseniuk’s team. I will be frank: with such ‘reformers’ we see today, we cannot even think of any kind of reform. This team should, first, be cleansed of the fifth estate and enforced with specialists. Second, give the President and Prime-Minister immunity from persecution for five years after retirement, and guarantee protection of their declared property rights. An appropriate law should be passed. What should the reformer team do within half a year?
It is necessary start with a radical GDP decrease, which would be redistributed through the budget and social funds (no more than 33%). Such a step will significantly increase the business funds in circulation and the Ukrainians’ income, which will create additional demand for GDP growth and ensure potential growth for appropriate financial resources.
The second step in reforming budget policies should be the redistribution of income in favor of the youth, those who create national wealth. The third step would be the redistribution of income in favor of local budgets from 43% today to 60% in 2015. Such steps will allow to significantly decrease taxes on account of decreasing practically all budget expenditures, except for those on defense and culture. What is more, they should stop emissive financing of the budget by the National Bank of Ukraine, which will positively influence the UAH exchange rate. Without such budget and pension system reforms, a catastrophe is inevitable.
The aforementioned steps only create preconditions for economic growth. Growth itself is possible when market economy mechanisms are launched, such as the credit and investment mechanisms. Not governments but central banks play the leading part in creating conditions for economic growth. Therefore, the NBU should first and foremost support this growth under conditions of financial and price stability. The NBU, with government support, should ensure annual loan growth at the level of 15-25% with acceptable rates for business and the people (inflation plus 4-6%). Normal inflation in 2015 is 5%. Which means that next year should be dominated by UAH revaluation trends. Is the NBU capable of such monetary policies? Obviously not. Its leadership should be updated significantly.
The success of reform will depend on whether they bring the Ukrainian society closer to a state of justice and not social populism the Ukrainian ‘elite’ is used to. After two Maidans, the Ukrainians are sensitive to social inequality. I am convinced, for example, that they will support pension reforms, including increasing retirement age, under conditions of its just differentiation: the increase of minimum pensions on account on limiting maximum pension expenditures. Smart pension reform should also create stimuli for long-term and intense work for Ukrainians and legal income reception. What is more, the reform should begin accumulating financial resources for long-term investments in the Ukrainian economy.
The last thing which should be noted: war only serves to make economic reforms harder, but it doesn’t block them. War made the UAH exchange rate reach 10, and the NBU and the economic government block made it reach 15 UAH/$. War made the GDP fall by 3-4% and the lack of reform will make the GDP fall to 7-8% in 2014! War blocks our external investments and loans, but the NBU and the government did not create the conditions necessary for domestic loans and investments. Primitive administrative methods of regulating the currency market conditioned the leak and deficit of currency in Ukraine.
The Poroshenko-Yatseniuk team has no moral right or time to delay reforms. Therefore, let us begin the reforms with passing the law on their political immunity.