Europe’s New Challenge: The Battle to Save Ukraine’s Economy

Ian Kearns

By Ian Kearns

Director

Joseph Dobbs

By Joseph Dobbs

Research Fellow

Friday 15 May 2015

70 years ago Europe stood wrecked from the devastation of the Second World War, and prospects were bleak for its recovery. Three years later the United States, understanding that a prosperous Europe was needed for a peaceful world, launched the US$17bn Marshall Plan (worth $120bn today), to rebuild the continent. It did so out of enlightened self-interest. Today, Europe’s leaders need to act out of the same enlightened self-interest to save Ukraine. If they do not, the European Union will have a failed state of 43 million people on its doorstep, and migration and refugee flows that will dwarf those of the current Mediterranean crisis. For a European continent already deeply divided on the issue of immigration and a European integration project already under pressure from nationalist parties in a number of countries, the consequences could be devastating.

The war in Ukraine’s east has claimed over 5,000 lives, wounded an estimated 12,000 more, and displaced nearly one million. Five million people are living in the conflict affected area, the damage to infrastructure from the violence runs into tens of billions of dollars, and the Ukrainian central bank estimates gross domestic product in the first quarter of 2015 to be 15% lower than in the same period in 2014. The embattled regions of Donetsk and Luhansk represent 19% of Ukraine’s industrial output, not including Crimea. Unemployment is rising, the currency has collapsed over the last 12 months and debt as a percentage of GDP is soaring. Despite significant willingness to reform on the part of many of the country’s leaders, Ukraine’s problems are further exacerbated by an economy, government and society that have long been corrupt.

European politicians have been quick to talk about supporting Ukraine but slow to do something about it. The European Leadership Network has calculated the maximum support offered to the government in Kyiv, from multilateral and bi-lateral sources, to be $28.9bn for the years 2015-2016[1]. The bulk of that support comes in the form of loans from the IMF and the EU, and the rest from a series of smaller loans or grants from the European Investment Bank (EIB), the European Bank for Reconstruction and Development (EBRD), and a series of bi-lateral contributions, inter alia, from the United States, Japan, Poland, Germany, Canada, and Sweden. The Ukrainian government hopes to free up further resources on top of this through securing around $15bn in debt relief over the next four years via negotiations with its public and private sector creditors. Assuming a debt re-structuring deal was spread evenly over the four years, this could add an additional $3.75bn a year, or $7.5bn of support over 2015-2016, therefore making the total international support package for Ukraine for those two years’ worth $36.65bn.

If the scale of the support offered sounds impressive, consider it against the assessed scale of Ukraine’s needs. At the end of 2014, the IMF said Ukraine needed $27.4bn for calendar years 2015-2016 just to help it through its short term economic crisis. Taking Ukraine’s debt repayment schedule into account, and the need to ensure Ukraine had around $15bn in hard currency reserves at the end of 2016 to pay for imports, JP Morgan assessed the need at $40bn. In our opinion, this figure would leave Ukraine with dangerously low foreign currency reserves. An extra $10bn would be required to get Ukraine close to the level considered prudent by most economists, namely the $25bn that would be enough to pay for three months imports.

This takes the overall need to around $50bn for 2015-16 but even this figure contains no amount to help repair any of the war damaged areas, the costs of which Ukrainian Prime Minister Yatsenyuk very conservatively assessed at $9bn in late 2014. Ukraine’s minimum requirement for this year and next is therefore $59bn and as a result, the maximum amount of $36.65bn on offer from the international community leaves Ukraine with a funding gap of somewhere in the region of $23bn for this year and next. Note also that this figure includes little by way of resources to invest in, modernise, and make competitive much of Ukraine’s ailing industry.

Former Lithuanian Prime Minister Andrius Kubilius has proposed, in this context, that the EU commit 3% of its €1 trillion budget for the years 2014-2020 to Ukraine, or €37bn in grants over the seven year period. This call is supported by independent economists, including Anders Aslund of the Peterson Institute, who points out that almost all of the international support for Ukraine thus far has come in the form of loans, only adding future debt obligations that Ukraine may not be able to meet. Support of this level would amount to a new Marshall Plan, and could be a potential game-changer for Ukraine’s reform minded government, giving it the confidence and credibility to push through socially painful reforms against the backlash of oligarchs long in the business of opposing change and a Russia intent on undermining Ukraine’s pro-European government.

A Marshall Plan, though desirable, is also not the only option. Ukraine could be significantly helped through a range of other instruments. For example:


• Restrictions could be removed from use of some EU funds in the Balance of Payments Assistance Facility and or the European Stability Mechanism. Both are currently limited to use by EU members but this could be modified if the political will to do so was there and funds not currently being used could then be directed at Ukraine;
• European governments could provide large scale free or heavily subsidized political risk insurance to private sector companies investing in Ukraine. This could speed up the process of modernising enterprises in several sectors of the Ukrainian economy while linking them into global supply chains and markets;
• Discussions over an EU-Ukraine Visa Free Travel Agreement could be accelerated, to help smooth the process of Ukraine developing closer links with the rest of the European economy.

A serious policy discussion focused on initiatives like these needs to take place in Europe and the wider world with some urgency, involving both political and private spheres.

An economic crisis and a failed state on Europe’s eastern periphery would strike at the heart of the EU’s raison d’etre, to promote stability and prosperity across the continent. The choice facing the European Union and its member states is whether to export stability or wait to import instability. Both will bring costs but only one of these options has the potential to leave Europe, and Ukraine, stronger. European leaders should act accordingly.

 

[1]  Committed International Support for Ukraine in 2015/16
The International Monetary Fund (IMF) has committed US$17.5bn through an Extended Fund Facility (EFF)
The European Union (EU) committed in March 2015 to a loan deal worth up to €1.8bn to be released in three tranches, and it will also release a further €250m loan in 2015 as part of an earlier agreement. The EU has also committed €1.4bn in development grants between 2014-2020, assuming the maximum annual delivery of €200m, Ukraine would receive €400m in 2015/16. The total EU support in 2015/16 is therefore €2.45bn (US$2.79).
The World Bank has announced that it will lend Ukraine US$2bn in 2015.
The European Investment Bank (EIB) has a €3bn lending program to Ukraine for the years 2014-16, and with €940m already disbursed, Ukraine can expect €2.06bn (US$2.35bn) in 2015/16.
The European Bank for Reconstruction and Development (EBRD) committed a total of US$225 in 2015 thus far, in the form of loans and debt restructuring, and US$11m through a Multi-Donor Fund. As yet, further commitments in 2015 have not been announced, so our assessment only includes US$236m for 2015/16.
The United States has signalled its intention to offer US$2bn in two separate loan guarantees to Ukraine in 2015.
Japan has provided an 110bn Yen (US$924m) loan to finance a project in Kiev.
Poland has announced a US$100m loan to Ukraine in 2015.
Germany has announced it will offer a loan of €500m (US$570m) to support infrastructure projects.
Canada announced in March 2015 a loan worth CA$200m (US$167m).
Sweden has announced a loan worth US$200m and a further US$52m in aid in 2015/16 (Total US$252m).
Total US$28.889bn (based on exchange rates from 14/05/2015)

The opinions articulated above represent the views of the author(s), and do not necessarily reflect the position of the European Leadership Network or any of its members. The ELN's aim is to encourage debates that will help develop Europe's capacity to address the pressing foreign, defence, and security challenges of our time.

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