Why IMF Will Never Solve Ukraine’s Economic Problem

Hundreds of protesters have gathered outside the country’s parliament building in Kiev on Dec 23, 2014 to protest the extreme austerity measures as the government plans to reduce the state budget by 10 percent. Up to 2,000 protesters rallied to demand the government not cut social benefits and abolish subsidies and price controls on utility rates. Ukrainian PM Arseniy Yatsenyuk is seeking financial aid from the IMF, World Bank and other financial institutions. Ukraine has already received $9 billion (€7.35 billion), but will need another $15 billion (€12.3 billion) next year. 

Ukraine’s Austerity Measures

Ukraine’s government is in the middle of implementing a set of stringent economic reforms agreed to in April with the International Monetary Fund (IMF) in exchange for a $17 billion bailout.  Kiev’s decision to implement painful austerity measures during its own political turmoil leading to even more instability and crisis.  

Reforms that reduce corruption and cut government spending and subsidies are necessary if Ukraine is ever going to come close to reaching its economic potential. However, with a collapsing economy and an ongoing war, Kiev needs a semblance of stability far more than shock therapy. 

Ukraine is currently in economic free-fall. Despite the economic crisis, the IMF’s loan requires Kiev to enact a series of policy changes, all of which will accelerate the collapse of the economy and decrease the purchasing power of ordinary Ukrainians. Ukraine government should make cutbacks to reduce fiscal deficit. To meet this requirements, Kiev enacted a series of laws raising excise and property taxes, reduced social income support expenditures for retirees and public employees, frozen the Ukraine’s minimum wage, cut public sector wages. 

Furthermore, it also targets the energy sector in which the government has to increase natural gas and heating tariffs for consumers by 56 percent and 40 percent in 2014, and by 20 to 40 percent annually from 2015 to 2017. As gas prices rise dramatically, gas subsidies to end users will be terminated over the next two years. In addition, National Bank of Ukraine has also applied a floating exchange rate for its national currency, the hryvnia, ending its fixed peg to the dollar. Both businesses and consumers have difficulty servicing their dollar-denominated loans. The country’s entire banking system is at risk of wholesale default. 

Why Austerity Program Will Not Help the Situation

The austerity program will not ease the situation in Ukraine. Majority of Ukrainians have opposed the decision. The policy would further alienate the people in Donbass, the restive eastern region currently hosting the worst fighting. If the country will ever be put back together, the people of the east must feel that Kiev takes their concerns into account. Unfortunately, by implementing austerity when industrial output has as of July declined by 29 percent year-on-year in Donetsk and a whopping 56 percent in Luhansk, the government in Kiev provides just the opposite message to the east. 

The Donbass is heavily industrialized. However, the IMF’s mandate that Kiev slash the large energy subsidies provided to its energy-inefficient Soviet-era factories and mines in the Donbass. It results in the region’s economy facing a double whammy from both war and the cutback in financial support. This in turn could raise unemployment in the Donbass, which is not exactly a recipe for promoting reconciliation. 

Austerity measures are part of the package of the Government’s decision taken to resort to the IMF’s aid to avoid the economy’s default. Yet, The Ukrainian government’s decision to deal with the IMF is a mistake that will bring about the country’s economy bleaker in the future. 

A Lot of Bad Examples Around to Look at for Ukraine 

Nevertheless, Ukraine is not the only country which has taken the wrong path overcoming the crisis with IMF’s receipt. A number of repeated histories should have made the Ukrainian government take more precautions in dealing with the IFIs. The debt crisis crippling the Latin American economies and Africa in 1980s and Asian Crisis in 1990s showed that external borrowing is not the key to growth neither the panacea for crisis. 

Like other banking institutions, the World Bank and IMF also seek for profits through giving loans. Interest rates and a number of policy recommendations are imposed potentially meddling in the domestic affairs of a country giving the IFIs opportunities to strengthen its foothold in the countries’ politics and economy. Moreover, the influx of capital in form of loans only creates the countries’ illusion of self-sustained development and encourages further unsustainable debt. 

Since its establishment, the IMF and the World Bank envision aid/external borrowing and investment as the condition for growth. Accompanying such a vision, a government should do a number of “adjustments” or austerity measures such as cutting off public spending or subsidies, privatization of assets, and some regulation reforms to make the country more appealing to investors. 

Many developing countries have undergone this process coming to an endless further economic hardship. The IFIs defender might blame the flaws of domestic policies and corruption done by debtors’ government. However, would neoliberal approach ever be compatible with the non-neoliberal structure having immature society? Moreover, the IFIs did support and were engaged with corrupt and dictator regimes. The institutions did neither suspend the debts nor revising its policies knowing the regimes corrupting the aid. 

 

The fact shows that once a country receives the credit from IMF and World Bank, it has the tendency to depend on them on the following years. More than 70 countries have relied on IMF for 20 or more years; 24 countries have depended on IMF credit for 30 or more years. Consider Kenya and Jamaica as examples. Interestingly, countries that discontinued its relations with IMF and the World Bank, either totally or partially, experienced higher economic growth than that of the countries continue to repay external debt, and won back significant degree of autonomy vis-à-vis the donor countries. Take Singapore as a model. 

Furthermore, the IMF’s bailing out economies create moral hazard both for investors and the debtors signaling IMF will come to rescue for each crisis and therefore resulting in risky behaviors of both by investors and governments.  Ukraine needs all helps it can get to ease their situation, but not the IMF kind of help.