Publication: Fortnight in Review Volume: 3 Issue: 5

The Fortnight in Review

The long-building tension in Ukraine between the politically possible and the economically necessary intensified over the past fortnight, as efforts to reinvigorate economic reform were stymied by a myriad of political interests. In Russia the situation was somewhat different. The installation of a new pro-reform government and indications of an upturn in the economy pleased international financial institutions in a way that could only make Kiev envious. But some wondered whether the new-found confidence in the Russian economy was not seriously misplaced. Meanwhile, Moscow continued its long-running joust with NATO over the alliance’s enlargement, while sauntering closer to Beijing and Tehran in a pointed — if not entirely convincing — demonstration to the West that it has friends elsewhere.

Ukraine: Political Constraints on Economic Reform

Ukraine’s late-starting, slow-moving economic reforms ground to a halt this fortnight, adding to President Leonid Kuchma’s daunting political problems. The president and his administration, who understand the imperative of reform and are prepared to assume certain political risks in pursuing it, came up against two seemingly impassable obstacles. The first is the leftist parliamentary opposition, which has coalesced around Oleksandr Moroz, the parliament’s Socialist chairman and a likely challenger to Kuchma in the next presidential election. The Socialists, Communists, and lesser leftist groups have acted as an ideological bloc on socio-economic issues in parliament, and carry sufficient strength to veto almost any initiative of the executive branch. The second obstacle involves parts of the dominant Dnipropetrovsk economic and political clans grouped around Prime Minister Pavlo Lazarenko’s cabinet. They ostensibly support the president — who was originally one of their own — but in practice often undercut his policies. The Dnipropetrovtsy use government powers to privilege and subsidize major economic sectors that they or their allies control. Lazarenko, currently their main exponent, is also a potential presidential candidate.

The Left Blocks Budget-Balancing Legislation

The conflict over reforms erupted this fortnight amid shifting political alignments. The most immediate stake centers on a package of tax and budget reforms that was rejected by the parliamentary left. The package envisages closing certain tax privileges and loopholes enjoyed by various interest groups and cutting some Soviet-style social benefits from the expenditures side of the budget. Yet these measures are in themselves insufficient to balance the budget and maintain monetary stability. Those goals necessitate continued lending by the International Monetary Fund, which has warned that further disbursements depend on enactment of tax, budgetary, and other reforms. Kuchma and reformist parliamentary deputies contend that the Lazarenko cabinet, in office for less than one year, has already wasted valuable time and that it shares with leftist deputies the responsibility for delays in international lending to Ukraine.

The president and his aides — notably presidential administration head Yevgeny Kushnarev — responded by threatening to dismiss Lazarenko’s cabinet for its "passivity" and failure to usher in a "fresh start of reforms." In his strongest attack to date, Kuchma described Lazarenko as "the first culprit" in the cabinet’s "virtual failure to pursue structural reforms, busying itself instead with micromanagement and putting out fires." Under such unprecedented pressure, Lazarenko duly lent a more energetic tone to his tensely awaited April 8 address to parliament. Taking aim at its rejection of tax reforms and a balanced budget, Lazarenko blamed the legislature for endless procrastination, evasion of responsibility, and the possible forfeit of indispensable Western loans. But the rhetoric notwithstanding, Lazarenko gave parliament in practical terms until July 1 to adopt the 1997 budget, and he postponed for 1998 the enactment of the overall "budgetary revolution." The parliamentary opponents of reforms appeared content to settle for further procrastination, and the stalemate looks set to continue.

Leading Reformers Lose Ground

The present correlation of forces has virtually paralyzed and isolated the few remaining active reformers in government, and impaired Kuchma’s ability to support them effectively. This fortnight provided two spectacular examples of this trend. The deputy prime minister in charge of reform strategy, Viktor Pynzenik, resigned in frustration over the government’s failure to press for reform legislation in parliament against leftist obstruction. He publicly charged that the "executive branch" — i.e. Kuchma as well as Lazarenko’s cabinet — lacks the political will to pursue reforms seriously, and that it follows an erratic policy, alienates foreign investors, and jeopardizes Western lending to the country. Pynzenik’s own powers in the cabinet of ministers had been drastically curtailed recently, and he was being used in an essentially decorative role which he declined to play any longer. Pynzenik had long worked closely with Kuchma and is an influential member of the parliament’s "Reforms" grouping, whose leaders are now signaling that they may turn against the president from the political right flank.

Only days after Pynzenik’s resignation, the parliament failed to pass Kuchma’s nomination of Volodymyr Lanovyi as chairman of the State Property Fund, an institution that in large part controls the privatization process. A narrow majority in favor of Lanovyi, who currently serves as the fund’s acting head, fell well short of the margin required. Lanovyi, a former deputy prime minister, has been a consistent advocate of market reforms and a critic of state-awarded monopolies and privileges. The failure of his nomination again illustrated the parliamentary left’s power to block, and the cabinet’s ability to undercut, the policies of Kuchma and his pro-reform allies. While a successor to Lanovyi has not yet been designated, Pynzenik’s successor is Privatbank chief Serhy Tyhypko, a certified Dnipropetrovets. Yet that once-homogenous clan has itself tended to differentiate into subgroups based on specific economic interests and generational ties, so that Tyhypko’s precise allegiance (if any) is still unclear.

Western Investment Jeopardized

Escalating their challenge to the president — and to the country’s own interests — leftist and many pro-government deputies have joined forces to eliminate incentives for foreign investors. This unusual political combination prevailed in the parliament’s April 10 vote to rescind tax breaks and customs exemptions hitherto available to joint ventures with foreign capital operating in Ukraine. The measure was presented as a means to close fiscal "loopholes" and increase budget revenue. This short-sighted motivation, however, ignores the risk that foreign investment in Ukraine could dry up as a result of this measure. Ukraine has managed to attract only a paltry $1.4 billion worth of direct foreign investment since 1992, and last month, Motorola withdrew from a major investment project. It cited unpredictable rules of the game and a variety of bureaucratic disincentives.

Kuchma lost no time in moving to limit the damage. He reactivated and upgraded a high-level Consultative Council to look into ways of attracting foreign capital investment. To be chaired by Kuchma himself, the council will include senior presidential administration officials and cabinet ministers, and a Secretariat as a standing working body headed by Kuchma’s senior aide, Valery Livitsky. Mandated "to apply the developed world’s economic experience and facilitate Ukraine’s integration into the international economy," the council is also designed as a forum for foreign investors to air complaints and suggest changes in policy and legislation. A score of leading international corporations from Western Europe, North America, and Japan with active or potential interests in Ukraine have been invited to send delegates to the Council’s deliberations. Several of these companies, including BAT, Cargill, Coca-Cola, McDonald’s, and Philip Morris are circulating an appeal to Kuchma to veto the legislation and are asking other similarly interested companies to join in the appeal. Livitsky and Tyhypko indicated that Kuchma is considering either using his right of veto or reinstating some of the incentives by presidential decree.

Political Stalemate Pending Elections

The aforementioned recriminations and efforts to evade responsibility contain an element of political posturing. Kuchma, himself a product of the Dnipropetrovsk clan, now sees a part of that power base eluding him. Yet he can hardly afford alienating the Dnipropetrovtsy and other old allies before building a wider political base of his own — something the president is currently attempting to do. For its part, the cabinet cannot afford simply to cater to constituent interests while quietly obstructing reforms, since the president does have the power to dismiss it outright and has demonstrated a will to use that power. The parliamentary left is in no position to restore socialist economics, notwithstanding its political promises to do so; but it will be able to frustrate the reforms at least until the next election. Pro-reform groups in parliament provide significant support to reformers in the executive branch, but are too weak — and in some cases simply unwilling — to enable the president to switch alliances entirely. The net result is political and economic stalemate.

The president’s room for maneuver is further constrained by the parliamentary elections due next spring. Kuchma and his camp plan an all-out effort to elect presidential supporters to the parliament. Once elected, those supporters would be expected to follow the president’s lead in backing economic reforms, in some cases for reasons of political allegiance. Kuchma has until now lacked a broad and reliable political base. The need to build one would seem to preclude any abrupt political moves that could antagonize significant forces other than the irreconcilable left. Political parties loyal to the Kuchma, and grouped in a consultative council attached to the presidency, are also hesitant to go all-out in support of reforms before the elections, though they may well do so afterward. The leading national-democratic force, the Rukh, could be more helpful by supporting the president’s efforts instead of maintaining a critical distance from him. The issue remains a controversial one within the Rukh itself.

The election campaign is off to a premature start, and the fate of Lazarenko’s cabinet will ultimately — and perhaps shortly — be decided by Kuchma primarily on the basis of electoral considerations. But that decision, one way or another, will not determine the fate of economic reforms in Ukraine. The coming parliamentary and presidential elections will. And the approach of those elections is forcing the presidency and some reform supporters to exercise caution and move more slowly than they realize is necessary. Will Western governments and lending institutions understand that political prudence?

Russia’s New Government Pays Early Dividends

There were signs of growing international confidence that, under its new government, Russia is returning to the path of economic reform. On April 14, the World Bank announced that it will lend Russia $6 billion over the coming two years to help the government pay off huge arrears in wages and pensions. The announcement followed a pledge by International Monetary Fund managing director Michel Camdessus that the IMF will resume the stalled monthly tranches of its $10.1 billion three-year loan. The Fund, which withheld the tranches for January, February and March, is expected to resume payments at the end of April, subject to progress on a sorely needed new tax code.

Is the "Great Depression" Over?

Camdessus predicted that Russia could become "an economic superpower" if it presses ahead with structural economic reforms. The Russian government followed up with statistics indicating that GDP grew by 0.2 percent in the first three months of 1997 compared with the same period last year. This would be the first quarterly growth since 1991, but independent economists were skeptical. They accused the government of changing its statistical methods in order to create the image of an upturn in GDP when, in fact, growth may not have taken place at all.

Critics charged, too, that the IMF’s decision to resume lending to Russia was based on political rather than economic criteria. They pointed out that it came just two weeks after the Helsinki summit at which U.S. president Bill Clinton pledged to bring Russia into the international economic community in return for Moscow’s acquiescence to NATO expansion. Camdessus himself acknowledged that Russia’s structural reforms have a long way to go before they can be called irreversible, and that Russia remains at risk of becoming mired in an "economic no man’s land between a centrally planned system and a fully functioning market economy."

Professor Mario Nuti of the London Business School went further. He told a conference in Cambridge, England, that Russia’s vaunted success in lowering inflation was fraudulent, not because the statistics were cooked, but because the reduction of inflation to its current annual rate of about 18 percent was achieved by the government’s "not paying for what it bought:" that is, not paying government sector salaries and not paying factories for goods delivered. It was grotesque, Nuti declared, for the IMF to stand by and applaud a "stabilization" achieved by such means. In forcing the population to "lend" to the state, the Russian government was behaving no better than Soviet central planners when they forced the population to "save" by allowing chronic shortages to prevail, Nuti concluded.

Battle Over Natural Monopolies Heats Up

Nowhere were the difficulties facing Russia’s reformers more apparent than in the efforts of Russia’s new government to reform the "natural monopolies" — the gas giant Gazprom, the electricity utility Unified Energy Systems, and the Railways Ministry. Newly appointed First Deputy Premier Boris Nemtsov has been charged with breaking up the monopolies into smaller, more efficient units. The measures Nemtsov has proposed — forced price cuts, a stringent audit, and changes in ownership structure — struck many economists as rather modest, but they provoked an immediate and furious response from Gazprom chairman Rem Vyakhirev. He stormed off to the Duma to tell parliamentarians that the plans were a conspiracy by the Finance Ministry, the IMF, and American oil and gas companies to undermine the Russian economy. The Communist-dominated Duma responded with a resolution condemning any effort to restructure the monopolies.

Though it was seen by many observers as a sign of weakness, Vyakhirev’s extraordinary attack produced results. Prime Minister Viktor Chernomyrdin, who as a former Gazprom chairman is considered the chief champion of the monopolies in the government, stepped in with a pledge that the government will take no decisions that would harm the companies, and he promised to remain personally involved in policy-making on the issue. Nemtsov also seemed to back off, saying he had "no intention of de-monopolizing Gazprom" and that Vyakhirev would retain operational control of the state’s 35 percent stake in the company. Apparently mollified, Vyakhirev promised in return that Gazprom will launch its own reorganization and shed approximately 100,000 jobs this year (26 percent of the workforce) so as to free up funds to pay off the 7,000 billion rubles it owes the state in back taxes. But Gazprom will remain a monopoly, Vyakhirev stressed, an assertion that appeared to underline the fact that Gazprom seems to have won the first battle in what may prove a long war.

No Breakthrough in NATO-Russia Talks

Despite a boost from the March 20-21 Russian-U.S. summit in Helsinki, talks between Moscow and the West on NATO enlargement appeared to stutter over the past fortnight, and some in the West even saw a renewed stiffening in Russia’s negotiating posture. That had not seemed to be the case in Paris on April 9, however, when Russian foreign minister Yevgeny Primakov announced that Boris Yeltsin had agreed — provisionally — to travel to France on May 27 for the signing of a NATO-Russian political agreement. But Western diplomats indicated later that they had in fact been disappointed by the tough demands laid down by Primakov during the closed door negotiations that had taken place in the French capital. In what these diplomats described as a step backward from Yeltsin’s negotiating position in Helsinki, they suggested that Primakov had effectively asked the Western alliance to rule out any future military reinforcement of new member states. Moreover, a fourth round of talks between Primakov and NATO secretary general Javier Solana on April 15 produced no evidence of an imminent breakthrough. And, although Boris Yeltsin announced during a visit to Germany on April 17 that he did indeed intend to travel to Paris for the May 27 signing, harsh criticism of NATO by Yeltsin’s press spokesman on the eve of the meeting with Chancellor Helmut Kohl only raised more questions about Russian policy.

The Russian and U.S. presidents appeared also in Helsinki to have moved forward on several key arms control issues, but complications have arisen in that area as well. On April 8 a Russian foreign ministry spokesman said that the U.S. could not unilaterally declare that its theater missile defense programs are in compliance with the 1972 Anti-Ballistic Missile (ABM) Treaty. That remark appeared to contradict both an agreement announced by the two presidents in Helsinki on allowable limits for "higher-velocity" theater missile defense systems, and the established U.S. position that each country could determine its own compliance with regard to such systems. The Helsinki summit appeared to have had a similarly low impact on the Russian Duma’s attitude toward ratification of the START II Treaty. Despite Boris Yeltsin’s confident pledge that the Duma would proceed with ratification "based on my advice," Russia’s lower house decided on April 9 to shelve discussion on ratification of the treaty indefinitely.

Moscow Courts Tehran and Beijing

The Kremlin moved defiantly on April 11 to reaffirm its friendly relations with Iran, despite the long-standing objections of Washington and a court decision reached in Germany one day earlier that opened a diplomatic breach between Germany — along with the EU as a whole — and the government in Tehran. Following talks with Ali Akbar Nateq-Noori, head of Iran’s parliament, Russian president Boris Yeltsin spoke approvingly of closer relations with Tehran, and the Iranian visitor received a standing ovation when he addressed the Russian Duma. The Kremlin’s reaffirmation of ties to Iran appeared aimed both at countering the West’s decision to proceed with NATO enlargement and to demonstrate that Moscow remains an independent player on the international stage.