Publication: Prism Volume: 4 Issue: 19

By Volodymyr Zviglyanich

The decision of the IMF board of directors to extend a loan of US$2.2 billion to Ukraine within the Extended Fund Facility program (EFF). brought a sigh of relief in both Kyiv and Washington. Ukraine will be able to pay off the interest on previous loans and replenish the hard currency reserves of the National Bank, thus averting the prospect of financial collapse. Washington and other foreign lenders will maintain political stability in the country, at least in the short term, and thus retain the hope that Ukraine may repay the loan. Both sides hope that reform and revival of the real economy will form the basis for Ukraine’s repayment of the loan (including the interest on it). over three years, starting in 1998.


Both sides put in a great deal of preparatory work in the build-up to the IMF decision. In 1997 negotiations with the IMF over a US$2.5 billion EFF loan ended in deadlock because the Ukrainian parliament–the Rada–disagreed with the proposed terms. At the beginning of 1998, the IMF stopped paying Ukraine the regular installments–amounting to US$542 million–of a previously approved stand-by credit. The World Bank consequently refused to grant Ukraine a US$600 million credit earmarked for restructuring the economy. Following this, the European Bank of Reconstruction and Development withheld from Ukraine a credit of US$600 million for reforming agriculture and the banking system.

Then began a mass exodus of foreign investors from the Ukrainian markets, accompanied by a collapse of the fledgling Ukrainian stock exchange. The PFTS index (Ukrainian equivalent of the Dow Jones). fell to 40 points from the 100 of the exchange’s opening in October 1997. The volume of deals concluded in the course of a day fell correspondingly from US$20 million to US$7-8 million. Treasury bill yields have sequently soared to around 60 to 70 percent. Interest rates have risen sharply since the end of September 1997. Long-term government debt regularly also fails to sell at weekly auctions, which tightens the government’s short-term debt crunch.

At the beginning of 1998, Ukraine was forced to borrow more than US$1 billion on European markets at a very high annual interest rate of 17 percent, against a European average of 5 percent. This was very reminiscent of the “pyramid” schemes, familiar to Ukrainian citizens from 1992-93, when dozens of phony “investment” funds and banks (such as MMM). promised double and triple digit yields on their deposits.

In August 1998, Ukraine was due to pay more than a billion dollars to foreign lenders. At the same time the reserves of the National Bank had shrunk to US$800 million, because the bank and its reforming director Viktor Yushchenko were desperately trying to stop the hryvnya from exceeding the limit of the corridor set in relation to the dollar for 1998 (2.25 hryvnya to the dollar)., which would effectively have meant a devaluation.

Despite these efforts, the hryvnya almost hit the upper level of this corridor in the summer of 1998, reaching 2.13 hryvnya to the dollar. A devaluation of the hryvnya would have meant a depreciation in the value of people’s remaining savings, and an appreciation in the value of foreign credits and a practical freeze on the repayment of previous loans–which would have resulted in a crippling increase in prices and inflation. To all intents and purposes, Ukraine stood on the brink of losing all that it had gained in seven years of independence–a stable currency and social situation in the country. The government faced the prospect of declaring itself bankrupt.


In Washington people understood the complexity of the situation in which Ukraine found itself due to its lack of progress in reforming the real economy. IMF analysts had warned Ukraine not to follow the apparently simple concept–but which in reality is fraught with serious financial and social consequences–of the “borrowing economy”, which envisages financing the budget deficit through “non-inflationary” sources–external and internal borrowing. This concept gave the impression of financial stability and relatively low inflation by dint of expanding the borrowing base and extending the circle of lenders.

In 1992-93, IMF analysts such as Oleh Havrylyshyn, former deputy minister of finance in Leonid Kravchuk’s administration, were already trying to move the Ukrainian economy away from the “borrowing economy” model to the “real,” that is, toward manufacturing competitive products. The real model is geared towards the open and transparent privatization of state monopolies and attracting foreign investors by providing them with guarantees for their investments, favorable investment terms and unrestricted sale of real estate including land.

None of these conditions were fulfilled–either by the administration of Leonid Kravchuk or, subsequently, that of Leonid Kuchma. This brought the country to the brink of financial disaster. In 1998 the IMF found itself on the horns of a dilemma. Granting an EFF credit was fraught with the danger that Ukraine would once again use the money to pay off salary arrears to reduce social tension, and to prop up noncompetitive state monopolies. Withholding the EFF credit meant that Ukraine would declare itself bankrupt. The Fund would thus lose all the previous loans it had given Kyiv. Such a development would mean that the rich nations, whose contributions form the basis of the IMF’s financial influence, would also lose their money. Eventually it was decided that Ukraine should not, in any circumstances, be abandoned to its fate. The crucial factor in the decision to extend the loan was the personal support of President Clinton and his recommendation to the IMF on this issue.


In Ukraine, the first signs have begun to appear of (1). an understanding of the need to reject the “borrowing economy” model in favor of a concept geared towards supporting economic growth by rationalizing the tax system and reducing the tax burden; strengthening financial and monetary institutions; (2). quickly introducing administrative reforms and rationalizing the number and size of budget organizations; and (3). adopting a transparent privatization program with the forward aim of deregulating the economy and reducing the level and scale of state intervention in economic activity. Particularly important is the reform of the energy sector–the reduction of the level of the energy-output ratio per unit of national income–and the agricultural sector–the gradual introduction of private land ownership.

Ukraine now has to move away from the linear model of encouraging foreign credits to finance the budget deficit, in favor of far-reaching qualitative changes in industry and taxation as the main sources of noninflationary development and financing the budget deficit. Changing the philosophy of taxation from the fixed rate confiscatory model–which stagnates industrial development and stimulates the black economy, capital flight and extensive borrowing at huge, unrealistic interest rates–to one which stimulates the development of the real economy, industrial growth, the manufacture of competitive products and, consequently, increases the tax base–is the turning point in Ukraine’s economic strategy. It is for this, basically, that the IMF is allocating the money.

Kuchma’s administration has recognized that the previous extensive pattern of using non-economic sources for liquidating the budget deficit was suicidal. From May to July of 1998, in a frenzied rush, Kuchma issued some thirty economic edicts, which were designed to reduce the number and scale of taxes, to deregulate production and to encourage small- and medium-size businesses.

The Ukrainian government is also planning to more than double its tax collection to 1.6 billion hryvnya by December 1998, while maintaining the current level of social benefit payments and reducing the backlog in this area by 700 million hryvnya by the end of the year. It further plans to allocate 100 million hryvnya for reducing military personnel, and another 200 million for restructuring the coal mines.

The IMF program also envisages an annual growth in GDP of from 3-5 percent–a patently overoptimistic point of reference–and an inflation rate of 10 percent in 1998 and 8 percent in 1999-2001. In 1997, inflation was 12 percent. The GDP for the same period fell by 5.7 percent. But do these optimistic expectations mean that the Ukrainian economy has recovered from its illnesses?


The central paradox of the Ukrainian economy is that it is essentially a centaur. Its head is the market model of development, with the corresponding rhetoric and individual economic reforms. Its legs, however, are the huge number of essentially soviet bureaucratic command traditions of state control of the economy. This combination of liberalism and “sovietism” strips all the attempts to reform the Ukrainian economy of integrity, and undermines the hopes of the IMF and the reformers within the country. Some of the more obvious paradoxes:

1. World market prices on practically all goods and services (except state subsidized prices for bread, milk, transport and accommodation). with salary levels of third world countries. Research published recently in Budapest by “World Economy Weekly” magazine reveals dramatic differences in standard of living between the post-communist countries of Eastern Europe and Austria. An Austrian worker works three minutes to buy a liter of milk. A Ukrainian has to work nearly an hour. A heavy smoker in Austria can buy seven packets of Marlboro by working for an hour and a half, whereas a Ukrainian can only buy one packet for the same amount of time. The average monthly salary in Ukraine, remembering the world market prices for goods and services, is 176 hryvnya (US$58.6).; the pension is 45 hryvnya (US$15)..

Given that chronic nonpayment of salaries has become an everyday reality in Ukraine, there can be no serious discussion of the issue of consumption and the consumer market in Ukraine. Similarly, it is impossible to seriously discuss the expected rise in production, because producing unwanted and noncompetitive products will simply be a re-run of the old Soviet methodology of achieving “gross output” without considering economic growth indicators.

2. The budget deficit and the increase in the number of budget organizations. Leonid Kuchma has set up a huge number of diverse institutes and academies “of the President of Ukraine,” financed exclusively from the budget. At the end of June he signed a decree setting a monthly payment of 400 hryvnya to members of the Ukrainian Academy of Sciences and 200 hryvnya to correspondent members.

3. Announcing the necessity of attracting direct foreign investments, while simultaneously removing all the favorable terms foreign investors enjoy.

4. The continuing bureaucratization of the economy, accompanied by tough market rhetoric. For example, in attempting to halt the flow of foreign capital out of the country, the National Bank of Ukraine laid down in telegram no. 13-211/2144 of 8 September 1998 that client applications to transfer foreign currency outside Ukraine would require presenting a certificate from the State Tax Authority confirming that the client is not in arrears in payments to the budget. The certificate would be valid for fifteen days. Tax authorities would not, however, issue these certificates–because they had not received the relevant directive to do so. The interbank currency market in Ukraine was practically wiped out overnight. Banks were forbidden to stockpile currency. Ukrainian GKO debts were restructured as conversion bonds with a 3.5- to 5-year return.

These are just a few of the paradoxes which, if they persist, will frustrate all the efforts of the IMF and international financial organizations to provide a new impetus to Ukrainian reforms.


The IMF loan may stimulate the development of the real economy on the platform of western liberalism (as happened in Poland, Hungary and Slovenia).. Another scenario is that, under the influence of “Ukrainian pragmatism,” among both the executive and the legislative branches of power, opposition to the IMF “diktat” intensifies; against this background the positive influence of Leonid Kuchma’s decrees is negated. And then there is the “doomsday scenario” described by Anders Aslund: “Ukraine goes into tailspin because of economic destabilization, as Bulgaria and Romania did in 1996. The reason for this: Ukraine has never deregulated sufficiently and is always on the edge of default.”

The existence of these scenarios suggests that the IMF loan has deferred an unavoidable crisis in Ukraine–Ukrainian specialists are talking about a few months, perhaps one year. Furthermore, it has, at the same time, defined the range of possibilities and potential strategies for economic development. From now on, however, it should not be forgotten that “reform is likely to be incremental rather than revolutionary.”

Volodymyr Zviglyanich is a senior research fellow of the Ukrainian Academy of Sciences’ Institute of Sociology, a research associate at George Washington University, and a Senior Fellow of the Jamestown Foundation.