Onus is on West to help Ukraine with finance

The West does not like to think it is at war with Russia. Yet the Russian government seems to think it is at war with the West. For President Vladimir Putin, his cronies and, increasingly, a large part of the Russian people, the history of the past 2½ decades is a sad affront rather than a tragically lost opportunity. Russia has thrown away the chance of living under an honest government subject to the rule of law. Instead of seeking to remedy that failure, its rulers wish to deprive Ukraine of that opportunity.

The question is how the West should respond. Nothing would do more to shake the Russian kleptocracy than the transformation of Ukraine into a stable and prosperous democracy. Putin and his associates fear this possibility. Nato, regardless of their huffing and puffing, does not threaten them. But the emergence of a democratic and law-governed Ukraine does. Evidently, there are risks in seeking that outcome – but do not ignore the long-run benefits.

The starting point has to be the economy. Ukraine at last seems to have a competent and determined team of reformers. The revolution that threw President Viktor Yanukovich out of office a year ago , and the subsequent onslaught, has had a purifying effect. The government seems to understand this is their country's last chance. A quarter century of corruption and incompetence has to end if Ukraine is to have not just a good future but, quite possibly, any future.

In 1990, Poland and Ukraine had similar standards of living. Poland's soared; Ukraine's fell. By 2013, Poland's real gross domestic product per head (at purchasing power parity) was 160 per cent higher than its eastern neighbour's. Russia has done far better than Ukraine – in part due to abundant natural resources.

Smashed confidence

Long-term performance has been chronically poor. Since the onset of war, this condition has turned critical. Real GDP shrank 8 per cent between the fourth quarter of 2013 and the third quarter of last year. The war was bound to have such a big impact, since Donetsk and Lugansk – the most affected regions – used to generate 16 per cent of GDP. The war has also savaged confidence. Foreign currency reserves collapsed to $6.6 billion in December 2014, or about one month’s imports, as capital fled. The hryvnia has collapsed. The result will be a spike in inflation and further pressure on living standards.

These, then, are the unhappy conditions in which the International Monetary Fund is seeking to negotiate a new multiyear extended fund facility. The aim, as Christine Lagarde, managing director, has noted, is to "support immediate macroeconomic stabilisation measures as well as broad and deep economic reforms over several years".

So what should such a programme look like? The most important feature must be a comprehensive set of reforms aimed at ending the corruption and clientelism that have marred the government, the private sector and the far-too-cosy relationship between the two. As Anders Aslund of the Peterson Institute for International Economics notes, important reforms are under way. These include the "unification of all energy prices at the market level, which would eliminate the greatest cause of top-level corruption and the need for vast subsidies".

Another reform is the “elimination of dozens of inspection agencies, permits, licences and certifications”. A third important one is cleaning up the remaining large state enterprises from corruption. Also important will be the reform of banking, particularly the elimination of lending by banks to the connected parts of larger business entities. This is aimed at limiting the dominance of the oligarchs, most of whom seized wealth in the early years after independence.

The government has made a strong effort to contain the fiscal deficit. Yet, as Aslund also notes, Ukraine will need more money to manage its foreign exchange crisis. He argues it needs at least $27 billion this year from the IMF, the US and the EU. It will also need substantial relief from private creditors. The aim of this support is to allow Ukraine to carry through the necessary reforms, even under assault. This support would have exactly the same purpose and justification as US support for western Europe in the early years of the cold war. The aim is to show the West will not abandon Ukraine, so long as it sticks to its newfound goals.

Stance on Russia

Providing the assistance Ukraine needs not just to survive but to carry through the reforms is a necessary condition for strategic success. It is not a sufficient one. There are obviously other big questions. Should Russia be threatened with tougher sanctions? Should Ukraine be armed, even if only defensively? My response to both questions would be yes. Yet these options carry big risks and might fail to deter Russia’s revanchism.

The case for helping Ukraine economically is morally and politically overwhelming. The West has the resources to stabilise the economy against all but a massive Russian invasion. Even $27 billion would be far less than 0.1 per cent of the combined economic output of the US and the EU – a small price to secure a stable large democracy.

Moreover, if that were achieved, the chances of persuading Russia to join this club would surely also increase, if only in the long run. Whatever one thinks of diplomacy, tougher sanctions or arming Ukraine, the West should give Kiev the help it needs to achieve a reformed economy. That may well prove to be insufficient. But it is evidently essential.– Copyright 2015 The Financial Times Limited