It’s easy to see how Ukraine could double the size of its economy in a matter of years.
It’s also easy to understand why the nation’s leaders are not doing so: oligarchic control of politics and the economy, whose size may reach only $119 billion this year for a shrinking nation of 42 million people.
Satu Kahkonen, the World Bank’s country director for Ukraine, Belarus and Moldova, and the institution she works for have written extensively about why Ukraine is not as prosperous as it could be.
In an hour-long interview with the Kyiv Post, Kahkonen, a native of Finland who has been in her current job for nearly two years, elaborated on them in greater detail.
She did not disguise her concerns about what is at stake.
“Now we are very worried where things stand at the moment. We view Ukraine now as at the watershed,” Kahkonen said on June 1 from the World Bank’s Kyiv headquarters overlooking the Dnipro River. “If reforms move forward, excellent; but we really worry about reforms not getting completed.”
Not least of her concerns is the “brain drain” that has seen millions of Ukrainians go abroad for better work opportunities. “People are voting with their feet,” she said.
She made it clear that Ukraine should be in better shape economically.
“Ukraine had a very deep crisis between 2014 and 2016. What we would expect from countries coming out of that crisis is that the recovery growth would be much higher — 5, 6, 7 percent annually,” Kahkonen said. “In Ukraine, we are seeing 2 percent because of structural bottlenecks. Unless Ukraine is moving forward with big reforms, they are going to fall and remain in a low-growth trap.”
Because of resistance to reforms, Ukraine is missing out on roughly $2.8 billion in various forms of assistance that the World Bank has held up, about $800 million of which is conditioned on Ukraine getting the International Monetary Fund lending program back on track. The IMF is holding up the last half of a four-year, $17.5 billion lending program until Ukraine adopts a law creating an anti-corruption court, brings household gas prices to market levels and holds its budget deficit to 2 percent of gross domestic product.
The World Bank is a major force in Ukrainian life and deepened its financial commitment after the EuroMaidan Revolution that drove President Viktor Yanukovych from power on Feb. 22, 2014.
Overall, since it starting working in Ukraine more than 25 years ago, the World Bank has invested $12 billion in 70 projects. It divides support into two areas: direct budgetary support for structural reforms, suspended during the Yanukovych era from 2010–2014 because of corruption, and long-term loans.
Here is Kahkonen’s sector-by-sector analysis of what’s happening:
Crony capitalism
On March 15, Kahkonen wrote an op-ed article whose headline asked “What is the cost of crony capitalism in Ukraine?” The answer: quite a lot. The World Bank found huge concentrations of wealth and political power. Specifically, it found that while only 2 percent of Ukraine’s firms are politically connected, they control 20 percent of the economy and at least 24 percent of the assets of all Ukrainian companies.
It’s hard to quantify the costs, but the World Bank said the nation’s economy would grow faster without the drag of crony capitalism.
“Oligarchs dominate large sectors of the Ukrainian economy, extracting rents and exerting their influence on the state through representation in the parliament,” Kahkonen said. “This has allowed oligarchs to tap into rich sources of corruption, including in energy, public procurement, privatization of state assets and tax administration.”
Consequently, given the absence of rule of law, the prevalence of corruption and the lack of property rights, she said, it’s no surprise that foreign direct investment clocked in at roughly $1.6 billion in 2017 after bank refinancing is subtracted. It’s an extremely low figure — one-hundredth of 1 percent inward FDI globally; Ukraine’s cumulative foreign direct investment since 1991 is estimated at less than $50 billion, also extremely low.
Banking
While hailing the closing of half of the 180 banks that once operated in Ukraine and while praising the National Bank of Ukraine, Kahkonen calls the sectoral reforms incomplete and warns of dangers ahead.
At least $20 billion got robbed from Ukrainians in a massive orgy of insider lending and bank fraud that did not get addressed until after Yanukovych fled to Moscow. Even then, owners of problem banks were allowed to strip assets out of their institutions before the state moved to close them.
But all is not well.
Ukraine has recovered little of the money and the prospects of getting more returned to the state treasury are grim. Lending has ground to a halt and no reliable credit rankings of consumers exist. Non-performing loans amount to 62 percent of the banks’ portfolios. More than 50 percent of the banking sector is in the state’s hands based on assets, largely through the three big banks of PrivatBank, UkrExImbank and Oschadbank.
Even worse, the crisis could happen again unless the state-owned banks establish truly independent supervisory boards that closely monitor the banks’ activities and improve their governance.
But legislation addressing these governance issues is “facing resistance” from vested interests in parliament, she said.
“There is still a significant unfinished reform agenda in the banking sector,” Kahkonen said. “The banking sector is not yet fully cleaned up.”
While the World Bank’s Stolen Asset Recovery initiative is working with the state’s Deposit Guarantee Fund, Kahkonen estimated no more than 10 percent of the stolen amount can be recovered, even under ideal circumstances. And Ukraine’s circumstances are far less than ideal.
“It’s very difficult after the fact to get the monies back,” she said. “It also requires significant international cooperation across different jurisdictions and that is not necessarily straightforward.”
She remains amazed by the scale of the fraud.
“The banking sector fraud was very large — one of the biggest we’ve seen in the world,” she said. “Seeing these bank owners take deposits, lend to relatives and friends and shift it offshore. For me, it’s remarkable it was allowed to continue as long as it did.”
Judicial reform
While the World Bank has largely let the European Union take the lead in judicial reform, the institution believes it’s important for Ukraine to establish an independent anti-corruption court as quickly as possible.
From the banking and other experiences, Kahkonen has concluded that “the courts are not working. We cannot count on courts to make unbiased and objective decisions in these cases.”
She said “the anti-corruption efforts in Ukraine are very critical to bringing private investors. Given the prevalence of corruption in Ukraine, we are very vocal about” the establishment of an anti-corruption court. “We are working very closely with the IMF…The anti-corruption court is only as good as the judges who are there, so the selection of judges is a critical issue for us, especially the role of the international experts.”
Energy
Ukraine faces danger signs all around. Russia’s construction of new pipelines that bypass Ukraine — Nord Stream 2 with Germany and Turkish Stream with Turkey — will harm Ukraine’s $2 billion-a-year status as the major transporter of Russian gas to Europe.
To improve its competitiveness, and to live up to its commitments to the EU, Ukraine needs to “unbundle” its state-owned Naftogaz monopoly — meaning to separate transit, production and storage operations — something it has promised to do for the last several years.
Unless it does so, investment is not likely to flow into these areas. And much of Ukraine’s energy infrastructure, including its gas transit system, is in dire need of investment and upgrades. Also, for instance, Ukraine’s natural gas production has remained stuck at roughly 20 billion cubic meters annually for many years, far less than its consumption.
Other World Bank priorities: Convincing the government to keep its commitment to raise household gas prices to “import parity level,” renovation of district heating utilities and synchronization of the Ukrainian electricity market with the European one rather than the Russian one.
Tax & customs
The biggest problem with Ukraine’s tax system is not the rates or the law, but the enforcement, which remains arbitrary and heavy-handed, Kahkonen acknowledged.
Corruption in customs has been identified as a potential source of billions of dollars in losses to the state each year. Untaxed imports and exports are believed to be large parts of Ukraine’s shadow economy, which some estimate is as high as 40 percent of all economic activity.
Successive finance ministers since 2014, from Natalie Jaresko to the current occupant, Oleksandr Danylyuk, have acknowledged that they have been unable to tame this sector.
It’s something that the World Bank is watching but not deeply involved in.
“Efforts were made to reform customs two years ago. That has stopped. That is a concern,” Kahjonen said. “I have to say that given that we are not involved in customs at the moment, we don’t have a clear picture. We are looking and seeing if there is an opening to eventually go in.”
Kahkonen said she’s opposed to efforts to reduce the Ministry of Finance’s oversight. Recently, a proposal has surfaced by Prime Minister Volodymyr Groysman to put the Cabinet of Ministers, not the Ministry of Finance, in charge of the State Fiscal Service that oversees taxation and customs.
“It is very important that the Ministry of Finance has the ability to have a say in the laws, policies and regulations that have a fiscal impact, that have an impact on the budget,” she said.
“It’s standard in every country.”
A farmer works his fields on April 17 in Kyiv Oblast. Ukraine’s failure to adopt an agricultural land market is hurting investment in the vital sector. Consequently, production is not as high as it could be. (Oleg Petrasiuk)
Agriculture
Kahkonen has invested a lot of time and effort in trying to persuade Ukraine’s policymakers and politicians to create a private agricultural land market.
The current restrictions on buying and selling parcels are clearly damaging the economy in one of Ukraine’s most important sectors.
“Ukraine is the only other European country (besides Belarus) that doesn’t have an agricultural land market. This is constricting agricultural production and overall growth. There’s a lot of corruption in the usage of state-owned land. Opening up the market, bringing in sunlight and transparency, will help a lot to eliminate those (corrupt practices).”
She wrote about this issue on Oct. 2, 2017, saying creation of a land market could boost agricultural production by billions of dollars a year.
“Land reform — lifting the moratorium on agriculture land sales — is the most powerful measure the government can take to boost economic growth and job creation, particularly in rural areas,” she wrote. “More than 70 percent — some 43 million hectares — of Ukrainian territory is classified as agricultural land. And that land is exceptionally fertile: Ukraine has one-third of the world’s black soil.
“But despite this abundance, agricultural yields in the country are only a fraction of those in other European countries whose land is not of the same quality. This is because land users have little incentive to invest in land management, as neither land owners nor users know if, when, or how the moratorium will be lifted. Moreover, getting credit is difficult and costly as land cannot be used as collateral.”
