Efrem Lukatsky/AP

Will stark economic pragmatism backfire on Ukraine?

IMF-imposed austerity measures could play into Russia’s ploy for a federalized Ukraine

When Arseny Yatsenyuk took the reins in Kiev after months of unrest toppled the pro-Russian government of Viktor Yanukovich, the former Minister of the Economy knew a politically costly overhaul of his country’s budget was needed to save the economy from imminent collapse and a projected ten percent contraction by year's end.

“The treasury is empty. We will do everything not to default,” Yatsenyuk said. “I’m going to be the most unpopular prime minister in the history of my country … but it is the only solution.” A month later, Yatsenyuk agreed to an $18 billion loan from the International Monetary Fund that mandated far-reaching austerity measures he called “very unpopular, very complex, hard reforms.”

The austerity measures, which include an end to costly gas subsidies and a freeze on the minimum wage, have yet to be implemented. But many analysts predict the stark economic pragmatism of the new, pro-European leaders in Kiev and their Western backers in the IMF could further enflame Ukraine’s volatile political landscape, which has featured rising calls for separatism in the Russian-speaking east matched by a Kremlin push for the federalization of Ukraine.

Critics say the abrupt belt-tightening, however transparent and well intentioned, could backfire at a moment when Kiev is urgently trying to win over its increasingly divided population ahead of elections in May.

Kiev and the IMF "have basically misdiagnosed the problem in Ukraine,” said Mitchell Orenstein, the chair of the political science department at Northeastern University and an associate at Harvard’s Davis Center for Russian and Eurasian Studies. “They’re aware it’s a heavily politicized situation, but they’re not really taking that seriously. They’re not playing politics the way it should be played, and it’s frankly stupid.”

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After months of mass unrest toppled Ukraine’s Russian-allied president and turned the country away from a budding Moscow-led customs union in favor of closer ties to Europe, a spurned Moscow responded by annexing the Russian-majority peninsula of Crimea and withdrawing a massive bailout offer that would have prevented Ukraine from defaulting on its debt. It also retracted its offer of discounted natural gas prices, which, coupled with the IMF-mandated end to government subsidies and the raising of prices from their artificially low rate, could spike household gas prices by as much as 100 percent.

But Moscow, many believe, has not given up on the newly West-facing Ukraine. Russian officials insist Ukraine is irreparably split along its ethnic and linguist east-west fault line and that ethnic Russians around the country are under threat. Russian Foreign Minister Sergei Lavrov has called for a federalization of its former satellite state into two (or more) regions with greater economic, political, and cultural autonomy — a system that would exploit regional tensions and redirect the country off its current path westward.

Failure by Kiev’s new leaders to cement their fragile legitimacy in time for the May elections could hasten Ukraine’s division along those lines. “I don’t think the IMF should have insisted on an immediate rise in the residential price of natural gas in the first place,” Mikhail Korchemkin, the founder of East European Gas Analysis, told Foreign Policy. “The situation in Ukraine is very unstable and there was no need to destabilize it more by unpopular decisions.”

In addition to the gas-price hike and minimum-wage freeze, Ukraine has also agreed to raise taxes on the country’s largest businesses, crack down on corruption, and close loopholes that allowed government officials to hand out government contracts to their cronies. But many feel these and other measures still compound pressure on the country’s working class and do not forcefully punish the oligarchs and government leaders who they say are responsible for Ukraine’s current economic turmoil.

Unpopular cutbacks could pose a particular threat in the Russian-speaking east, a mining and industrial region that exports a large portion of its product to Russia. Many there feel the recent uprising failed to represent their economic concerns and threatened their economic ties to Moscow.

“The slowdown in the economy has already affected the east and the IMF austerity measures, i.e. the gas price hike and a cut in some public sector salaries is expected to hit harder in the east than elsewhere,” said Chris Weafer, a founding partner of the Moscow-based consultancy Macro-Advisory. Plus, he said, “there is already a sense of ‘them versus us’" given Kiev's rejection of Yanukovich and other pro-Russian leaders who the east helped elect.

Not every economist agrees the austerity measures will be more damaging to the east. But to disenfranchised Russian speakers who live there, Russia’s argument that Ukraine is better off as part of the Eurasian customs union has already begun to resonate. Meanwhile, Russian troops continue to hover along Ukraine’s eastern border, seemingly poised for another incursion into Ukrainian territory should residents get fed up with Kiev's policies and rally for Russian intervention.

On Monday, pro-Russian separatists seized a provincial administration building in the eastern city of Donetsk and proclaimed the region an independent republic, an isolated incident but one that nonetheless underlined the existential threat to a unified Ukraine.

The IMF austerity measures will also bite shortly after Russia announced it would raise pensions in its newly claimed territory of Crimea. In doing so, Moscow appears to be dangling Crimea before the eyes of mainland Ukrainians, who are about to see their own pensions cut, as if to lure them back to their former economic master. Disaffected Ukrainians shouldn’t be fooled by Russian propaganda, experts say; Moscow has a history of supporting pro-Russian breakaway regions and then abandoning them economically, most recently South Ossetia in Georgia. But acute economic hardship could still blind Ukrainians to that precedent.

What has puzzled many analysts about the loan program is that the IMF appears to be ignoring its own advice by demanding such severe austerity measures so soon after an uprising. An IMF report on its failure to resurrect the Argentinean economy in the 1990s noted that any successful financial package hinges on the government’s ability to curry political favor before making unpopular budget cuts. “It is debatable whether greater structural conditionality — or stricter enforcement — would have succeeded in ensuring that structural reforms would be undertaken, given that political consensus and ownership were lacking,” the report said.

“An incumbent trying to win an election in a stagnating economy must stimulate growth. This is one of the most basic principles of modern politics," Orenstein of Northeastern University wrote. "And yet the west, which wants to help its allies in Ukraine’s interim government win the general election…seems to have forgotten it."

Easing Ukraine into much-needed austerity measures until after the May elections — if not later — would allow Kiev some breathing room, he added, whereas the current plan is to "come in and offer a social contract that says Ukraine is going to get worse rather than better.”

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