The prime minister stands for austerity.

Photographer: Sergei Supinsky/AFP/Getty Images

Fund Ukraine Only After It Reforms

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Ukraine urgently needs a new IMF bailout, and that may finally force the country to make drastic and unpopular economic changes. The government already has a new action plan that contains a number of effective steps. For now, Ukraine's Western sympathizers might do well to withhold financing to make the government move faster on the reforms.

According to a report in the Financial Times, which the Ukrainian government has not denied, the International Monetary Fund has identified a $15 billion shortfall in Ukraine's funding that the country needs to eliminate within weeks to avoid a financial meltdown. Ukraine's international reserves are enough to cover only six weeks of imports; even twice that much would be barely adequate. The $17 billion rescue package already agreed with the IMF -- before conflict erupted in Ukraine's eastern regions -- will no longer suffice.

Prime Minister Arseniy Yatsenyuk is acutely aware of the need to attract more funding, and of Western governments' reluctance to even begin lining it up unless Ukraine slashes government spending and starts revamping the economy -- something it has put off doing since March, when pro-European politicians took power in Kiev. So he has proposed a program of action, summed up in a concise presentation on the Ukrainian government's website. 

Yatsenyuk envisages cutting government spending, now at 52 percent of gross domestic product, by 10 percent of GDP. That target has been suggested by volunteer advisers to the Ukraine government, including Anders Aslund of the Peterson Institute for International Economics and Daron Acemoglu of the Massachusetts Institute of Technology. A leaked government document lists hundreds of budget-cutting proposals that voters are not likely to appreciate: taxing large pensions, for example, increasing the retirement age by 10 years for women and five for men, and eliminating free meals in schools and hospitals. 

The proposals are so dire, in fact, that Simon Black argued on his Sovereign Man blog that they amount to breaking the social contract:

Now, I happen to quite like the idea that a government is pulling itself out of the business of education, healthcare, security, etc. But it begs the question -- if the government is no longer going to provide these services… then why the hell should anyone have to pay tax?

The Ukrainian government has a kind of answer to that: Ukrainians have not been paying taxes, anyway. Yatsenyuk told a cabinet meeting that, in Kiev, 40 percent of private sector employees now have salaries below the subsistence minimum, set at $64. He proposes slashing taxes on small and medium businesses by half and reducing payroll taxes from 41 percent to 15 percent -- to get businesses to stop paying salaries under the table. Once people start paying taxes, it will provide services more or less in accordance with what it's able to collect in a poor country with a depressed economy, bled by a military conflict in its most industrialized regions.

Yatsenyuk's program, however, has its problems. It spreads the 10 percent GDP spending cut over two years, though Aslund and Acemoglu have called for making it immediately. Proposed reforms to Ukraine's health and education systems are to be rolled out over two to three years. The program calls for defense spending of 5 percent of GDP in 2015, even though in 2013, the country's last peaceful year, it amounted to only 1.35 percent of GDP. The proposal also envisages a costly program to fortify Ukraine's border with Russia.

Yatsenyuk and President Petro Poroshenko have resisted the idea of trimming the number of government ministries: That would make it impossible for the parties in the ruling coalition to secure cabinet appointments for their key people. The unreformed ministries have continued making demands on the budget, however, and if the proposed austerity program is to succeed, these claims will need to be tightly controlled.

The government plan faces opposition in parliament: Today, Yury Lutsenko, leader of the parliamentary faction of Poroshenko's bloc, called it "more than disappointing." Eventually, however, some version of it will be passed: If Ukraine wants to avert economic collapse, it has no other option.

Then, Western lenders can do one of two things: find more money to allow Ukraine to stretch out the reforms over several years, with no guarantees that the government won't drag its feet, or push Kiev to speed things up by dangling the promise of cash for specific results. The second option is best: The Ukrainian government understands what it needs to do, but it still needs to develop a strong sense of urgency.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Mary Duenwald at mduenwald@bloomberg.net