Ukrainian crisis and its evolutions

Beginning of the political crisis. Protests in Kiev broke out after President Viktor Yanukovych’s government suspended in November 2013 the signature process which would have led to a far-reaching Association Agreement with the European Union, thus leading to three months of protests which ended with the Ukrainian Parliament removing in February 2014.

President Yanukovych from office and setting early presidential elections for May 25, 2014. But after the ousting of the former President and the establishment of a new pro-European ad interim government – headed by acting PM Yatsenyuk, and acting President Oleksandr Turchynov – tension started running high also in Crimea, the pro-Russian peninsula of Ukraine where – at the end of February 2014 – the buildings housing the parliament and government were seized by pro-Russian forces and a pro-Russian leadership installed. The situation became even worse once, on 11 March 2014, the local parliament of Crimea voted on a declaration of intention to favour independence from Ukraine – just five days before the provided referendum of 16 March, when the peninsula’s residents finally chose to secede from Ukraine and join the Russian Federation (96.8% of voters within 83% of the peninsula’s inhabitants voting). Later, on 18 March, Putin addressed the parliament defending Moscow’s actions on Crimea and signing a bill to absorb the peninsula (bill approved by the Duma on 21 March) which is now a de facto Russian territory. Meanwhile, Ukraine – March 21 – and European leaders signed the political elements of the Association Agreement and on April 1^st, the Ukrainian Parliament ordered security services to disarm all “illegal armed groups” in the country and voted to allow NATO to hold joint military exercises with and other countries on Ukrainian soil.

Spill-over effect on the south-eastern Ukraine. It is worth noting that the protests continued also in the south-east regions of Ukraine (see maps below) – Luhansk, Kharkiv and Donetsk – where, at the beginning of April 2014, pro-Russian protesters occupied governmental buildings, asking for a referendum to secede from Kiev and join Moscow. As of today (end of April 2014) official buildings in at least nine cities and towns remain occupied. Despite Ukrainian police and interior ministry’s special forces cleared protesters out of the regional administration building in a bloodless operation in Kharkiv, but protesters continue to hold the regional administration building in Donetsk and the Ukrainian Security Service’s (USB) building in Luhansk. On Saturday 12, masked men armed with Kalashnikov assault rifles seized also the police station and the district of Security Service of Ukraine headquarters in Slavyansk, a Donetsk Oblast city of 125,000 people. Later in the day, the Interior Ministry in Donetsk was also seized by gunmen. Nonetheless, previous ultimatums issued by Kiev to pro-Russian separatists to abandon buildings they had seized in about 10 towns and cities in mostly Russian-speaking eastern Ukraine (for the geographical distribution of ethnic Russians and Russian-speaking people in Ukraine, see the two maps below) had been followed by little action. Moreover, as of today (end of April 2014) official buildings in at least nine cities and towns remain occupied.

Protesters’ arguments. The separatists argue that Ukraine’s new pro-western government has failed to adequately decentralise power and funding to the region and has threatened restrictions on the Russian language, discriminating against a significant minority in the east of the country. According to a local businessman, “today the majority want to live in Ukraine, not in Russia. But if this place becomes anti-Russian, we do not want it … they don’t want to see armed neo-fascists from western Ukraine and Kiev in their region”.Such sentiments are believed to be widespread in the east, whereas Kiev central authorities are often believed not to take enough in account these complaints about a clampdown on the Russian language and a resurgence of nationalism. Indeed, as pointed out by another influential lawmaker and businessman from Donetsk region and close associate of Ukraine’s richest oligarch Akhmetov, “Kiev’s new pro-western government could defuse separatist sentiment by swiftly devolving more governing authority and control over finances to regional governments”.

– Government’s reaction. Hence, acting President Turchynov announced earlier on Tuesday 15 an “anti-terrorist” operation to end the grip of separatists, sending in the army to try and secure control of government buildings in 9 cities of the Donetsk Oblast region (see maps below), which he insisted would be “phased, responsible and balanced”. On the other hand, Kiev also said it was ready to open dialogue with pro-Russian groups in the east – a move that Russian Foreign Minister Lavrov said was “certainly a step in the right direction, albeit very belated”. A day after, on April 16, acting president Turchynov, argued that troops had retaken Kramatorsk airport, but pro-Russian forces were showing no signs of retreat. Meanwhile, prime minister Arseniy Yatseniuk told the cabinet that a newly-formed “constitutional commission” would swiftly draft constitional changes delegating more governing power from Kiev’s central government to regional legislatures and administrations. Despite the 17 April international  peace deal, which stipulated an immediate end to violence in eastern Ukraine and called on illegal armed groups to surrender their weapons and leave official buildings, the stand-off in towns across the eastern Donetsk region appears to be intensifying. Therefore, the Ukrainian authorities have re-launched an anti-terror operation to take back several towns in the east overrun by pro-Russian militants. Acting President Olexander Turchynov said he had ordered the operation to restart after two men – including local politician Vladimir Rybak – were found dead after being “brutally tortured”.

– International reaction. (1) On Sunday 13, the United Nations Security Council held an emergency session to discuss the escalating crisis in Ukraine, following Russia’s request – after Moscow called Kiev’s planned military operation to restore control of government buildings in Ukraine as “a criminal order” and pledging to “protect” people in eastern Ukraine from violence if necessary. Nonetheless, no concrete action was decided, especially due to fierce disagreements. More specifically, while the US ambassador to the UN accused Russia of orchestrating the recent protests and seizures of buildings in eastern Ukraine – according to the US state department “Russia is now using the same tactics that it used in Crimea in order to foment separatism, undermine Ukrainian sovereignty, and exercise control over its neighbour”, Russian Ambassador Vitaly Churkin denied all claims that Moscow was behind the violence, putting rather the emphasis on the incapability of the West to “see the real reasons for what is happening in Ukraine”, thus putting the blame on it “it is the West that will determine the opportunity to avoid civil war in Ukraine”. (2) Following the unfolding of the events after the beginning of Ukraine’s anti-terrorist operation on April 15, international concernes heightened. More specifically: as for Russia, the Kremlin argued that “the Russian side expects a clear condemnation from the UN and the international community of these anti-constitutional actions”, heightening concerns that any bloodshed resulting from attempts by the Kiev authorities to retake control of eastern Ukrainian cities could prompt direct military intervention by Russia; as for the US, they “agreed that the use of force is not a preferred option”, but defended Ukraine’s government responsibility “to provide law and order” as “these provocations in eastern Ukraine are creating a situation in which the government has to respond”.

Russian President Vladimir Putin has reiterated his readiness to deploy troops in eastern Ukraine if diplomatic efforts fail to resolve the escalating crisis there. More specifically, he underlined that he hoped for a political resolution to the crisis but warned that the campaign for Ukraine’s May 25 presidential election was “being run in an absolutely unacceptable way”. He also called on Kiev to withdraw its forces from southeastern Ukraine and engage in dialogue on the country’s future with pro-Russia protesters in the region.

Finally, at the meeting of US, the EU, Russia and Ukraine Foreign Ministers on April 17 in Geneva – discussing the possible diplomatic progress in the conflict and the de-escalation of the crisis, main points agreed:

– All sides refrain from violence, and reject expressions “of extremism, racism and religious intolerance, including antisemitism”;

– All illegal armed groups must be disarmed; all illegally seized buildings must be returned; all illegally occupied streets and other public places in Ukrainian cities and towns must be vacated;

– Amnesty will be granted to protesters and to those who have left buildings and other public places and surrendered weapons, with the exception of those found guilty of capital crimes;

– The OSCE would play a leading role in helping the authorities implement the agreement;

– Constitutional reform would be inclusive, transparent and accountable;

Oligarchs’ involvement/position in the unfolding of the crisis. It is believed that Mr Akhmetov (his diversified holding company controls nearly half of the country’s vast mining, steel and electricity sectors ) and other politically connected oligarchs from Ukraine’s industrial eastern heartland have been playing a double game in the crisis. Their wealth increased further under ousted president Yanukovich, whom they long backed but ultimately disowned. Several accepted the new government’s hasty offer of regional governorships in central and eastern Ukraine, pledging to hold the country together. But critics charge that some of Ukraine’s richest businessmen may now be using the threat of separatism as a negotiating chip with Kiev’s new pro-western leadership. “There is lots of supporting evidence backing the view that Akhmetov and Yefremov – another influential politician-businessman, former regional governor anf the leader in parliament for Mr Yanukovich’s Regions party – are playing a double game in the battle against separatism in eastern Ukraine”. According to a local political analyst, “they were using the separatism threat  either . . . as a card in negotiations with Kiev’s new authorities aimed at preserving their influence going forward, or playing into Russia’s interest in case the region gets taken over by Russia”. Although they are believed to have the “clout to quash any separatist movement”, “they seem reluctant to do so as they are bargaining with both the Kremlin and the new Ukrainian authorities to agree a status quo where their businesses and assets will be protected and allowed to prosper in a post-Yanukovich Ukraine”. Nonetheless, they officialy deny these claims, with Mr Akhmetov for example joining negotiations last week with separatists in Donetsk and resenting himself as a peacemaker, who promised to help them secure more autonomy from Kiev and rights for the Russian language – spoken by the majority of eastern Ukrainians – while insisting that territorial integrity must be preserved.

Ukrainian Presidential elections and future challenges.On March 31, the campaign for the Presidential elections officially began. Indeed, next  25 May, 36.5 million of Ukrainian are called to vote for a successor to the former President Yanukovych, who will be in charge of leading the country out of its deepest political crisis since the independence in 1991. Anyhow, the latest post-revolution polls highlight that the oligarch Petro Poroshenko – also known as “the king of chocolate” for its activities in the agricultural and food sector – could most probably become the next Ukrainian President thanks to his substantial advantage (see charts below), especially in a possible second round of elections: about 34% higher on the second most popular candidate, the former Prime Minister Tymoshenko. Moreover, Poroshenko will also benefit of the support of Vitali V. Klitschko – one of the best-known faces of the anti-government protests – who decided to put aside his presidential ambitions to gain the office of Mayor of Kiev – at the same time declaring his support to Poroshenko. The latter will also count on his experience at the Secretary of Defense and the National Security Council, and then at the Foreign Ministry of Economic Development as well as at the chair of the Board of the Central Bank of Ukraine. However, it is worth noting that the next President will face important challenges such as  1. improving the economic conditions; 2. manage the tough node of the Crimean peninsula; 3. reducing tensions with Russia – especially due to the additional pro-Russian protests in the south-eastern regions of the country and 4. leading Ukraine towards the European Union.

Economic scenario. As the interim government grapples with Russia’s annexation of Crimea, spreading separatist unrest in the east and gas bills that will almost double, Kiev is slipping closer towards financial breaking point. The recent events are clearly influencing the economic stability of the country. Therefore, a combination of numerous effects are expected to lead to a large contraction in the economic activity during 2014. Moreover, Russia has also the potential to re-inforce an unavoidable contraction in GDP via a number of channels, including by halting trade, gas or demanding repayment of its $3bn bond. Overall, among the numerous effects expected to lead to contraction in 2014: 1. the need to consolidate a large budget and C/A deficit; 2. the impact of deposit flight and currency depreciation; 3. a sharp slowdown in tax collection between now and the election; and 4. Ukraine’s low level of FX reserves, which recently sank to just over two months of import cover, far below the roughly six months median for emerging economies (see figure below). In this scenario, public debt to GDP is forecast to rise to 38% in 2014 whilst the real GDP is expected to tackle a contraction of 6%. However, this is largely neutralised by a spike in inflation (6.7% in 2014). Moreover, local currency is expected to stand at 10.75 of its average value in 2014 whilst – due to the higher interest bill and the weak revenue performance – the budget deficit should be in excess of 7% of GDP. In this regard, the IMF projected that without policy action, the combined government/Naftogaz (Ukraine’s state-run gas company) budget deficit could widen to over 10% of GDP in 2014.  

Moreover, it is worth noting that, on April 14, the National Bank of Ukraine raised its discount rate from 6.5% to 9.5% and nearly doubled the overnight loan rate to 14.5% from 7.5%. The dramatic move was aimed at stabilising its currency, in order to bring inflation under control and encouraging depositors to keep their cash in the country (until last February, the hryvnia was de facto pegged against the US dollar, making it impossible for the central bank to use monetary policy to stabilise the economy – the move towards a more flexible exchange rate system meets a key condition set by the IMF). 

On the other hand, by signing the political parts of the Association Agreement with the EU, Ukraine had to give up Gazprom’s discount on gas of December 2013 (with the Dec. 2013 bailout agreement Russia’s Gazprom had slashed the price Ukraine had to pay for gas supplies, with more than a 30% cut). Indeed, recently, Gazprom announced that the price of gas for Ukraine is set at $485 per 1,000 cubic meters as of April 2014. It also stressed the necessity for the Ukrainian gas society ‘Naftogaz’ to pay off its accumulated debt for Russian gas deliveries, estimated – to date – at more than $2.2bn. Moreover, on Wednesday the 9^th, Russian President Putin and other senior Russian officials threatened to restrict supplies of natural gas to Ukraine and reiterated that Ukraine owes Russia more than $16 billion in unpaid gas bills and other debts.    

Financial aid. IMF: Besides the weak economic situation, on March 2014, the International Monetary Fund (IMF) has reached a “preliminary” agreement to fund Ukraine with a loan accounting for $14-$18 bn which should unlock an international aid of nearly $27 bn over the next two years. In particular, domestic authorities have suggested that the first IMF tranche (maybe to be disbursed in early May) – once the programme is approved – will be $3bn in size, of which $1.5bn to be channelled to the Ukrainian national Bank whilst another $1.5bn to the Ministry of Finance. (2) World Bank: Moreover, the World Bank has indicated that it plans to inject $3bn this year, including $1.6bn to support the energy efficiency and up to $1bn for budget financing – of which, the first tranche ($750 million) should be available in May.

EU: On April 14, the EU Council adopted a decision providing up to €1bn in macro-financial assistance (which is part of the support package of €15bn announced by the EU Commission on March 5)and a regulation granting unilateral trade preferences, providing for the temporary reduction or elimination of customs duties in accordance with a schedule of concessions set out in an annex to the EU-Ukraine association agreement. The EU financial aid will be provided from its MFA facility and will be also conditional on the fulfilment of economic policy and financial conditions, focusing on structural reforms and sound public finances, to be laid down in a memorandum of understanding (MOU) to be agreed between the EU and Ukraine. The MFA will be made available for a period of one year starting from the entry into force of the MOU.

To benefit from the international financial assistance, Ukraine will be obliged to follow the so-called “priority actions” of the IMF including the adoption of difficult and unpopular reforms in the energy sector (the government has recently announced a 50% increase in gas bills for households and 40% for businesses), the reimbursement by the end of 2014 of foreign public debt’s maturities, the adoption of a flexible exchange rate and a budget deficit’s reduction by 2016.

International sanctions. In March 2014 the EU Foreign Affairs Ministers adopted restrictive measures (asset freeze and travel bans) in respect of actions undermining or threatening the territorial integrity, sovereignty and independence of Ukraine. The Decision included a list of individuals – 33 Russian and Ukrainian officials linked to unrest in Crimea – and will be in force for six months – until 17 September 2014. Moreover, on April 14, the EU Council sanctioned four additional individuals identified as responsible for misappropriation of state funds in Ukraine (and whose assets with the EU will be frozen).

EU foreign ministers met in Luxembourg on April 14 to discuss possible economic sanctions against Russia but: Germany, Italy and Spain did not want to antagonise Moscow ahead of Thursday’s meeting in Geneva, while Britain, Poland and the Netherlands said the 28-member bloc needed to draw up plans for potential sanctions. Nonetheless, Britain remains cautious about imposing sanctions that could have an impact on the City of London’s reputation as an open global financial centre and on companies, notably BP, which have big investments in Russia (eg. the company has a 20% stake in Rosneft, the Kremlin-controlled oil company).

Also the United States moved in the same direction, freezing assets and imposing sanctions on 30 Russian and Ukrainian officials, while Japan announced a package of “measures” against the Federation and leaders of the G7 “temporarily” suspended Moscow from the G8, as long as it does not follow a more “appropriate” approach to de-escalate the crisis. Last but not least, NASA suspended all contacts with Russian government representatives, including travel to Russia, teleconferences, visits by Russian government officials to NASA facilities and exchange of emails with Russian officials and NATO suspended all practical cooperation with Russia – both military and civilian – and ordered military planners to draft measures to strengthen its defenses and reassure nervous Eastern European countries. As for most recent developments, the US has warned Russia to tone down its aggressive rhetoric on Ukraine, or face further sanctions. US Secretary of State John Kerry told his Russian counterpart over the phone that Moscow must call for pro-Russian gunmen to lay down their weapons.