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The Ukrainian Reformation
Oleksandr Danyliuk, Finance Minister of Ukraine, speaks during a panel discussion during the the 2017 IMF Spring Meetings in Washington, April 20, 2017 (Samuel Corum/Anadolu Agency/Getty Images)
Samuel Corum/Anadolu Agency/Getty Images

The Ukrainian Reformation

Walter Russell Mead

Ukraine’s Finance Minister sat down with Walter Russell Mead in April to discuss his ambitious reform project and hopes for a self-sustaining economy. Below is an edited transcript.

Walter Russell Mead: Welcome to Washington! Let me begin by asking—what brings you here?

Oleksandr Danylyuk: I’m here to attend the spring meetings, the premier events of the financial world. We have a pretty busy agenda—meetings with the IMF, the World Bank, and private investors as well. I’m doing all this because we are preparing to tap the market after a break of several years. It’s part of our IMF program, but more importantly, any normal state should have access to markets, to attract financing when necessary.

WRM: Will these bonds be denominated in dollars, euros, hryvnia?

OD: They will be standard euro bonds.

WRM: There’s been an issue with some Russian debt that hadn’t been restructured. Has that been more or less resolved or is it still weighing on Ukraine and the capital markets?

OD: So-called Russian debt! As you know, the London court ruled in favor of Russia, but we have appealed. We’re going along with this process to defend our position, and we have very good reason to believe that we will win.

WRM: While you’ve been in Washington have you met, or do you plan to meet, with anybody from the Trump Administration?

OD: Yes. Obviously the main purpose of this trip is the meetings with the IMF and World Bank. But while I’m here we’ll meet with members of the Trump Administration—Secretary [of Commerce Wilbur] Ross, for example. We also have a meeting with some advisers from the National Economic Council. I think we’ll need to make a separate trip for even more meetings! It’s very important to keep in contact with the new Administration, as the broad support of America is essential for us.

WRM: Ukraine had several years of negative economic growth. More recently there’s been a turnaround, though we’re now seeing some growth predictions scaled back a bit. The Ukrainian government is predicting, what, about 1.9 percent?

OD: 2.2 percent.

The annexation of Crimea and our industrial areas in East Ukraine had a profound negative impact on our economy, especially because Russia had previously been our main economic partner. We had two years—actually, three years—of consecutive decreases in GDP.

But since then, we have refocused on other markets and implemented reforms, which are now producing growth. It’s not dramatic growth, but it’s important that we broke the trend. This past year it was 2.2 percent. This year we would have predicted 3 percent, maybe even a bit higher. But then the Russians confiscated some companies on uncontrolled territory, and we took countermeasures. That set us back. As a result, we’ve reduced our growth forecast by 1 percent. So it will be 2.2 percent for this year as well. We’ll do our best to compensate for that.

WRM: When you look at the progress of Ukrainian reform over the past few years, what would you say is the brightest spot?

OD: The most difficult decision was the takeover of the largest bank in the country, PrivatBank. It’s not really a reform, but a lot of thought and effort went into it. It was quite risky because PrivatBank had a very large number of depositors—22 million.

WRM: There are, what, 42 million people in the country? So it is a large share.

OD: Yes, very substantial. And that’s just the size of the bank. Its share of payment transactions was huge—70 percent. But more importantly, it was owned by two oligarchs, who controlled several media outlets and had interests in other companies. The decision to nationalize it was very difficult.

We worked together with the National Bank, the Prime Minister, and the President. And despite all the complexity, we did it without taking any risks. This bank is now state-owned, and the Minister of Finance is a shareholder. Unfortunately, the result is that the Finance Minister now owns 55 percent of the banking system. That’s not where you want to be, right? It wasn’t our goal. The next task is figuring out how to use the state’s shares in the banking sector. That requires even more work.

As for reforms, I cannot say that we have fully completed any. I don’t consider the process to be enough; reforms need to bring results. But we have achieved a lot on anti-corruption. Specifically, we put in place a new anti-corruption structure—actually, that one was completed, I would say. We started in 2014 by creating the National Anti-Corruption Bureau [NABU] from scratch, because none of the law-enforcement agencies were able to perform that function. Some organizations are just impossible to reform. So the new institution was put in place, but it took some time to start working properly.

Second was the National Agency for Prevention of Corruption. Whereas NABU investigates suspected cases of corruption, this agency analyzes the asset declarations, conflicts of interest, and financing for political parties in order to prevent corruption.

The last component was the introduction of mandatory electronic asset declarations for all high-level officials and civil servants. This was an unprecedented step; few if any other countries put a comparable amount of information into the public domain. These three elements are now starting to bring results.

We learned during the investigation of corruption cases that courts create something worse than a bottleneck—a barrier, I would say. Even if the National Anti-Corruption Bureau put together a case, it could get stuck in court. This reduces the effectiveness of the whole system. The next step will be to set up the special anti-corruption court, which will happen at the beginning of next year. That should complete the anti-corruption infrastructure.

The results? Very recently, the National Anti-Corruption Bureau arrested the head of the state fiscal service, the highest official to be arrested for corruption so far. It’s a strong signal to everyone that we are very serious about this.

Meanwhile, we have an energy reform, which is not completed yet. It will take a lot of changes before we get where we want to be, but until that’s done the market will not work properly.

I’m also working on a budget reform at the moment, but it won’t be completed in a year either. This past year, we did a sort of pilot program. We built into the budget process the foundations for health care and education reform. These must be addressed in the budget process or they won’t happen.

Instead of a typical budget process, in which we get requests from different ministries, then put them together and say “Okay, we have less money than you want, so let’s cut things down somehow,” we did something different. We sat with them and said, “Listen, what reforms do you want to do? We will only finance reforms. You want to do healthcare? What exactly do you want to do with healthcare and how can we help you?” Those who came in saying “It’s all wonderful, everything’s okay, we just want some money to fund the institution”—their programs were the first to be cut. This year we’ll institutionalize the process, so it will not be something the Ministry of Finance just chooses to do. The new budget code will prescribe it. We will also move to a three-year budget, because no reform can be completed within a couple of months or a year.

WRM: When Americans try to figure out what’s going on in Ukraine, one of the things that surprises people is that there are these very powerful forces of opposition to reform, sometimes inside state institutions, sometimes outside. Ukraine has had three revolutions since 1990. Yet the French somehow seem to do their revolutions more thoroughly.

OD: They had guillotines! But these are banned by the European Union.

WRM: Well, sometimes they just use lampposts.

OD: Turkey’s trying to get back to that point.

WRM: Yes, exactly. Are we going to suggest a Turkish option for Ukraine? But seriously, it is interesting that the state still seems so powerless to change itself, much less reorder society. Why is that process so slow? Why have so many revolutions not revolutionized?

OD: It’s not the state that reforms itself. The people need to elect the right leaders to reform the state and then support those leaders’ positions. Not all reforms are pleasant. Some of them are very unpopular and difficult.

WRM: Which are the most unpopular and painful reforms?

OD: At the moment the most difficult reform ahead of us is pension reform. Many countries went through it; Ukraine didn’t. It was constantly postponed.

WRM: Pension reform never means a pension increase. It means a pension decrease.

OD: Actually, the unpleasant part of the reform will be complemented by an increase in pensions, because it’s very important to propose a balanced solution.
In the beginning of 2014, people would have accepted any kind of reform. They understood it was important, they saw the changes already occurring, they were ready. But three years have now passed and their patience has decreased. So now we need to be especially careful with such a reform. We cannot avoid it—that would be wrong. It is necessary and should have been done years ago. It’s our responsibility to do it. We’re not populists; we are people who want to make reforms and be proud of them.

But in order for this reform to be accepted, it needs to be fair. Even if people don’t like something, if they feel it’s fair they accept it. In the current system, one worker may have a higher pension than a coworker at the same level, or have the right to retire early. The question is why. It doesn’t make any sense! So there will be some increases in pensions, simply to balance out the disparities.

WRM: What is the normal retirement age in Ukraine?

OD: The way it works is that there is a statutory retirement age. For men it’s 60. For women it’s 58 at the moment.

WRM: A lot of American women will be interested in immigrating to Ukraine.

OD: The bad news is that it increases every year by half a year. If we were to advertise we’d say: Go to Ukraine now, because in one year it will be 58 and a half, and then 59.

WRM: How much is the median pension that people can expect to get?

OD: The minimum is 2,400 hryvnia, which is less than $100. The average pension is, I would guess, about $120.

WRM: Again, to try to help Americans understand what that means. What do you need to live in Ukraine?

OD: It’s difficult to live on a pension.

WRM: The pension would put you below the poverty rate?

OD: Just a little bit above, which is not good. Many pensioners still work, and often their families have to help, too. Of course, we want to increase pensions overall. But the economy is not there yet.

WRM: I’m trying to help Americans understand the reform discussion, because it’s very hard for them to see. The prices of a lot of things go up with reforms. Energy reform would raise the price of heating and cooking. By how much? Will someone with a small pension, one that may be reformed in some way, see his rent go up as part of the reform? How does all that work?

OD: One of the good things about Ukraine is that renting is quite rare, because most people own their houses and apartments.

WRM: Did this happen after the breakup of the Soviet Union?

OD: Yes, pretty much everything was privatized for free, I believe. In terms of utilities, gas is a big part of the problem. Many houses were built at a time when the Russian Republic supplied gas within the Soviet Union.

WRM: At very low prices.

OD: Yes, it was very cheap. And so the houses were not built to be energy efficient. After the Soviet Union fell, utility bills were high unless the state subsidized them. So the state subsidized gas for many years. As a result, no one bothered with energy efficiency, because if gas is cheap, why should you save? Meanwhile, we were still dependent on Russia, and we were losing money because of the state subsidies. After the decision this past year to move to market prices for gas, our gas monopoly NaftoGaz, which used to incur losses because of the gas rates policy, has become profitable. It doesn’t mean that people pay market prices, however—or not always. We provide targeted subsidies.

WRM: It’s a household subsidy, not a gas subsidy?

OD: Exactly. We provide subsidies to households that need them, and many do. So people ask, “What did you change?” We changed a lot. Now people are motivated to save. As people get used to saving on energy and the economy develops, the number of people receiving subsidies will go down. But at the moment we are still putting the incentives in place—both for energy efficiency and for increasing gas production. It is all coming together.

Here is an illustration of the old system. Somebody who had a 1,000 square-meter house (there are such people) and somebody who had a 50 square-meter apartment paid the same rate. The amount the state spent on subsidizing the 1,000 square-meter house could have covered hundreds of small apartments. That is just unfair. And it was financed with taxpayers’ money.

WRM: Because of economic decline and structural changes, the average household consumption in Ukraine has been falling for many years. How sharp is that decline in living standards? Again, how can we help an American audience understand what’s happening to people in Ukraine?

OD: Again, I don’t have the statistics right now. But my speculation is that average household consumption has fallen by about a third since the conflict in Eastern Ukraine started. It’s quite a significant drop.

WRM: How does that translate into politics, and has it affected political support for reform? Because people say, “Okay, we have all these revolutionaries and reformers and the more we elect them the poorer we get.” Is this creating political problems for the government?

OD: It’s unavoidable, unfortunately. Populists are on the rise in Europe now, and they play on this dissatisfaction with reforms. But there is no other way. Delaying reforms for too long kills a country, because even if somebody comes along later wanting to make them, by then people are unable to tolerate it and the country self-destructs. Of course we wanted to achieve more over the past three years, but it is what it is.

We are about to make two very important reforms, pension and market reform, that cannot be delayed. They need to be done or people will not get their pensions in a few years. Since the current system is unsustainable, refusing to make reforms would be like playing hot potato. We’d just be passing it along—and we cannot afford to do so.

WRM: What keeps you up at night when you think about the future of Ukraine or the future of the reform program? What worries you most?

OD: The better question is, “What keeps you up for part of the night?”, because part of the night I’m in the office, working. As for the remaining part, sometimes while I sleep my brain is still going and I wake up in the morning with the solution.

What worries me is the possibility that we could miss the window of opportunity for reform. That doesn’t mean that it’s the end of the world—I don’t believe it’s a matter of “do this now or you lose the country.” I just believe it’s our duty to help people live better lives. If we fail now, the opportunity will come again, but we will be weaker, and many people who need it now will go without help. That worries me. I’m extremely happy that we’re finally going to enact this pension reform after so many years of discussion. The populists are painting it as disastrous, almost like homicide, but that’s absolutely stupid. It’s the action of a responsible government.

WRM: When you think about what would make your term in office a success, what do you think of? What signs should I be looking for to determine whether the administration is achieving its goals?

OD: Are you asking about the government or the Ministry of Finance?

WRM: The Ministry of Finance.

OD: We are not a typical ministry of finance. If you just look narrowly at what our Ministry of Finance usually does, its agenda might include tax reform, institutional reform of state fiscal services, a midterm budget, the creation of a financial investigation unit, and the elimination of the tax police, an oppressive historical relic. That would be a small agenda.
But we’re more than that. I brought in a team of reformers who had been working in other areas. For me, it’s extremely important that we start healthcare reform either this year or next. This year we will make progress on education reform. We did some interesting things this past year, including some changes of the stipend system for students. Can you imagine? We dared to take on the most active part of society. We just said, “Listen, 70 percent of you should not be getting stipends.”

WRM: Don’t tell American students this or they’ll want one, too.

OD: I received a stipend myself at one time, so I’m not against them in principle. But the system didn’t take into account how successful students were. So we separated it into two parts. A limited number of people now receive an academic stipend, which incentivizes good study habits, and a larger number of people receive a need-based stipend. We tried it this past year, and received pushback—people said, “How can you do this? You should not touch students. They’re very active. Everybody will hate us.” But guess what? We’ve got support from the students themselves, because they think about their future. Do not underestimate people.

WRM: One final question. What would you like from the United States? Not just speaking as the Finance Minister, but as a member of the Ukrainian government. What does Ukraine want from the United States?

OD: I don’t have a Christmas wish list. I believe in our potential and I think we have to do the work ourselves. But there are certain areas where we need support. For example, the situation in the east of the country. Although we did everything possible to reform our military, we lack the training and weaponry to counterbalance the much-larger Russian army. And sometimes we need support for our institutions. For example, the financial investigation unit (which we are planning to set up soon) and the National Anti-Corruption Bureau (which has already been set up) would be impossible for us to create on our own; we just don’t have the experience. In order to do these things quickly and successfully, we need assistance from the American government.
Now, financially we’ve got support, but only for the short term. I believe that by 2018 or 2019 we will be on the road to a self-sustaining economy. But these are difficult times in Europe, and it is hard to find political support there. We still need the United States to maintain sanctions against Russia and to strengthen them if Russia acts badly. That’s what really helps, because the Russian economy is suffering. The sanctions change its behavior.

WRM: Thank you very much.

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