We are just a few days from the final round of the presidential election and a comedian, Volodymyr Zelensky (pictured), is favourite to become the next president of Ukraine. With no clear policy platform or party, it is very difficult to predict how Zelensky will translate his populist rhetoric into economic policy, and a real danger that this will stall, or even reverse the necessary but painful process of economic reform, writes Vladimir Krulj.
It is very easy to underestimate what Ukraine has achieved recently. Despite the massive disruption caused by Russia’s illegal occupation of Crimea and the war it launched in the Donbass region, and the difficulty of pursuing often unpopular reforms, the Ukrainian government has managed to pass a series of economic and institutional reforms aimed at strengthening the rule of law, fighting institutional corruption, deregulating the economy, privatizing state enterprises, and improving the overall business environment.
While this process is far from complete, the benefits can already be seen. Ukraine’s economy has been brought back from the brink of near total collapse, with a fall in GDP of 12% in 2015 transformed into forecasted growth of 2.7% in 2019 driven by a diverse range of sectors.
No sector is more important to Ukraine than energy. It is the foundation of the economy and central to its ambitions of closer European integration. It has also undergone a dramatic transformation. The process of replacing a Soviet-era energy grid – one that has a remaining operating life of 10 years – and politically-controlled electricity tariffs with a market-based system is a fundamentally challenging one. But, again, real progress has been made. Starting from 2019, electricity generation, distribution, and supply are due to be unbundled and the markets for energy supply liberalized. Although further reforms, including the privatization of state-owned coal mines, still need to take place to complete the energy liberalization process.
The role of the EU has been vital. The EU-Ukraine Association Agreement and the €3.3 billion of financial support provided to Ukraine since 2014 have encouraged a process of administrative, policy, and regulatory alignment with the EU, while also increasing bilateral trade. The successful carrot and stick approach deployed by the EU has been mirrored by the international financial institutions who are an increasingly important source of external financial support.
In just a few years, Ukraine has jumped 81 spots in the global ease of doing business rankings, and now ranks 43rd on the Global Innovation Index. This, combined with the macro-economic stability and the liberalization agenda, has put Ukraine on the map for international investors. Since 2015, Ukraine has attracted $850 million of foreign investment into the renewable energy sector alone, and total investment in 2018 amounted to $2.87bn.
This is significant, but not nearly enough. It is estimated that a full upgrade for Ukraine’s energy grid will require between $80-95bn of investment, and the Ministry of Finance believes that annual investment of $10bn is required to accelerate Ukraine’s economic growth rate.
With the ongoing threat to Ukraine’s gas transit revenues from Russia compounded by Nord Stream 2, it is more important than ever that Ukraine establishes a competitive gas market in order to benefit from its massive gas reserves, which are second in Europe only to Norway. Key to untapping this potential is a complete unbundling of the gas sector and the introduction of an auction system for gas production.
Economic reform is beginning to deliver real benefits for both business and Ukrainian citizens. Perhaps most clearly, poverty is declining and real wages are increasing. However, the economy is still relatively fragile and any attempts to frustrate or roll back the economic reform agenda will dampen growth and slow international investment.
The biggest current danger to the process of economic reform in Ukraine is the domestic political situation. Despite positive recent developments, the electorate remains extremely pessimistic about the country’s prospects and is deeply skeptical, to say the least, about the political class and system. Zelensky is a clear manifestation of this discontent.
Whatever the populist pressures may be, and irrespective of who wins the elections, Ukraine is too important from a geopolitical and security perspective to allow the process of economic reform to be derailed. The EU and international financial institutions, such as the IMF, will have a vital role to play after the election in ensuring that Ukraine continues on the path of market liberalization and integration with the West.
Vladimir Krulj is a fellow of the Institute of Economic Affairs.