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Kiev leaves us no option but to keep cash flowing


Ukrainian babushka with a H&K submachine gun

Ukrainian babushka with a H&K submachine gun

Ukrainian babushka with a H&K submachine gun

The conflict in Ukraine is quickly becoming one of the great tragedies of post-World War II Europe. The vast country of almost 50 million people has been in a state of war for more than a year. The death toll is estimated by the UN to be over 5,000 but it may be considerably higher. And Russia's aggressive interventions, including its annexation of the Crimean peninsula, have transformed the entire continent's security environment.

Europe and the US, fearing direct military conflict with a nuclear Russia, have been extremely reluctant to arm the pro-western government in Kiev. If that is understandable, the limited financial assistance being offered is less so.

The economy is in a state of collapse. Russia is limiting gas flows. Industry is grinding to a halt. The currency is tanking, causing Ukrainian households -already among the poorest in Europe (see chart) - to see their wages and pensions eroded.

The economy contracted by 7pc in 2014 (as much as Ireland's in the worst year of the crash) leading to the evaporation of tax revenues. As a result, austerity is sucking further demand from the economy, made all the worse by the diversion of resources to the war effort. The government is running out of money fast. The dreaded D-word - default - is being whispered.

Although bailouts are not popular in the countries who pick up the tab, and concerns about what happens to money given to Kiev are many (the apparatus of the Ukrainian state is both corrupt and inept), it will be good for nobody except Russian leader Vladimir Putin if the economy sinks further. Conversely, propping up the regime in Kiev is, by a considerable distance, the least bad option available to democratic Europe.

The group of seven rich nations, known as the G7, are mulling over a large aid package to help Ukraine stave off bankruptcy. Last year, such bodies as the World Bank and the EU, along with Canada and Japan, were chipping in funds.

But in the long run, the most useful initiative might be the agreement announced with the IMF last month. Worth €15.5bn bailout over four years, the agreement comes with strict requirements for the kind of economic reform the country badly needs.

While Ukraine's economic woes have been brought to crisis point by its conflict with Russia, in truth it has performed poorly since the dissolution of the USSR in 1990. What is surprising is that it did so from a relatively privileged starting point.

In Soviet times, Ukraine had primacy in agriculture and heavy industry. As the second largest economy in the confederation after Russia, it was well-positioned to take off after the dissolution of the USSR.

But it has made little of its propitious start. It has failed to evolve beyond agriculture, mining and heavy industry. It has a large shadow economy and is among the bottom 35 countries in the world (out of more than 170) in Transparency International's corruption perceptions index.

Because of all this, it is not a popular destination for foreign direct investment - and it is losing domestic investment potental. Furthermore, its high placing on the world remittances table suggests that many of its more enterprising citizens have left.

One relic of a bygone era is the state-owned Naftogaz energy company, which provides subsidised energy - despite much of it being imported from Russia - which regularly exploits its neighbour's dependence. As no one has any incentive to cut back on usage, energy consumption levels are among the highest in Europe. All of this soaks up a large share of the government budget.

Ukraine's poor performance over 25 years stands in stark contrast to the Czech Republic and Poland - the latter a country of similar population, as the second chart shows.

Between 1990 and 2013, Ukraine's output doubled, but that pales in comparison to the Czech Republic (which grew fivefold) and Poland (now eight times what it was then).

Poland, starting the 1990s with almost identical GDP per capita, has left Ukraine trailing in its wake.

But if Ukraine needs economic reform as much as it needs financial aid, it is less clear that the IMF will find its task straightforward. Recent IMF interventions in Ukraine have come unstuck all too quickly. In the words of the IMF, a programme of €12.6bn in 2008 "went off-track" in late 2009.

It was followed , in 2010, by another attempt with a similar sum of money - but, again, the IMF was unsuccessful in persuading Ukraine to restructure its economy to facilitate growth. A suggestion to pursue full- cost recovery in the energy sector (large subsidies meant customers paid only one third of the real cost) was resisted, presumably on the basis that it would prove unpopular.

If aid and IMF funds provide some prospect of financial and economic stability, Ukraine now seems even further away from the kind of development that is not measured in financial terms alone.

The dispute that sparked the conflict within Ukraine was between those who expected accession to the EU and those who favoured closer ties with Russia. Although Ukraine was in the queue for EU membership, the most recent report on its readiness for membership makes clear that much remained to be done.

While unfailingly diplomatic in tone, the EU report described progress in most areas as "mixed", and highlighted the need for progress on human rights, police conduct, the application of justice, media freedom, management of the public finances - and corruption.

For a growing number of Ukrainians, there are more immediate concerns. The UN Refugee Agency estimates almost 1 million people have been displaced within Ukraine, while half that amount again have applied to move to neighbouring countries. In recent months, the agency's attempts to provide humanitarian aid to refugees in the east of the country have been hampered by new security clearance procedures.

In the 1990s, the Yugoslav wars sparked a refugee crisis, with over 2 million people internally displaced or fleeing to neighbouring countries. The conflict in Ukraine - double the size of Yugoslavia - has the potential for a great deal more human misery, and for much of that to spill into the rest of Europe.

Sunday Indo Business