Black clouds over Ukraine

In earlier postings, I have speculated on what a bailout by the International Monetary Fund (IMF) would be Ukraine's economy and people. But the situation has deteriorated and getting to the problems associated with the IMF is a long shot.

Right now, The Kiev government and the West nations are wondering about Russia's intentions. And beyond that, could Russia's intentions have 'unleashed' tensions internally that cannot be controlled? Today, the three most likely outcomes are: Russia continues its annexation of land on its borders; Russia is content with annexing Crimea but a civil war encompasses the rest of Ukraine, or things settle down and the IMF program is implemented.

What Does Putin Want?

So before getting to the IMF agreement, let's use history to speculate on what Putin's intentions are and what the West could do to put him at ease. Return to the Cold War: The USSR's 'bloc' included the former members of the USSR: Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Tajikistan, Turkmenistan, and Uzbekistan. It also included: Albania, Bulgaria, Czechoslovakia, East Germany, Hungary, Poland, and Romania, and the former members of the USSR.

Does Putin need to re-establish the USSR? He might. But it is out of the question. Certainly Azerbaijan, Bulgaria, Estonia, Georgia, Hungary, Latvia, Lithuania and Poland would have absolutely no interest in such an alliance.

Western attempts to 'recruit' these countries have made Putin uneasy. Why has the West done this? A continuation of Cold War politics? Well, it has failed. Why not let allow Russia to have its sphere of influence, including Ukraine? At this point, Western nations have staked too much on a Ukraine 'democracy' to pull back. So Putin's intentions will remain a real danger, threatening an armed conflict with the West.

Russia is satisfied but….

Let us suppose Russia is satisfied with seizing Crimea for the moment. It is quite possible that Russia's actions have already let 'the genie is out of the bottle' and a Ukrainian civil war will ensue. History has many stories of people who dislike one another being kept at peace by a dictator, e.g., Tito - Yugoslavia, Saddam Hussein - Iraq. But once they were gone, civil wars took place. Think of Russia as the 'dictator equivalent' that has kept Ukraine at peace. Once the dictator is gone, chaos - a civil war. And the history of civil wars is not good. All out civil war is close in Ukraine.

But let us stretch credulity further; suppose that somehow Russia is satisfied and the citizens agree to decide their future at the polls. We then have the IMF agreement. What would it mean?

What has happened in Greece is instructive here. In order to get IMF funds, Greece had to reduce its government deficit. So under pressure from the IMF and Germany, the Greek government deficit fell from 15.6 percent of GDP in 2009 to a projected 3.3 percent this year. It was understood that this deficit reduction would reduce purchasing power and increase unemployment. In fact, the IMF did a study of fiscal actions taken to reduce government deficits in 15 advanced countries in the 1980-2009 period. It concluded: a fiscal consolidation equivalent to 1 percent of GDP led on average to an increase of 0.3 percentage points in the unemployment rate.

What actually happened in Greece? Its unemployment rate was 9.46 percent in 2009. It is now over 27 percent!

The bearer of bad news?

So how is what happened in Greece applicable to what can be expected in Ukraine? Details of the reforms the IMF will insist on are not yet publicly known. But the leader of the IMF mission to Ukraine highlighted the following at a recent press conference:

· The IMF program will require a reduction in the government deficit;

· The currency peg will have to be removed so the Ukraine currency will weaken;

· Energy subsidies will be reduced/eliminated.

Those actions will not come without consequences: First, a government deficit reduction can only happen via lower government expenditures or higher taxes, both of which will reduce aggregate demand and increase unemployment. Second, in recent months, the Hryvnia (Ukraine currency - UAH) has weakened against the US dollar. Ukrainians now have to pay 12 UAH for every US dollar whereas a few months ago, a dollar only cost them 8 UAH. This means Ukrainians have to pay more for imports, thereby reducing available purchasing power for other goods causing unemployment to rise. And third, lower energy subsidies will also mean a reduction in purchasing power and higher unemployment.

FocusEconomics estimates that Ukraine's fiscal deficit now exceeds 5 percent. It estimates that the country's unemployment rate is 8 percent. Implementation of the IMF agreement will cause it to rise substantially. And keep in mind that Ukraine is effectively 'at war' now. That is never good for an economy: FocusEconomics reports on what a number of international banks and other institutions are predicting for Ukraine - one prediction is that investment will fall by 11 percent. It will probably fall more.

In short, implementation of the IMF program in the context of an already slumping economy will make matters worse. And this will mean serious problems for a new government trying to curry favor from its citizens.

There does not appear to be a good outcome for Ukraine: Putin's intentions are not clear. Even if he is happy with Crimea, a Ukrainian civil war likely. And even if the IMF gets to implement its program, the government will become extremely unpopular, even in the western parts of the country.

Elliott Morss has spent most of his career teaching and working as an economic consultant to developing countries on issues of trade, finance, and environmental preservation. For several years, he worked in the Fiscal Affairs Department of the International Monetary Fund. He later helped establish Development Alternatives, a firm that became the largest contractor to the US foreign assistance program (AID). Since his first IMF assignment in Ghana in 1966, he has worked in 45 countries.