Fiddling While Ukraine Burns

KIEV, Ukraine -- Ukrainian politicians have been squabbling over the economy for months, but so far all they've achieved is a refined talent for making each other look the fool.

The foolish rivalry between the former 'Orange' allies has led to policymaking paralysis while inflation soars.

The political buffoonery peaked on 13 May, when legislators loyal to Prime Minister Yulia Tymoshenko thwarted President Viktor Yushchenko's state-of-the-nation address before parliament by physically blocking the speaker's chair. Yushchenko had to cancel the speech.

Tymoshenko loyalists called the confrontation retaliation for the president's efforts to block votes on legislation designed to treat a Ukrainian economy infected with rocketing inflation. For his part, Yushchenko blames the premier's office for inaction on inflation.

Central figures in the 2004 Orange Revolution, Tymoshenko and Yushchenko have since seen their relationship deteriorate. The parliament episode demonstrates the fragility of their coalition at a moment when they should be cooperating to fix, not bickering over, the economy.

Instead, they're racing to blame the other for Ukraine's woes before elections in 2010, when Tymoshenko is expected to vie for the presidency.

But the leaders had better start putting as much energy into reconciling as they have into humiliating each other. "Galloping inflation," as Tymoshenko calls it, threatens to become a millstone around the economy's neck.

It has reached unsustainable levels and will remain high if neglected—and 46 million Ukrainians, some of them voters, will be the ones to suffer.


"[Inflation] breached the 30 percent mark in April, again above consensus and clearly something that policymakers have to tackle immediately," analyst Simon Quijano-Evans of UniCredit told Reuters recently.

That annual figure, the highest in the Commonwealth of Independent States, is largely due to rising global food prices. Today, bread is reportedly 20 percent more expensive than a year ago in Ukraine, and the price of eggs is up 70 percent.

Increasing energy costs, growing consumption driven by rising incomes and the dollar's decline against the euro are also fueling price growth. The cratering dollar is significant because the Ukrainian hryvnia is de facto pegged to the U.S. currency.

This means Ukraine imports the inflation of rising food and energy costs through its dollar peg.

The National Bank of Ukraine has intervened to strengthen the hryvnia by allowing its peg to fluctuate over a wider range against the dollar.

This appears to have helped: monthly inflation fell to 3.1 percent in April from 3.8 percent in March.

Tymoshenko, who's publicly committed to reducing price growth, has made much of this. She said the April figure proves the economy is righting itself, a flimsy assertion that makes the Ukrainian premier Hillary Clinton's top rival for the honor of the world's most skilled politician at recasting modest gains as resounding triumphs.

In reality, the best-case scenario is 20 percent inflation by year-end, so much more needs to be done.

The International Monetary Fund has recommended fiscal tightening, since Ukraine can do little about food or energy prices. The government should run a balanced budget in 2008 and reorient spending from social benefits to things like infrastructure, according to the IMF.

Fiscal discipline, however, has not seemed like either Tymoshenko or Yushchenko's priority recently. Since retaking office in December, the prime minister has backed populist policy initiatives such as wage and social benefit hikes that not only increase state spending but also drive inflation by encouraging consumption.

This comes just as the president is squeezing state coffers by stalling several privatization projects worth billions of dollars. One, the Odessa Portside Plant, Ukraine's largest nitrogen fertilizer and ammonia producer, reportedly has a sticker price of $600 million.

Ukraine is expected to have a budget deficit of around 1 percent of GDP this year. The president blames both it and inflation on Tymoshenko, who maintains she inherited the former prime minister's dysfunctional economy and that Yushchenko is trying to undermine her government.

Nevertheless, it's clear both leaders' policies are contributing to a budget imbalance that will keep inflation high.

On the positive side, economic growth remains robust—the IMF's 2008 forecast is 5.6 percent—and Ukraine's entry into the World Trade Organization this month will invigorate the trade economy.

But, as Fitch Ratings noted when downgrading its outlook for Ukraine from positive to stable 14 May, sustained high inflation will erode the economy. The agency urged leaders to develop a clearer inflation strategy.

Allowing the hryvnia to further appreciate is at the center of any meaningful plan, many economists say. That is largely the domain of central bankers, but the prime minister and president could contribute to a broader inflation-reduction strategy by cooperating to meet the IMF's balanced budget target.

The former allies in the struggle to make Ukraine a more open, progressive country would have to put politics aside to do this, of course. Unfortunately, a lust for power seems to have consumed their commitment to progress.

Source: Business Week


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