How Debt Is Driving The Ukrainian Crisis

CREDIT: AP Photo/Mindaugas Kulbis

Demonstrators gather outside the Russian Embassy in Lithuania to protest against Russian intervention in Ukraine

Riots in European streets have become a common sight for cable news viewers in recent years. And while the threat of war makes Ukraine’s current standoff with Russia something different and scarier, the tense situation in eastern Europe is a product of some of the same basic economic factors underlying those other, more limited scenes of unrest. Ukraine’s debts and the economic policymaking paralysis that has kept Kiev from resolving them in recent years are some of the key drivers of the tug-of-war over the country between Russia and the European Union. With billions of payments coming due soon, Ukraine must choose which of its neighbors will rescue it from a catastrophic default.

The protests and violent clashes in Ukraine began when then-president Viktor Yanukovych suddenly backed away from an economic and political allegiance with the European Union late last fall. But the debt cycle that drove Ukraine to seek such an arrangement with its neighboring economic powers long predates the public unrest that led to Yanukovych’s ouster. Ukraine has faced crisis-level national debt payments for several years now, and on two separate occasions the International Monetary Fund (IMF) has extended a bailout package to the country, only to cancel it when Kiev authorities failed to meet requirements in the deals. The nature of those failures echoes the situations in numerous other high-debt European nations in recent years.

At the height of the global financial crisis in 2008, the IMF extended a nearly $17 billion bailout to Ukraine on the condition that it would work toward balancing its budgets. The Fund froze the payments a year later after Yanukovych increased wages and pension benefits for workers during an election campaign, violating the balanced budget pledge attached to the money.

The first bailout was replaced by a new, slightly smaller package in 2010, and this time Ukraine agreed to balance budgets and allow its currency to fluctuate freely in value rather than artificially inflating its exchange rates. But a year later, Ukraine’s leaders had violated IMF terms again and the second bailout package stalled.

Without the 2008 collapse, which undermined the price Ukraine gets for its steel exports and exacerbated the country’s inflation problems, the country might never have needed international rescue packages. But the credit crunch brought on by the crisis helped turn the country’s high natural gas costs into an unpayable burden. Ukraine imports its natural gas from Russia at an extremely high price compared to the rest of the natural gas market and its gas utility routinely runs far behind on payments to the Russian monopoly Gazprom that supplies the fuel. Ukrainians pay just 20 percent of their fuel bills with the government financing the other four fifths, which means that most of the roughly $20 billion in debts it must pay or refinance over the next two years is tied back to the cost of Russian natural gas. The tussle over back payments to Gazprom is a major driver of tensions with Russia, and the artificially high price used for the fuel in deals between Ukraine and Gazprom facilitates corruption in both countries. “Simply put, powerful Ukrainians and Russians skim billions of dollars a year through opaque financial arrangements between the two countries,” as Quartz’s Steve LeVine puts it.

That corruption, coupled with past failures to honor the terms of international financial aid, leave Western authorities reluctant to simply bail Ukraine out of its current crunch. European authorities had hoped instead to draw Ukraine into closer economic ties with its western neighbors. The EU offered an “association agreement” that would have eliminated tariffs and opened European markets to Ukrainian exports, expecting that the major boost in growth that Ukraine would enjoy from such an opening would help resolve its debt problem. After Yanukovych rejected that deal, Russia not only dropped the threat of raising gas prices but extended a $15 billion bailout to Kiev.

Without the threat of default on its debts, Ukraine would have been able to continue playing Russian and European interests off of one another and profiting from its role as natural gas go-between for Moscow and western European powers. But because it faces the risk of default and economic collapse, Ukraine finds itself choosing economic sides between its largest neighbors.

But regardless of the outcome, Ukraine will find itself facing the same economic hardships that have rocked relatively more stable places like Greece, Portugal, and Ireland, such as steep cuts to public services and other economic shocks. Those austerity measures have driven Greece to the brink of collapse and deepened its economic woes far more than international authorities had promised. Ireland has finally emerged from its austerity years, much the worse for wear but with brightening future prospects. Portugal and other smaller struggling nations won concessions from the bailout authorities that are helping buffer working people from further hardship. But as brutal as the debt resolution process has been in those states, none has raised the prospect of an actual war.