Too Much, Too Soon

The International Monetary Fund is giving billions of dollars to Ukraine's cash-strapped government. Will that make the country's new rulers even weaker?

The International Monetary Fund's rescue package for Ukraine, worth up to $27 billion, is good news for the nearly bankrupt country and a potentially huge win for the country's fragile, pro-Western central government. But the belt-tightening the IMF requires could be disruptive as Ukraine tries to move forward and prepare for elections in May -- and it could wind up threatening the survival of the government it is meant to help save.

The IMF reached a tentative agreement with Kiev's new government Thursday that includes $14 billion to $18 billion in aid directly from the IMF and the rest of the $27 billion from individual countries that promised to chip in. But it comes with strings: long-needed, but politically difficult, changes to the Ukrainian economy including cutting energy subsidies, cracking down on corruption, and strengthening the country's banks.

"If the political will is there and you have the population on board for turning the ship that's probably the best thing that you could hope for at the outset," said Heidi Crebo-Rediker, a senior fellow with the Council on Foreign Relations and a former State Department chief economist.

But will the population be on board? Ukrainians took to the streets of Kiev when former President Viktor Yanukovych rejected a European political and economic deal with similar conditions, in favor of a $15 billion no-strings-disclosed deal from Russia. It's not clear that the reverse will be true -- that they will now rejoice at the idea of paying higher taxes and watching their heating bills increase if Kiev removes generous but extremely costly natural gas subsidies.

In addition to raising natural gas prices to market levels, the IMF also wants Ukraine to rein in government spending, be more transparent, and close loopholes that make it easy for officials to hand out lucrative government contracts to their cronies. But cutting natural gas subsidies will likely be the most difficult. Right now the government buys gas from Russia at high prices and then sells it to companies and consumers at low prices, a holdover practice from Soviet days that continuously leaves a gaping hole in the national budget.

Ukraine's leaders, left with little alternative, have agreed to the conditions. "We have no choice but to tell Ukraine the truth," Ukrainian Prime Minister Arseniy Yatsenyuk said Thursday in an address to parliament.

Yatsenyuk said he wouldn't allow the country to go bankrupt and introduced a set of what he called "very unpopular, very complex, hard reforms" to parliament that would raise taxes on the wealthy and big business, as well as on the sale of alcohol and tobacco.

The huge increase in heating bills Ukrainians are set to see over the next few years will be far more painful. State-owned Naftogaz said Wednesday that it would raise gas prices by 50 percent starting May 1, the first of many rate hikes promised between now and 2018 as Kiev tries to close the budget gap left by the heavily subsidized natural gas it sells to its citizens.

Those subsidies eat up about 8 percent of gross domestic product (GDP), a whopping percentage for such a poor country.

The huge amounts of money Kiev is spending each year to subsidize gas sales is a similar problem to the one the IMF has identified in a spate of countries in the Middle East and North Africa, where governments routinely underwrite cheap, domestic energy as a way to placate their citizens -- but at a tremendous economic cost. In both the Middle East and Ukraine, ending those subsidies could curb profligate energy use and restore a measure of fiscal health, but only at the risk of sparking popular anger which could undermine the governments trying to carry out the reforms in the first place.

The IMF wanted Ukrainian leaders to make some changes right away to prove that they're serious. That's because the IMF has started loan programs for Ukraine before and previous leaders have not followed through on changes they agreed to make.

But some observers think the IMF pressed for too much reform too fast and the changes could divide the fragile country.

"I don't think the IMF should have insisted on an immediate rise in the residential price of natural gas in the first place," said Mikhail Korchemkin, the head of consulting firm East European Gas Analysis. "The situation in Ukraine is very unstable and there was no need to destabilize it more by unpopular decisions of the government."

Chris Weafer of Moscow-based consultancy Macro-Advisory said the gas hikes "will be hugely unpopular and are likely to prove very divisive in the upcoming elections." Weafer said the changes could be particularly problematic in eastern Ukraine, a region already on the radar screens of many world leaders because of mounting evidence of a potential Russian invasion.

"A large number of people there are unhappy with the political changes which they see as being imposed on them by Kiev," Weafer wrote in an email. "The austerity measures will only deepen that discontent."

In a way, the IMF's insistence on painful economic reforms is a consequence of its own high-profile, and much-criticized, role in steering other countries such as Argentina through tough times. When depression hit the Argentine economy in the late 1990s, the IMF continued supporting Argentina with loans, even as fiscal discipline and macroeconomic indicators spiraled downward.

While the IMF took plenty of criticism later on for its role in dealing with Argentina's crisis, most notably from Argentine politicians, the IMF's own conclusions about its performance were starkly different. In an internal review, it concluded that it should have attached more conditions, not fewer, to the financing it provided Buenos Aires.

Even then, the IMF concluded in its review, getting political buy-in for its reform program is the starting point for any successful financing package: "It is debatable whether greater structural conditionality -- or stricter enforcement -- would have succeeded in ensuring that structural reforms would be undertaken, given that political consensus and ownership were lacking." That seems to apply as much today to Kiev as it did then to Buenos Aires.

In recent years, the IMF has pushed other struggling countries to quickly implement painful macroeconomic reforms, usually prioritizing fiscal health over economic growth. The IMF's recipe for Spain as it reeled with 25 percent unemployment and a budget deficit near 10 percent of GDP was to slash pensions and accelerate deficit reduction, for example. While the IMF then and now urged deep labor-market reform as a pathway to future growth and job creation, it essentially put austerity at the center of its playbook.

Similar measures have caused political unrest in Greece and other European countries that have needed bailouts during the continent's debt crisis. Yet German Finance Minister Wolfgang Schaeuble said that Greece could serve as a template for a future lifeline for Ukraine.

"If ever we were to reach a situation in which we had to stabilize Ukraine, we would have many experiences from Greece" to draw on, Schaeuble said Wednesday, according to Bloomberg.

The requirements in the IMF deal, which still has to be approved by the fund's board, are the same that were attached to the deal discussed last fall with Yanukovych before his ouster. Russia, which sees Kiev's new government as illegitimate, has since withdrawn all financial support and natural gas discounts, which could make Ukraine's economic recovery even more of a long shot.

"It was difficult enough looking at getting Ukraine's economy back on track without an outside spoiler, so I don't think anybody's underestimating just how difficult this will be," said Crebo-Rediker.



U.S. Intel Sources: Russian Invasion of Eastern Ukraine Increasingly Likely

American intelligence agencies have told Obama administration officials and key congressional staffers that there is mounting evidence that Russia is putting the pieces in place for an invasion of eastern Ukraine, and that the possibility of an imminent assault cannot be ruled out, according to people with direct knowledge of the matter.

The numbers of troops near Russia's border with Ukraine have been steadily increasing since Russian forces conquered Crimea in February. And near Ukraine's eastern border, troops are reportedly being supplied with food and medical supplies, which they would need in the event of further operations -- a development that U.S. intelligence agencies have noted with alarm. On Capitol Hill, U.S. spy agencies have given Congress increasingly dire assessments of the Russian activity and indicated that the likelihood of an invasion is rapidly growing, according to a participant in the discussions who spoke on the condition of anonymity to discuss classified information.

Still, the intelligence officials have been careful not to offer a definitive conclusion that Moscow will invade or to predict the precise timing of a Russian military operation in Ukraine. Assessing the intentions of Russian President Vladimir Putin has been hampered by the fact that the U.S. has alarmingly little in the way of signals intelligence, or intercepted communications, that would indicate that he had decided to invade or when a strike was scheduled to start, one official said. Despite the tens of billions of dollars given to the intelligence community each year, the United States also has no real-time video footage coming from drones in the region and is relying largely on still photos from satellites, another official said.

Further Russian aggression against Ukraine has seemed a distinct possibility since forces stormed into Crimea and took control of the peninsula and then moved to seize Ukrainian military bases in the region, facing practically no resistance. U.S. officials have become increasingly concerned about a potential domino effect in the region should Russian actions against NATO member countries force the alliance to enter the conflict.

"Our concern is that Russia won't stop [in Crimea]," NATO Secretary-General Anders Fogh Rasmussen told Foreign Policy in an interview last week. "There is a clear risk that Russia will go beyond Crimea and the next goal will be the eastern provinces of Ukraine." President Barack Obama has used a trip to Europe this week to warn Putin in increasingly strong language not to invade eastern Ukraine.

Independent reporting from the region bolsters the intelligence community's assessment that Russia was assembling the necessary troops and military resources to invade if Putin gives the order.

On Thursday, Voice of America reported that the Russian military had established a field hospital in the Bryansk region, about 20 kilometers from the Russia-Ukraine border, and that train cars have been arriving near the border with troop supplies. That could mean that Russian forces are just settling in for a long stay -- troops in the field need to be fed, clothed, and tended to when they get sick -- without preparing a strike.

However, two officials said that the intelligence warnings have taken on a more alarming tone in part because the CIA failed to predict Putin's Crimea invasion. At the time, some in the intelligence agencies had determined that Russian forces had no intention of invading Ukraine, despite a massive buildup of troops along the border. That missed call has chastened U.S. intelligence analysts and forced them to reassess their judgments about Putin, one official said.

How the spy agencies failed to predict the Crimean invasion has been a subject of considerable debate in recent weeks. Some officials have claimed that leaks about classified intelligence-gathering methods had given the Russians a roadmap for evading America's surveillance nets. A spokesperson for the Office of the Director of National Intelligence said this week that U.S. adversaries "have 'gone to school' on the leaks of how the United States collects foreign intelligence," referring to disclosures by the former National Security Agency contractor Edward Snowden.

But other current and former officials dismissed the suggestion that Snowden's leaks had helped Russian military forces. One U.S. intelligence official, who asked not to be identified when discussing ongoing operations, said that the Russians practiced superb operational security in the runup to the Crimea invasion, and suggested that the reason so little traffic had been intercepted was because Russian forces were smart enough not to discuss their plans over radios and cell phones, channels that could be spied on by the Americans.

"It looks like the Russians learned from Osama bin Laden and used couriers," said Joel Harding, a former military intelligence officer who worked for the Army's intelligence command and has experience in surveillance operations. "They held access to those with a need to know and exercised strict discipline in communications security. That is the best professionalism I've seen from them ever."

If U.S. intelligence agencies underestimated the skill of their Russian adversaries, they seem determined not to repeat that mistake.

At the Pentagon, there remains confidence in the assurances provided to Defense Secretary Chuck Hagel from Russian Defense Minister Sergey Shoygu that the Russian troops amassing on the border with Ukraine were there only for exercises.

"[Shoygu] told me that they had no intention of crossing the border into Ukraine," Hagel said at the Pentagon this week. But standing beside Hagel in the Pentagon briefing room was U.K. Secretary of State for Defense Philip Hammond, who noted that he thinks Putin alone seems to be driving all the decision-making, and wondered aloud if Shoygu was as trusted a Putin aide and called into question the assurances he is providing the international community.

"Other Russian players, including Minister Shoygu, may express views, but it's a moot point, and we cannot know, we do not know to what extent all of those people are really inside the inner circle in which President Putin is planning this exercise," Hammond said.

On Thursday Pentagon press secretary Rear Adm. John Kirby said "there's no light" between Hagel and Hammond on the issue of trusting Shoygu, saying only that the Pentagon is watching it all very closely -- and hoping Shoygu keeps his word. "I'd say we don't have a full knowledge of their intent," he said. "But regardless of the intent, it does nothing to de-escalate the tension in Ukraine, it does nothing to improve the stability in that part of the world."

Gordon Lubold contributed reporting.