Perils of Ukraine’s revolution
A window has opened in Ukraine but Western aid to the new pro-EU rulers will hinge on tough reforms, and Russia is leaving us guessing
At a time when cynicism and scepticism about European integration are at a record high, the drama unfolding in Ukraine is a salutary reminder that the values of freedom, democracy and the rule of law remain a beacon of hope to many in post-Soviet Eastern Europe.
Ukraine, the largest country in Europe by land mass, whose 46 million-strong population has been split between a European-leaning west and a Russia-leaning south and east ever since the country became independent in 1991, has just undergone a revolution.
This is its second in 10 years, following the 2004 "Orange Revolution", which failed to act as the catalyst many had hoped it would be for a much need-ed reform and modernisation of Ukraine's woefully ineffic-ient and corruption-ridden economy.
After street battles in Ukraine's capital Kiev last week, in which scores of people were killed as opponents of the former Russia-friendly regime of Viktor Yanukovich were pitched against rooftop snipers allegedly linked to special forces troops, a new pro-European Union government is beginning to take shape as fears of a disorderly debt default grow.
But will a renewed westward shift in Ukrainian foreign policy succeed in integrating the former Soviet state much more closely with the EU, or will Russia, whose political and economic influence over the country remains significant, undermine such a move and potentially trigger the country's disintegration? The stakes are extremely high for Ukraine, the EU and Russia.
The fallout from a geopolitical tug-of-war between the West and Russia over the fate of Ukraine could prove extremely damaging at a time when emerging markets are under severe pressure and the EU is still reeling from the crisis in its 18-member single-currency area.
The reaction on the part of Russia, whose foreign ministry has denounced the change of regime in Ukraine as a Western-sponsored coup and has put its own aid programme for the country on hold, is of particular concern.
Although Crimea, the peninsula of Ukraine on the northern coast of the Black Sea which has strong cultural and political ties to Russia, is emerging as a flashpoint in geopolitical tensions over Ukraine, Moscow has little to gain from a civil war in its neighbour.
A more sensible approach for Russia to adopt would be to allow the International Monetary Fund and the EU to take charge of the financial rescue of Ukraine while at the same time pushing for a more decentralised Ukrainian state in which Russian-leaning regions are granted more autonomy.
The last thing Moscow needs right now is for market sentiment towards Russia, which has deteriorated markedly this year, to worsen further because of heightened tensions over Ukraine.
Russia's currency, the rouble, is the second-worst-performing major emerging market currency this year after the Argentine peso, sliding around 8 per cent against the US dollar.
Russia has had to go so far as to cancel some of its recent auctions of government debt because of poor demand for its rouble-denominated bonds. The yield on benchmark Russian 10-year domestic debt has risen 25 basis points in the last two weeks to 8.25 per cent.
More worryingly, growth has collapsed, with investment contracting 7 per cent on an annualised basis in January. Alfa Bank, a Russian bank, believes Russia's economy may have shrunk last month after growing a meagre 1.3 per cent last year.
If Russia ends up intervening in Ukraine, possibly by lending its support to separatist action, this would be the clearest indication that the Kremlin's geopolitical sensitivities are more important than financial and economic stability - a worrying thought.
The other big concern is whether Western aid to Ukraine will come quickly enough.
Ukraine's plea for hefty bilateral loans from the US and Poland within the next fortnight smacks of panic.
The Institute of International Finance reckons Ukraine's foreign exchange reserves have dropped to a dangerously low US$12 billion. Given that it needs to repay US$13 billion this year, according to ratings agency Standard & Poor's, Ukraine is desperately in need of swift financial aid to avert a default.
Yet this is where things get even messier.
The IMF has made it clear that it will only disburse funds if a new pro-EU government grasps the nettle of fiscal and structural reform, which would involve scrapping energy subsidies and undertaking a sharp devaluation of Ukraine's currency, the hryvnia.
Such reforms would be politically feasible only if the EU were to dangle the prospect of membership of the bloc in front of Kiev - an extremely contentious issue given enlargement fatigue within the EU and persistent doubts about Ukraine's political, institutional and economic preparedness for meaningful reform.
What's clear is that a window of opportunity for radical economic change has reopened for Ukraine. Whether a new government is able to seize it is another matter.
Nicholas Spiro is managing director of Spiro Sovereign Strategy