Storm clouds gather over Ukraine – By Alexander Mercouris

As economy sinks Ukraine’s belligerent law on Donbass, point to growing instability and a return to war

In a recent article for The Duran I wrote of how the economic situation in Ukraine appeared once more to be deteriorating, with economic statistics apparently being distorted to conceal the extent of the rise in inflation, making the claimed figure of 2% GDP growth in 2017 unlikely.

In a further sign of a deteriorating economic situation, recent reports from Ukraine speak of rolling electric power blackouts in some regions, suggesting growing energy shortages as the price of oil hikes.

In a symptom of how bad the situation has become, the Ukrainian government has quietly dropped its sanctions prohibiting coal imports from Russia, indicating that Ukraine is being forced to turn to Russia for imports of coal in light of the gathering energy crisis.

In this situation, as Paul Goncharoff has recently pointed out, the decision of the Stockholm Arbitration Tribunal to force Ukraine to resume gas purchases from Gazprom actually helps Ukraine,  since the gas Gazprom is able to supply Ukraine is actually cheaper than the gas Ukraine has up to now for political reasons been buying in Europe.

A further sign that economic pressures are causing a certain return to economic rationality in Ukraine is shown by a recent report from Interfax that Ukraine wants negotiations with Moscow to secure the transit of Russian gas to Europe across Ukraine

Ukraine is ready to discuss future transit of Russian gas following the ruling on their gas contract dispute from the Arbitration Institute of the Stockholm Chamber of Commerce, Naftogaz Ukrainy chief Andriy Kobolev told Interfax during “Ukrainian Breakfast” at Davos.

The government and Energy and Coal Industry Ministry might represent Ukraine at those talks, Kobolev said.

“Naftogaz is ready, but there is one nuance. The government wants to engage in these talks. Therefore, there is the likelihood that [Deputy Prime Minister Volodymyr] Kistion will go to the transit talks together with [Energy and Coal Industry Minister Ihor] Nasalyk,” he said.

Earlier, Vice President of the European Commission in charge of Energy Union Maros Sefcovic invited Russia and Ukraine to discuss with each other future transit of Russian gas through Ukraine following the Stockholm arbitration ruling.

Russia supplied 94 billion cubic meters of gas to the EU through Ukraine last year, witnessing to the importance of this transit route in future.

“I think this can well be considered an achievement, and the massive gas volumes signal that this transit route is very important for Gazprom (MOEX: GAZP) as the supplier, for Ukraine as the transiter, and for the EU as the consumer. I will discuss with him [Ukrainian President Petro Poroshenko] how we will operate after the Stockholm arbitration ruling in order to create a constructive atmosphere in order to be convinced that this transit route will remain an important route for supplies to Europe, that will be sufficient up to 2019,” he said.

Note the heavy lobbying for these talks by the European Commission, which is politically committed to preserving Ukraine’s role as a gas transit state.

Whether the Russians will be prepared to agree to allow Ukraine to remain a gas transit state notwithstanding the Stockholm Arbitration Tribunal’s decision to uphold the provisions of Gazprom’s gas supply contracts with Ukraine’s Naftogaz – which Ukraine had disputed – is another matter.

With project financing for Nord Stream 2 now in place and with construction of Turk Stream already underway there seems no obvious reason why the Russians should continue to transit gas across Ukraine once the present contracts expire.

Having said this, the mere fact that the Ukrainians now say that they are prepared to discuss future gas transit arrangements with Moscow at a government level – suggesting that they are prepared to provide interstate treaty guarantees in order to ensure the safety of Russian gas transiting to Europe – is a sign of the pressure they are now under.  Whether the Russians would accept these guarantees given the total lack of trust they now have in Ukraine is of course another matter.

However the single clearest sign of the growing economic pressure in Ukraine is that Ukraine’s Central Bank – just placed by President Poroshenko under new leadership – has today hiked its key lending rate to 16%.

Here is Interfax’s report about this

The National Bank of Ukraine has decided to hike its key policy rate to 16% per annum, effective from January 26, the NBU said in a press release.

“The tighter monetary policy will help decrease the inflation and bring it back to the target range in the middle of 2019,” the NBU said.

“In 2017, headline inflation reached 13.7%, exceeding the target of 8% ± 2 pp set for the National Bank of Ukraine in the Monetary Policy Guidelines for 2017 and Medium Term,” it said.

“Inflation sped up to 12.4% compared to 2016, mainly due to factors on which monetary policy tools have only a limited effect. In particular, acceleration of inflation was mainly driven by a decrease in the supply of some foods resulting from the unfavorable weather conditions seen in the first half of last year, the unstable situation in animal breeding, and a rise in the global prices of, and demand for, Ukrainian foods, mainly meat and dairy products,” the NBU said.

“An increase in production costs, especially labor costs, and fast recovery of consumer demand also contributed to the growth of prices,” it said.

“In addition, the end of last year saw an increase in hryvnia exchange rate fluctuations and a noticeable easing in fiscal policy, thanks to, among other things, sharp increase in pension payments and budgetary spending being unevenly distributed over the year. This increased underlying inflationary pressure, as evidenced by a rise in core inflation, to 9.5% in December, and high inflation expectations. As a consequence, the deviation of inflation rate from the target was larger than the NBU anticipated in its October 2017 Inflation Report,” it said.

This is the NBU’s third rate hike in almost as many months: the rate went up from 12.5% to 13.5% in October 2017 and was raised to 14.5% in December. The NBU had lowered the rate prior to that.

This surge in interest rates – with the key lending rate rising from 12.5% to 16% in three stages over just three months – may be a further sign that the official inflation rate of 13.7% in 2017 is too low, and that the true inflation rate in 2017 was higher, and was really 16-17% as various Russian commentators are speculating.

Note that the Central Bank’s target range for inflation – 8% + – 2pp – is still by international standards very high, and the Central Bank does not now expect to achieve it before the middle of 2019.

I would add that if the true rate of inflation in Ukraine really is higher than is being reported, and was closer to 16-17% than 13.7% in 2017, then interest rates in Ukraine may before long rise still further.

This is happening alongside an increase in the financial burdens being borne by the Ukrainian economy.

The Central Bank’s claims that the surge in inflation in 2017 is the result of higher demand for Ukrainian foodstuffs against the backdrop of tough agricultural conditions caused by poor weather in the second half of the year has very much the look of special pleading and of an attempt to give a positive spin (“Ukrainian food products are in high demand”) to what is unequivocally bad news.

It seems inherently more likely that the inflation pressures within Ukraine in 2017 were caused by the rise in oil prices, the knock on effect of the blockade of the Donbass, the continued fall in production of Ukrainian finished goods, and the fiscal loosening which the Central Bank says took place towards the end of the year, which is not backed by goods or services but which Poroshenko’s government nonetheless resorted to in order to buy off growing political opposition within Ukraine from the population by increasing its pension and benefit payments.

On top of this Ukraine is now expected to make payments to its external creditors of $20 billion over the next two years.  Others put the total amount of external payments even higher, saying that they will average out at $14 billion each year over the next two years.

To these must now be added the $5 billion the courts in London and Stockholm have now said Ukraine must pay Russia and Gazprom.

In addition the government’s seizure of Kolomoisky’s Privatbank has apparently exposed a $5 billion hole in the bank’s accounts – something which will surprise no-one – with further reports that large quantities of funding provided Ukraine by the IMF cannot be fully accounted for and may have been misappropriated, something which if true will not surprise anyone familiar with the situation in Ukraine either.

Though this is a terrible situation, it should not be an irretrievable one.  Many of Ukraine’s worst problems are self-inflicted and a return to rational decision making would quickly cause them to abate.

Putting to one side the question of corruption, which is a very serious in Ukraine but which is also one which is both longstanding and intractable, it should be obvious that Ukraine’s economic problems over the last three years are the direct consequence of its conflict with Russia.

Not only has this upset much of Ukraine’s population, resulted in a civil war which has resulted in the loss of much of the Donbass – Ukraine’s industrial heartland and its economically most productive region – but the severing of economic links with Russia and the feckless spending on the military in a confrontation which can never be won are placing burdens on Ukraine’s economy which it simply cannot carry.

A reversal of these foolish policies is what Ukraine urgently needs if it is to achieve an economic stability which is sustainable.

The trouble is that despite the occasional glimmers of rationality of the sort discussed above, this would involve adopting the opposite course to the one which Ukraine’s Maidan establishment is determined Ukraine should follow.

This the background to Ukraine’s extraordinary and deeply alarming new Donbass integration law, which in flagrant violation of the Minsk Agreement treats the territories of the Donbass and Luhansk People’s Republics as territory occupied by Russia – denying the reality of Ukraine’s civil war – and which converts Ukraine’s military campaign against the two People’s Republics from an already grossly misnamed “anti-terrorist operation” into a self-depicted military conflict with Russia.

In other words instead of looking for ways to end the conflict in the Donbass and to mend relations with Russia – which is what Ukraine urgently needs if its economy is to stabilise – the Maidan establishment in Kiev is set on doing the opposite, and has embarked on path which can logically only lead to more war.

Anyone familiar with the Maidan movement ought to know by now that this is its invariable response when it comes under pressure.  Instead of moderating its course and adjusting itself to the prevailing realities, its invariable response when it comes under pressure is to intensify its course still further.  As it drives towards the cliff edge, its impulse is to slam down the accelerator instead of the brake.

Behind this there may be a calculation by some people within the Maidan movement that greater confrontation with Russia is the way to rally support for Ukraine in the West, with the hope that if the conflict in the Donbass escalates funding from the IMF and the European Union – which has now stopped – will resume.

However it is probably a mistake to look for much calculation in these decisions.  My impression is that hostility to Russia on the part of the Maidan movement and its supporters is so hardwired into their conditioning that their actions are largely visceral, and have little calculation behind them.

How else to explain their bizarre decision to mount a totally counter productive economic blockade of the two People’s Republics which even Anders Aslund, one of their staunchest supporters, says was misguided and which was one of their actions last year which now has him wringing his hands in despair (see my article here)?

In the meantime the responsibility of Ukraine’s Western allies for this darkening picture cannot be overstated.

Though it is Ukraine not Russia which is openly and flagrantly violating the Minsk Agreement – Russia is not a party to the Minsk Agreement, merely its guarantor – the European Union continues to reward Ukraine for its ever grosser violations of the Minsk Agreement by prolonging the sanctions against Russia.

It does so on the completely illogical premise that it is Russia – which is not a party to the Minsk Agreement – which is responsible for its implementation rather than Ukraine.

This policy is so absurd that it is has been coming under growing criticism across Europe, with the right wing parties which now look set to win the March parliamentary elections in Italy calling it  irrational – which it is – and committing themselves to reversing it by vetoing any further extension of the sanctions if they win the elections.

However both of the parties that currently form Germany’s failing ‘grand coalition’ government – Angela Merkel’s CDU/CSU and the SPD – remain committed to this ‘irrational’ policy even though it is known that many senior members of both parties are filled with doubts about it.

Compounding this folly was a recent disastrous visit to Ukraine by Germany’s Foreign Minister Sigmar Gabriel over the course of which he publicly endorsed Ukraine’s call for a peacekeeping force to be deployed across the whole of eastern Ukraine in order to bring the territory of the two People’s Republics once more under Kiev’s control.

The Russians have repeatedly and publicly ruled out this proposal – Lavrov has just said in response to Gabriel’s comments that the proposal is intended to ‘strangle’ the two People’s Republics and is therefore unacceptable to Russia – but Gabriel appears to have deluded himself that it was a route to ending the conflict so as to get Germany off its own self-inflicted sanctions hook.

In reality, by endorsing a Ukrainian proposal the Russians have repeatedly and publicly rejected Gabriel has only managed to increase Russian suspicions of German intentions whilst giving further encouragement to the Maidan hardliners in Kiev.

However Gabriel’s folly has been far capped by that of the US administration with its recent reckless decision to supply Javelin anti-tank missiles to Ukraine.

In a recent article published by The Duran on 26th December 2017 I discussed the extraordinary folly of this decision and the high probability that it will spur on the Maidan hardliners to launch more attacks on the two People’s Republics in eastern Ukraine in the coming months.

In that article I also said that the Javelin anti tank missiles do not provide the ‘magic bullet’ that will give the Ukrainians the superiority over the armed forces of the two People’s Republics that the Ukrainians themselves and many others appear to imagine.

Since that article I have read various discussions of the Javelin anti tank missile on the internet which suggest that it is not only difficult to use but very vulnerable to counter measures of a sort that the armed forces of the two People’s Republics – by now well trained and advised by the Russians – would have no difficulty implementing in response to it.

One discussion of the Javelin anti tank missile I have read by a seemingly well-informed military technology commentator from New Zealand even said that the result of these very simple counter measures would not only nullify the Javelin anti tank’s missiles supposed advantages but would render it less effective than the Russian Metis-B missile, which costs fifty times less.

Even if these criticisms of the Javelin exaggerate the Javelin anti tank missile’s weaknesses, the underlying point I made in my article still stands: supplying Javelin anti tank missiles to Ukraine in whatever quantity cannot change the overall military balance on a battlefield in eastern Ukraine where former US President Obama admitted the Russians will always have “escalatory dominance” over the US.  It will however encourage the Maidan hardliners in Kiev to think that if Ukraine attacks the two People’s Republics it will have US support.

Overall it is difficult to look upon the emerging situation in Ukraine this year with anything other than a profound sense of foreboding.

The risk of further war in Ukraine has always been high.  Indeed a crisis atmosphere and lawlessness and armed conflict have been Ukraine’s continuous reality ever since the Maidan protests turned violent in December 2013.

With the political and economic situation in Ukraine steadily deteriorating, and with the Western powers once again doing everything possible however thoughtlessly to aggravate the process, the country seems to be slipping back towards war.

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