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Economic Growth of Ukraine Depends on Completing Pending Reforms Quickly

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Ukraine’s economy grew by 2.5 percent in 2017, the second year of modest growth, according to the World Bank’s latest Ukraine Economic Update.  Growth in manufacturing, services, and construction was robust, but weaknesses in the agriculture and mining sectors, together with delays in key reforms to further strengthen investor confidence contributed to the modest overall growth performance.

“Faster growth is needed to improve living standards for the people of Ukraine who continue to hurt from the economic crisis of 2014-2015,” said Satu Kahkonen, World Bank Country Director for Belarus, Moldova and Ukraine. “This will require decisive measures in the next few months to complete pending reforms to bolster investor confidence and safeguard macroeconomic stability.”

Economic growth is projected at 3.5 percent in 2018 if pending reforms in anticorruption, land markets, state-owned banks, and privatization can be advanced in the next few months. This would provide an important signal to investors. If reforms are delayed, growth could drop below current levels in an uncertain macroeconomic environment as financing risks rapidly increase.

Ukraine faces major financing needs to repay public debt and fiscal pressures from higher public sector wages and social benefits in 2018 and 2019. Mobilizing adequate international financing by completing pending reforms in the months ahead will be important to maintain macroeconomic stability.

Meeting the fiscal deficit target of 2.5 percent of GDP in 2018 will require improving targeting of housing utility subsidies, making further wage increases contingent on measures to optimize the school and hospital network and public-sector staffing, and identifying affordable options to update public sector pensions.

Fiscal Pressures and Reform Options …

According to the World Bank’s Special Focus Note on fiscal pressures and reform options, Ukraine has made progress in reducing its large public spending since 2014. However, sustaining these gains while also improving the effectiveness of public services will require implementation of reforms in education, health, public administration, pensions, and social assistance in a fiscally affordable manner.

Public expenditures increased significantly in 2017, by 11.7 percent in real terms, reaching 41.5 percent of GDP, due to the doubling of the minimum wage and over 40 percent increase in wages of teachers and doctors. Spending on social programs also increased.

The recently adopted reforms in education, health, and public administration seek to improve compensation for teachers, doctors, and public servants to strengthen incentives and attract quality personnel. Achieving this in a fiscally affordable manner will require coordinating further increases in salaries with time-bound measures to optimize staffing and the school and hospital network.

The social assistance package in Ukraine is not only fiscally costly—costing 5 percent of GDP in 2017, but is also poorly targeted—with only 30 percent of assistance going to the bottom 20 percent of the population. Fixing this will require improved targeting of the large HUS program.

The recently adopted pension reform helped improve adequacy of benefits and stabilize fiscal costs. Additional initiatives going forward should avoid undermining these core objectives of the pension system. The timeline to create a funded pillar system by January 2019 needs to be reconsidered since this will undermine contributions to the pay-as-you-go system, create contingent fiscal liabilities, and face inadequate availability financial instruments.

Background

Since May 2014, the World Bank Group has provided a total of more than US$5 billion to Ukraine (including 4 development policy loans, 7 investment operations and 1 guarantee) from the International Bank for Reconstruction and Development (IBRD).

The World Bank’s current investment project portfolio in Ukraine amounts to US$2.5 billion.  Investments support improving basic public services that directly benefit ordinary people in areas such as water supply, sanitation, heating, power, roads, social protection and healthcare, as well as private sector development. Since Ukraine joined the World Bank in 1992, the Bank’s commitments to the country have totaled over US$12 billion in about 70 projects and programs.

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Eastern Europe

South Caucasus: Prospects and challenges

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During an online conference on the current situation in the South Caucasus, hosted by Rossiya Segodnya news agency, the executive director of the “Eurasian Development” center Stanislav Pritchin and Alexander Karavayev, a researcher with the Russian Academy of Sciences’ Institute of Economics, presented their joint report on the “Settlement of the Armenian-Azerbaijani conflict and the development of the South Caucasus: prospects and challenges.”

Earlier, Russia’s Foreign Minister Sergei Lavrov met with his Azeri and Armenian colleagues on the sidelines of the meeting of the Council of Foreign Ministers of the CIS to discuss humanitarian and economic issues related to Nagorno-Karabakh. They noted that the Russian-mediated ceasefire agreement in Nagorno-Karabakh, signed on November 9, 2020, was the first document in many years to tackle systemic issues of settlement and offer a primary plan for normalizing relations between the conflicting sides.

During the online conference, Stanislav Prichin and Alexander Karavayev outlined potential areas of cooperation in various fields and identified the role of external actors, primarily of Russia and Turkey, in realizing the existing potential. They also analyzed the prospects of economic development in the South Caucasus.

Stanislav Pritchin said that the idea of writing the report came right after the signing of the peace accord in Nagorno-Karabakh. In addition to the usual collection of information, several roundtables were held, attended by Russian experts, and Armenian and Azerbaijani specialists were polled and asked the same questions. Naturally enough, Baku and Yerevan had diametrically opposite views of the results of the ceasefire agreement, with  Azerbaijan seeing them as a reflection of the changes brought about by its military victories, while Armenia views them as a major defeat that forced it to make major concessions. There was even talk about the resignation of Prime Minister Nikol Pashinyan and his government. Pashinyan has so far managed to stabilize the situation, with early parliamentary elections slated for this coming summer, which will most likely keep him in power. Polls also showed that even if Pashinyan’s party loses out, Armenia will still be forced to comply with the terms of the agreement simply by virtue of its position. Indeed, Yerevan has been quick to give the Akdam, Geybaldar and Lachin regions back to Baku.

Speaking of risks and challenges, the expert noted that we are primarily talking about domestic political risks both in Armenia and Azerbaijan, as well as external ones – exacerbation of contradictions between outside players and, finally, the danger of a new conflict flaring up directly between Yerevan and Baku. … First of all, Armenia finds itself in the former group of risks. A  survey of experts done in February showed that 67 percent of respondents  believed that Nikol Pashinyan would not stay in power, while only 33 believed he would. The situation in Azerbaijan is calmer: they expect Armenia to fulfill all the terms of the trilateral agreement. By the way, Azerbaijan has a lot of work to do to restore the region’s infrastructure and resettle the refugees, which will prove a heavy burden on the country’s budget.

As far as external risks go, the gravest concern is the regional rivalry between Russia and Turkey. Seventy-two percent of the Armenian experts surveyed believe that this is fraught with destructive consequences, and only 28 said that Russian-Turkish interaction will help stabilize the region. The overwhelming majority of Azeri experts have no problem with the Russian and Turkish influence on the peaceful settlement in Nagorno-Karabakh. The role of the OSCE Minsk Group in the settlement of the Karabakh problem is assessed differently in Armenia and Azerbaijan. While the Armenians pin hopes on the Group, the Azerbaijanis do not see any benefit from it.

The status of the Russian peacekeepers, who will stay on in the conflict zone for the next five years, is an important issue. Their mandate will automatically be renewed if it is not objected to by either side. As of now, 42 percent of Azeri experts believe that five years from now the mission of the Russian peacekeepers will be over. Just as many believe that they will still be needed, and 16 percent said that it will depend on the situation. In Armenia, 85 percent of respondents answered that five years from now the presence of Russian peacekeepers will still be needed.

The dispute between Armenia and Azerbaijan over Nagorno-Karabakh remains the biggest sticking point, with Azerbaijan considering this territory as its own, which is confirmed by the relevant resolutions of the UN Security Council issued in the wake of the Soviet breakup. The Armenians, conversely, believe that even after the conclusion of the November trilateral agreement, Nikol Pashinyan does not recognize Azerbaijan’s right to Nagorno-Karabakh. A survey of the two countries’ experts showed that in each of them the absolute majority – more than 80 percent – thinks that within the next five years the status of Nagorno-Karabakh will not acquire a mutually acceptable legal form. Pritchin also considers the problem of border delimitation in disputed territories as being intractable.

Wrapping up the political section of the report, Stanislav Pritchin outlined three possible scenarios of political development in the South Caucasus: negative, neutral and optimal. In a negative scenario, one or more parties opt out of the trilateral accord. According to the neutral scenario, some of the provisions of this agreement will be implemented, while some will not. The positive scenario sees the implementation of all provisions by all the signatories to the deal. The majority of experts in Armenia (about 80 percent) and a significant number (over 40 percent) of those in Azerbaijan, gravitate towards the second, neutral variant.

The economic part of the report was presented by Alexander Karavayev, who emphasized that it is for the first time in 30 years that a post-Soviet state is restoring its territorial integrity, including in economic terms. Not only did the territory of Nagorno-Karabakh suffer from the ethnic conflict of 1991-92, but it was not developing economically and did not have any investment status. The development took place only at the microeconomic level; there were no large-scale recovery programs sponsored by the state, including those aimed at luring major foreign investors. Karavayev warns that given the enormity of the tasks at hand one should not expect any quick results – we are talking about a decade, no less.

The Azeri leadership has outlined the first stage of restoration to run until 2025. In 2021, US 1.3 billion will be allocated for the reconstruction of energy facilities, the construction of roads, trunk infrastructure, including the creation of transit transport communications across the territory of Armenia and Nagorno-Karabakh. To fill them with goods, Armenia, as the party that has suffered the most from the conflict, must see the prospects for making up for the losses. This could be achieved through exports, primarily of raw materials, such as copper ore and rare earth and precious metals (molybdenum, gold, etc.). In practical terms, the export of raw materials from Armenia to Mediterranean ports would be facilitated by modernizing the old Soviet railway via the Nakhichevan autonomous region to the Turkish port of Iskenderun, where there is a terminal of the Magnitogorsk Iron and Steel Works. Alexander Karavayev warned, however, that the implementation of large-scale economic projects would attract big investors and competition between them could stir up contradictions between large regional players. He still believes that “the game is worth the candle.”

The main conclusion that can be drawn from the report is that the signing of the trilateral agreement has opened a “window of opportunity” for the gradual normalization of political and economic relations between Armenia and Azerbaijan, including the settlement of the situation in Nagorno-Karabakh.

From our partner International Affairs

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A Grey Swan: Is There a New Conflict in Donbass?

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The prospect of a new exacerbation in Ukraine’s Donbass region has worried market players. It is difficult to talk about the strong influence of bellicose statements on the currency and stock markets. However, investors have again started talking about “geopolitical risk”. The key concern stems from the fact that the resumption of a large-scale armed conflict will inevitably lead to new sanctions against Russia. Moreover, the scale of such restrictions is difficult to predict, which gives rise to the uncertainty of expectations. Should strict sanctions be viewed as a baseline scenario? What is to be expected from the development of the situation?

Ceasefire violations in Donbass were already evident in winter. The ceasefire has been in effect since July 27 last year. However, on March 31, in the Contact Group on Conflict Resolution, the Ukrainian side raised the issue of a new ceasefire statement. In fact, this meant that Kiev considered the existing agreement invalid, citing cases of shootings and military losses. Moscow criticised this initiative. All this is happening against the background of the concentration of Ukrainian troops in the conflict zone. Russian troops are also moving to the state border. Statements by Ukrainian officials, who cited a conversation between ministers, about US support in the event of a war with Russia, added fuel to the fire.

A military exacerbation may well be viewed as one possible scenario. At least it is not devoid of precedent. During the August 2008 war in in Georgia, Mikheil Saakashvili launched a military campaign, citing the support of the United States, among other things, as one of his motivations. Later it turned out that such support was only conditional, but confidence in it could become a trigger for radical decisions. There is also the experience of the recent war in Nagorno-Karabakh. For a long time it was believed that it would be difficult for both sides to win in the conflict. As a result, Azerbaijan won a victory using new tactics: with the help of unmanned aerial vehicles. Ukraine also plans to use Turkish drones, although they have not yet appeared in large quantities in service in the Armed Forces of Ukraine. Kiev may also believe that a new conflict will have a high cost for Russia. Even in the event of the defeat of the Ukrainian Armed Forces, Moscow is unlikely to go beyond the existing boundaries of the DPR and LPR. New sanctions will be imposed against Russia. Perhaps the Ukrainian leadership also hopes for good luck. Even tactical successes in Donbass will strengthen the Ukrainian position.

However, this scenario is still extremely risky for Kiev. In recent years, Russia has shown that it is ready to take decisive action. Force can be used without undue hesitation. Moscow understands that the West will side with Ukraine in any scenario. But political support is one thing, and military intervention is quite another. The United States and its allies are unlikely to agree to such an intervention. Even the supply of lethal weapons will have its limits. Without a doubt, they increase the combat readiness of the Armed Forces of Ukraine. However, they are unlikely to allow it to achieve qualitative and quantitative superiority, even on the scale of the alleged theatre of military operations. The Russian army has undergone a high degree of modernisation. It is capable of rapidly concentrating well-trained and well-armed small units, units and large units. The threat of sanctions will also fail as a deterrent. There’s no doubt they will damage the economy. However, Moscow is unlikely to be stopped if it comes to a military conflict. In addition, Russia has a certain amount of space to vary the degree of its involvement. It can range from active support of the forces of the LPR and DPR to direct involvement in the conflict and the defeat of the Armed Forces of Ukraine in the conflict zone.

Apparently, the Ukrainian leadership does not intend to bring the matter to a direct clash. It is escalating the situation, trying to attract the attention of Western partners and gain points for the future. Most likely, the Kiev authorities initiated the current manoeuvres of their own accord, and they are not the result of the “insidious game” of the West. However, the American and EU diplomats may well use such manoeuvres to put pressure on Russia. The main threat is the loss of control over the situation, should the symbolic whipping turn into a real conflict.

In the end, full-scale military operations in Donbass in the near future are not the baseline scenario. Russia is a strong adversary; the risk of big losses for Ukraine are great. Accordingly, it is hardly worth considering a scenario of a sharp tightening of sanctions against Russia. No radical aggravation—no radical sanctions.

At the same time, politics likes surprises. Erroneous assessments, the personal ambitions of leaders, the peculiarities of group decision-making with their “shift to risk”, random incidents and much more can give rise to an extreme scenario. War in this case is a “grey”, rather than a “black swan”. It is unlikely, but its parameters are quite clear. Low chances of winning a war can be offset by high expectations of its consequences. Is it not an attractive scenario to give Russia a military slap in the face during an election year? However, in Moscow, such a scenario is also, apparently, expected. With appropriate organisational conclusions.

From our partner RIAC

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Blue Ocean Strategy for South Caucasus

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The recent arrival of Russian peacekeepers in Nagorno-Karabakh has underlined the difficulties for a number of international institutions–the United Nations (UN), the Organization for Security and Co-operation in Europe (OSCE), the European Union (EU) and the Eurasian Economic Union (EAEU)–to provide a diplomatic answer to violent conflicts that emerged in the aftermath of the collapse of the Soviet Union.

Nagorno-Karabakh is the latest example, as most of the ethnic quarrels in the South Caucasus are still ongoing since 1991, with Abkhazia and South Ossetia remaining de facto [1] independent from Georgia, while only one of the three recognized countries (Armenia, Georgia, and Azerbaijan), Armenia, has managed to join a supranational framework [2].

In over three decades, the political-economic context of the region has deteriorated with a continuous decline in birth rates coupled with emigration, difficult economic recovery and the rise of autocratic political regimes and confirmed cronyism. Some experts believe it is time for the South Caucasus countries to develop a Blue Ocean strategy [3] and abandon the idea of joining the Euro-Atlantic institutions (the EU and NATO) or Russian-led alternatives (the EAEU and the CSTO). This may seem challenging, but given the economic and diplomatic achievements of the past decade and the political crisis in the context of the COVID-19 pandemic, it is perhaps a viable option for restoring prosperity and stability in this part of the world.

What is the Blue Ocean Strategy and how can it be applied in international politics?

The Blue Ocean Strategy is a concept developed at INSEAD by Renée Mauborgne and W. Chan Kim. Although the approach usually applies to business strategy, it can be combined with a SWOT analysis to develop new geopolitical alternatives and provide innovative thinking in politics.

Therefore, by looking at the SWOT matrix for the South Caucasus, we can establish similarities between the countries and see how the Blue Ocean strategy approach can develop the “opportunity” part in the region:

SWOT Matrix of the South Caucasus
StrengthsLocated between great players – Russia, Turkey, EU and Asia – the South Caucasus can be successfully used as a platform for the production, transfer and transformation of goods; Favorable climate for the development of renewable energies and products in with a high demand on international markets (e.g. Georgian wine on the Chinese market).
WeaknessesDifficulties to overcome the events following the break-up of the Soviet Union (e.g. rhetoric regarding separatism in Georgia) and political repetition compulsion; Insufficient resilience to international influence, as highlighted by the interest of all parties in joining an alliance (e.g. the European Union), which makes it ambiguous for the state(s) to develop an independent international policy; Corruption and cronyism in governments resulting in a paucity of innovation by the institutions and little support for the growth of innovative businesses.
OpportunitiesUnder-explored markets such as renewable energy, biological agriculture and high-tech; Affordable and skilled labour resources available; Possible regional cooperation between the three main countries – Georgia, Armenia, Azerbaijan – instead of seeking different alliances outside the South Caucasus
ThreatsRemaining ethnic tensions (internal and external) and the constraint of continuous political repetition compulsion regarding the de facto autonomous territories; Laissez-faire the corruption and cronyism at all levels of the state hampering the development of innovative thinking and increasing the human capital flight (brain drain); An emphasis is on external actors to solve internal problems (e.g. the European Union to solve economic issues instead of investment in higher education and entrepreneurship).

By analyzing the SWOT matrix, we can establish similarities between the three recognized countries and the three de facto/partially recognized states–Abkhazia, South Ossetia, Nagorno-Karabakh–having close SWOT profiles.

As such, the SWOT matrix underlines the countries’ profiles in the South Caucasus, and difficulties seem to stem from weak institutions, with an enforced political repetition compulsion [4] by elites and citizens alike, rather than from external threat(s) [5]. Nonetheless, the external threat is presented as the main one (e.g. Russia in Georgia and Turkey/Azerbaijan in Armenia), while the problems seem to be mostly domestic, having a lot to do with corruption or difficulties to accept the change of borders in the post-Soviet order.

Towards the effective implementation of a Blue Ocean strategy in the South Caucasus

A major obstacle to effective implementation of a Blue Ocean strategy in the region will come from the phenomenon of repetition compulsion and the fact that elites and citizens are not used to listening to another political discourse, often asking for outside help to solve domestic issues. As such, we can assume that states in the South Caucasus will be more likely to continue to focus on finding external alliances instead of using their own internal resources to develop their potential.

This phenomenon is linked to the in-group bias, which is the tendency to assume that ‘your’ problems are coming from the outside (e.g. Russia in Georgia) instead of assuming the responsibility related to ‘your’ own failing policy [6]. Thus, a nation will tend, even more so in times of crisis, to assume that the problem is due to an outside event.

The second obstacle that states will face in the South Caucasus is that neighboring countries have an incentive in keeping the states located next to them under control. At present, the main outsiders–Russia, the EU/NATO and Turkey– have little or no interest in seeing the South Caucasus enjoy greater autonomy.

In fact, some have even developed the rhetoric of ‘grandiosity [7],’ which refers to an unrealistic sense of superiority, characterized by a sustained view of oneself as better than the other, which is expressed by disdainfully regarding them as inferior. This approach is implemented in numerous forms through instruments of power, such as the Eastern Partnership (EaP) which aims to promote European values without taking into account the possibility that a state in the South Caucasus may differ in the way it wishes and should develop.

In the eyes of many EU citizens, the EaP is a means of promoting EU’s identity such as democracy, while non-Europeans would point out such an instrument has been implemented to achieved an economic and/or political superiority (the rhetoric of ‘grandiosity’) over participating states as they can only wish, in the mind of the one implementing them, to be like the EU member states [8]. The rhetoric of grandiosity is identified when the proponent refuses to assume that it may be wrong (cognitive dissonance).

The South Caucasus nations will therefore have to change their internal thinking and concentrate more on what they have and develop strengths instead of waiting for outside assistance. For instance, rather than focusing on how to get the separatist territories back and who could help them achieve this geopolitical goal, in order to increase their internal performance and economic capacities they could focus on fighting corruption, thus making themselves in fine more attractive in the eyes of autonomist regions (soft power) and a valuable political alternative.

Once this is achieved, there will be resistance from the major players–Russia, the West, and Turkey–to seeing the South Caucasus states outside their sphere of influence, which will be another obstacle to the long-term development and continued implementation of the Blue Ocean strategy for self-development.

In many ways, the strategy for the South Caucasus can be inspired by South Korea, a country that, instead of focusing on recovering control over North Korea and explaining a poor economic performance because of the difficult regional context (proximity to the USSR and the People’s Republic of China), managed to see its national advantages and emerge as a self-sustaining economic power.

While North Korea remains a priority in foreign affairs, as does the relationship with Beijing, Seoul has focused on internal development after 1953, subsequently or complementarily on international alliances. Like South Korea, the South Caucasus might focus on solving internal issues before outside matters, especially considering the stagnation with para-states for already more than three decades.

  • [1]de jure according to some states such as Russia, Syria and Venezuela
  • [2]Armenia is a member of the Eurasian Economic Union, however without Nagorno-Karabakh which is recognised to be de jure part of Azerbaijan.
  • [3]Blueoceanstrategy
  • [4]Edward Bibring (1943). The Conception of the Repetition Compulsion. The Psychoanalytic Quarterly. 12 (4): 486–519.
  • [5]The situation in Abkhazia and South Ossetia is stabilised since 2008, and the rhetoric of a Russian interest in occupying the whole Georgia does not goes in line with a geopolitical reality. As such, Tbilisi could develop its internal policy on the short run and focus on the two “occupied” territories (Abkhazia and South Ossetia) on the long run instead.
  • [6]Hall. Taylor, Donald M.; Doria, Janet R. (April 1981). Self-serving and group-serving bias in attribution. Journal of Social Psychology. 113 (2): 201–211.
  • [7]Elsa F. Ronningstam (2005). Identifying and Understanding the Narcissistic Personality. Oxford University Press.
  • [8]Women’s rights, democracy, freedom of expression, human rights are all examples of what EU citizens believe they can bring to the South Caucasus through the Eastern Partnership. This does not mean that they are not valuable to the countries, but rather that the lack of debate on whether and why to promote them expresses ‘grandiosity’, the assumption of values superior to any others, similar to what happened during colonialism, when Europeans considered Christianity to be superior to any other religion in colonised countries.

From our partner RIAC

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