EBRD's Sergei Guriev on Zelenskyy's Presidency and Upcoming Elections
17 July, 2019

The economic future of Ukraine is now in the hands of a new leadership. The economic relationship that Ukraine has with world partners, including Russia, is continuously changing. Not to mention, domestic policies can drive or stall economic growth. What to do about tax and interest rates, in what direction land reform will go, and how Ukraine will fight corruption are all aspects of President Zelenskyy’s new economic policy proposal.

Hromadske sits down with Sergei Guriev, a chief economist of the European Bank for Reconstruction and Development, and talks each of these points. Additionally, the relationship with the IMF, risks, privatization, the investment climate in Ukraine and the future of investments in the Donbas among other topics are frankly discussed in this exclusive interview.  

You watched the series “Servant of the People,” read the new party program. I know that representatives from European Bank for Reconstruction and Development (EBRD) met with the new president Volodymyr Zelenskyy. Was there anything noteworthy that you saw in the economic program? How is what you saw in the series different from the party program, and what was announced verbally?

The economic factor is not actually the core of the program – it is more about the fight against corruption, reforms to the judicial system. This is really the most important thing that Ukraine needs today. If the Servant of the People party manages to drastically improve the situation regarding competence and unbiased reasoning within the courts and improve the situation for the fight against corruption, it would be the greatest contribution to the economic development of Ukraine. Other things are related to shortening the timespan of bureaucratic procedures (decline in regulatory time), to land reform – these are also very important things. But in general, it seems to me the most probing problem in Ukraine is the fight against corruption, unbiased courts, including freedom of the courts from business groups – this is the most important aspect. 

Sergei Guriev, a chief economist of the European Bank for Reconstruction and Development, speaks to Hromadske on July 6, 2019 in Kyiv, Ukraine. Photo: Hromadske

And have you looked over the economic program? The critique was that the program was non-existent. What exactly does the president and his team suggest?

Indeed, this is a question about how political life is organized, how specific the program should be with regard to the interest rates, tax rates and so on. I’m not sure how important this is to have today. Such things, should probably be included in the coalition agreement. It should be after the elections, when the new parliament is formed, when an agreement between the parties is reached, then at that point should a more concrete plan be established. Exactly how, for example, the land reform is to be carried out, what exact changes to the tax system are necessary. But, in general, at this stage it is not so important that the program is too specific. We shouldn’t forget that this was written very quickly, that the economic team was actually formed in a matter of weeks. Therefore, it is not surprising that there is still no concrete plan. 

Let’s talk about Zelenskyy’s specific proposals, which he voiced in his first electoral campaign and which are now included in his party’s campaign. First is a tax on withdrawn capital. The previous president had lengthy discussions about this idea. Initially, international organizations criticized this idea, then it fell silent. How do you feel about the idea of introducing a tax on withdrawn capital. What effect would this have on the Ukrainian economy? 

To be honest, we still don’t know how it would work. So we refrain from commenting on the tax on withdrawn capital. 

Land reform. Would it be possible to carry out a land reform in Ukraine within 5 years? 

Undoubtedly it is possible to carry out a land reform in Ukraine within 5 years. Undoubtedly, this is an important step forward from the viewpoint of increasing Ukraine’s competitiveness, increasing Ukrainians’ income, increasing the productivity of agriculture and agribusiness. Undoubtedly, we welcome land reform, just like we welcomed it under the previous government. 

I will quote you from a different interview. You said that reforms are not sustainable and can’t be irreversible, if the people do not approve of them. Now our politicians, with whom we spoke, who work with people before the elections say: The people categorically do not accept them. Well, in general, because of the rhetoric that has been around for years. What do we do with this?

I think the population needs to be told in detail what exactly the land reform entails. Today’s situation does not contribute to the wellbeing of people who live and work on this land. The fact that land cannot be used as collateral, not allowed to be sold, means that agricultural productivity is lower than it should be. Especially, when we talk about state land: it rather helps people who get access to this land through schemes and who do not pay much for it.

I understand the risk that people see is that it would be like with privatization in the 1990’s. That some rich people would buy everything up, and they would be left with nothing. Is this risk easy to eliminate today? Does it really exist?

Indeed, privatization should be real, competitive, and open. We see that in previous years Ukraine has come a long way. Including in this area. Today, small state assets are sold through ProZorro, through an open and competitive system. We cannot say that it is impossible to conduct an honest privatization in Ukraine. Today, there is much more confidence that Ukraine possesses the institutions, funds, and resources in order to conduct this privatization fairly. 

Could the land reform serve as a driver for economic growth?

This is certainly one way to drive growth. Different estimates suggest that today’s situation with a lack of a land market reduces Ukraine’s GDP by about 1%.

Another one of Zelenskyy’s initiatives is capital amnesty. The proposal is such: entrepreneurs can pay 5% tax on what they possess and thus legalize it. How effective is this measure? Can it be implemented on its own, without a package? 

This proposal also requires further detailed study. Amnesty in itself may or may not work depending on how the rest of the tax system is organized. At this moment, it seems to me, we are not ready to discuss this in detail. Indeed, not all international organizations regard this proposal as positive. In general, of course, we need to ensure that people are ready to pay taxes and do not have to fear tax inspectors. But this measure alone, without a combination of other reforms can not solve all of the problems. 

Ukraine is closely linked with international financial organizations, it depends on them directly. How will they react to the fact that taxes will be reduced and taxes in Ukraine will be lower than in the countries which donate money to international organizations? This is also one of Zelenskyy’s declarations: taxes will be reduced. 

Tax cuts alone are not the redline for international organizations. International organizations would like the countries, whom they help, to implement a responsible budgetary policy. Roughly speaking, when the IMF gives loans, the IMF wants to receive these loans back, i.e. the money back. Because the IMF is responsible to its shareholders, including Ukraine. If the IMF gives loans, it can not give loans to countries which plan to spend this money and never return it. Responsible fiscal policy is always a part of the IMF program. You can reduce taxes if you can prove that this will lead to higher tax revenues and not the opposite. There is no prohibition on lowering taxes as such, there is a prohibition on populist promises that lead to a growth of the budget deficit. Lowering taxes is not such a promise per se. One can imagine a situation, when taxes are low, but revenues are increasing due to more people paying taxes. 

And what do you consider a populist promise? Going back to Zelenskyy’s meeting with the leadership of EBRD, what things were heard and clearly understood: yes, our fears connected with even rather populist slogans – which were in the film series, which are a bit anti-Western and concerned the economy – have vanished. What further actions do you expect? 

If you watch the film, the president ends cooperation with the IMF there, but at the same time respects the obligations to the European Bank for Reconstruction and Development, pays the bills on account. And we naturally welcome this because we are also held accountable to our shareholders and we can not give out loans which will not be returned. If we speak seriously, the main question is adherence to the cooperation with the IMF and international creditors. Before the elections, we heard promises of a default, and people who support Zelenskyy discussed the need to default on external debt. 

Sergei Guriev, a chief economist of the European Bank for Reconstruction and Development, speaks to Hromadske on July 6, 2019 in Kyiv, Ukraine. Photo: Hromadske

The main mouthpiece of this idea is Ihor Kolomoisky. From interview to interview, the message is clear. 

And we heard that President Zelenskyy did not consider default necessary which made both the IMF and us happy. This actually contributes to macroeconomic stability in Ukraine immensely. Ukraine is heading towards macroeconomic stability. Any economic growth, any investment depends on the macroeconomic stability. Macroeconomic stability is a required condition for investment growth. And the fact that Ukraine’s inflation is declining today – even though it is due to the high interest rates –  nonetheless inflation declines and it is possible that it might reach the inflation target as early as next year. Each time someone says that we need to default, the likelihood of lower interest rates is postponed. In itself, this is very dangerous talk. Fortunately, President Zelenskyy in conversation with both the IMF and the president of the EBRD said that he will fulfill all obligations, and in this respect we heard then what we wanted to hear. 

The biggest fears are concerning the return of Ihor Kolomoisky to Ukraine, and there is the fear that there will be another denationalization of PrivatBank. You work with Valeria Gontareva, who did an interview with our team recently, in which she said that she was really afraid of returning to Ukraine. What does this affect? What are the  redlines? I think that some of our audience does not understand why everyone, including the West, are so worried about Kolomoisky.

I don’t think anyone has any personal relationship with Ihor Kolomoisky. This is really about PrivatBank. It was and remains one of the largest Ukrainian banks. If the largest bank of the country lacks capital, assets are invested in enterprises and projects affiliated with the main shareholder, this is a threat to the financial stability of the country. Banking systems cannot function if there is no capital in the largest bank. Therefore nationalization was the correct choice. And the IMF and EBRD supported the position of the National Bank of Ukraine (NBU) at that moment, both when it was led by Valeria Gontareva, and now when Yakiv Smoliy heads it.

READ MORE: Former NBU Head Gontareva on Threats from Kolomoisky and PrivatBank Nationalization

And in the meeting with the president of EBRD, did the president of Ukraine talk about this? Was the issue of PrivatBank raised? How does he see this problem?

I will not talk about what was discussed over this topic, but at present, there are no clear statements about how the president sees this problem. While we don't know what happens next, we stand by the view that PrivatBank was nationalized. Sooner or later, it will probably be privatized, but there is no talk about the two billion dollar compensation to the former shareholders. We know about the litigation taking place here and abroad, including in the United States. We are following these proceedings, but we build on the fact that the strategy for managing state owned banks will be realized, that they will improve the quality of corporate governance. My guess is that PrivatBank will be privatized at some point, but there is no talk of compensating former owners or returning the bank to them.

READ MORE: Privat Empire: What Does Oligarch Ihor Kolomoisky Own in Ukraine?

You have already touched on the topic of oligarchs. How do you see this journey that Ukrainian oligarchs have made? Because Ukrainian oligarchs are still different from Russian ones. And where do they go from here?

It seems to me that the word “oligarch” is key for Russia, Ukraine, and some other countries. The main problem of economic development hindering the creation of a market economy in such countries is that big businesses influence the rules of the game. If you are a foreign investor and thought of investing in a country with powerful oligarchs who control the media, the courts, politicians, then you worry about the fact that when you invest and have a business conflict, that you will lose in a biased court. This dramatically undermines the attractiveness of this country as a place to invest. The same applies to small Ukrainian businesses because it is very difficult to compete with oligarchical businesses that control the media, the courts and politicians. The main question for President Zelenskyy or his TV character President Holoborodko, is how to protect state institutions from the influence of big businesses. This includes an independent Central Bank, independent regulatory agencies, parliament, media, courts. We in the EBRD do not resist big businesses or protest against big businesses. In many countries, in order to be competitive, you need to be big. And in other countries, it is exactly how it works: big businesses do not define the rules of the game. They play according to the rules, and the rules of the game are determined by a democratic political process. It seems to me that Russia and Ukraine must do the same. 

President Zelensky enjoys success in Berlin, Paris, Toronto, talks a lot about foreign investment. In principle, hey says what people like to hear. On the other hand, the investment, to recover the Donbas economy, constitutes 10 billion. How realistic is this? We see that recent investments in Ukraine over the past few years were miserly, they are not the largest companies. President Poroshenko said: look Ryanair entered our market, Ikea is coming. But we understand that these are very small companies compared to investments in the region in general.

You’re right, the foreign investment in Ukraine is still very small. In terms of investment per capita, Ukraine is at the level of Moldova. Relative to GDP, Georgia is way ahead of Ukraine. It seems to me that the example of Georgia is quite indicative. If you want to attract foreign investment, you can do it. Georgia is farther from the European markets, Georgia has geopolitical problems and risks too. Georgia has a much smaller economy and in this sense is less attractive to large investors. Georgia also has deep and comprehensive free trade areas with the EU, agreements with the EU. But Georgia attracts investment, so Ukraine can also attract investment.

What is the difference?

The difference lies in the quality of the investment climate. Actions speak louder than words. We’ll see what the new government achieves.

READ MORE: The Old and the New: Who Will Form Ukraine's Next Parliament?

What does the Ukrainian state need to do for the investor to come to the Donbas? I mean the territories that have been affected by warfare. This is not even about Ukraine: it is clear that it is tough here. And what should be done to encourage investment there?

This is a good question. I would like to add that it is necessary that the investor does not just come to Donbas, but to Ukraine in general. After that, there will be investments in the Donbas. If you are talking about the destroyed territories, then first of all, it is not the private sector, but some donors who are trying to restore what has been destroyed. On the other hand, we at the EBRD are working with Mariupol and consider it to be an absolutely normal city where you can invest. But speaking generally about the quality of investment, we must return to where we started. The focus in the Servant of the People’s program, is on the fight against corruption and judicial reform. I believe that foreign investors need to know that the courts do not work for oligarchs.

Sergei Guriev, a chief economist of the European Bank for Reconstruction and Development, speaks to Hromadske on July 6, 2019 in Kyiv, Ukraine. Photo: Hromadske

If we talk about the populism of Western partners, people often perceive that Western partners demand reform from Ukraine, which is connected with tariffs and gas. It is clear that the price has risen, we are fighting for some kind of energy independence from Russia, this is the price of this issue. As soon as the question of tariffs arises, everyone brands it populism. I watch our reports - from Odesa, from Kharkiv, from Toretsk, any town. I recently spoke to MPs from different parties. They are coming back from tours. I ask them: what do the people ask here in Kyiv or somewhere in Odesa. They say: tariffs. Every single one says: tariffs. If the population of the country really cannot afford them, what do we do? We see that this is still a key issue for almost the majority of Ukrainian citizens.

There are no miracles. If you have a market price, you must pay it. Another thing is that if you do not have enough money for it, the state can give you help, subsidies and so on. If you subsidize tariffs, as it was before: I sell you energy at lowered price, someone has to pay for it. Other taxpayers pay for this. In this sense, such an opaque non-market system leads to the fact that some taxpayers subsidize others. At the same time, oddly enough, if the tariffs are low, then it is the poor that subsidize the rich, because if you live in a large apartment and you have air conditioning, a dishwasher, a washing machine, and a dryer, then you consume a lot more electricity. And poor people who consume less pay for you. There are no miracles here. The good news is that the more energy investments in Ukraine and the better the energy market works, the lower the prices will be. We have seen that the government has moved to market pricing, but the prices fell this year because market prices have fallen too. The market does not always mean high tariffs. It sometimes means a reduction in tariffs.

You analyzed Zelenskyy’s program. The ideologue of his party Ruslan Stefanchuk told us that he believes that the ideology in this party is libertarianism. Did you see libertarianism there?

The word libertarianism can mean completely different things. I saw there a commitment to the idea that prosperity is created by the private sector and therefore the government need not interfere with the private sector. Libertarianism does not mean that the state should do nothing at all. In particular, the work of the state is to ensure that the courts work efficiently and independently of the business. This is an important part for real libertarians. This program also has it. An important test is whether this party, the new government will be able to carry out land reform. As you remember, over the last five years, talk about land reform resumed almost every year, but the reform has not been carried out.

READ MORE: Second Wave: What Does Zelenskyy’s Servant of the People Party Promise to Ukraine?

Our first interview that I did with you in Paris 5 years ago was about how much the Crimea will cost the Russian economy and the cost of sanctions for the Russian economy. How important is Crimea for the Russian economy and everything else that has been happening in Russia over the years? How much did the sanctions affect Russia? And what are they? The question that is constantly important for Ukraine is whether they will be implemented or not, how do they really affect the Russian economy, or can it find other options in China, anywhere, and can carry on like this for a long time.

The Russian economy does suffer from sanctions. Any statements that the sanctions are only for the benefit of Russia are not true. If you look at the actions of the Russian authorities, they often try to ensure that the sanctions are lifted. It is very difficult to assess the quantitative effect of sanctions, because de facto they reinforce the isolation of Russia, associated with a bad investment climate, with a high level of corruption and state domination. In general, the Russian economy is in a difficult state, although from a macroeconomic point of view a crisis is unlikely: the Russian macroeconomic situation is stable, but there is no economic growth either. Economic growth is at the level of 2 or one and a half per cent per year, in some periods even lower. And just now the official forecast of the government was announced to be less than one and a half percent this year. In any foreseeable future, no acceleration of growth can be seen. The market believes that reforms are needed to accelerate growth. The market believes that these reforms will not be carried out. Whether it depends on the sanctions or simply on the fact that the Russian authorities are not going to carry out reforms - this is quantitatively difficult to distinguish. But if you compare Russia with the countries of central and eastern Europe, which grow by 2 or one and a half percent, and 3 or 4, these two percentage points of growth that Russia is losing are the price of a bad investment climate and sanctions.

Is the sanctions regime in place now, the maximum one, or do you still have other serious sanctions, if some things don’t happen? We can always get stuck at the status quo, but the status quo is not something that satisfies Ukraine. It remains an unresolved issue, this is an abnormal situation. Most likely, it will not improve substantially in the near future.

My job description does not include a discussion of geopolitical issues. But as to whether additional sanctions and restrictive measures can be imposed - yes, of course. Moreover, it is the threat of such restrictive measures that is the main deterrent in international politics. The United States have already passed certain laws. If there are any new political or geopolitical changes and if these laws are enforced, it would cause additional damage to Russian companies, and the Russian population too.

READ MORE: What to Expect From Ukraine’s Parliamentary Elections