Losing Credibility – The IMF’s New Cold War Loan to Ukraine

In April 2014, fresh from riots against the kleptocrats in Maidan Square and the February 22 coup, and less than a month before the May 2 massacre in Odessa, the IMF approved a $17 billion loan program to Ukraine’s junta. Normal IMF practice is to lend only up to twice a country’s quota in one year. This was eight times as high.

Four months later, on August 29, just as Kiev began losing its attempt at ethnic cleansing against the eastern Donbas region, the IMF signed off on the first loan ever to a side engaged in a civil war, not to mention being rife with insider capital flight and a collapsing balance of payments. Based on fictitiously trouble-free projections of the ability to pay, the loan supported Ukraine’s currency, the hryvnia, long enough to enable the oligarchs’ banks to move the money quickly into Western hard-currency accounts before the hryvnia plunged further and was worth even fewer euros and dollars.

This loan demonstrates the degree to which the IMF is an arm of U.S. Cold War politics. The loan terms imposed the usual budget austerity, as if this would stabilize the war-torn country’s finances. The financings obviously were devoted mainly to rebuilding the army. The war-torn East can expect to receive nothing even nothing even though its basic infrastructure has been destroyed for power generation water, and hospitals. Civilian housing areas that bore the brunt of the attack are also unlikely to profit from the IMF’s uncharacteristic generosity.

A quarter of Ukraine’s exports normally are from eastern provinces and sold mainly to Russia. But Kiev has been bombing Donbas industry and left its coal mines without electricity. Nearly a million civilians are reported to have fled to Russia. Yet the IMF release announced: “The IMF praised the government’s commitment to economic reforms despite the ongoing conflict.” No wonder there was almost no comment in the news or even the business press!

The loan is bound to create even more infighting among IMF staff economists than broke out openly at their October 2013 annual meeting in Washington. Dissension over the disastrous IMF $47 billion loan to Greece – at that time the largest loan in IMF history – prompted a 50-page internal IMF document leaked to the Wall Street Journal. Acknowledging that the IMF had “badly underestimated the damage that its prescriptions of austerity would do to Greece’s economy,” IMF staff economists blamed pressure from eurozone countries protecting their own “banks [that] held too much Greek government debt. … The IMF had originally projected Greece would lose 5.5% of its economic output between 2009 and 2012. The country has lost 17% in real gross domestic output instead. The plan predicted a 15% unemployment rate in 2012. It was 25%.

The IMF’s Articles of Agreement forbid it to make loans to countries that clearly cannot pay, prompting its economists to complain at their Washington meeting that their institution was violating its rules by making bad loans “to states unable to repay their debts.” One official called its Debt Sustainability Analysis, “‘a joke,’ a [European] commission official described it ‘a fairy tale to put children to sleep’ and a Greek finance ministry official said it was ‘scientifically ridiculous.’” In practice the IMF simply advanced however much a country needed to pay its bankers and bondholders, pretending that more austerity would enhance the ability to pay, not worsen the debt trap, while Kiev also used the loan for military expenses to attack the Eastern provinces.

This raises the question of whether the IMF’s loan is legally an “odious debt,” being made to a military junta and stolen by government insiders. John Helmer’s Dances with Bears calculates that “of the $3.2 billion disbursed to the Ukrainian treasury by the IMF at the start of May, $3.1 billion had disappeared offshore by the middle of August.”

Unlike the IMF’s most recent disastrous loan to Cyprus, the IMF did not reveal its reasoning. But it made it clear that the National Bank of Ukraine (NBU) – its central bank – was simply turning money over to the kleptocrats who ran the country’s banks as part of their conglomerates, and funding the government’s military attack on the East: “The proportion of government securities and loans to banks increased from 28 percent of NBU total assets at end-2010 to 56 percent at end-April 2014.” The financial situation was getting worse. Facing rising insolvency risks, Ukraine’s leading banks were reported to need another $5 billion over and above the IMF’s $17 billion commitment.

In preparation for October’s scheduled elections, the eastern provinces are in no condition to vote, and the junta has banned the Communist party and also banned TV and media reporting that it does not like. The leading pro-war parties are polling very low even in the West (as of early September). There are warnings of a coup by the Right Sector and allied neo-Nazi Ukrainian nationalists, headed by the oligarch Ihor Kolomoyskyy, who has fielded his own private army. From Johnson’s Russia List* (no online version):

A defeat in war frequently leads to regime change. The spectre of a coup is once again roaming the streets and squares of Kyiv. Surviving National Guard fighters are threatening to turn their weapons on Poroshenko. A third Maydan [Independence Square protest movement] is taking shape, which is to sweep aside the present regime. The instigators of this Maydan are militants from the punitive battalions created with Kolomoyskyy’s money. It is obvious that the oligarch is playing his game against Poroshenko. Subordinate to him Kolomoyskyy has quite a strong private army capable of carrying out a coup.

IMF- and US-backed Privatization Plans for Ukraine

Ukraine’s main problem is that its debt is denominated in dollars and euros. There seems only one way for Ukraine to raise the foreign exchange to repay the IMF and NATO creditors rounded up to help Westernize the economy: by selling its natural resources, headed by gas rights and agricultural land.

Here the shadowy figure of Kolomoyskyy resurfaces, with support from the United States. Recent Senate Bill 2277 “directs the U.S. Agency for International Development to guarantee loans for every phase of the development of oil and gas” in Ukraine, Moldova and Georgia.

Vice President Biden’s son, R. Hunter Biden, recently was appointed to the board of Burisma, a Ukrainian oil and gas company registered in Cyprus, long a favorite for post-Soviet operators. The firm has enough influence over Kiev politics to make prospective gas fracking lands a military objective. From the PEU, citing an Economic Policy Journal report**:

Ukrainian troopers help installing shale gas production equipment near the east Ukrainian town of Slavyansk, which they bombed and shelled for the three preceding months, the Novorossiya news agency reports on its website citing local residents. Civilians protected by Ukrainian army are getting ready to install drilling rigs. More equipment is being brought in, they said, adding that the military are encircling the future extraction area.

The Western press has failed to convey Ukraine’s East/West hostility to the gas and agricultural issues, but one report notes: “The people of Slavyansk, which is located in the heart of the Yzovka shale gas field, staged numerous protest actions in the past against its development. They even wanted to call in a referendum on that subject. … Countries like the Czech Republic, the Netherlands and France have given up plans to develop shale gas deposits in their territories. Not only them but also all-important Germany, which two weeks ago announced it would halt shale-gas drilling for the next seven years over groundwater pollution concerns.” U.S. and IMF backing seems intended to help reduce European dependence on Russian gas so as to squeeze its balance of payments as part of the New Cold War deterrent.

But it has involved a potentially embarrassing U.S. alliance with Kolomoyskyy as reportedly the major owner of Burisma through his Privat Bank. Robert Parry points out he “was appointed by the coup regime to be governor of Dnipropetrovsk Oblast, a south-central province of Ukraine. Kolomoysky also has been associated with the financing of brutal paramilitary forces killing ethnic Russians in eastern Ukraine.”

The other natural resource to be sold off is farmland. Already there is heavy Monsanto investment in genetically engineered grain. A recent report by the Oakland Institute, Walking on the West Side: the World Bank and the IMF in the Ukraine Conflict, describes pressure to deregulate Ukrainian agricultural land use and promote its sale to U.S. and other foreign investors. In particular it notes that “IFC advised the country to ‘delete provisions regarding mandatory certification of food in the listed laws of Ukraine and Government Decree,’” and “to avoid ‘unnecessary cost for businesses’” by regulations on pesticides, additives and so forth.

What makes this so puzzling is that neither Russia nor many European countries accept genetically engineered foods. It would seem that the only way Ukraine can export this food is if U.S. diplomats pressure Europe to drop its anti-GMO labeling. This threatens to drive yet another wedge between the United States and European NATO members.

It will be expensive to restore power and water facilities that have been destroyed by the Kiev forces in Donetsk, which faces a cold dark winter. Kiev has stopped paying pensions and other revenue to the Eastern Ukraine, all but guaranteeing its separatism. Even before the Maidan events the local population sought to prevent gas fracking, just as Germany and other European countries have opposed it. Also opposed is the appropriation of land and other properties by Ukrainian kleptocrats and especially foreigners such as Monsanto for genetically modified seeds – again, just as Germany and other European countries have opposed crops produced by GMOs.

U.S. Stratagems to Save Ukraine from Having to Pay Its Debts to Russia

The “inner contradiction” in the IMF loan is that Ukraine owes the entire amount to Russia for gas arrears and current needs as winter nears, and also for the euro loan by Russia’s sovereign wealth fund on strictly commercial terms with cross-defaults if Ukrainian debt rises above 60 percent of GDP. Yet U.S. Cold War strategy is to minimize payments to Russia out of IMF and NATO “reconstruction” lending.

In the wake of the New Cold War confrontation in mid-2014 after Russia re-absorbed Crimea, the Peterson Institute for International Economics, floated a proposal by former Treasury official Anna Gelpern to deprive Russia of legal means to enforce its claims on Ukraine. “A single measure can free up $3 billion for Ukraine,” she proposed. Britain’s Parliament might pass a law declaring the $3 billion bond negotiated by Russia’s sovereign wealth fund to be “foreign aid,” not a real commercial loan contract worthy of legal enforcement. “The United Kingdom can refuse to enforce English-law contracts for the money Russia lent,” thereby taking “away creditor remedies for default on this debt.”

The problem with this ploy is that Russia’s sovereign wealth fund lent Ukraine euros with strict financial protection aimed at limiting the country’s overall debt to just 60 percent of its GDP. If debt rises above this level, Russia has the right to demand full immediate payment, and this may trigger cross-default clauses in Ukraine’s foreign debt.

As recently as yearend 2013, Ukraine’s public debt amounted to just over 40 percent – a seemingly manageable $73 billion. But in view of the fact that Ukraine had only a B+ rating – below Russian sovereign fund normal limit of requiring at least an AA rating for bond investments – Russia seems to have acted in a prudent financial way in inserting protection clauses precisely to distinguish its investment from general purpose aid.

Waging civil war is expensive, and Ukraine’s currency is rupturing. The black market exchange rate already is reported to have plunged by one-third. If recognized officially (once the kleptocrats have moved their money out at IMF-supported hernia rates), this would raise the country’s debt/GDP ratio to the 60 percent threshold making the debt to Russia payable immediately. Unlike foreign aid, Russia’s loan gives it “power to trigger a cascade of defaults under Ukraine’s other bonds and a large block of votes in any future bond restructuring. This is because all of the government’s bonds are linked among themselves. When one bond defaults, the rest can do the same.”

What the U.S. Government classifies as foreign aid also typically takes the form of loans to be repaid, and insists on matching funds in local currency, e.g. for Public Law 480 food exports. Congress insisted already during the Kennedy Administration that the U.S. balance of payments, and specifically its farm exports, must benefit from any such “aid.”

Reviewing the possibilities of how to prevent IMF and NATO credit from being paid to Russia for its bondholdings and gas arrears, Prof. Gelpern points out that “governments do not normally sue one another to collect their debts in national courts.” If this should occur, the pari passu rule would prevent some debts from being annulled selectively. She therefore raises another possibility – that Ukraine may claim that its debt to Russia is “odious,” addressing the situation where “an evil ruler signs contracts that burden future generations long after the ruler is deposed.” She suggests that “Repudiating all debts incurred under Yanukovich would discourage lending to corrupt leaders.”

The double standard here is that instead of labeling Ukraine’s long series of kleptocratic governments odious, she singles out only Yanukovich, as if his predecessors and successors are not equally venal. But an even greater danger in declaring Ukraine’s debt “odious”: It may backfire on the United States, given its long support for military dictatorships and kleptocracies. Ukraine’s sale of bonds to Russia’s sovereign debt fund and its contracts signed for gas purchases were negotiated by a democratically elected government, at prices that subsidized domestic industry and also household consumption. Unlike the case with Greece, there was no removal of a national leader to prevent a public referendum from taking place over whether to approve the loan or not. If this debt is deemed odious, what of Eurozone loans to Ireland and Greece or U.S. loans to Argentina’s generals installed under Operation Condor?

Gelpern acknowledges that Ukrainian refusal to pay the bonds by invoking the odious debt principle “is fraught with legal, political and market risks, all of which would play into Russia’s hands.” This leaves the most promising solution to hurt Russia to be the above-mentioned ploy for Britain’s Parliament to pass a sanctions law invalidating “the Yanukovich bonds.” Such a sanctions law would reduce Russia’s “ability to profit from selling the debt on the market” simply by denying Russia legal rights to grab Ukrainian assets.

Gelpern concludes her paper by suggesting a universal principle: that contracts “used to advance military and political objectives … should lose their claim to court enforcement.” This opens a can of worms in view of the fact that “[t]he United Kingdom and the United States have both used military force in the past to collect debts and influence weaker countries. Is it legitimate for them to punish Russia for doing the same?” Are not the vast majority of inter-governmental debts either military or political in character? On this logic, shouldn’t most inter-governmental debts be wiped out? Do not Gelpern’s arguments cited for not paying Russia serve even more to provide a legal basis for nullifying Ukraine’s debt to the IMF and subsequent NATO loans on terms that force it to forfeit its natural resource rights for gas and land to foreign investors?

The legal review ostensibly seeking reasons to isolate Russia economically thus has the seemingly ironic effect of showing the legal and political difficulties in trying to achieve this. If Ukraine borrows from the IMF and/or EU, and then breaks up – with the East becoming independent – who will be obliged to pay? Certainly not the East, attacked by the military coup leaders.

So we are brought back to this month’s financial news in preparation for next month’s IMF annual meeting: Where then does the Ukrainian loan leave the IMF’s credibility?

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