Independence Day 2007: governing in the gaps between elections

Sixteen years, and the country is holding its second parliamentary election in eighteen months. The immediate cause was a presidential decree dissolving parliament in April, the legality of which parliament disputed, and which was ultimately resolved not by a court but by a negotiated agreement to hold the vote anyway. That sentence describes the central problem of Ukrainian governance more accurately than any amount of analysis.

The 2004 constitutional amendments moved substantial powers from president to parliament without clearly delimiting the boundary between them. What was intended as a check on presidential authority produced instead a permanent jurisdictional dispute, resolved case by case through political bargaining. The Constitutional Court, which exists to settle exactly this, has spent much of the year unable to assemble a functioning bench.

The economy is not paying attention

The striking thing about 2007 is how little the political paralysis has cost in output terms. Growth is running close to eight per cent, the strongest since 2004. Investment is up sharply. Construction in Kyiv, Odesa and the western cities is visibly booming, and the retail sector is expanding faster than at any point since independence.

There is a lesson in this that gets forgotten in both directions. Political instability of the parliamentary kind — coalitions collapsing, elections repeating, ministers rotating — has surprisingly little effect on an economy where the binding constraints are external demand, energy prices and credit availability. What damages an economy is instability in the rules: expropriation risk, arbitrary tax assessment, courts that can be bought. Ukraine has plenty of the second kind too, but it has not got worse this year, and that is enough for the growth numbers to hold.

The credit boom deserves more attention than it is receiving. Bank lending to households is growing at rates above seventy per cent annually. Foreign banks — Raiffeisen, UniCredit, OTP, BNP Paribas, Swedbank — have bought Ukrainian banks at multiples that only make sense if this growth continues for a decade. A majority of new mortgage lending is denominated in foreign currency. The National Bank has raised reserve requirements twice and issued warnings, which is the correct response and will prove insufficient.

Inflation is the real number to watch

Consumer price inflation has accelerated through the year and will finish above fifteen per cent, possibly well above. Food prices are the largest single contributor, driven by a poor grain harvest and by export restrictions that were introduced to hold domestic prices down and had the usual effect of discouraging planting.

Grain export quotas are worth dwelling on, because the pattern repeats. When world prices rise, Ukrainian governments restrict exports to protect domestic bread prices. Farmers respond by planting less the following season, which reduces supply and raises prices further. The policy is popular, comprehensible and counterproductive, and it has been applied in some form in most of the last ten years.

What business does with a year like this

The practical advice being given by everyone experienced in this market is the same: use the political noise as cover to do the unglamorous work. Register your trademarks. Regularise your customs classification before someone else does it for you. Move your holding structure into a jurisdiction with a functioning treaty. Get your land title documented properly, because the moratorium on farmland sales means every agricultural arrangement in the country runs through leases whose enforceability nobody has really tested.

Companies that spent 2005 to 2007 doing that quiet work were the ones still standing in 2010. The ones that spent it lobbying, positioning and waiting for stability are mostly gone, because stability never arrived and the window for cheap preparation closed.

Sixteen years in

The anniversary reading this year is about institutions rather than economics. Ukraine has demonstrated repeatedly that it can transfer power without violence and can hold elections whose results are genuinely uncertain in advance — a description that does not fit most of its neighbours. What it has not yet built is a mechanism for resolving disputes between institutions other than by holding another election.

That is the gap that will matter most over the next decade, and no amount of GDP growth fills it.

Related in this archive

• Independence Day 2006: fifteen years, and a gas bill that changed the arithmetic
• Independence Day 2008: the last good summer
• Independence Day 2005: the year after, and the bill for it
• Ukraine Annual Review 2007: the last good year, and why it was the most dangerous