Crashed
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With goodwill a compromise between the EU’s Association Agreements and the Eurasian Customs Union could no doubt have been worked out. But that was not the mood on either side. The technical and economic issues of harmonizing two different economic blocs were overlaid by geopolitical tension whether Brussels acknowledged it or not. There was a choice to be made: Did the East European governments want to face west or east? Brussels let it be known that membership in Putin’s Eurasian Union was incompatible with an EU Association Agreement. Commission president Barroso refused the Kremlin’s invitation for negotiations between the two blocs.22 Brussels did not accept their equivalence. In the absence of any agreement between the two, Moscow informed Ukraine and Armenia that if they proceeded with the EU, they should expect sanctions from Russia. Signing an Association Agreement would be a “suicidal step.”23 Under the anodyne labels of association, cooperation and convergence, a heavy geopolitical weight was being imposed on a fragile region under considerable economic and political stress.
II
Across the post-Soviet world, the economic and political recovery from the shock of 2008 was uneven. On the northern flank, the Baltics continued on their course toward the West. Estonia joined the euro on January 1, 2011. Latvia, the pivotal crisis country of 2009, adopted the common currency on January 1, 2014, followed a year later by Lithuania. The rest of Eastern Europe was supposed, under the terms of their 2004 accession, to join the euro in due course too. But progress in that direction was set back severely by the eurozone crisis. Polish foreign minister Sikorski announced in December 2011 that he looked forward to Poland joining the euro by 2016, but only if the currency union was reformed and it was clearly in Poland’s national interest to do so.24 Donald Tusk, as prime minister, promised to launch a national debate on euro membership. But the main opposition, the nationalist Law and Justice party, promptly responded by denouncing any further steps toward European integration as “subordination to Germany.”25
In Poland the nationalists were in opposition. In Hungary they were the government. In the April 2010 election, the ruling Socialist Party paid the price for its corrupt and duplicitous handling of economic policy and the financial disaster of 2008. Promising to protect the Hungarian nation and Hungarian pensioners from the depredations of the IMF, a coalition headed by the nationalist Fidesz party and the Christian Democrats won 53 percent of the vote. Even more startlingly, the Jobbik movement, which toyed openly with neofascism, scored 17 percent, bringing the total nationalist vote to 70 percent. Among Fidesz’s heresies was its refusal to separate the questions of political sovereignty and financial dependence. Ignoring protests from the IMF and the EU, it justified its taxes on foreign banks and a raid on private pension funds in terms of harsh historical necessity.26 Since freeing itself from the Soviet yoke, over the past twenty years Hungary “had to bitterly experience the validity and truth of the old wisdom that a nation can be subjugated in two ways—with the sword or with debt.”27 As Greece was submitting itself to the troika in April 2010, a defiant Prime Minister Orban told a news conference: “In my view, neither the IMF nor the EU’s financial bodies are our bosses. We are not subordinate to them.” Hungary would negotiate but it would not accept “diktats.”28
Orban’s aggressive nationalism and Fidesz’s campaign to curtail civil liberties and political pluralism reversed the liberalization of Hungarian political culture since the end of communism. But, after their own fashion, Orban’s aggressive revenue-raising measures and nationalist austerity worked. Inflation came down to below 2 percent. In December 2011 an agreement was reached with the foreign banks on a deal to share the cost of restructuring household debts. With Hungary having met the 3 percent budget deficit target, the EU lifted the humiliating Excess Deficit Procedures under which the country had labored since its accession to the union. In the context of the emerging market boom, foreign lenders looked leniently on Orban’s nationalist experiment. With ample funding, in the summer of 2013 Hungary paid off the IMF and asked the Fund to shut its office in Budapest.29 To further bolster his position, in early 2013 Orban embarked on a new détente with Moscow. An alliance with Russia was by no means an obvious choice for a Hungarian nationalist. But Orban was given a warm welcome in the Kremlin. Putin cheered his experiment in illiberal democracy and offered material assistance in the form of nuclear reactor technology and subsidized gas supplies, which were popular with Fidesz voters.30
Securely embedded in both the EU and NATO, Hungary could afford to take the risk of balancing between East and West. A tiny candidate country for an EU Association Agreement, like Armenia, menaced by sanctions from Russia, was not in the same position. Faced with a clear threat from Moscow, in September 2013 Yerevan pulled back. It declared its intention of joining Putin’s Eurasian Customs Union, prompting Brussels to close the door on the Association Agreement.31 This setback for the EU’s Eastern policy made Ukraine all the more important. Given its size and geopolitical significance, it was Kiev’s posture that would decide the balance of influence in the region. The EU was convinced of its own legitimacy. It offered the rule of law and prosperity. Its promise was the future. Ignoring the evident risk that Ukraine was too weak economically, too fragile politically and too exposed in geopolitical terms to stand the pressure generated between Russia and the West, Brussels pushed forward.
That Ukraine needed a change was undeniable. Even after the losses of 2008–2009 were made good, according to official figures average incomes in 2013 were barely higher than in 1989. Unlike in its neighbors to the west, the post-Communist transition in Ukraine had produced a generation of stagnation. While a tiny minority grew fabulously rich, the standard of living for the least well-off was kept at a tolerable level only by a system of pensions and energy subsidies that consumed 17 percent of GDP. In 2008 the IMF had provided emergency assistance. But the program came with demands for changes in taxes and benefits that made it impossible for a government to sustain legitimacy. By the time of the February 2010 election, much of the population was deeply disillusioned. Ukraine was falling further and further behind not only its Western neighbors but Putin’s Russia too. President Yushchenko effectively withdrew from the electoral race, leaving Prime Minister Tymoshenko to go head-to-head with Yanukovych, whose fraudulent election had triggered the revolution of 2004. With the electorate split between East and West, in 2010 it was Yanukovych who won a narrow majority fair and square.
Yanukovych was a corrupt manipulator who tacked back and forth between the West and Russia. He took funds from the IMF. He continued negotiations with the EU.32 He imprisoned Tymoshenko on corruption charges and used her as a pawn. At the same time, he dallied with Putin and his Eurasian bloc. As his clan enriched itself, his popularity drained and foreign exchange reserves dwindled. On the occasion of the next elections, which he had little hope of winning, it seems that he was preparing the security forces for a showdown.33 But the 2014 election was not the only deadline. Already in 2013, negotiations with the EU and the Russians had reached a point that forced Kiev to a decision that would depend, among other things, on the shifting international financial climate.
Ukraine 7-Year Government Bond Yield
Source: Benn Steil and Dinah Walker, “Was Ukraine Tapered?,” February 25, 2014, Geo-Graphics Blog CFR, https://www.cfr.org/blog/was-ukraine-tapered.
Up to the spring of 2013, under the impulse of the Fed’s quantitative easing, dollars flowed even to Ukraine. On April 10, 2013, Kiev turned down the latest offer from the IMF to help finance its gaping current account deficit and instead launched a 1.25 billion eurodollar bond issue, which was eagerly taken up by the markets at the comparatively modest interest rate of 7.5 percent.34 But then Bernanke’s taper pronouncement of May 22 hit the markets. Interest rates surged to 10 percent. Searching for alternative sources of funding and personal enrichment, Yanukovych canvassed the world for options. He explored shale-gas development with Shell and Chevron. In
the fall of 2013 a deal was on the books to lease to China an enormous holding of 7.5 million acres of prime farmland—5 percent of the entire land mass of Ukraine, 10 percent of its arable land, an area the size of Belgium. China was not just after Lebensraum. It was also offering to put $10 billion into port facilities in Crimea.35 But it was the talks with the EU that were pivotal. The promise that Yanukovych had made to the Ukrainian population was the promise of Europe. Ukraine’s officially sponsored media were talking up the Association Agreement as a prelude to full membership. The EU gave no indication that that was likely, but it did nothing to deflate expectations. Western press sources billed the Vilnius summit quite openly as the climax of a “six-year campaign to lure Ukraine into integration with the EU and out of the Kremlin’s orbit.”36
The threat was not lost on Russia, and its threats of sanctions mattered: 25 percent of Ukraine’s exports went to the EU, but 26 percent went to Russia, and much of the rest went to CIS states within Putin’s reach. In early September Yanukovych was still browbeating reluctant pro-Russian members of his party to accept the Western deal.37 What was not clear, until Kiev received the IMF’s letter of November 20, 2013, was quite how unattractive the Western terms would be. The IMF offered Ukraine only $5 billion and noted that it would be expected to use $3.7 billion of it to repay the 2008 loan due in 2014. No one in Kiev had reason to expect generosity from the IMF. But the EU’s offer came as a real shock. A committee of German experts had estimated that Ukraine would stand to lose at least $3 billion per annum in trade with Russia due to sanctions. In Kiev the estimated loss had been inflated to something closer to $50 billion. Brussels swept all these figures aside.38 In conjunction with the Association Agreement, all that the EU was willing to offer was 610 million euros. In exchange the IMF demanded big budget cuts, a 40 percent increase in natural gas bills and a 25 percent devaluation.39 It was anything but the pot of gold that Yanukovych had promised. There were Ukrainian oligarchs with personal fortunes larger than this. Even without considering the sanctions to be expected from Russia, to have accepted such a deal would have been a political disaster.40 In Kiev there was outrage. “We could not contain our emotions, it was unacceptable,” Ukraine’s permanent representative for NATO told Reuters. When his country turned to Europe for help, they “spat on us. . . . [W]e are apparently not Poland, apparently we are not on a level with Poland. . . . [T]hey are not letting us in really, we will be standing at the doors. We’re nice but we’re not Poles.”41 Fortunately for Kiev, or so it seemed, Moscow had an alternative plan. On November 21, 2013, Putin offered, and Yanukovych accepted, a gas contract on concessionary terms and a $15 billion loan. The condition was that Ukraine, like Armenia, would join the Eurasian Customs Union.
In light of subsequent events, Yanukovych’s decision would come to be seen as the Pavlovian response of a pro-Moscow stooge. It was quite possible that he was subject to Russian blackmail. But setting such rumors aside, his choice was hardly inexplicable. As Ukraine’s prime minister, Mykola Azarov, explained, “[T]he extremely harsh conditions” of the EU-IMF package had decided the issue.42 Nor was this logic hidden from the Europeans in the immediate aftermath of the debacle. On November 28, 2013, speaking to Der Spiegel, European Parliament president Martin Schulz admitted that EU officials made mistakes in their negotiations with Ukraine. “I think we underestimated the drama of the domestic political situation in Ukraine.”43 Ukraine, he said, “had been in a deep economic and financial crisis” since the introduction of democracy. “They desperately need money and they desperately need a reliable gas supply.” Schulz said he understood why Ukraine moved toward Russia. “It is not especially popular in Europe to help states which are in a crisis . . . and if you look at Moscow’s proposals, they would offer Ukraine short-term assistance that we, as Europeans, cannot and do not want to afford.”
What no one reckoned with—not Yanukovych, the Russians or the EU—was the reaction of a vocal and bold minority among the Ukrainian population. The opinion poll evidence does not suggest that there was an overwhelming majority for a decisive shift toward the EU. According to Kiev’s International Institute of Sociology, in November 2013 only 39 percent of respondents favored association with the EU, barely 2 percent more than the 37 percent who favored a Russian-led customs union.44 And those numbers were based on a hypothetical, not the stern terms offered by the IMF and the EU. But events in Ukraine in 2013 were not decided by a referendum on the basis of clearly costed alternatives. They were driven by enthusiastic, fired-up minorities inspired by hopes and fears of Russia and Western Europe and an eclectic range of political imagery drawn from every part of the political spectrum.
In November and December hundreds of thousands of people rallied to Kiev’s freezing streets to protest Yanukovych’s abrupt decision to reject the Association Agreement. But they made no overthrow attempt and Yanukovych might have ridden out the storm but for the ill-advised decision, encouraged by Moscow, to crack down. By using his majority in parliament to ram through constitutional changes, on January 16 he triggered a second wave of mass protests and the occupation of government buildings across Ukraine. At this point, the involvement of the EU and the United States became overt. Quite how deeply Washington was engaged was revealed by the infamous bugged conversation between Victoria Nuland, assistant secretary of state for European and Eurasian affairs, and the US ambassador to Ukraine, which is as illuminating in its characterization of US-EU relations at this point as it was in its blunt instrumentalization of Ukraine’s politicians. On January 28, 2014, as Nuland discussed options with Ambassador Pyatt, she casually remarked: “That would be great I think to help glue this thing and have the UN glue it and you know, fuck the EU.” For Nuland’s taste, the EU was too slow moving and too willing to compromise with President Yanukovych, with whom it had been eagerly pursuing a comprehensive Association Agreement only a few months earlier. Without flinching, Ambassador Pyatt replied: “We’ve got to do something to make it stick together, because you can be pretty sure that if it does start to gain altitude the Russians will be working behind the scenes to try to torpedo it.”45
Two weeks later, a desperate last stand in the streets of Kiev brought an end to Yanukovych’s presidency. On February 21, in talks that were brokered by the foreign ministers of Germany, France and Poland and witnessed by Putin’s representative on the spot, Yanukovych was offered the protection of his office until new presidential elections were held at the end of 2014. But as support from within his party and the security forces melted away, he thought better of taking the risk.46 He too remembered Gaddafi’s fate. Early in the morning on February 22 he fled, leaving a vacuum. Short-circuiting constitutional procedures, a new provisional government took office pending elections scheduled for May 25. What the EU had intended as a protracted transition had become a revolutionary overthrow. And rather than waiting for the outcome of the election, the provisional government, dominated by Tymoshenko’s Fatherland Party and a sprinkling of Maidan activists, moved rapidly to consolidate the new dispensation. It would reverse Yanukovych’s abrupt decision of November. It would draw a clean line with Russia, sign the European Association Agreement and conclude new financial agreements not with Russia but with the IMF and the European Union.
How was Moscow to react? The choice at Vilnius in November 2013 had been pitched by both sides as a strategic turning point. Thanks to the niggardliness of the IMF-EU offer, Moscow had won a significant victory, only for that to be overturned by popular protest and regime change, which, even if it had the support of a considerable fraction of the Ukrainian people, was of dubious legality and was undeniably Western inspired. For Russia to have meekly accepted this outcome would have been worse than if Yanukovych had signed the Association Agreement in the first place. On the night of February 22–23 the Kremlin decided to act. Taking advantage of local protests and activating plans prepared in 2008 to counter a fast-track NATO application, on February 27, 2014, Russian troops in p
erfunctory disguises seized control of the Crimean peninsula.47 A few days later, to further ramp up the pressure on Kiev, Russia put its muscle behind a separatist uprising in the eastern region of Donetsk.
III
The comprehensive economic, political and diplomatic clash between the West and Russia that had been foreshadowed in the proxy war in Georgia in 2008 was now unleashed on an altogether more significant stage. With Ukraine’s territorial integrity at stake, on April 13, 2014, the provisional government in Kiev launched an “antiterrorist” operation to take back control of the Donbass. In Washington and at NATO headquarters there were those calling for immediate military aid for Kiev and a full-throated return to the cold war. McCain and other Republican hawks would have loved to have rallied a war party. Doing so perhaps might have contributed to restoring coherence to their troubled party. But as he had done in Syria in 2013, Obama refused the call to escalate.48 In Europe there was no support for military action. It was not that Ukraine would be denied weapons. But, as in Syria, the arms would be supplied through covert channels. The public front of the West’s reaction was economic sanctions.
Putin’s line had always been that geoeconomics were geopolitics. In Ukraine, struggles over trade negotiations and customs treaties had escalated into an undeclared war. Now the economy itself would be weaponized. Or would it? To pressurize Iran, the United States had developed a ferociously effective regimen of sanctions. Russia as a globally integrated economy was far more vulnerable. Not only did Russian businesses need to export but they had supped deeply at the trough of cheap dollar credit. By early 2014 they owed $728 billion.49 But by the same token, large vested interests in the West were at stake. Apart from anything else, Russia was the number two supplier of oil and gas exports to world markets. At a time of extreme fragility in the emerging market economies, the United States did not want to precipitate further tension in commodity markets. To the frustration of the hard-liners, the United States stayed its hands and never applied the full force of its sanctions weapon. Instead it targeted individual members of the clique close to Putin, the most prominent of whom was Igor Sechin, the boss of oil giant Rosneft.50 Furthermore, Washington limited access to capital markets for key corporations—Rosneft, Novatek, Gazprombank and VEB.51 This was painful, but given the limited volume of US-Russian economic relations, it was far from decisive.