EUobserver opinion: Corruption is greatest threat to Ukraine sovereignty

When Aleksandr Lapko received his drafting notice from the Ukrainian defence ministry, he was faced with a dilemma: either spend $2000 of his own money (the equivalent of 10 average monthly wages in the military) to buy the military equipment needed to serve, or pay a $2000 bribe to be declared medically unfit for service.

He chose the first option and is now working with the Nato liaison office in Ukraine.

This story, published by Transparency International, captures in a nutshell the challenges faced by Ukrainians in their daily struggles: either pay from their own money to cover for the endemic corruption of officialdom, or bribe their way out of a rut.

This malaise has become so prevalent that Ukrainians barely shrugged when Prime Minister Yatsenuk said earlier this year that 40 percent of all state procurements are lost each year to graft.

As a result, the economy barely grew in the past 20 years, making Ukraine the worst performing economy of the ex-Soviet bloc; its GDP grew by 50 percent since 1992, whereas Armenia’s expanded by an eye-popping 400 percent.

With a relentless civil war raging in the East, Ukraine’s economy is already teetering on the brink of collapse. Entrenched corruption coupled with higher-than-expected spending on the military sent Ukraine into an economic tailspin in 2014.

GDP contracted by 10 percent, the hryvnia was named the worst performing currency in the world, tax revenues from the East plummeted by 30 percent, inflation rose to 25 percent and the country’s foreign reserves dwindled from $20 billion in autumn to some $9 billion in January.

Back in October, the finance ministry estimated that rebuilding Luhansk and Donetsk, Ukraine’s main industrial heartland, would require at least $2 billion from international donors. And to top it all off, Ukraine needs a $20 billion-plus loan just to make it to the end of the year, a sum that, if raised, will come with painful conditionalities.

Default, the financial markets' boogeyman, has become so widely expected among watchers, that Moody’s estimates the chances of Ukraine defaulting on its international debt as “exceedingly high”. Ukrainian bonds took a nosedive on 22 January, sparking fears of an impending restructuring of the country’s debt.

"You don’t grease, you don’t ride"

Beyond immediate financial assistance, what Ukraine needs most is to establish a functional, self-sustaining economic environment. Policy-makers, both in Kiev and Brussels, should understand that the main vector of Russia’s success in both Crimea and the Eastern regions of Luhansk and Donetsk has not been rooted solely in disinformation campaigns, covert operations or sheer military might.

Beyond such artifices, Moscow tapped into the widespread sense of hopelessness shared by most Ukrainians following two decades of bad governance and rampant corruption.

Transparency International ranked Ukraine 142 (out of 175) in its annual corruption survey while a 2012 study by Ernst & Young placed Ukraine as one of the three most corrupt countries in the world, alongside Colombia and Brazil.

Past data from Transparency International shows that, in the past 15 years, the country’s anti-corruption efforts have been paltry at best - Ukraine has barely budged from the bottom positions of TI’s staple studies.

Indeed, the Orange Revolution played out as a catch-all, pro-European movement that rose up against the corruption of the Kuchma regime and the manipulation of the polls in the run up to the 2004 Presidential election.

On a similar note, the Euromaidan, nominally prompted by President Yanukovych’s refusal to sign the EU Association Agreement, must be seen as a symbol of the dysfunctionalities inherent to Ukrainian politics - a declaration of the widespread belief that only closer EU ties will bring much needed reforms.

Federica Mogherini, the EU’s foreign policy chief, correctly observed in January that good ties between Ukraine and Brussels are fundamental in order to dismiss the fear that "the choice in favour of the Association Agreement with the EU led to negative consequences for all Ukrainian people”.

Despondent citizens in Ukraine’s East, alienated by Kiev's weak policies and economic mismanagement, were quick to embrace Russia’s promises of a brighter tomorrow.

It shouldn't be surprising that one of the first measures passed by the new Crimean government following the annexation had been to raise the wages of civil servants, increase pensions by 50 percent, and pledge massive investments in infrastructure and other public works.

Banishing Moscow’s appeal has to start from Kiev and its policy-makers. Otherwise, Ukraine will simply become a basket case, reliant on international aid that is continuously syphoned off by corrupt officials or used to pay off debts incurred through government malfeasance.

In conjunction with structural reforms meant to increase the efficiency of resource use over the medium term, some short-term measures need implementation.

Reforming the tax system

A good place to start would have been reforming the country’s tax system, largely responsible for the shabby state of public finances.

Improved in a first phase under the administration of Oleksandr Klymenko, when Ukraine jumped some 50 spots in the Ease of Doing Business rankings over the course of two years, the reforms of the Yanukovych era official were not fully implemented.

Unfortunately, the piecemeal package enacted by the Yatseniuk government on 28 December has received a chilly reception from analysts. Although it incorporates some elements hashed out by Klymenko, such as expanding the use of electronic VAT invoices, the reform is short on specifics and expands the overall tax burden, a move that could put the breaks on the already embattled economy.

Preferential tax treatments for IT companies have been axed, payroll taxes for employees have increased and a controversial property tax has been instituted for businesses.

What’s more, in order to finance the ongoing military campaign, the current government has implemented a series of taxes that could cancel out some of the past years’ reforms, such as a 1.5 percent “military tax” on all salaries.

The rate of royalties demanded from gas producers has also been a point of contention, drawing the ire of the International Monetary Fund. Introduced in the summer as a temporary tax to fill up war coffers, it was made permanent in the final form of the bill, sparking fears that it will discourage investments and increase Ukraine’s energy dependency on Russia.

In this shaky context, the 2015 budget is based on the assumption that the government will raise 26 percent more in taxes compared to 2014, a grossly overstated figure.

If Aleksandr Lapko’s case is any indication, Ukraine, a country with a rich history of swindling the taxman, will find ways to adapt to the extra tax burden. But that means that Kiev just lost a great opportunity to change the mores of the past.

Maryla Krol is a Geneva-based economist