Pension Reform Painful but Necessary – and Good Politics, Too

July 13, 2011
James George Jatras
Deputy Director, AIU

The passage of an unpopular pension reform law by the Verkhovna Rada presents President Viktor Yanukovich a classic “damned-if-you-do, damned-if-you-don’t” choice. On the one hand, his signing the bill may further erode Party of Regions’ (POR) already declining popularity, not least among his core constituency in eastern Ukraine, where socialist concepts of economic security still hold some appeal. On the other hand, few can doubt the unsustainability of the current benefit structure, which consumes 18 percent of Ukraine’s GDP and boasts one of the world’s worst ratios of retirees to contributors (9 to 10). Like it or not, pension reform is a key demand of the International Monetary Fund (IMF) to extend the next $1.5 billion tranche out of the IMF's $15 billion lending package.

Under the most favorable circumstance, this would be a tricky maneuver for Yanukovich to execute, with the best face being that the IMF held a gun to his head. Failure to accede to the IMF’s demands and consequent downgrading of Ukraine’s credit rating would reverse his early successes in securing continued credit support for Ukraine and would cut off any prospect for lending and investment. Of course, these are hardly the best of circumstances, with the POR government pursuing on many fronts what looks like incoherent tactical squirming: refusing to join the Moscow-led Customs Union (CU), rejecting a Gazprom-Naftogaz merger, opposing South Stream, and reneging on promises to POR’s voter core (notably elevating the Russian language to official status) while vainly chasing votes in west Ukraine.

On the IMF and pension front, however, Mr. Yanukovich seems to have gotten the politics right. First, he has forced his opponents to draw a line in the sand on a battle they cannot hope to win. The opposition, notably the Yulia Tymoshenko Bloc, as much as concedes that their constitutional challenge to the Rada’s method of voting used to pass what they hyperbolically call “pension genocide” will not be sustained. Moreover, they transparently have no answer to the problem either: the numbers speak for themselves, and IMF patience is not without limits. Second, while some POR allies, notably the Communist Party, also oppose the reform law, it is not likely to result in a serious or permanent break in Yanukovich’s legislative dominance. Thirdly, regarding POR’s electoral base, while the pension reform is a bitter pill, pushing it through now would be less likely to cause Greek-style disorders of the sort that might result from either complete collapse of the pension system or, alternatively, of the economy if foreign credit and investment were cut off.

In this regard, Ukraine can take some small solace in the travails afflicting the rest of the world. At least Kiev has the ability to make sovereign decisions about its own budget arrangements – under pressure to be sure, but unlike (for example) Athens, which can’t even control the value of its own currency but must mechanically obey the diktat of the Brussels, Washington, and international banking bureaucracies. Even the United States, whose taxpayers supply most of the IMF’s funding must suffer the indignity of listening to Christine Lagarde warning Washington of “real nasty consequences” if President Barack Obama and Congress can’t reach a deal on raising the U.S. government’s debt limit above the current $14.3 trillion by August 2. At any rate, Kiev can be comforted by the fact that the reform (as described by Kiev-based Dragon Capital in a note to investors) “marks a huge positive step towards ensuring sustainability of Ukraine’s public finances and improves the prospects for disbursement of the next IMF lending package. The bill also sets the foundation for introducing the second pension pillar, which is viewed as crucial to fostering growth of the domestic financial market.”

The reference to the domestic financial market is not incidental. Each credit benchmark inevitably is followed by another, as sure as each summer is followed all too soon by winter. Last year Kiev hiked household natural gas prices to land the first two IMF tranches totaling $3.4 billion. The just-enacted pension reform will now unfreeze the disbursements from that tranche but it is expected that the IMF will remain tough with its final key condition concerning a hike in domestic gas tariffs. In a country where pensions are about $100-140 per month and where poor economic conditions are still reflected in some of the lowest salaries, life expectancy, and living standards in Eastern Europe, Yanukovich cannot afford to let his painful win on pensions be followed by fuel price increases. This again exposes the dangers of further dithering on larger economic priorities and the need for Kiev to stop chasing the mirage of any early accession to the EU (itself in crisis) and rather to cut a hard bargain with Moscow on joining the CU and on Gazprom-Naftogaz in exchange for Ukraine’s energy security and affordability. Not only Ukraine’s economy but POR’s fortunes depend on it.