Ukraine vs. the Oligarchs

By Chris Miller, Assistant Professor of International History at The Fletcher School of Law and Diplomacy at Tufts University

U.S. President Donald Trump says he is deeply interested in fighting corruption in Ukraine. If so, he has a daunting task ahead of him. Ukraine faces a $5 billion struggle to retake control of the country’s banking system, in which oligarchs are facing off against Ukraine’s government and its Western backers. At stake are assets worth billions of dollars. The battle risks driving Ukraine’s government toward bankruptcy and pushing the country into an economic crisis. Thus far, the White House seems not to have noticed.

What is causing this crisis? The story starts with Ukraine’s need for foreign financing. After Russia invaded Ukraine in 2014 and seized a chunk of its territory, Ukraine sunk into a painful recession. The country has never been an economic powerhouse, but the Russian intervention made most of Kyiv’s problems—low tax revenue, an expensive social safety net, and an ineffective government—even worse.

The International Monetary Fund (IMF) stepped in to help, leading a consortium including Japan, the United States, the European Union, the World Bank, and others that have extended loans to Ukraine to help it stabilize its economy. In exchange for a $40 billion package of credits and loans, including $17.5 billion from the IMF, Ukraine agreed in 2014 to a series of reforms to balance the country’s budget and to cut corruption.

The reforms that Ukraine agreed to that year were far from easy. Some of the changes, such as cutting pensions or hiking consumer gas prices, were painful for Ukraine’s people but necessary to balance the country’s budget. Other reforms hurt not Ukraine’s citizens but its oligarchs. Western lenders demanded changes to reduce oligarchs’ ability to steal money from the government. The leadership of the state-owned gas company, Naftogaz, was replaced with more amenable management, and Ukraine’s parliament established independent institutions to prosecute corrupt officials.

One of the biggest anti-oligarch reforms was to clean up the country’s banking system—an effort that is now under threat. Before the reforms of recent years, the main problem in Ukraine’s financial system was a bank called PrivatBank. It is the country’s largest bank, and before 2016 it was controlled by Ihor Kolomoisky—a controversial and powerful oligarch whose ambitions now seem to be threatening the future of Ukraine’s economy and its relationship with the IMF.

In 2016, PrivatBank controlled 37 percent of Ukraine’s bank deposits. The institution was so large that a collapse would have brought the rest of Ukraine’s economy down with it. With their bank too big to fail, PrivatBank’s leaders extracted $5.5 billion from it, knowing that they could always stick the government with the bill. Rather than making loans to credible businesses or individuals, PrivatBank’s leadership extended credit to themselves; by late 2016, an independent investigation by the company Kroll found, more than 95 percent of the firm’s loans had been made to “parties related to former shareholders and their affiliates.” Many of those loans were extended to offshore entities that disguised the true recipient. It was, the auditor reported, a “large-scale money-laundering scheme.”

Few of the supposed loans that the banks’ managers made to themselves were ever repaid. But because PrivatBank was so large, it could not be allowed to go bankrupt, as that would have imperiled Ukrainians’ deposits and the integrity of the country’s financial system. The government had no choice but to bail it out.

In late 2016, backed by the IMF, Ukraine’s government nationalized PrivatBank. It had to recapitalize the bank with $5.6 billion—funds that came from Ukrainian taxpayers and from Ukraine’s Western supporters. Kolomoisky, the billionaire who ran PrivatBank, fled the country to his homes in Geneva and Tel Aviv, Israel. He denies the charges and argues that they are politically motivated.

The PrivatBank saga was a sad tale, but until this year it had a silver lining. PrivatBank’s leadership had stolen billions, according to the auditors, but at least the government had cleaned it up. Or so it seemed. But after Ukraine’s presidential election earlier this year, Kolomoisky returned to Ukraine. Now he is demanding that the bank be returned to his control. And one Ukrainian court has ruled that the nationalization of PrivatBank was illegal. Many analysts interpreted the decision as part of a Kolomoisky-led campaign to retake the bank. His efforts are understandable. Now that PrivatBank has been recapitalized with so much IMF money, it is again an attractive asset to own. Returning PrivatBank to Kolomoisky’s control would, in effect, be giving him and his partners that cash.

Why would Ukraine’s leaders agree to give PrivatBank back to Kolomoisky? Ukraine’s new president, Volodymyr Zelensky, has positioned himself as an anti-corruption trader. But he has a long history of business dealings with Kolomoisky, stemming from the days that Zelensky’s comedy show aired on Kolomoisky’s TV channel. Some people think Zelensky is indebted to Kolomoisky because of this shared past. More likely, Zelensky is afraid that if he crosses Kolomoisky, the oligarch will turn his TV channel against Zelensky, attacking the president and reducing his popularity.

The IMF and Ukraine’s Western partners have been insisting that Ukraine will find further financial support hard to come by unless Kyiv guarantees that it will not reverse PrivatBank’s nationalization. Kyiv needs more financing from the IMF soon, without which it will struggle to pay the bills next year. Kolomoisky has argued that Ukraine should improve ties with Russia and spite the West. He has even suggested that if the IMF doesn’t provide more cash, maybe Russia will.

For anyone worried about corruption in Ukraine, this is a dangerous moment. Zelensky’s presidency is at a crossroads. The IMF looks unlikely to dispense further aid without assurances that the money will be spent properly. This means that Ukraine’s government must promise that PrivatBank will not be given back to its old owners, who they believe have already stuck Ukrainian taxpayers with a large enough bill. Yet Zelensky must also be afraid, knowing that if he rejects Kolomoisky’s demands, he faces attacks from Kolomoisky’s TV channel.

Anyone who cares about fighting corruption in Ukraine should be encouraging Zelensky to stand up to the pressure. The acting U.S. ambassador in Kyiv, William Taylor, has publicly warned Zelensky about Kolomoisky’s nefarious influence. But Trump and Secretary of State Mike Pompeo have been silent. If America’s self-proclaimed corruption-fighter-in-chief is really worried about the rule of law in Ukraine, this would be a good time to say something.

This piece was republished from Foreign Policy.