Russia

How to reform Ukraine's economy

April 2, 2014: 11:57 AM ET

The International Monetary Fund recently agreed to help the debt-stressed country with up to an $18 billion loan, but it can't do it alone.

By Heidi Crebo-Rediker and Douglas Rediker

A market trader counts out hryvnia currency banknotes at a fruit stall in Kiev, Ukraine, on Feb. 3, 2014.

A market trader counts out hryvnia currency banknotes at a fruit stall in Kiev, Ukraine, on Feb. 3, 2014.

FORTUNE -- After weeks of urgent negotiations with Ukraine's interim government, the International Monetary Fund last week agreed to provide up to $18 billion to prevent the country's default. The loan, spread over two years, represents Ukraine's best chance to finally transition its economy and institutions away from its past and open a new chapter in its history.

While the IMF will clearly play the lead role in Ukraine, the country's success or failure will largely depend on its ability to implement reforms to get its economy back on track. To do this, Ukraine will need assistance from the IMF, the European Union, the United States and perhaps -- most of all -- from the European Bank for Reconstruction and Development (EBRD).  With its highly relevant expertise and financial resources, the EBRD should return to its core mandate -- which explicitly includes advancing democratic values -- by shifting its focus away from Russia and toward playing a central role in Ukraine's transition.

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The EBRD is able to bring to bear over two decades of experience in Ukraine, trained professionals who speak the language, and its presence on the ground. The bank has already worked tirelessly for years with Ukrainian companies and banks in attempting to improve standards, fight corruption, and create a more sustainable corporate and investment environment. This has not always been an easy task in Ukraine, and has met with both mixed successes as well as lessons learned.

Corruption plagues Ukraine on many levels. The EBRD knows where many of the bodies are buried (figuratively) in key industries, particularly in the energy sector. Experience has left the EBRD with enough healthy cynicism to make wise choices and realistic recommendations. With new-found political support at the top and a desire by its people to move to a better and more prosperous future, the chances of success on the part of the EBRD in Ukraine are greater now than ever before.

But the EBRD has limited resources -- both financial and professional. To increase its Ukraine effort, it needs to decrease its efforts elsewhere. For many reasons, Russia deserves to pay the price of this increased Ukraine effort. The EBRD spent the past two decades lending significant financial resources to Russia. The bank has directed nearly a quarter of its loans and investments to Russian entities since the EBRD started operations; making Russia the largest single recipient of EBRD financing of any member country. Some of these loans were made to state banks and state-owned enterprises -- including to state-controlled behemoth Gazprom and the Russian state-owned railway, headed by Vladimir Yakunin, who was included last week on the U.S. Treasury's sanctions list. When the EBRD signed the $500 million 10-year loan to Russian Railways in 2009, it was the largest in the EBRD's history.

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Lending to and investing in Russia was profitable business for the bank and helped the overall credit quality of its loan portfolio. Unfortunately, it did not do enough to support Article One of its charter, agreed to by all of its shareholders. The EBRD is unique in that -- unlike every other multilateral development bank -- it has the advancement and pursuit of democracy as a core mandate. All member countries, including Russia, committed to the fundamental principles of multiparty democracy, the rule of law, respect for human rights, and market economics when they joined the bank.

Article One of the charter establishes the central purpose of the bank as fostering transition toward open market-oriented economies in countries that are "committed to and applying the principles of multiparty democracy, pluralism, and market economics." Over the years, the EBRD has been able to justify large lending and investment operations in Russia, particularly to state-owned enterprises, as part of the transition mandate. The EBRD argued it was pushing the needle in the right direction on democracy, though the needle was a very heavy one to push.

Given recent events, Russia's commitment to the democracy mandate has clearly been called into question. The EBRD answers to shareholding countries, the largest of those being the United States, followed by Germany, U.K., France, Italy, and Japan. Shareholders should ensure that future lending to Russia clears a very high bar, especially with regard to Article One. Future lending to state-owned or state-controlled companies should cease altogether. It is time for the EBRD to focus more of its resources -- talent, experience, and its balance sheet -- to where they are desperately needed. In supporting Ukraine, there is no question that EBRD will be doing precisely what it was intended to do by the charter that brought the bank into existence just over two short decades ago.

Heidi Crebo-Rediker is the former chief economist at the U.S. State Department and is currently a senior fellow at the Council on Foreign Relations. Douglas Rediker is a former member of the Executive Board of the IMF and is currently a visiting fellow at the Peterson Institute for International Economics.

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