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Eastern Europe’s largest country is profoundly unstable. Ukraine has been in a state of stress ever since it gained independence in 1991 due to multiple handicaps: its location in a contested borderland; its severe ethnic and cultural cleavages; and its lack of any prior experience of either statehood, democracy or free markets. For ordinary people, the conditions of life are woeful. Since Ukraine left the Soviet Union, real GDP per capita has fallen by a fifth, there are few economic opportunities and 60% of the population lives in poverty. This has created an environment of permanent unresolved grievance which occasionally flares up into violence.

 

The latest chapter in Ukraine’s difficult history began in 2014 when a young, broadly reformist constituency, centred mainly in the west of the country, rose up against the government of Viktor Yanukovych, demanding the adoption of a Western political and economic system and integration with the EU. This triggered a backlash from a more conservative constituency in the east and the south which has invested its hopes in a restoration of Ukraine’s hybrid economic model and close trading relations with Russia. In a climate of heightened agitation, the regions of Donetsk and Luhansk declared their independence from Ukraine, setting the stage for a military confrontation with the government in Kiev and a severe shock to the local economy.

 

On the economic front, matters have started to improve. After contracting nearly 15% in 2014 and 2015, the economy has now returned to growth; inflation has fallen sharply (to 12.4% in December); and the hryvna has stabilised at around UAH28:EUR1, supported by an IMF funding arrangement and bilateral loans from the US. Meanwhile, the government has embarked on a programme of structural reform intended to stabilise the public finances and revive long-term economic growth.

 

However, Ukraine faces a myriad of problems. These begin with the capture of the political institutions by specialised interests, including nefarious business elites and organised criminal gangs which run an oligopolistic economy in their own interests. Not only is this impeding a raft of reforms which are necessary for creating a law-bound, market-based economy, but corruption is also fueling widespread cynicism with the political process. Unfortunately, despite the change in government in 2014, there is no discernible improvement.

 

Linked to this, the institutions of government are chronically weak, limiting their power to implement reform. Parliament is fractious, relations between the various organs of government are tense, and the government struggles to assert its authority across the country: many people in the south and east remain bitter at the unconstitutional overthrow of the Yanukovych government and inhabitants of the Donbas deny the legitimacy of the central government altogether. This has created political space for groups, especially on the far right, which reject the current constitutional order.

 

Meanwhile, Russia is actively subverting Ukraine’s internal stability in the hope of bringing down the current government and replacing it with a pro-Russian administration that abandons plans to integrate Ukraine with the West. Russia is using a variety of means to achieve this goal, including infiltration of the institutions of state, especially the parliament and the army; the delegitimising of government by means of negative propaganda and media coverage; economic sanctions; cyber attacks; and threats to cut off Ukraine’s gas supplies.

 

Most importantly, Russia has successfully exploited Ukraine’s multiple cleavages, especially that between Ukrainians and ethnic Russians in the Donbas, convincing the latter that the government in Kiev is hostile to their interests and providing military assistance to resist its influence. As a result, Ukraine exists in a state of permanent low-level warfare - sometimes hotter, sometimes cooler - that drains the government’s limited physical and financial resources, and prevents it from thinking strategically about Ukraine’s future. So far, Russia has successfully resisted attempts by external mediators to resolve the conflict, not least by denying any involvement in it. Even if the conflict now ended, and the breakaway Donbas were re-integrated with Ukraine, the government would continue to falter due to the cost of rebuilding a shattered region and regaining the loyalty of its population.

 

To complicate matters further, the European Union is losing interest in integrating Ukraine, despite playing a pivotal role in precipitating the uprising in 2014. In part, this is because of the EU’s internal crisis, which has put the question of EU enlargement on permanent hold, especially into a large, troubled state such as Ukraine. In part, it is also a response to Russia’s violent backlash against moves to integrate the country. Not only are Western economies suffering as a result of the reciprocal sanctions regime imposed in 2014, but few governments are willing to risk a full-scale military confrontation with Russia.

 

Forecast

 

As 2017 begins, Ukraine stands at a crossroads. In a best-case scenario, the economy will gain in strength and the government will survive, riding out a difficult winter in which much of the population has struggled to make ends meet after a doubling a gas tariffs in 2016. This will position the government continue on the road of political and economic reform. In a median scenario, the government could fall in the face of popular anger, triggering new elections and auguring a period of political disruption. In this case, reformists led by Yulia Tymoshenko and the Fatherland Party would probably manage to retain power and continue the current direction of government policy.

 

The worst-case scenario is that popular disappointment with the reformist movement, especially among Ukraine’s Western-orientated young, leads to renewed in-fighting and creates space for Ukraine’s pro-Russian conservatives to regain power, as happened after the Orange Revolution. While this would probably pave the way for an end to the conflict in the east and a general de-escalation of the ‘New Cold War’, it could also generate a new backlash by marginalised reformists, as happened in 2014, only under much more complex circumstances. Unlike before, the reformist movement is now fractured; the EU and the US are far more deeply invested in Ukraine than the last time there was a popular uprising; and the country is territorially divided in the Donbas. Not only could the country could face renewed internal instability, pitching reformists, nationalists, pro-Russians, oligarchs and various outside powers against one another; but Ukraine’s overall territorial integrity could be at risk.

 

 

Immediate Impacts

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• Political instability is undermining macroeconomic and financial stability, eroding GDP and severely complicating efforts at structural reform.

 

• Civil order is at risk due to the widely held grievances in the wider population and a tradition of street demonstrations: a third Maidan is possible.

 

• Russia’s continued involvement in Ukraine is perpetuating reciprocal economic sanctions between the West and Russia.

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Potential Impacts

 

• Instability in Western Ukraine could spill over its borders into Central Europe, and entangle countries such as Hungary which have diasporas in Ukraine.

 

• Instability could also spread to Transnistria, entangling neighbouring states such as Romania which have direct interests in Moldova.

 

• The rise of an extremist party risks a massive outflow of capital and people into Central and Western Europe.

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