"This is a victory of freedom over tyranny," Yushchenko told a crowd of some 100,000 followers packed into Kiev's Independence Square. "This is the victory of law over lawlessness. Ukraine opens the history of Europe for the third millennium."
Impressive as it was, however, Yushchenko's victory is only half won. Having liberated the country's political system, the onetime central banker now faces the equally vital and daunting challenge of freeing the country's economy from the stifling bureaucracy and corruption that marked the rule of his predecessor, Leonid Kuchma. That will mean taking on a handful of powerful oligarchs who control the bulk of Ukraine's prize industrial assets and who backed the campaign of his bitter rival, former prime minister Viktor Yanukovych.
During Kuchma's decade as president, most of Ukraine's hard-currency-earning industry was privatized into the hands of a tight circle of businessmen, including Kuchma's son-in-law Viktor Pinchuk and his former chief of staff, Viktor Medvedchuk. Pinchuk became one of three Ukrainians who cracked Forbes magazine's global billionaires list for the first time this year. The other two are oligarchs from the eastern industrial city of Donetsk: Rinat Akhmetov, head of Systems Capital Management, and Sergey Taruta, who controls the Industrial Union of Donbass. Rounding out the head table of old-regime favorites is Igor Kolomoyski, who runs Privat Group from Kuchma's home city of Dnipropetrovsk.
Like their Russian counterparts, these business insiders got their companies on the cheap through noncompetitive privatizations or bankruptcy proceedings in a fledgling court system, then enhanced their profits by obtaining generous tax breaks from the state. The group's steel mills, iron foundries and chemical plants accounted for more than half of Ukraine's $33 billion in exports last year. "This country has been run as an ATM for a dozen families," says Natalia Feduschak, an American Fulbright scholar who teaches journalism at Taras Shevchenko National University in Kiev.
Yushchenko's challenge is to crack down on past abuses, as he has promised, while "avoiding the Yukos effect," as Kamen Zahariev, the European Bank for Reconstruction and Development's country director for Ukraine, puts it, referring to the chilling impact on business confidence in Russia that has resulted from the Kremlin's crackdown on that country's wealthiest man, Mikhail Khodorkovsky. Yushchenko has promised to reopen as many as several dozen of Ukraine's most controversial privatizations and reclaim any improperly obtained assets, vowing to be just as resolute in tackling the oligarchs as he was in taking on his political opponents.
"I am a believing Orthodox Christian and a reasonably humane person," he told Institutional Investor at a meeting with American correspondents in Kiev in April, on the eve of a trip to the U.S. "But first, I have to think of justice for the millions of Ukrainians who suffered from the same bandits as I did. And those bandits were the former power."
Yushchenko also has to clean up the fiscal mess created by Yanukovych, who nearly doubled payments to the country's 11 million pensioners and raised public sector salaries by 20 percent before leaving office just before the first round of the presidential election in October. The new president has vowed to maintain those increases, but the largesse threatens to worsen a budget deficit that most analysts believe will rise to 5 or 6 percent of GDP this year, and to fuel a rise in the country's 12 percent inflation rate.
Economic success is essential for Yushchenko to achieve his overriding ambition of putting Ukraine on track to join the European Union, following the path of neighbors to its West freed from Soviet domination.
"My goal is to place Ukraine in the forefront of prosperous democracies," Yushchenko said in a speech to the U.S. Congress last month. "For us, a European future is a powerful incentive to attain high political, social and economic standards." Or as Oleh Rybachuk, the deputy prime minister for European integration, puts it, "Our mission is to become Europe-compatible -- to show we have become part of the club of nations that share the same values."
Key to Yushchenko's economic plan is leveling the playing field, which is impossible without curbing the influence of Kuchma's business insiders. On paper Ukraine has already achieved significant reforms. Tax rates are a flat 13 percent on personal income and 25 percent on corporate income, levels comparable with Russia's. Tariffs are largely compatible with World Trade Organization guidelines. Most of the economy -- except for natural monopolies like gas, transportation and fixed-line telephony -- is in private hands.
Under Kuchma, however, the economic rules were largely a façade. Favored business groups received tax exemptions in 2003 that nearly equaled the national budget of 75 billion hryvnia ($14.5 billion), according to SigmaBleyzer, a private equity fund backed by Ukrainian-American investor Michael Bleyzer. Oppressive import and licensing procedures kept foreign competitors at bay. "We want to simplify customs procedures so that importers will not have to deal with ten different inspectors, each of them potentially corrupt," Finance Minister Viktor Pynzenyk says in an interview (see box).
A tight political timetable makes these problems all the more challenging. Yushchenko's reign as a Russian-style president with virtually unchecked powers over domestic and foreign policy is due to end in September, when he has agreed to hand over to the Verkhovna Rada, or Parliament, key powers such as the authority to appoint ministers. Parliamentary elections are to follow in March 2006, when Yushchenko's Our Ukraine Party will seek to obtain a majority of 226 seats in the 450-seat Parliament. It holds 100 seats currently, making it the largest of the dozen parties represented in the Rada.
The shifting of power to Parliament is likely to bolster the influence of Yulia Tymoshenko, the mercurial ally Yushchenko appointed as prime minister in January, who is viewed with distrust by the president's free-market supporters. The charismatic Tymoshenko, who blends uncompromising rhetoric -- like calling Kuchma a "redheaded cockroach" -- with delicate physical beauty, demonstrated her political clout by getting the usually fractious Rada to approve the government's budget in March by an overwhelming margin. She has promised to support Our Ukraine in next year's elections and to back Yushchenko for reelection as president in five years' time, but many political insiders believe she will pursue her own ambitions after the prime minister's authority is strengthened later this year.
All of this means Yushchenko has the rest of 2005, at most, to assert primacy over the oligarchs and get the country's finances in order.
For their part, the business barons have expressed loyalty to the new president while vowing to resist any attempt by the state to grab their wealth. Their money and media power could make them fearsome opponents of Our Ukraine in the 2006 parliamentary elections. Alexander Pilipenko, investment director at the Industrial Union of Donbass, insists the government must let bygones be bygones for the good of the country. "A reversal of even 30 privatizations would put Ukraine's attractiveness to investors on the level of Uganda or Botswana," he tells II. Under the leadership of Kuchma favorite Taruta, the Industrial Union of Donbass has gained control of more than 40 mines, iron and steel mills and light industrial plants since 1995.
Yushchenko appears determined to overturn some privatizations he regards as having been rigged. "We will restore justice," he says. "To entrepreneurs I say that the assets will return to the state for only a short time, followed by a new tender. Our only condition in future privatizations will be who bids the most money."
The president has several strengths to rely on as he confronts his many challenges. His courage in standing up to the old regime -- to which the scars on his face bear constant testimony -- has given him an extraordinary moral stature in the country and around the world.
The Orange Revolution, after all, did more than change a government: It gave birth to a nation. Ukraine gave up its sovereignty in the mid18th century when Cossack rulers, who had thrown off Polish control 100 years before, agreed to the region's absorption by Russia. After the collapse of the Soviet Union in 1991, the country limped through its first 13 years of independence as one of Russia's orphaned backwaters. Ordinary Ukrainians flooded Moscow illegally in search of work they could not find back home. Kuchma, who like most of his countrymen grew up speaking Russian, learned the national language only after he took office as president in 1994. Yushchenko's native tongue is Russian also, and he makes grammatical mistakes when speaking Ukrainian, according to local journalists.
But Yushchenko's struggle against the Kuchma clan and their backers in Moscow transformed Ukrainian nationality from a vague concept to a source of pride and hope. "My wife is a Russian speaker who never took any interest in politics," says John Conlan, a former U.S. congressman who now lives in Kiev and advised Yushchenko's presidential campaign. "Then after Yushchenko was poisoned, she suddenly said: 'This is my country. I have to fight for it.'"
The president's courage and ideals have won him firm backing from the EU, which Ukraine aspires to join, and from the U.S. EU election observers helped sustain the Orange Revolution by declaring Yanukovych's victory in the first ballot a fraud, fueling street protests in Kiev. The Union hasn't given a firm commitment to Ukraine's accession, but Danuta Hübner, the EU commissioner for regional policy, has said the country could possibly join by 2015.
Yushchenko hasn't pressed yet for a date to begin EU membership negotiations, but Rybachuk indicates that the government wants to move quickly. "We will wait a few months and show you how fast we can move forward," he told a recent meeting of the European Business Association in Kiev.
In the U.S., meanwhile, President George W. Bush pledged to support Ukraine's bid to join the WTO during Yushchenko's recent visit to Washington.
Yushchenko has inherited one of the biggest economic booms in Europe. The Ukrainian economy has been on a rampage thanks to rising global prices for the products of its metallurgy industry -- a network of iron, steel and coal businesses clustered around the southeast city of Donetsk, which is also Yanukovych's home city and was the center of his electoral support. The country's growth rate accelerated to a torrid 12 percent last year, from 9.4 percent in 2003. The International Monetary Fund expects expansion to cool this year but still remain strong at 7 percent.
The surge in metals exports has facilitated a shift to the West in Ukraine's trade and decreased the country's economic dependence on Russia. Ten years ago Ukraine shipped more than half its exports to Russia and other ex-Soviet states and less than a quarter to Europe. Today, Europe takes more than 40 percent of exports, and the former Soviet states less than 25 percent.
The changing trade patterns have sparked European investment interest in a country that combines Western educational levels with Chinese-like wages -- an average of about $150 a month. Ukraine also shares a border with three countries -- Hungary, Poland and Slovakia -- that joined the EU last May. Austria's Raiffeisen Bank announced in March that it was in talks to buy Aval Bank, Ukraine's second-biggest. Norway's Telenor, meanwhile, already owns 55 percent of the country's top cellular operator, Kievstar.
Ukraine's increasingly Western orientation is weakening Moscow's influence, even in energy, where the country is dependent on imports: Ukraine today buys more natural gas from Turkmenistan than from Russia. Russian President Vladimir Putin, who campaigned in Ukraine for Yanukovych and declared him the winner before the country's first ballot was thrown out by the courts, accepted Yushchenko's victory pragmatically, inviting him to the Kremlin the day after his inauguration. Yushchenko repaid in kind. "We have always stood, and will stand, for Russia being our eternal strategic partner," he declared after the meeting. "We would like to establish rational relations and throw away myths and legends."
The recent boom notwithstanding, Ukraine remains a backward economy in desperate need of development. Economic output is currently 60 percent of its 1989 level, on par with Serbia's and Bosnia's and far behind those of Russia and the new Central European EU members. Per capita income stands at about $1,100, compared with roughly $2,800 in Russia, according to the World Bank.
To see why, consider agriculture. Ukraine in the 19th century was the breadbasket of Europe. It is nearly twice as large as Poland and boasts flat, fertile fields and a favorable summer climate. After 1991 the government divided the Soviet-era kolkhozy, or collectives, into tiny plots, but a ban on sales of farmland has prevented a shift to industrial-scale agriculture. More than one third of the population still makes its living off the land, with the average peasant statistically owning 2.5 cows.
Ukraine's industrial base, meanwhile, has been starved of foreign investment because of corruption and a leaden bureaucracy. The country has attracted less than $8 billion in foreign direct investment since 1991. That's roughly the same amount that currently pours into Poland each year, according to the EBRD. Trading in Ukrainian stocks amounts to less than $10 million a day, says Tomas Fiala, president of Kiev investment bank Dragon Capital. The first Ukrainian company listed in London only this February, when dairy producer Ukrproduct Group raised £6 million ($11.5 million) on the Alternative Investment Market, for 27 percent of its equity.
VIKTOR ANDREIEVICH YUSHCHENKO WAS BORN IN 1954 in a village in the Sumy province in eastern Ukraine, near the then-invisible border with Russia. His father, Andrei, was a schoolteacher who survived Auschwitz as a Soviet prisoner of war.
Yushchenko moved to western Ukraine to study at the Ternopil Finance and Economics Institute, where he obtained an undergraduate degree in economics in 1975. Ternopil is in the Carpathian Mountains, a region that was part of the Austro-Hungarian empire, then Poland, before it was absorbed by the Soviet Union in 1945. It was here that Yushchenko developed both a passion for mountain climbing and sense of Ukrainian patriotism. Since 1990 he and a group of friends have annually climbed the highest peak in Ukraine, Hoverla, on the same day in July that the Verkhovna Rada voted for independence from the Soviet Union.
"Sport is venturesome, unpredictable and sometimes violent," says Yushchenko. "The same is true of politics."
After graduating from Ternopil, Yushchenko went to work in his hometown affiliate of the State Bank of the USSR. He earned a Ph.D. in finance from the Ukrainian Institute of Economics and Agricultural Management in 1984, moved to Kiev and spent nine years rising through the state banking system as an agricultural credit specialist. When Ukraine formed its prototype national bank in the late 1980s, Yushchenko was named deputy chairman.
Following independence he became head of the new central bank in 1993, one of a handful of reformers known simply as "the boys" who were appointed by the country's first president, Leonid Kravchuk, to reassure the IMF and other lenders. Others in the group included Viktor Pynzenyk, now Finance minister, and Serhiy Teryohkin, the current Economics minister.
In his six years as the chief of the central bank, Yushchenko ended hyperinflation, which was running at about 50 percent a month when he took over, and in 1996 replaced the virtually worthless karbovanets with a new, stable hryvnia. Inflation fell to the single digits in 2002 but edged up to just over 8 percent last year, from 5.2 percent in 2003.
Yushchenko's economic competence and gentlemanly demeanor gradually won him a political following. "Ukrainians like him because he mirrors the way we like to think of ourselves: a little bit melancholy, nonaggressive, devoted to family," says Yuri Blaschuk, who worked with Yushchenko at the national bank and today is chairman of International Mortgage Bank in Kiev. The 51-year-old president has five children from two marriages.
In December 1999, with Ukraine reeling from the aftershocks of Russia's 1998 financial collapse, Kuchma turned to Yushchenko as prime minister. In 16 tumultuous months as premier, Yushchenko showed his fearlessness in taking on corrupt practices. He began paying agricultural subsidies directly to farmers rather than to middleman firms, which had been skimming off most of the money. He also forced power utilities to pay and collect their bills in cash, curtailing an anarchic chit system that allowed electricity customers to pay kickbacks to managers rather than settle their bills with the company.
Yushchenko tried to inject competition -- particularly from foreign companies -- into Ukraine's privatization process. He achieved one success in 2001 when U.S.-based power company AES Corp. bought electricity distributors in the Kiev and Rivne regions for a combined price of $70 million. Yushchenko intervened at the last minute, pushing through legislation that allowed utilities to cut off power to nonpaying customers. "The tender was coming up, and I told Yushchenko we couldn't participate the way the laws were written," recalls Garry Levesley, Ukraine representative for AES. "So I flew into Kiev one Saturday, and he sat his cabinet down and wrote five new laws."
"Yushchenko is a classic European liberal who believes in good," says Myron Wasylyk, who heads the Kiev office of Washington-based PR firm PBN Co. and served as a media adviser to the Yushchenko campaign. "He doesn't dictate to people. He would rather get 20 advisers together and sit there until they reach consensus."
As part of his drive to reform the energy sector back in 1999, Yushchenko recruited Tymoshenko, now known throughout the country simply as "Yulia," to serve as deputy prime minister for fuel and energy. A 44-year-old former Communist Youth League leader and factory economist from Dnipropetrovsk, Tymoshenko is an unlikely ally. She came to prominence in the mid-1990s as a protégé of Pavlo Lazarenko, a governor of Dnipropetrovsk and later Ukrainian prime minister who last year was convicted in a U.S. court of 29 counts of extortion and money laundering. While Lazarenko was premier in 1996'97, a company Tymoshenko controlled with her husband and father-in-law, Unified Energy Systems of Ukraine (no relation to the Russian utility with a similar name), became the country's leading gas distributor. Ukraine's top tax official at one point accused Tymoshenko of illegally sending $1.2 billion abroad.
Russia issued an arrest warrant for Tymoshenko on charges of bribing officials in 1996. Although Moscow provided no details on the purpose of the alleged bribery, General Prosecutor Vladimir Ustinov has said it cost Russia "hundreds of millions of dollars." He promised that Tymoshenko would not be detained if she came to Moscow on a state visit, but she canceled a planned trip last month, saying she needed to oversee Ukraine's spring agricultural planting.
During her stint as deputy prime minister, Tymoshenko turned on her former power sector rivals and customers, forcing them to declare revenue and pay an estimated $2 billion in taxes. Her husband was arrested in August 2000 on embezzlement charges, and prosecutors began investigating Yulia herself. Kuchma fired her in January 2001, and the following month she was arrested for alleged fraud and money laundering. She spent six weeks in jail before being released on grounds of ill health. The charges were eventually dropped.
Yushchenko himself was fired in April 2001. Tymoshenko formed a party under her own name for the 2002 parliamentary elections, but her Yulia Tymoshenko Bloc won only 20 seats. Yushchenko's Our Ukraine Party took 100, setting him on a path to the presidency.
Tymoshenko played a leading role in the Orange Revolution last fall, captivating crowds with her calls for "the destruction of this regime." Says Fulbright scholar Feduschak: "Yulia is the wild card in Ukraine. Everybody knows she wants to be president herself, and she is the one person you don't want on the other side of the barricades."
Others are more frankly suspicious of her agenda. "Yushchenko is a man of vision, morals and stable principles," says one Kiev banker. "Tymoshenko is just the opposite: tactics and using whatever means are available."
Now President Yushchenko and Prime Minister Tymoshenko -- who has focused on domestic priorities like the budget while Yushchenko trots the globe reshaping his country's image -- face the Kuchma-era business elite again. Former first son-in-law Pinchuk heads Interpipe Corp., which owns three factories that produce pipe for the oil and gas industry. He also controls popular TV channel Inter. Forbes estimates his net worth at $1.3 billion. Medvedchuk, who was chief of Kuchma's presidential administration, owns two other channels, ICTV and H1, plus half a dozen regional utilities and Kiev Dynamo, the country's leading soccer club. Competing against the three oligarch-run television channels is TV 5, whose owner, Petro Poroshenko, backed the Orange Revolution and now serves as chairman of the National Security and Defense Council of Ukraine. There is also one state network, which ignored Yushchenko entirely during the election campaign.
Industrial Union of Donbass chief Taruta was trade director at the Azovstal Iron and Steel Works ten years ago and is a baron worth $1 billion today. His fellow Donetsk tycoon, Rinat Akhmetov, has ridden Systems Capital Management -- which holds a similar profile of steel, ore and mining assets -- to a fortune of $2.4 billion, by Forbes's reckoning. Privat Group's Igor Kolomoyski, a former central bank colleague of Yushchenko's, has focused on raw materials such as iron and manganese. The group also owns Privat Bank, one of the country's largest banks.
These Ukrainian oligarchs began to buy up their assets after Kuchma was elected president in 1994 and kicked off a mass privatization program similar to Russia's. The worth of their holdings has increased rapidly since 2002, in line with soaring metal and coal prices.
With Yushchenko's political ascendancy posing a growing threat to the cozy ways of the Kuchma regime last year, the former government hurried through a number of privatizations, or as Deputy Prime Minister Rybachuk calls them, "outrageous cases of practically robbing the country." Prime among them was the sale of Kryvorizhstal, the country's largest steel complex. Pinchuk and Akhmetov teamed up to buy 93 percent of the plant for $800 million through a vehicle called Investment Metallurgical Union. LNM Group, the giant steelmaker that has been active in Eastern Europe and the former Soviet Union, reportedly bid $1.5 billion and promised to invest a further $1.2 billion. It lost out, however, when the government restricted bidding to companies that had produced 1 million tons of coke in Ukraine during the preceding three years.
A second deal Yushchenko promises to revisit is Ukrrudprom, a state holding encompassing ten coal and iron mining complexes that was privatized in several stages last year. A consortium controlled by Akhmetov and Privat Group bought nine of the ten enterprises for 1.4 billion hryvnia. The real value of the assets was much higher, the new government contends.
The Kuchma government pulled off dozens, if not hundreds, of similarly questionable transactions in the months before the election. The Ministry of Defense, for example, transferred a hectare of land in downtown Kiev worth tens of millions of dollars to an unknown counterparty in exchange for 50 apartments in the city of Chernihiv with a collective value of about $500,000.
Fury at this sort of backroom dealing drove many of the Orange revolutionaries into the streets last December. "The mass of people who stood up for Yushchenko did not really care about him or any other politician individually," says Irina Paliashvili, a Georgian-born lawyer whose practice is split between Washington and Kiev. "All they cared about was that they no longer wanted to succumb to cheating and abuse."
Yushchenko says the prosecutor's office is compiling a comprehensive list of targets for nationalization and reprivatization, but so far he has not specified any others besides Kryvorizhstal and Ukrrudprom. He sidesteps a question about possible prosecution of oligarchs, saying simply, "Whoever breaks the law must bear responsibility."
Rybachuk is a bit more specific about the government's plans to reopen dodgy privatizations, estimating that there are "about seven cases that the minister of Justice feels confident about." Once these are disposed of, he predicts, the government will develop productive relations with the industrial barons.
"These business groups will never go into opposition," Rybachuk says in an interview with II. "We will make sure that all of them are paying taxes and are clean. Then they will get our support, as any country supports its investors."
Pilipenko insists the Industrial Union of Donbass is ready to cooperate with the new government. "We never thought any sort of so-called Russian separatism was a serious political option," he says, referring to Yanukovych's campaign threat to split the country and merge the industrial east with Russia. "This was Yanukovych grasping at the last straw of populism." Pilipenko says the company plans to publish its accounts under international standards (he has hired Ernst & Young as auditor), hive off non-steel-related businesses and eventually prepare for an IPO.
Such conciliatory noises are music to the ears of Kiev's tight-knit financial community, who are eager to bury the past and start capitalizing on the future. "The coming year will be a year of compromises," predicts Andrey Sirko, a partner at SARS Capital, which advised AES on its utility purchases. "The big business groups should survive. The healthier ones are figuring out how to go ahead under the new conditions."
For all the warm words, however, Kuchma's oligarchs have made no concrete offers to hand back any ill-gotten gains -- or add retroactively to the purchase price, which some financiers suggest as a possible compromise.
The government's questioning of the Kryvorizhstal sale prompted Pinchuk to hire Kiev law firm Pravis, which represented Yushchenko before Ukraine's Supreme Court during the electoral dispute last winter.
"We support the president and the new regime," says Serhiy Vlasenko, a partner at Pravis. "But there are no grounds for reviewing existing decisions. If you do, you're going to have crowds with flags marching to city halls all over the country, demanding that thousands of privatizations be reversed." In April, Vlasenko also petitioned the European Court of Human Rights in Brussels, claiming Ukrainian courts were denying Pinchuk a fair hearing.
Capturing more tax revenue from big business (Ukrainian tax revenues were 80 billion hryvnia in 2003, according to the IMF) is essential if Yushchenko is to solve his other big problem, the spiraling budget deficit. Last September, a month before the first presidential ballot, Yanukovych abandoned years of fiscal restraint and persuaded the Rada to increase pensions for the country's 11 million retirees (out of a population of 47.4 million) to 285 hryvnia a month from 180 previously; the legislation will raise pensions further, to 330 hryvnia, in January 2006. The Rada also approved a 20 percent increase in public sector salaries. This spending spree would have caused the deficit to explode this year to 30 billion hryvnia, or 10 percent of GDP, without corrective measures, Finance Minister Pynzenyk calculated after taking office in February.
Yushchenko and his ministers hope to fix the budget by plugging the many gaping holes in the state's revenue structure. The Kuchma regime created numerous exemptions to the country's 20 percent value-added tax. It also set up two dozen special economic zones, which were ostensibly designed to attract foreign investment but have been exploited mainly by native oligarchs.
Pynzenyk drafted a new budget abolishing more than 100 tax loopholes, and Tymoshenko scored a political triumph by ramming it through the ordinarily fractious Rada in late March, with an overwhelming 376 votes in favor. "We will name the names of deputies who stand against us," she warned wavering lawmakers before the vote.
The new measures will slash the deficit to 1.5 percent of GDP, promises Pynzenyk. Revenues were already running 30 percent ahead of target in March, before the raft of new laws was passed. Most private analysts expect a higher deficit of 5 to 6 percent of GDP this year, however. "We would like people to understand what is happening here, understand that a new Ukraine has been born, [one with] political will," the Finance minister says.
Pynzenyk and Yushchenko will need every bit of that will to transform Ukraine's political and economic culture and bring the country into the European mainstream.