Carrots for Ukraine, Sticks for Russia: What the International Financial Institutions Can Do in Response to Crimea

The IMF, World Bank, EBRD, and the European Investment Bank have all emerged as significant players in the dramatic events in Ukraine in recent weeks. The Obama administration has very visibly sought to educate Congress on the central role of the IMF in helping to shore up the country’s shaky economy. And the three development banks have figured prominently in press releases coming from the European Union and the United States as a demonstration of the international community’s support for Ukraine’s interim government.

While each of the international financial institutions (IFIs) has already signaled its willingness to support Ukraine, it’s worth considering further their ability to act in concert, not only to shore up Ukraine’s economy, but to bolster the new government’s commitment to democratic and accountable governance and to reinforce international principles of national sovereignty and territorial integrity.

Achieving all of this will require an approach of carrots for Ukraine and, perhaps more controversially, sticks for Russia, an argument that Martin Wolf makes very effectively in the FT this week. I take that general approach and apply it here to the role of the IFIs.

Carrots for Ukraine

These institutions, with the international community behind them, need to deliver on two things when it comes to assistance for Ukraine: quick and large scale financial commitments, and a credible, sustained engagement that ensures the delivery and effective use of this financing. The interim government needs an immediate and strong commitment from the IFIs in order to shore up domestic support for a reformist agenda, and sustained IFI engagement increases the chances that this agenda will succeed.

Of course, the quick show of support has already happened to some degree with announcements of an EU-led $15 billion package (which includes EBRD and EIB commitments), $1 billion loan guarantee from the United States, $3 billion from the World Bank, and a commitment from the IMF to support Ukraine (with Ukraine’s government seeking $15 billion from the fund). All told, that’s potentially just shy of $35 billion.

But more could be done to increase the scale of assistance. For the World Bank, “more” is matter of signaling large scale financing on a multi-year basis, making clear that the new $3 billion commitment is just the starting point. For the European institutions, they should be pressed to test the limits of any prudential concerns that arise with concentration risk in a dicey Ukrainian economy. As I noted previously, it’s troubling that the EBRD’s current offer represents a slight decrease from the bank’s level of assistance under the old regime, a regime that demonstrated no willingness to implement the types of economic and governance reforms that would decrease overall investment risk in Ukraine’s economy. With a new government signaling its willingness to tackle these issues, the EBRD should show more ambition in return.

Of course, the IMF will be in a stronger position to deliver adequate support for Ukraine if the US Congress acts on IMF quota reform, which will increase the amounts Ukraine (and other countries) are eligible to borrow.

But delivering on the promises of donor and IFI press releases will also require sustained and effective IFI engagement with the government as the reform agenda is implemented. For Ukraine, economic reform means energy subsidy reform, which carries tremendous political risk for the government, even if it’s handled well.

The IMF’s ability to make subsidy reform and fiscal consolidation politically possible for the new government  will depend critically on the ability of the World Bank and other development institutions to provide a strong backstop to the country’s social safety net.

Moving these pieces together in a timely manner has proved challenging historically.  As a result, there is a fair amount of cynicism toward the United States, its allies, and the IFIs in these situations, with charges that announcements of large financing packages rarely deliver as promised. Certainly, the experience of the Arab Spring and efforts of the US and Europe to play a major financing role in support of fledgling democracies points to a more complicated story, but one that can also feed that cynicism.

So if the major shareholders of the IFIs are to use these institutions to mobilize large scale financing for Ukraine, then they must also be diligent in seeking to ensure that the IFIs are working effectively with each other and the Ukraine government on a reform agenda that supports the economy, generates jobs, and ultimately reinforces the country’s commitment to democratic governance.

Sticks for Russia

Using the IFIs to deliver carrots to Ukraine should not be particularly controversial. Seeking to punish Russia for its actions in Crimea is a different matter.

What would an IFI “stick” applied to Russia look like? Simple: the IFIs that are providing financial assistance to Russia would stop. That means the halting of World Bank support of about $100 million a year through the IBRD and $1 billion a year through the IFC, EBRD support of about $3.5 billion a year, and EIB support that has totaled over $2 billion in the past decade.

Well, not so simple actually. As I noted in an earlier post, the one institution among them that has a legal basis, requirement even, not to support undemocratic regimes also has Russia as its largest client. For the World Bank and EIB, there is no such “democracy” mandate. And the World Bank has argued for many years that it has a legal mandate not to interfere in the “political affairs of any member.”

But what about when one of its members interferes in the political affairs of another of its members? Unfortunately, short of UN sanctions (Russia made sure that wasn’t going to happen) there seems to be little in the way of punishment the MDBs can exact under a strict interpretation of their rules.

While the World Bank institutionally may hew to a legalistic conservatism in these matters, World Bank presidents have on occasion used the considerable power of their office to take action. Most recently, Jim Kim very publicly halted bank lending to Uganda in reaction to the country’s crackdown on the rights of homosexuals. And Bob Zoellick earlier caused a stir when he applied public pressure on Cote D’Ivoire’s Laurent Gbagbo to recognize the outcome of the 2010 elections and step down.

And in the past two years, a number of the IFIs’ shareholders have sought to withhold support for Rwanda in the wake of a UN report that alleged President Kagame’s support for rebels operating in neighboring Democratic Republic of the Congo.

It’s probably no coincidence that all of these examples involve small African countries. These cases are also distinguished by a degree of arbitrariness, particularly since there are no clearly defined principles in the IFIs’ charters to guide these actions. As egregious as the Uganda case is from a human rights perspective, the rights of homosexuals are unfortunately no less targeted elsewhere in Africa and globally.

Of course, Russia is not a small country, and for that reason alone, it is highly unlikely that an IFI head would seek to punish Russian aggression unilaterally.

But there is a way forward in taking a harder line with Russia, and one that also guards against arbitrariness. The United States and EU member countries can announce that they will no longer support IFI projects in Russia in light of Russia’s actions in Crimea. In doing so, they can also call on other IFI shareholders to join them.

Some will argue that this action would open the door to the politicization of the IFIs’ development agendas, such that any member country with a grievance against another member could seek to block assistance. But IFI shareholders have hardly been pure on this matter to date. And the very prospect that the United States and Europe might act together in such a way demonstrates the extraordinary circumstances involved in Russia’s annexation of Crimea.

So how is this not arbitrary or simply a direct extension of US foreign policy? Ultimately, these institutions act on behalf of the collective will of their shareholders, the so-called “international community.” If the weight of opinion within that community sees the need for an IFI response to a violation of international norms and principles, then these shareholders can exercise their voice and vote within the IFIs to act. Yes, the United States might lead the charge, but the US ability to convince other shareholders to go along would give the action the legitimacy it deserves.

Would any of this have an impact? From an economic perspective, no. The current level of IFI financing barely registers in the Russian economy. But given Russia’s ability to block any firm UN response, the ability of the rest of the international community to act decisively through the IFIs sends a powerful message. All the more so given Russia’s clear interest in playing a leading role in these very institutions, particularly on the heels of Russia’s G20 presidency.

As with the Obama administration’s measured approach to sanctions toward Russia, a decision to punish Russia through the IFIs should be taken with care. In part, it depends on Russia’s stance toward IMF assistance in Ukraine going forward. If they play a reasonably constructive role within the fund, that might argue in favor of maintaining the current stance toward Russia’s borrowings in the other IFIs. But if Russia’s actions cause President Obama and European leaders to further escalate their responses in the form of tougher sanctions or other measures, then using the IFI stick might well be unavoidable.