ANALYSIS: Is capital outflow a portent of change? (04/13/03)

ANALYSIS

Is capital outflow a portent of change?

by Dr. Viktor Stepanenko
RFE/RL Poland, Belarus and Ukraine Report

Back in February, National Bank of Ukraine Chairman Serhii Tyhypko said $2.27 billion was taken in illegal flows of capital out of Ukraine in 2002, $898 million in 2001, and "only" $385 million in 2000. This massive capital outflow from Ukraine abroad during 2000-2002 was half as much as the amount of direct investment into the Ukrainian economy over this period.

The progressive increase in the flight of capital from Ukraine abroad is a clear indication of the chronic illness of the Ukrainian economy, approximately half of which, according to experts' estimates, is operating in the "shadow," that is, outside legal regulation. The economic reasons for this situation are well-known. Ukraine's deformed tax system imposes harsh tax burdens on legal and effective businesses, while simultaneously offering tax breaks to business clans that are loyal to the authorities and close to the Ukrainian political elite. Ukraine also possesses one of the highest ratings on the world corruption index; consequently, foreign investors are reluctant to work more actively in the country.

These factors account for the flight of capital from the country, but they do not explain all the reasons for the progressive dynamics of this trend.

The flight of capital also is characteristic of the unstable political situation found within the country, and it indicates mass distrust on the part of Ukrainians, including businessmen, toward the state, including such important financial institutions as banks.

According to an annual representative poll conducted in the spring of 2002 among 1,800 respondents by the National Academy of Sciences Institute of Sociology, only some 9 percent of respondents said they trust Ukrainian banks. The painful memories of a massive loss of savings in the former USSR, the unsavory experience with financial pyramids that were legalized in 1993 by Leonid Kuchma (then prime minister), and the bankruptcy of Ukraina, one of the country's largest banks, have all added to citizens' pessimism and their distrust of the banking system.

However, the main factor of political instability that seems to have also stimulated the flight of capital from Ukraine abroad is the upcoming presidential elections in 2004. The long, "stable" epoch of the semi-criminal economy, which has been developing for almost 10 years under the political authority of President Leonid Kuchma, is poised to come to an end in 2004 with the election of a new president.

The incumbent, Mr. Kuchma, has no constitutional chance to remain in office beyond 2004. Viktor Yushchenko is considered to be the most realistic candidate for the next presidency, which is seen as alarming for powerful clans of oligarchs in Ukraine. In this context, the progressive dynamics of the flight of capital from Ukraine abroad can be seen as the clans' reaction to the approaching possibility of political change in the country.

This explanation seems quite plausible. The money accumulated by the powerful Ukrainian clans flows out abroad through a system of criminal centers of illegal currency exchange and legally questionable stock-exchange manipulations.

There may be another motive also for the powerful Ukrainian oligarchic clans to extradite their capital from the country. As attested by secret recordings of former presidential security officer Mykola Melnychenko, the "dirty money" from Ukrainian semi-criminal and shadow businesses were used as financial support for Mr. Kuchma's presidential election campaign in 1999.

The bad memories and the methods of violent financial extortion and pressure that were applied to businessmen by presidential election staff led by oligarch Oleksander Volkov for obtaining contributions to Mr. Kuchma's election fund may have forced Ukrainian oligarchs to hide more of their money abroad and in offshore zones.

How effective and realistic can the countermeasures declared by NBU Chairman Tyhypko and other top Ukrainian officials against the flight of capital be? Though the authorities are trying to demonstrate to the world in general, and the Financial Action Task Force in particular, their determination to the struggle against the shadow economy and money laundering in the country, these intentions so far look like a regular official PR campaign. Mr. Tyhypko's announcement publicizing a list of 20 Ukrainian banks allegedly involved in criminal financial activities has still remained only a declaration. Against whom should one fight?

According to the Melnychenko tapes, Mykola Azarov, the current first vice prime minister and former head of the State Tax Administration, reported to President Kuchma in the summer of 2000 that at least two Ukrainian banks were suspected of illegal financial activities. These were Intercontinent-Bank, controlled by the Medvedchuk-Surkis oligarchic empire, and PrivatBank, which was established and controlled by Mr. Tyhypko himself. Comment seems to be superfluous.

Dr. Viktor Stepanenko is a senior research fellow at the Institute of Sociology, National Academy of Sciences of Ukraine, and director of the Center for Public Policy Development.

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