Ukraine Reform Monitor: December 2015

The main political event in Ukraine during the October–November period was the October 25 local elections. These much-anticipated elections did not fundamentally change the balance of political power in the country. However, they renewed concerns about the enduring power of oligarchs in some regions and demonstrated the residual strength of former president Viktor Yanukovych’s Party of Regions in others. The economic situation improved slowly, and the government approved a number of sectoral liberalization measures.

The Ukraine Reform Monitor provides an independent, rigorous assessment of the extent and quality of reforms in Ukraine. The Carnegie Endowment has assembled an independent team of Ukraine-based scholars to analyze reforms in four key areas. This third memo covers October and November 2015. The monitor is supported in part by a grant from the Open Society Foundations.

The main political event in Ukraine during the October–November period was the October 25 local elections. These much-anticipated elections did not fundamentally change the balance of political power in the country. However, they renewed concerns about the enduring power of oligarchs in some regions and demonstrated the residual strength of former president Viktor Yanukovych’s Party of Regions in others. The economic situation improved slowly, and the government approved a number of sectoral liberalization measures. In late November, violations of the ceasefire in Donbas in eastern Ukraine became more frequent, leading to fresh worries about the future of the Minsk agreement aimed at ending the fighting. Despite modest progress on the issue of decentralization, fundamental differences about the form this should take remained unresolved.

Political and Judicial Reform

Local Elections

• Local elections took place on October 25 in a highly competitive atmosphere. Although decentralization reform is far from complete, local councils already have new responsibilities, including bigger budgets, functioning local executive committees, and the ability to merge into new, larger communities. According to the Central Electoral Commission, 46.6 percent of those eligible to vote turned out to elect 155,970 members of local, district, and oblast councils as well as mayors. Local elections were not conducted in Crimea or in the separatist-controlled regions of Donbas.
• The three parties that performed best in the elections were the president’s Petro Poroshenko Bloc; former prime minister Yulia Tymoshenko’s Fatherland party; and Our Country, a new political movement linked with the president’s bloc (see table 1).

• In some oblasts and cities—for example, Dnipropetrovsk, Kharkiv, and Zaporizhia—oligarch-backed parties and mayors made a strong showing, while in others, such as Mykolaiv and some smaller towns in government-controlled parts of Donbas, they lost ground.
• The Organization for Security and Cooperation in Europe (OSCE) Election Observation Mission gave the elections a largely clean bill of health. However, the organization expressed concern over “the dominance of powerful economic groups over the electoral process, and the fact that virtually all campaign coverage in the media was paid for.”

Constitutional and Judicial Reforms

• The Council of Europe’s Venice Commission, an advisory body on constitutional issues, approved constitutional amendments that deal with decentralization and judicial reform. The revised judicial reforms ensure judges’ independence. They introduce a three-tier court system designed to improve citizens’ access to justice and the quality of appellate court hearings.
• On November 10, the National Reform Council recommended that the president submit amendments to the judicial reforms to ensure a competitive and transparent process for selecting judges for new courts. On November 25, the president submitted such amendments. Pro-democracy reformers have expressed concern that these will deny the parliament the right to hold a vote of no confidence in the general prosecutor. Reformist NGOs are also concerned that this process may hinder ongoing efforts to oust civil servants employed under Yanukovych, may increase judges’ dependence on politicians, and will make it impossible to remove corruption from the courts.

Party Financing

• The parliament passed a law that will provide public financing for political parties and require parties to disclose the sources of their funding. The new law will go into effect in July 2016. Public funding will be provided to parties that secure at least 5 percent of the vote in parliamentary elections. Extra funds will be available as a reward for parties that achieve a gender balance. Public financing for political parties is expected to reduce their dependence on oligarchs.

Association Agreement

• After votes in the Greek and Cypriot parliaments, all EU member states have now ratified the Association Agreement between Ukraine and the EU.

Anti-Corruption Measures and EU Visa-Free Regime

• November 9 was the deadline for the anti-corruption and anti-discrimination legislation required for the EU to implement a visa-free regime for Ukrainians traveling to the EU. Despite some opposition, the parliament adopted amendments to the Labor Code banning discrimination on the basis of sexual orientation. The legislature also approved about ten other bills related to the visa-free regime, but some anti-corruption provisions were weaker than those that had been promised to the EU. Visiting Ukraine on November 19, European Commissioner for European Neighborhood Policy and Enlargement Negotiations Johannes Hahn said that in light of the bills’ approval, he hoped the EU would make a positive decision on a visa-free regime for Ukraine.
• The parliament passed a bill establishing the State Bureau of Investigation. The bureau’s task will be to investigate crimes committed by senior officials, civil servants, judges, and law enforcement officers, except when these crimes fall within the jurisdiction of the National Anti-Corruption Bureau.
• General Prosecutor Viktor Shokin appointed Nazar Kholodnytskyi of Lviv to serve as the top anti-corruption prosecutor in the anti-corruption bureau. The appointment followed a protracted struggle over Shokin’s representatives on the eleven-person selection commission. After Shokin withdrew two of his four representatives, the commission offered two candidates for the post of anti-corruption prosecutor, from whom Shokin chose Kholodnytskyi.
• Hennadiy Korban, a close associate of controversial Ukrainian oligarch and former Dnipropetrovsk governor Ihor Kolomoyskyi, was arrested in early November on corruption charges. In an unrelated development, a Yanukovych-era justice minister, Olena Lukash, was also arrested in early November on suspicion of corruption. Both arrests have led to accusations that the government is using the judicial system to settle political scores.

Economic Policy

General Outlook

• Ratings agency Standard & Poor’s raised Ukraine’s sovereign rating from SD to B-, Ukraine’s highest score since 2013. The improved rating is due largely to successful debt restructuring.
• Ukraine’s GDP fell in the third quarter of 2015 by 7 percent year on year—an improvement on the drop of 14.6 percent recorded in the second quarter. This slight improvement was due mainly to a smaller decline in manufacturing output.
• Annual consumer inflation was 46.4 percent in October, the lowest figure in seven months. However, the National Bank of Ukraine decided to keep the discount inflation rate at 22 percent amid concerns about a possible seasonal inflation spike at the end of the year.

Monetary and Exchange Rate Policy

• In early November, the hryvnia fell below the informal exchange rate target of 23 hryvnia to the dollar, forcing the central bank to intervene to prop up the currency. The hryvnia’s weakness reflects falling world prices for Ukraine’s major exports, namely agricultural and ferrous metal products.
• The central bank eased some administrative barriers to access to the interbank foreign exchange market, a move that should facilitate foreign capital inflows and shore up the hryvnia, although restrictions on currency outflows remain in place.

Financial Sector

• The parliament still has not appointed its representatives to the Council of the National Bank of Ukraine, which consists of nine members: four from the parliament, four selected by the president, and the bank’s governor. The council is responsible for the bank’s long-term strategy. The council’s approval is needed of the Monetary Policy Fundamentals for 2016, which calls for a shift to inflation targeting.
• The central bank began daily publication of the fair value of its securities portfolio. This move is intended to improve confidence in the bank’s ability to regulate liquidity and promote the development of a secondary market for government bonds.

Energy Sector

• The National Energy and Utilities Regulatory Commission adopted ten secondary pieces of legislation related to the gas market law, which entered into force on October 1. The cabinet adopted new social standards for housing subsidies, including norms for central heating in residential buildings.
• The cabinet created a commission for selecting a gas supplier of last resort, to step in when a gas company fails to deliver contracted gas.

Deregulation and Business Climate

• The cabinet decided to make public over 300 databases and registries, including all the regulatory acts of Ukraine, in line with the latest edition of the law on access to public information. The timeline for implementing this measure has not been established yet.
• The Ministry of Economic Development and Trade decided against the so-called regulatory guillotine, proposed as a means of eliminating excessive regulations. Instead, the ministry set up an Effective Regulation Office to improve Ukraine’s regulatory climate.
• According to the Index for Monitoring Reforms, several deregulation steps have been made in the agricultural sector. These include the lifting of price controls on corn, barley, milk, and butter.
• Another positive signal to investors and the Ukrainian business community came from the Ukrainian Redevelopment Fund, administered by Soros Fund Management, a U.S. investment management firm. The Ukrainian Redevelopment Fund became one of the seed investors of the New Ukraine Fund, which was created to enhance business performance and upgrade the technology used by companies.

National Security

Security Challenges

• There was a spike in violence in eastern Ukraine in November, triggering increased expressions of concern from Ukrainian, Western, and OSCE representatives. According to Ukrainian officials, significant numbers of Russian-controlled military personnel remain inside the occupied areas of Donbas. Kyiv once again asked the United Nations to deploy an international peacekeeping mission to eastern Ukraine.
• President Petro Poroshenko said that if attacks continued, Ukraine would stop the withdrawal of heavy weaponry from the conflict zone—one of the conditions of the Minsk agreement—and the army would be permitted to return fire when lives are in danger.
• On November 20, the second anniversary of the start of the Euromaidan anti-government revolt, two pylons supporting cables carrying electricity to Crimea from mainland Ukraine were damaged in a series of explosions. Two more pylons were blown up two days later. With the peninsula effectively cut off from its chief source of electricity, the Crimean authorities briefly declared a state of emergency. The pylons were repaired, but the Kyiv government has imposed a blockade of Crimea, and as of the time of writing, the electricity supply has not been restored. The blockade and the explosions, which were reportedly carried out by Crimean Tatar activists and Ukrainian nationalists, highlight the leverage Ukraine has over the Russian-occupied peninsula and the limits of Moscow’s de facto control over it.

Defense

• The Ukrainian army has become one of the largest military forces in Europe, increasing in size from 146,000 to 280,000 soldiers over the last year. The government indicated that military and security spending would be maintained at 5 percent of GDP in 2016, amounting to $4 billion.
• According to the government, the online procurement system launched in summer 2015 has saved the Ministry of Defense over $7 million since it was set up. The number of companies submitting bids for Ministry of Defense contracts has increased by 50 percent since the online system began. The system represents an important anti-corruption step.
• The Ministry of Defense began conducting polygraph exams for applicants to finance-related jobs.
• The Ministry of Defense adopted a new policy of allowing short-term (six-month) contracts of military service. This will enable the ministry to deploy more troops more rapidly in emergencies. The government indicated it would modernize training to help prepare such troops quickly.
• Ukraine received two new anti-artillery radar systems from the United States. This brings total U.S. security assistance to more than $265 million since 2014. The U.S. Senate passed the 2016 National Defense Authorization Act, which includes up to $300 million of defense assistance to Ukraine.

Ministry of Internal Affairs and National Police

• The law on a new national police force went into effect on November 7. Former Georgian minister of education Khatia Dekanoidze was appointed as Ukraine’s new chief of national police, and former Georgian chief of police Giorgi Grigalashvili was named the new head of Ukraine’s Internal Security Department.
• A process of recertification was launched in Kyiv. This is designed to weed out incompetent officers from the ranks of the former militia (separate from the privately funded battalions fighting in eastern Ukraine). The process will continue throughout Ukraine in the next six months. Preliminary results suggest that around one-third of currently serving officers will be laid off due to their failure to pass the recertification tests.
• The selection started of a Rapid Response Unit consisting of specialist police officers who can respond to high-risk situations, and the United States helped prepare trainers for the force.
• Public confidence in the traffic police increased from 5 to 85 percent with the introduction of a new traffic police force.

The General Prosecutor’s Office

• In late October, a few dozen members of parliament from the president’s party signed an appeal calling for the resignation of General Prosecutor Viktor Shokin. Civil society organizations collected over 25,000 signatures on a petition to oust him, though he remains in office. Shokin has been widely criticized for obstructing investigations of allegedly corrupt political allies of Prime Minister Arseniy Yatsenyuk.

Decentralization

Local Treasury Functions

• The cabinet extended the powers of the State Treasury Service, enabling it to access data on local budget funds held in banks and on tax arrears. These powers aim to enhance local budget transparency and the accountability of local governments.

Open Budget Portal

• A new open budget portal is now fully operational and being extended, with new data being added to the initial database. As the portal contains budget data for local authorities as well as the national government, it is a key part of the effort to increase transparency and accountability, including at the local level.

Price Indexation of Public-Sector Salaries

• In September, the government raised salaries for all employees funded from public budgets, beyond the automatic monthly adjustment for inflation. This widely debated decision was made after a surplus was recorded in the first six months of the implementation of the annual budget. The raise will involve a significant cost—and financial strain—for local budgets.

Strategy for Regional Development

• The government finalized and approved the midterm action plan to implement the strategy for regional development to 2020, which was agreed to in 2014. The action plan links regional development projects to funding available from the Regional Development Fund, EU budget support, private-public partnerships, and existing sectoral programs. The plan contains a set of development programs for each region of Ukraine.

Reform of Local Police

• Police reform will establish temporary law enforcement centers at the oblast level. The existing sub-oblast structures—638 militia units in cities, districts, and transportation hubs—are being folded into 26 oblast offices. The national police will remain a central government institution, but amendments to the 2014 Budget Code allow any local government to create municipal law enforcement units if it finds local resources to fund such additional services. Unlike the national police, which reports to the central government, municipal law enforcement units report to local councils and focus on enforcing local government decisions, such as parking limitations, sanitation rules, and local safety measures. The national and municipal bodies are expected to cooperate but remain institutionally, financially, and functionally distinct.

Finalization of Proposals for Education Reforms

• The Ministry of Education finalized and submitted to parliament a law on education reform. The text of the law has not been made public yet, but preliminary reports indicate that it will provide for significant delegation of regulatory and administrative powers to subnational education authorities.

Voluntary Amalgamation of Communities

• There were important new developments in the process of voluntary territorial amalgamations. On October 25, the 159 communities that chose to amalgamate with neighboring authorities elected their first councils and mayors. The cabinet approved twelve more regional amalgamation plans.

EU Support for Decentralization

• The EU approved a €100 million ($109 million) grant to support decentralization. The bulk of the new program will be for capacity building and technical support for the newly amalgamated communities. In particular, the grant will help set up subregional advisory centers to consult new local governments as well as administrative service centers for citizens living in these areas.

Overall Assessment

The long-awaited local elections represented a notable step forward in democratization, helping improve the legitimacy of local government. In the aftermath of the elections, there was much debate about the strength of the ruling coalition in Kyiv. Overall, the elections provided a boost to Poroshenko and the ruling coalition. At the same time, the results also revealed the enduring power of oligarchs in local politics in some parts of the country.

There has been some modest progress on the thorny aspects of judicial reform and anti-corruption mechanisms. Economic performance has stabilized, and the steady pace of regulatory reform has been sustained. The Ukrainian government continues to strengthen the capacity and transparency of security-sector institutions, albeit in an uneven and fragmented fashion. There are renewed concerns about the resilience of the Donbas ceasefire.

The relatively technical aspects of decentralization have advanced. As in previous periods, the more systemic and political dimensions of decentralization remain unresolved and will be conditioned by the broader dynamics of the conflict in Donbas.

Ukraine Reform Monitor