Political Risk Insurance for FDI in Ukraine: How the Eastern European Pivot State Can Be Saved

Ukrainian and European Union flags fly in Kiev, by Evgeny Feldman via Wikimedia Commons, CC BY-SA 3.0.

Ukrainian and European Union flags fly in Kiev, by Evgeny Feldman via Wikimedia Commons, CC BY-SA 3.0.

European misconceptions of the Ukranian-Russian conflict are the result, among others, of a lack of expert knowledge about Ukraine, among the member states of the European Union. The most recent example of continued misunderstanding is a Western fixation on quality of governance issues and not on the Ukrainian state’s principal chances of survival. In Ukraine today, a major strategic task is the de-poisoning of the investment climate, especially in the South-Eastern Azov and Black Sea regions. In light of ongoing threats from Russia, Kiev needs Western-backed guarantees to insure foreign direct investment (FDI) against political risks, especially in Ukraine’s russophone parts.

In 2014, two major events in post-Cold War European politics overlapped in Ukraine. First, the end of 2013 saw the onset of a sociopolitical revolution in Ukrainian society that continues today. Second, this was followed, at the end of February 2014, by an initially covert and later increasingly open Russian military intervention in Crimea and the Donets Basin. Many observers have come to view these two lasting shifts in European politics as inexorably or even causally linked with one another. This misperception is partly attributable to the role of Russian mass media in shaping interpretations of the Russian-Ukrainian conflict.

In many Western public debates, not least in Germany, the idea of Moscow merely reacting to domestic political developments in Ukraine, during the winter of 2013-2014, has been prominent. These interpretations are more often than not accompanied by expressions of at least partial understanding of Moscow’s unusual foreign policy conduct, or even with concessions of its inevitability. Such apologetics are usually linked to an assertion of a dominant, if not decisive, Western role in provoking the events in Kiev, since November 2013. These fateful happenings supposedly drove, if not forced, Moscow into its erratic international behavior when Ukraine’s pro-Western insurgency approached its victorious end.

Domestic Determinants of the Euromaidan

Despite its name, the Euromaidan (literally: “European Square”) was an event driven predominantly—though not exclusively—by Ukraine’s internal affairs and national history. In shaping the objectives, rhetoric, and symbols of their upheaval, the Ukrainian revolutionaries permanently related back to proto-democratic points of reference in Ukrainian history. This concerned, for instance, the medieval vicha, local citizen assemblies, of the Kievan Rus, or the early modern era Cossack men’s republics in the Dnipro river region. Both of these traditions are associated not only with Western influenced right-bank Ukraine, but also with the russophone left bank, as well as, partially, with the history of the territory of the present-day Russian Federation.

Moreover, the Euromaidan was both, in the perception of many Ukrainians and in terms of its leaders’ biographies, a continuation of the anti-Soviet student “Revolution on the Granite” in Kiev of 1990, and the famous “Orange Revolution” electoral revolt of 2004. Furthermore, the Euromaidan followed the pattern of several lesser-known, but also large protests on Kiev’s Maidan Nezalezhnosti (Independence Square), such as the “Ukraine without Kuchma” campaign of 2000-2001, or the “Tax Maidan” of 2010. The first was the start of the pro-democratic and anti-oligarchic movement that eventually led to the Orange Revolution which ended the rule of former President Leonid Kuchma’s clan; the latter was a short-term protest by entrepreneurs against changes in Ukraine’s tax legislation, under former President Viktor Yanukovych. During these earlier mass actions of civil disobedience, international issues, like Ukraine’s conclusion of an Association Agreement with the European Union and possible future NATO membership, played an even smaller role than during the Euromaidan, or were completely absent. The earlier protests and other domestic impulses behind the escalating mass demonstrations between November 21, 2013 and February 21, 2014 were more important than the role of the European Union and/or NATO in the escalation of Ukraine’s political crisis—an overemphasized factor confusingly stressed by too many Western commentators.

The interpretation of recent events in Kiev as the sad story of a geopolitical object rather than as a fateful decision made by a self-determined subject is largely attributable to the European political and intellectual elite’s lack of elementary knowledge about Ukrainian history, culture, politics, and society. The rudimentary academic community of Ukrainian affairs specialists does not represent a consolidated scholarly discipline in the European Union. Hence, the fixation of most political observers in EU member states on geopolitical schemes familiar from the Cold War, and not on contemporary insights from relevant area studies, in order to explain the Euromaidan and Russian-Ukrainian conflict, is unfortunate but unsurprising.

In contrast to North America, the European Union does not have a single significant academic research center or influential scholarly publication organ with a focus exclusively on Ukraine. To be sure, some EU countries have relevant institutions and publication series. For instance, in Germany, there are the biweekly Ukraine-Analysen published by the Bremen Research Center on Eastern Europe, the Ukrainian Free University at Munich, the German Association of Ukrainianists, the Berlin-based NGO “Kiev Dialogue”, the “Ukrainicum” Summer School of the University of Greifswald, among others. These are, however, initiatives with, so far, only limited societal impact and fragile institutional foundations. Despite, for instance, high-quality reporting on Ukraine by German premium newspapers, from the left-leaning Die Tageszeitung (The Daily Newspaper) to the right-leaning Die Welt (The World), there is still considerable ignorance among many German policy makers and opinion leaders regarding basic facts about the geographically largest fully European country in the world. The black box “Ukraine” is often conceptualized as a buffer state, tragic hybrid, or involuntary pawn between predominant superpowers or geopolitical blocs instead of as a political nation with a unique history, composition, and culture.

To be sure, the recent political escalation was linked to one of Kiev’s most important foreign affairs as it followed the Yanukovych regime’s abrupt halt of Ukraine’s European integration process in November 2013. Yet Kiev’s rejection of Brussels’ offer of association was then only a repeat action by an Eastern Partnership country. Armenia, a country with a different geopolitical position, population structure, and international significance, had several weeks earlier also unexpectedly cancelled its parallel preparations for its own EU Association Agreement, under obvious pressure from Russia. This suggests that Ukraine’s presumptively fateful geographic setting and demographic composition played a less relevant role than sometimes claimed.

Furthermore, the character of the Ukrainian demonstrations quickly escalated from a small pro-European protest of Kiev intellectuals to a trans-class, inter-regional mass movement with more widely defined goals. For many Ukrainians, “Europe” represented more of a guiding metaphor during the Euromaidan than a concrete plan of action. Their focus was less on bureaucratic steps to prepare Ukraine for EU accession than on the exemplary function of “Europe” as a visionary and mythologized model for a better and renewed Ukraine. For this reason, the palingenetic formula of a “Revolution of Dignity” rather than the internationally connoted term “Euromaidan” has, in Ukraine, become dominant to describe the three-month-long uprising. The term connotes that the Ukrainian people rose up not to follow foreign advice. Instead, Ukrainians re-asserted themselves, in their Revolution of Dignity, as citizens who would no longer tolerate the disregard, insolence and abuse that Yanukovych’s regime had been showing towards them for more than three years.

Misunderstanding Post-Revolutionary Ukraine

A combination of the (a) complexity of the post-Soviet situation, (b) effects of Russia’s disinformation campaign, and (c) underdevelopment of Ukrainian studies in Europe also has consequences for the West’s comprehension of Ukraine after the victory of the Revolution of Dignity. Until a couple of years ago, Ukraine had been no more than a “white speck” or “hallucination in reverse” on many Europeans’ mental map. It is thus not surprising that, in spite of the rapid developments of the last year, numerous current Western public debates focus on pre-revolutionary, rather than the actually topical problems that the Ukrainian state has been facing since the start of Russia’s invasion in late February 2014.

Prior to the Euromaidan, many observers today view post-revolutionary Ukraine still through the lenses of political transitology and EU neighborhood policies. In spite of the obvious drama, social depth and implications for European security of the events of 2014, the categories and criteria for evaluating Ukraine’s challenges have thus far changed only little. Before the Revolution of Dignity, issues like corruption, oligarchy, and reform resistance, as well as general distrust of the Ukrainian elite shape much of the western media coverage and public debates on post-Soviet affairs. Sometimes, the new Ukrainian president, Petro Poroshenko, is presented as an only slightly improved remake of kleptocrat Yanukovych, now wanted by Interpol.

To be sure, Ukraine’s older pre-revolutionary challenges have today hardly become second- or third-rate issues. Insufficiently decisive reforms cannot be offset against the military threat posed by Russia. President-turned-oligarch Poroshenko is certainly no angel, and has yet to sell his various assets as he had promised during his election campaign. Nonetheless, the serious international change around, and deep changes within, Ukraine during 2014 have transformed the context and rank order of Kiev’s challenges. The circumstances for an implementation of the still much-needed reforms as well as their wider political context are fundamentally different today than prior to 2014.

One the one hand, the victory of the Euromaidan and signing of the Association Agreement with the European Union, in 2014, have improved the preconditions for reforms in Ukraine. The weight of pro-European parties, Ukrainian civil society, international governmental institutions (European Union, IMF, Organization for Security and Cooperation in Europe, etc.), foreign non-governmental organizations (foundations, watchdogs, think tanks, and so on), Ukrainian and European media outlets, as well as the global Ukrainian diaspora (particularly in North America and Europe), within Ukraine’s political process, has significantly increased. The growing involvement of Ukrainian civic activists, the EU Delegation and Mission in Kiev, well-educated Ukrainian repatriates, as well as other new actors in the transition efforts increase their chances of success. Even the war in eastern Ukraine has not only corrosive effects, but also a disciplining and consolidating impact on Ukrainian society.

On the other hand, however, successful reforms are no longer sufficient for improving the living standards of the Ukrainian population or for even securing the continued existence of Ukraine as a country. Ukrainians’ primary concerns at the moment center less on the quality of their democracy, rule of law, or public administration. Instead, they are, first of all, concerned about the basic chances for the Ukrainian state to survive the Kremlin’s ongoing hybrid war against their country. The West’s frequent referral to the contribution of successful Ukrainian reforms to achieving victory in the conflict with the Kremlin is not incorrect. Yet, this assertion can also function as window dressing for a far more serious challenge. Even if Ukraine tomorrow became an eastern European Switzerland, it would not stand a chance against a superior neighbor inclined to and capable of sabotaging Ukrainian nation-building and Europeanization, or even driving the Ukrainian state into ruin.

The Primacy of State Security

The most pressing current issue for Ukraine appears sometimes only on the sidelines of even major Western political announcements and opinion pieces: to what extent is the government in Kiev in a position to carry out its principal function as guarantor of basic security on the state’s territory of, at least, present-day rump-Ukraine? Many commentators assume that a comprehensive Europeanization as a result of implementing the EU Association Agreement represents Ukraine’s royal road to succeed and follow the Polish and Slovak examples, among others. This laudable hope proceeds from the unspoken assumption that the Ukrainian state can sustainably control its territory as well as secure its infrastructure. It presumes that Kiev will be trusted, by its people and foreign partners, to plausibly protect law and order in the future. Europeanizing the Ukrainian state through the association process will obviously only succeed if the government can fulfill its primary function as guarantor of basic security.

A main goal of the current reforms is to stimulate the Ukrainian economy. Deepening association with the EU should enable better economic management and freer trade. A precondition for this is that domestic businesspeople and foreign investors feel sufficiently motivated to expend their money, time, and energy to utilize, renew, and create Ukrainian production facilities. Putin’s strategy in Ukraine aims to deprive the Ukrainian state of its ability to offer credible physical and legal protection for private property and social stability. The two so-called “people’s republics” in the Donbass have little value for the Kremlin in themselves. Instead, they are instruments for preventing a definitive calming of Ukrainian society, and a sustainable improvement in the business climate of Ukraine.

The government in Kiev is too weak, the Ukrainian military too ill-equipped, the Ukrainian security apparatus still too fragile and, finally, the Russian-Ukrainian border too long and porous for Kiev to prevent Russia’s continuing subversion of Ukrainian national sovereignty. This Ukrainian dilemma will probably continue for years—a recognition that is already commonplace in Kiev. Ukraine’s state of limbo would only be brought to an end by a fundamental redefinition of Russia’s national interests in Ukraine. A foreign policy reorientation in the Kremlin will, however, only be possible after a regime change in Moscow. The West will hardly dare to officially speculate about this, much less work towards it.

The West cannot fundamentally solve this new principal quandary for the government in Kiev. The Western community can nonetheless offer help for self-help, in order to at least limit the economic consequences of Putin’s subversive tactics. This support encompasses not only continued sanctions against Russia, technical advice for ongoing reforms in Ukraine, support for the reconstruction of Ukrainian security institutions, delivery of defensive weaponry to Ukraine’s armed forces, and macroeconomic financial assistance for Kiev. In a May 2014 article in The Guardian, influential donor and magnate George Soros identified a principal strategic task for the West with regard to Ukraine: the creation of an insurance mechanism that would partially neutralize the current poisoning of Ukraine’s business climate via international coverage of foreign direct investment in the Ukrainian economy.

Asset Guarantees as Help for Self-Help

To be sure, the West cannot and does not want to protect Ukraine militarily and in its entirety from Moscow. It can, however, partially compensate for Russia’s targeted subversion of basic preconditions for doing business in Ukraine with a guarantee fund to insure FDI against political risks. Now an especially fragile destination for foreign economic engagement, Ukraine could thereby at least be relieved of a few fundamental risks in the conduct of business activities. This concerns above all those Ukrainian regions threatened by military destruction (as has occurred in the combat zones), arbitrary expropriation (as has occurred in Crimea) and coercive measures enforced by threat of force (as has occurred in the separatist-controlled Donbass areas). The local impact, model function, and signal effect of increasing foreign investment in Ukraine’s hinterlands would accelerate the country’s modernization and integration into the global economy.

This would particularly help those eastern and southern regions of rump-Ukraine located near the Russian border, the separatist Luhansk and Donetsk “People’s Republics,” or occupied Crimea. They are thus in the vicinity of regular Russian forces, irregular commandos, and secret service units that by their mere presence—not to mention their covert or overt activities—are scaring investors away. An example is the city of Mariupol in southeastern Ukraine near the Azov Sea. This Russian-speaking town is not only strategically critical for Kiev, as it occupies a possible land corridor between the Kremlin-controlled Donbass territories and Crimean peninsula. Mariupol’s chemical and heavy industries are of larger economic importance to Ukraine. Because of nearby Russian invasion troops, as well as heavily armed Russian mercenaries and extremists, those regions of rump-Ukraine with relatively high proportions of ethnic Russians, like Mariupol, will have particular difficulty attracting and retaining foreign investors. Resulting continued economic depression in these regions will create an increasingly explosive social situation—a result that presumably is the exact goal of the Kremlin.

The provision of foreign investment guarantees by public actors is not an unknown instrument in international development. One of the World Bank’s five subdivisions, the Multilateral Investment Guarantee Agency, focuses primarily on this issue. Berlin’s so-called Hermes Cover export credit guarantees play an important role in Germany’s economic relations with partners in politically unstable world regions, including the post-Soviet space. The European Union should be interested in both the direct results of investment in Ukraine, for example, the creation of local jobs, as well as its indirect results, for example higher government tax receipts. Absent these investments, the flow of illegal immigrants from Ukraine to the European Union will increase, and the Ukrainian state may remain reliant on fresh financial support from the West for many years to come.

Foreign direct investment guaranteed by Western states and institutions would also function as a protective mechanism for the Ukrainian state, and constitute, for some, an alternative and, for others, an addition to supplying defensive weapons to Kiev. Publicly-insured direct investments, particularly in southern and eastern Ukraine, would create a close link between Western financial interests and future destabilizing activity by Russia—a connection that should have a calming influence on the Russian-Ukrainian conflict. The documentation, by Western governmental and non-governmental observers, of the Russian state’s deep involvement in the conflict in eastern Ukraine is continually improving. More numerous Western assets and ventures located in Ukraine—particularly in the potential conflict areas in the russophone East and South—would create new interdependence.

Moscow would run the risk that investors, owners, or insurers affected by Russian military activity, paramilitary actions, or secret service operations in eastern Ukraine would attempt to recover financial losses incurred as a result of the Kremlin’s covert operations by the Russian Federation via international courts. Foreign real estate and valuables of Russian governmental companies or organizations in the home countries of aggrieved corporations or affected guarantee funds would be threatened with seizure. Future reimbursement operations could follow the example of currently ongoing attempts to restitute, via court orders, the losses incurred by the shareholders of Mikhail Khodorkovsky’s YUKOS corporation that was fraudulently broken up and seized by the Kremlin in 2003.

From a Conflict Zone to an Emerging Market

Insuring political risks of FDI could beneficially interact with other developments that should improve Ukraine’s business climate. By January 1, 2016, the Association Agreement should be fully ratified, and the Deep and Comprehensive Free Trade Zone between Ukraine and the Europoean Union will start operating. This would accelerate Ukraine’s ongoing gradual inclusion into the European Union’s economic, legal, political, social, and normative space. Hopefully, by early 2016, Kiev will have also met all conditions of the Visa Liberalization Action Plan, and thus secure free travel of Ukrainian citizens to the Schengen Zone. Ideally, at its 2017 Eastern Partnership summit, the European Union would offer to Ukraine, along with Moldova and Georgia, a conditional and long-term, but unambiguous and official possibility of future accession to full membership in the Union. The resulting more active involvement by foreign investors in Ukraine would be both economically important for the war-torn country and beneficial from domestic political and sociopsychological perspectives. Local and international confidence in the future existence and prospects of the Ukrainian state would grow with each additional foreign investor arriving in the country. This would create cumulative effects extending beyond the guaranteed investments, stimulate further business activity, and curb the brain drain Ukraine is suffering.

Western support for Kiev that is not situational but instead strategic would have larger repercussions in light of post-Soviet Ukraine’s earlier abrogation of its large atomic warheads arsenal and currently accelerating European integration. Sustained Western help to Kiev and deterrence of Russia’s subversive acts in rump-Ukraine would conform to the spirit of the 1968 Treaty on Non-Proliferation of Nuclear Weapons, the 1994 Budapest Memorandum on Security Assurances (protecting Ukraine’s territorial integrity), and the 2014 Association Agreement between the European Union and its member states, and Ukraine. Visible Western assistance to Kiev would thereby strengthen the global nuclear weapons control regime and improve the reputation of Brussels’s Neighborhood Policy. Last but not least, easing this over-demanding challenge for the Ukrainian state would put the ball back in Kiev’s court concerning the proclaimed Europeanization of the country. Ukraine’s government would then be responsible for creating all of the remaining conditions necessary for attracting foreign investors to the country.

Translated from German by Andrew Kinder.

About Author

Andreas Umland

Dr. Andreas Umland is a Senior Research Fellow for the Institute for Euro-Atlantic Cooperation at Kyiv, and General Editor of the ibidem Press book series "Soviet and Post-Soviet Politics and Society" in Stuttgart. He is a former Thyssen Fellow at Harvard's Weatherhead Center for International Affairs where he published, in 2002, the paper "Toward an Uncivil Society? Contextualizing the Recent Decline of Extremely Right-Wing Parties in Russia," which can be accessed by following this link: http://wcfia.harvard.edu/publications/toward-Uncivil-Society-Contextualizing-Recent-Decline-Extremely-Right-Wing