Tom Warner,
Chief Strategist, Concorde Capital

(published abridged)

The formation of an "Orange" coalition and the pending return of Yulia Tymoshenko at the head of a new government sets a course of western-oriented reforms for the year ahead. With the political landscape changed by her growing popularity, her second term should be more productive than her first. With steel prices recovered from last year’s slump, the economy should be able to absorb higher gas prices and still post moderate growth.

After months of topsy-turvy negotiations, the three parties that led the 2004 Orange Revolution have finally committed to reuniting in a new ruling coalition. It was a pivotal decision which sets the course for Ukraine for the year ahead.

Faced with the intensifying geopolitical rivalry between the West and Russia, Ukraine is practically forced to choose sides. The decision is to go West.

This is a very positive outcome, as Ukraine’s long-term interests are clearly in reforming its economy according to western models and integrating into the common European market. If opponents of the Orange Revolution had been brought back to power, it would have given the impression that Ukraine was having second thoughts about its recent western-oriented course. Much of the pressure on the EU to open its markets and on Ukraine to carry through with reforms would have dissipated.

The coalition has agreed on a detailed reform program that goes much farther than anything the last two governments promised. With a little voting discipline, World Trade Organization membership could be achieved by the end of this year.

Don't assume Tymoshenko won't last

Whereas last year’s government served at the president’s pleasure, this year’s coalition government will be supported by a revised constitution that greatly bolsters the powers of the cabinet and the parliamentary majority.

The results of the March parliamentary elections and Tymoshenko’s continuing popularity have greatly strengthened her position. Yushchenko’s powers as president have shrunk and his popularity has fallen. So has the popularity of his political movement, Our Ukraine.

Given their weakness, Yushchenko and Our Ukraine are mainly interested in securing their defenses. They insisted on maximum control over law enforcement, including the interior and justice ministries. The president still controls the general prosecutor, the SBU national security police and the defense ministry. Yushchenko and Our Ukraine also insisted on the speaker position, which is a good bully pulpit for criticizing the government, and an important position to hold if they were to decide to quit the coalition.

They seem to have intentionally given Tymoshenko free reign on economic policy out of hope that she will foul up and wreck her popularity.

As for Poroshenko, he has been very successful in maneuvering himself into a strong position within Our Ukraine, which lacks any other dynamic leader. He and a group of his allies effectively forced Our Ukraine’s party leadership to nominate him as speaker by threatening not to support the coalition (the decision was subject to approval by the broader Our Ukraine bloc, which includes several smaller allied parties). But he is very unpopular with voters, and many in Our Ukraine resent him. He appears to hope that by putting himself in the public eye he can gain popularity.

As long as Tymoshenko maintains her popularity, Yushchenko and Our Ukraine would gain nothing from breaking their alliance with her. If Our Ukraine forged a coalition with the Regions party, Regions would get almost all the real power, due to its much greater numbers in parliament (186 seats to at the very most 55 Our Ukraine MPs who would join such a coalition).

Dissenters from Our Ukraine would create a new centre-right party that would aim for Our Ukraine’s electorate. Yushchenko would stand little chance of reelection in 2009 and Our Ukraine would have grim prospects in the next parliamentary vote, as their voters would feel betrayed. Tymoshenko would return, stronger than ever. That is why Yushchenko and Our Ukraine did not form a coalition with Regions now. There’s no reason to assume this situation will change in six months or a year or even two years.

So, most likely, this coalition will last.

Tymoshenko vs oligarchs, round two?

Tymoshenko should perform better this time around. She is a year older and a year wiser. She has assembled a bigger and more professional political team and she is getting better advice from a wider range of consultants. She is likely to make the best progress in again prodding big industrial groups to further improve their transparency and corporate governance. She has made clear that she will not launch any new efforts to reverse old privatizations. Her old project to reprivatize Nikopol Ferroalloy, which has been dangling in a state of near completion since she was sacked last year, might finally be finished off.

Despite the continuing rivalries within the Orange camp, this parliament will be far more supportive of reforms than any previous legislature. All three parties in the coalition have clearly committed themselves to the project of aligning Ukraine’s legislation with EU norms. Even the opposition is largely supportive.

That in itself is an historic breakthrough, although of course the implementation won’t happen quickly or easily. There is also strong support from both the coalition and opposition in favor of developing Ukraine’s capital markets.

Tymoshenko has reiterated her commitment to revising the gas supply agreement made in January 2006 and excluding the intermediary RosUkrEnergo, whose main shareholders are Gazprom and a shadowy Moscow-based Ukrainian business group with strong ties to the Kremlin. She said she would do so in a "friendly manner". The response from Moscow has been mixed: Gazprom reacted harshly, warning that Europe’s supplies could be threatened, but Alexander Zhukov, a deputy prime minister, said the response would depend on what Tymoshenko suggests. Poroshenko has supported Tymoshenko’s position.

The US government has very strongly supported her position and offered its help, although it’s not clear what the US could do. Tymoshenko is appealing to European governments to get involved in an advisory committee that she wants to set up.

Since the gas price in the January agreement was not fixed, any Ukrainian government would have faced tough negotiations. Tymoshenko is doing the right thing by taking on the issue now rather than waiting till winter.

However, the price of renegotiation is likely to be a commitment by Ukraine to a schedule of price increases leading to full market prices. In our view the most important thing is security, which the January agreement did not deliver.