ISSUE 2-2010
Ростислав Павленко Виктор Замятин
Владимир Воронов Oleksii Izhak
Mykola Riabchuk Отар Довженко
Алена Гетьманчук
Petrovich Ivan Sidorov

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ISSUE 2, 2010

       The whole period of the government led by Yulia Tymoshenko was distinguished by the permanent discussion what the condition of Ukrainian economy is. Prime minister said about the complicated situation but on the other hand she tried to persuade the nation that she had situation under control. Her opponents asserted that Tymoshenko´s performance was disaster leading Ukraine to catastrophe. Could you say what economy did Mr. Yanukovych inherit?
        Ukraine’s economy has started to gradually revive by the beginning of 2010 when Viktor Yanukovych was elected as the President of Ukraine. According to the State Statistics Committee of Ukraine, in the first quarter of 2010 the real GDP increased by 4.9% in year-on-year (yoy) term against very low statistical base of the previous year. The recovery was mainly export-driven thanks to revival of demand for Ukraine’s metal and machinery.
        Still, many economic problems persisted. Banking system has remained fragile. Amount of outstanding loans has been declining against high credit risks. Several banks are still under temporary administration of the National Bank of Ukraine.
        Recovery of households’ final consumption has been very moderate (+0.5% yoy in the first quarter of 2010) despite stronger growth of real disposal incomes (+3.7% yoy). The situation is explained by still significant debt burden faced by households, high unemployment (9.0% of labor force), and uncertainty about future economic prospects.
        However, the major problem inherited by Mr.Yanukovych is in a fiscal sphere. According to the IMF estimates, Ukraine’s 2009 fiscal deficit including bank recapitalization financing and transfer to financially shaky Naftogaz reached 11% of GDP. The gap was driven by drop in revenues not compensated by cut in expenditures. In particular, the central fiscal revenues reduced by 2.7% yoy in 2009 and tax collection were 11.3% lower, while central fiscal expenditures were even higher than a year before. The most of expenditures were recurrent social spending, the burden of which persisted or even augmented in 2010.
        Non-reformed social system, including deficit-prone Pension Fund of Ukraine, is among key problems undermining fiscal sustainability of the country. According to the State Treasury Report, the Pension Fund received UAH 48.9 bn from budget as fiscal transfer. In addition, the Fund received Treasury loans estimated at another at least UAH 15 bn. It total, the amount of fiscal financing of the Pension Fund was equal to about 7% of GDP in 2009.
        To finance the fiscal deficit, the state debt was accumulated. The direct and guaranteed state debt of Ukraine rose by 67.3% in 2009 and reached UAH 316.9 bn. In terms of GDP it augmented from 20.0% in 2008 to 34.6% in 2009.

        Mr. Yanukovych has been more than three months in the power. What has been the best result of this presidency in sphere of economy?
        Three months are insufficient to make any serious judgments about the impact of the presidency on the economy. The system has too much inertia. Low statistical base of the previous year, revival of world steel market, and better economic conditions in Russia that consumes a lot of the Ukrainian exports will be factors driving economic recovery in the country in 2010. These factors don’t depend on political environment.
        To achieve above-trend GDP growth rates, it is necessary to make breakthrough in some important areas like improvement of regulatory climate, investment and innovation stimulus, reduction of fiscal burden on entrepreneurs. A lot of important reforms were announced in the Presidential Program of Economic Reforms for 2010-2014 presented to public in June 2010. However, this program has no official status as of now, and thus has no legal driving force for its implementation.
        So far real success stories are limited. In April, the Parliament managed to pass State Budget-2010 Law that resolved fiscal vacuum of the beginning of the year. However, the Budget was passed with still large deficit (5.3% of GDP not taking into account bank recapitalisation). Moreover, the Budget envisaged continuation of social payments’ expansion and heavy-borrowing policy increasing future fiscal burden.
        To resolve VAT repayment over-due arrears problem, the Government launched an issue of the VAT bonds. This initiative could be assessed as moderately positive. However, without resolving structural problem of accumulation of the VAT arrears, this decision is a very short-term.
        The Law on Public Procurement was passed aligning Ukraine’s legislation in this sphere with the EU norms and regulation. The adoption of this legislative act is very important for improvement of public procurement efficiency. But its immediate impact on the economy is likely to be limited.
        Yet other positive step had been an abolishment of some capital flow and foreign investment restrictions established as anti-crisis measures. Moreover, the Government launched serious reorganization of public institutions responsible for investments and innovation policy. Though, the efficiency of this reorganization cannot be judged right now.
        Controversial from the geo-political point of view, Kharkov agreements between Ukraine and Russia envisaging provision of 10-year gas discount in exchange for 25-year extension of the Russian Fleet stay in Sevastopol are likely to benefit Ukraine’s economy in the short-term. According to Dmytro Naumenko, energy expert of the Institute for Economic Research and Policy Consulting (Kyiv, Ukraine), agreed discount would allow Ukraine to reduce the natural gas price from expected USD 333 per thousand cubic meters (tcm) to USD 233 per tcm in the second quarter of 2010. In the short run, the Government will be able to keep the gas price for the industrial consumers at 2009 level, which otherwise should have been grown due to current oil price increase. This will also allow keeping the domestic retail gas price at below-market levels complying with populist pre-election promises.
        Long-term benefits of these agreements are far more ambiguous. Stimulus to reduce energy consumption in the country famous for its energy inefficiency reduces with lower prices. Cross-subsidization on gas market persists making the gas sector less investment-attractive and capable. Moreover, the discount mechanism does not change basic provisions of the 2009 gas contract. After the discount expires, Ukraine will get a jump in gas prices, while hampered modernization of energy system in the country might make Ukraine’s economy even more sensitive to gas price changes than it is now.

        Where is it possible to observe his the biggest mistake in the same sphere?
        One of major failures of the economic policy associated with the first months of Mr. Yanukovych presidency is increased tax pressure on enterprises, including administrative pressure, initiated by the Government. This activity insured higher tax collections but spoils business environment. Taking into account already very high share of shadow economy, tax pressure creates adverse incentives and could result in increase in the shadow thus undermining future fiscal revenue collections.
        The Tax Code passed in the first reading in May continues this alarming trend. The draft Code envisages significant widening of rights of tax authorities and reduction in taxpayers rights, thus denying their equal treatment in tax process. Tax authorities are proposed to receive a right to interpret tax-related laws. In case of ambiguity regarding tax payment, the amount is proposed to be collected automatically and only afterward the conflict could passed to court. It is suggested that tax inspectors could enter private premises without court decision to make indirect evaluation of personal incomes. Also, tax authorities could make a decision to confiscate property to cover tax arrears without court decision. Confidentially of bank information appears under threat. Number of tax inspections and of reasons for them is proposed to be significantly higher than it is nowadays. Opportunities for small and medium enterprises to use simplified tax regime is expected to be considerably narrowed. If these initiatives are implemented, the adoption of Code would result in serious deterioration of business climate in the country and thus hampers its economic development.
        In general, the Tax Code is necessary. However, it should be aimed at reducing tax pressure, making it more equal, as well as ensuring smoother and simpler tax administration both for taxpayers and tax authorities. However, it seems that the current draft is far from reaching this goal.

        The political success and the condition of economy are very closely linked matters. Does Mr. Yanukovych have a chance to reach positive results in the economy and to receive a positive social echo in this way?   
        The most positive result of the first three month of Mr.Yanukovych presidency is a stabilization of political environment. Namely, the work of the Parliament was unblocked, and permanent tensions between the President and the Prime-Minister typical for the previous ruling coalition were removed. However, this stabilization is not sufficient to ensure strong economic revival and future stable growth. Reforms are to be implemented.
        As of positive social echo, continuous increase in social standards without reforming the system could result in soon fiscal collapse wiping out all short-term political gains. 

Print version
Petrovich Ivan Sidorov
Ростислав Павленко
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