ANALYSIS: Ukraine: economic outlook (07/26/98)

ANALYSIS

Ukraine: economic outlook

by David R. Marples

The Ukrainian economy grew by 0.1 percent in January-May of this year, making the first time any growth has been recorded since the country gained its independence in 1991. In the first four months of the year industrial production increased by 0.9 percent over the same period last year.

Ukraine is currently in the process of convincing the International Monetary Fund (IMF) that it has met the conditions required for a much delayed $2.5 billion Extended Fund Facility loan over a period of three years. The IMF turned down a possible loan last year because Ukraine did not appear to be making progress on economic reforms, awarding instead a one-year standby facility loan of $542 million. In April 1998 the IMF halted the standby program also because of a growing budget deficit of almost 6 percent in the period January-March 1998. The IMF made another visit to Ukraine in June, which was followed by a personal visit by IMF head Michel Camdessus on June 20.

Thus, there has been a concerted effort on Ukraine's part to convince the IMF representatives prior to these visits that the necessary economic stringencies have been adopted. The practical results of these visits have yet to be determined.

Ukraine's case has been made more acute by two external events and two internal. The former are as follows:

The financial crisis in Russia, where interest rates in late May were raised to 150 percent in order to prevent a collapse of the ruble.
The crisis in the markets of East Asia, which coincidentally has raised IMF fears about continuing to prop up economies that are no longer viable.

The internal events are:

The failure for two months to elect a Verkhovna Rada which prevented passage of important measures to carry out a new structural reform package for the economy. It is generally accepted by the country's experts that monetarist policies alone are insufficient to lift Ukraine out of its present financial quagmire.
Increasing treasury bill redemptions - one year T-bills will peak in August, thus raising questions about whether the National Bank of Ukraine (NBU) has sufficient reserves to meet such payments.

Impact of Russian and East Asian crises

The short-term impact of the Russian crisis was seen when Ukraine raised its bank rates from 41 to 45 percent in May. This was a reversal of the policy of mid-March, when rates for refinancing were lowered from 44 to 41 percent, but levels have fluctuated widely in response to international events. On May 28, the rate was further increased to 51 percent.

Problems in Russia have also meant that the Ukrainian government bond market alone will be used to service the large T-bill debts in August. The Russian and East Asian situations have restricted further borrowing by Ukraine on the international bond market. Finally, in response to the Russian crisis, the hryvnia slipped on the international exchange rate, from 1.89 hrv to the U.S dollar at the beginning of 1998 to 2.05 hrv by mid-May. In mid-June it remained at this same level.

However, the hryvnia is not about to be devalued. The chairman of the NBU, Viktor Yuschenko, has maintained firmly that the currency will remain in a fixed exchange band between 1.80 and 2.25 hrv at least until the end of 1998. Though some impact was seen on the Ukrainian currency, it was not the catastrophic slide that some had feared.

Economists have compared today's economic situation in Ukraine to that in Hungary four years ago. In the latter country, like Ukraine, an internal budget deficit was offset through the issue of paper money, but this measure was followed by an austerity program that witnessed the devaluation of the currency.

Mr. Yuschenko insists that this is unlikely to happen in Ukraine - it is not ruled out entirely - and if it were to occur, this would certainly not take place before 1999. At the same time Ukraine's financial picture (and the IMF attitude) would tend to place the country in a less favorable position than that of Hungary in 1994.

Impact of parliamentary hiatus

Ukraine's recent parliamentary elections saw a backlash against even the half-hearted reforms implemented under the government of President Leonid Kuchma and Prime Minister Valerii Pustovoitenko. The recent miners' strike to receive a lengthy backlog of wages is illustrative of the unwillingness of many sectors of the workforce to make sacrifices.

Recently, a presidential advisor noted that government measures were directed toward revamping budget expenditures and bringing down the tax burden in order to stimulate production. However, he noted, little could be done without the cooperation of the Verkhovna Rada in putting together a series of measures. The failure for two months to elect a Rada chairman and the election of Oleksander Tkachenko, a member of the Peasants' Party, does not bode well for an improvement in Ukraine's economic picture.

State borrowing

The lack of money in the state budget is a constant dilemma for Ukraine. In January, when the new budget was sanctioned by the parliament (an achievement in itself given the delay in approval in 1997), it specified revenues of 21.1 billion hrv and expenditures of 24.5 billion hrv, or a deficit of 3.3 percent of the GDP. In late May, the government announced that the rate was being cut further to 2.3 percent to meet IMF demands.

This is highly optimistic, especially given that in the first four months of 1998 budget revenues amounted to 4.1 billion hrv, and debt servicing and repayment costs 4.7 billion hrv. The budget revenues are now almost exactly equal to the cost of servicing and repaying the state debt.

In addition, as a result of widespread tax evasion and delayed privatization, over 5 billion hrv in revenues have not been collected thus far this year. In mid-June, the Ukrainian government reported that the receipts from privatization between January-May were 214 millon hrv against the annual target of 1.04 billion hrv.

In August, the one-year domestic treasury bill redemptions will mature and have to be paid for through NBU reserves. Though the bank does have reserves to meet them (the total cost is around $2 billion U.S.), the difference between reserves and necessary payments is only about $200 million U.S., and thus the situation is unstable. Any drop in exports would see a fall in the amount of foreign currency in the country.

This summer has already seen a reduction of steel exports from Ukraine, partly as a result of production problems and partly because of a fall in the world price of steel. It is vital that Ukraine receive more direct foreign investment. Here, for the moment, the outlook seems brighter. In the first quarter of 1998, direct investments rose by 15 percent compared to the same period in 1997, principally in monetary form and property. The main investments came from non-residents from (in descending order), the United States, Holland, Germany, Cyprus, Russia and the United Kingdom.

However, long-term confidence in the recovery of the Ukrainian economy may not be sustained without government action to improve the business climate.

Perspectives

In fact, Ukraine's position is quite precarious for several reasons:

Though the economic situation has stabilized somewhat thus far in 1998 (inflation is likely to be 5-6 percent), and this process may continue for the remainder of the year, there is an acute shortage of credit resources and privatized firms that can show a high profitability.
About half of Ukraine's existing factories are running at a loss, according to official figures.
Privatization itself has fallen well behind schedule.
Currently over 40 percent of all transactions in the economic field are made by barter. The country needs to convert many of these to a monetary basis.
The key problem remains the government debt, exacerbated by huge annual budget deficits. It has been estimated that Ukraine will borrow about $2.5 billion U.S. on international capital markets in 1998 just to cover the domestic debt.

Unless urgent measures are taken - particularly changes in financial policy - the recovery in growth will be very short term. There are prognostications in Kyiv that even if a growth rate in GDP of 0.5 percent is maintained for the remainder of 1998, a further decline of around 3 percent is expected in 1999.

However, the government cannot act without the support and approval of the Verkhovna Rada. Thus the position of chairman has become politically almost as important as that of the president itself. Four more years of virtual stagnation and an impasse between the government and a leftist-led Parliament can imperil the very foundations of the Ukrainian economy.

The economic situation is similar to that of Southeast Asia, except that to date Ukraine has not managed to attract the confidence of either international financial institutions or individual investors to the same degree. As a transition economy, Ukraine has succeeded in reducing inflation, but has not managed to secure a stable currency or an economy based mainly on monetary exchanges - in itself this could raise the inflation rate, but this is a separate problem. Finally, Ukraine must improve its collection of taxes.

The country will need to convince the IMF not only that it is fully aware of these problems, but that it is prepared to take measures to deal with them in a decisive and comprehensive fashion. The slight growth in the GDP may brighten an otherwise rather gloomy picture.

David R. Marples is professor of history at the University of Alberta in Edmonton and director of the Stasiuk Program for the Study of Contemporary Ukraine at the Canadian Institute of Ukrainian Studies, which is based at that university.