January 7, 2016

Ukraine faces new set of economic challenges

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Andrey Kravchenko/UNIAN

Finance Minister Natalie Jaresko carries her files at the early morning session of the Verkhovna Rada on December 25, 2015, when the 2016 central budget was approved. Afterwards, she said she’s not sure if the International Monetary Fund will approve of the changes made.

KYIV – Ukrainians rang in the new year with unprecedented economic challenges. In response to the January 1 launch of the Ukraine-European Union free trade area, the Russian government in December imposed a trade embargo on food-related imports from Ukraine and nixed their free trade zone launched in 2011.

In addition, changes introduced by Ukraine’s Parliament to the 2016 central budget, approved on December 25, 2015, were not cleared with the International Monetary Fund (IMF), making it uncertain as to whether the next loan tranche of $1.65 billion, needed by the Ukrainian government to ensure stability, will arrive this month.

After this year’s economic depression, with an expected 11.5 percent drop in GDP estimated by the government, Ukraine’s economy is widely expected by economists to stabilize, but grow not more than 2 percent. And that’s only if the war in the Donbas doesn’t escalate.

“The minimization of trade with the Russian Federation is continuing, while the territories controlled by the Kyiv government will remain unchanged,” said economist Andriy Blinov, the director of the Uspishna Krayina (Successful Country) project. He predicts growth of 1 percent this year.

“The year will be characterized by the absence of large state investment programs and significant direct foreign investments into the country,” he noted.

That’s despite the launch of the Ukraine-EU Deep and Comprehensive Free Trade Area. And that’s especially true with regard to Russia, whose president, Vladimir Putin, on December 16, 2015, signed a decree halting Russia’s free trade agreement with Ukraine within the framework of a wider free trade zone created in October 2011 within the Commonwealth of Independent States (CIS).

As it turned out, however, Ukrainian economists said there’s no need for alarm over Mr. Putin’s decision. For instance, other CIS leaders, including Belarus and Kazakhstan, announced they would not cancel their free trade areas with Ukraine.

“We don’t need to cry about what we’ve lost, but to build pragmatic relations with the markets of Belarus and Central Asia, since the Customs Union is incompetent, and we will be hearing its loud tearing at the seams,” Alexei Blinov, the chief economist at Alfa Bank Ukraine, wrote on his Facebook page.

“And that’s without mentioning the strengthening of the economy’s orientation on the rest of this enormous world. It’s creative destruction in action,” he added.

In addition, the new import duties that emerge as a result of canceled free trade to Russia are largely meaningless if embargoes are in place, some of which extend as far back as 2012, Mr. Blinov pointed out.

That not to say the consequences of the canceled free trade agreement won’t hurt Ukrainian producers, but it won’t have a critical effect on the economy, said Alexander Paraschiy, the head of research at Concorde Capital investment company in Kyiv.

Russia accounted for 12.8 percent of Ukraine’s exports in the first 10 months of 2015, compared to 19.1 percent in 2014 and 29 percent in 2011, he said. That level will dip below 10 percent next year, with Ukrainian producers looking increasingly towards other markets.

An example of that is the European Commission giving 10 Ukrainian dairy producers access to the EU market starting January 10, as reported on Facebook by Vladyslava Rutytska, a deputy minister of agrarian policy and production.

That will serve to offset the embargo on Ukrainian agricultural and food imports that was imposed by the Russian government with a December 21, 2015, resolution that accompanied the canceled free trade area.

“We took one more step towards diversifying the supply of dairy products,” Ms. Rutytska said.

The embargo on agricultural and food imports from Ukraine will have an even smaller effect than canceling the free trade zone, Mr. Paraschiy said. Exports to Russia amounted to $200 million in the first 10 months of this year, compared to $800 million in the same period in 2015 and $1.6 billion in the same period two years ago, he estimated, demonstrating a consistently declining trend.

“It’s clear this decision won’t be painful anymore,” he said.

Despite the minimal damage expected, the Ukrainian government slapped its own set of countermeasures on the Russians.

On December 30, 2015, the Cabinet of Ministers issued two resolutions that boosted import duties on Russian goods and imposed an embargo on a list of Russian imports that included meat, vodka, confectionary products, cigarettes, pet food and insecticides.

Yet Ukrainians have already been buying less of Russian goods as a result of the war, said Oleksandra Kovalchuk, the agricultural markets expert at the Ukrainian Club of Agrarian Business, as reported by Interfax-Ukraine.

“Taking into account the volumes of domestic production and the possibility of purchasing corresponding goods on other foreign markets, none of the categories banned by Ukraine’s government are particularly critical,” she said.

To offset the economic turbulence with Russia, the Ukrainian government has been working to secure another loan tranche from the IMF in order to keep the economy stable and maintain public confidence in the economy.

A tranche was scheduled for October 2015, but the Ukrainian government failed to prepare the 2016 budget in time. As a result, Ukraine may decide to ask for a doubled $1.65 billion tranche (to compensate for October), but that could delay its arrival beyond January, which could make business nervous, Mr. Paraschiy said.

“For the hryvnia’s stability, the sooner the tranche comes, the better, of course. Currency speculators can manipulate the public’s perception, off which they profit,” he said, pointing out that Ukraine’s foreign currency reserves are stable at the moment.

That’s not to say the government isn’t itching for the tranche as well. Among the arriving funds, it has already earmarked about $7 billion to cover pensions, about $4.6 billion for the National Guard and about $1.6 billion for energy subsidies for those unable to afford the higher natural gas prices (which were required by the IMF).

Another concern is that Parliament approved a version of the 2016 budget that differed from what was proposed by the Cabinet, which earned the IMF’s approval.

As of the year’s end, economists didn’t have access to what was approved (and signed by the president on December 31). But the known changes included the payroll tax being reduced to 22 percent from the current 41 percent, but higher than the 20 percent called for by the Cabinet.

Agricultural producers are allowed to retain only 15 percent of value-added tax, compared to 25 percent as originally planned by the Cabinet, among other losses of tax benefits.

“I can’t say how the IMF will evaluate these changes. I can’t forecast when the new tranche will arrive or when the IMF will decide,” Finance Minister Natalie Jaresko said in an interview published on delo.ua news site on December 25, 2015.

She pointed out that the 2015 budget had been adopted in late December 2014 but the IMF required its revision as late as March 2015, which she said shouldn’t be ruled out this time as well.

But Mr. Paraschiy said he expects IMF approval could come sooner rather than later, considering the approved budget meets the IMF’s main requirement, which is that the budget deficit doesn’t exceed 3.7 percent of projected GDP.

What concerns him more is the $3 billion debt owed to the Russian National Welfare Fund that was taken on by former President Viktor Yanukovych, but which the Ukrainian government was unable to pay when the deadline expired on December 20, 2015.

The IMF will be able to overlook this December 20 default – when deciding on whether to issue the next tranche – if it determines that the Ukrainian government acted in good faith when trying to negotiate this debt payment with the Russians.

“Ukraine doesn’t perfectly match the IMF’s criteria of performing ‘good faith efforts’ to resolve the issue. That said, we remain optimistic that its judgment will favor Ukraine,” Mr. Paraschiy said.

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