Moody’s bond rating service formulated the country’s risks very well: “Deterioration in the country’s institutional strength against the backdrop of poor policy predictability.”
If the government does not regain the confidence of financial markets, then the economic forecast will be downgraded. A positive outlook is based on the shaky assumption that global demand for Ukraine’s export commodities will increase in 2013. In fact, demand will be modest given difficulties still faced by major economies in the world.
Many firms will still work way below their capacity, having not recovered fully from the 2009 financial meltdown. Moreover, Ukraine’s manufacturing is gradually losing its competitiveness after so many years of weak investment activity.
Agribusiness, with its growing yields and ever rising demand, is perhaps the only bright spot among Ukraine’s export sectors.
Most importantly, the economic outlook for 2013 assumes changes in the domestic economic policy — namely, that Ukraine would resume cooperation with the International Monetary Fund.
Aside from helping Kyiv repay about $5 billion in IMF loans from previous years, it implies that the government enacts austerity measures, including increasing gas prices for households and introducing a more flexible exchange rate – hence, hryvnia devaluation.
Ukraineâs manufacturing is gradually losing its competitiveness after so many years of weak investment activity.
The problem with this assumption is that the government continues to cling to its pre-election habit of avoiding tough decisions. This greatly disappoints financial markets and undermines trust in Ukraine.
Moreover, key institutions are failing their mandate. There are strong reasons to doubt the independence of the National Bank of Ukraine and the energy regulatory authority, both of whom appear to pursue business interests and have a political bias.
The government has not offered a realistic alternative to the need to cut budget expenditures and increase revenues. Cooperating with Russia does not seem to be a suitable replacement for an IMF loan. A possible multibillion-dollar loan from a Russian bank and a significant discount in gas prices would, of course, help ease the balance of payments deficit.
For financial markets it may not be particularly important who bails Ukraine out in 2013 – Russia or the IMF. However, creditors would still expect Kyiv to enact austerity measures, as it is the only way for the country to reduce the risk of failing to meet its commitments in the future.
Balancing the state budget will not be an easy task. Budget revenues are flat as businesses pay much less taxes with economic growth close to zero, while the profit tax rate would go down to 19 percent because of changes introduced by the new tax code. The tax administration’s efforts to bring incomes out of shadow in 2012 were not very successful and there are no reasons to expect a better result next year.
Privatization of state property would only partially help to close the gap. The government intends to sell a number of unprofitable state-owned companies, which are heavily subsidized, particularly in the coal industry.
Yet, investors would need time (and access to capital markets) to make profits. Quite a few enterprises would continue to require government assistance. The financial situation is troubling in the transport and energy infrastructure. Those companies are highly indebted because of Euro 2012 investments and regulations to subsidize consumers.
Finally, while a final deal with Shell and Chevron is expected soon, these two giants are not likely to immediately invest billions of dollars. Russian acquisition of rights to control the Ukrainian gas transportation system would also require time and would deprive Ukraine of transit cash flows in the not so distant future.
On top of it all, the government has little room for maneuver in cutting social expenditures. Pensions and wages in the public sector are protected expenses.
Ukraine wastes a large share of its budget through the corrupt public procurement system or through its inefficient social safety net, which is poorly targeted and, hence, socially unjust.
The financial markets would not care whether the required changes are made in an autocratic or democratic manner.
Yet, it seems the government has no other option but to start a social dialogue to win public support. While reform failures over 2010–2012 are blamed on vested interests or low administrative capacity, lack of public support was another important impediment.
Ukraine can avoid an economic crash in 2013. But there are no easy policy decisions left. The steps required to mend the economy have been identified and, if communicated properly, there is a chance that the authorities will get public support domestically and confidence from the outside.
Ildar Gazizullin is a senior analyst at Kyiv’s International Centre for Policy Studies. He can be reached at [email protected].
