Short term pains should be rewarded by long term gains if right policy path is chosen
Now everyone knows how to get members of Ukraine’s parliament to do something useful: dangle a lot of money in front of their noses and spell out tough conditions they must agree upon in order to receive the cash.
At least it appeared to work for the International Monetary Fund, which was expected on Nov. 5 to consider a $16.5-billion loan designed to help brace Ukraine’s economy for the hard times ahead. The aid is coming in the nick of time, but with strings attached that will cause economic pain for average citizens.
Still, the loan is seen as an essential prop, especially with the nation’s currency sinking to all-time lows and the country facing debt payments of $100 billion – more than 70 percent of the annual gross domestic product. Nearly half of that amount is due next year.
Getting the fractious group of 450 lawmakers to pass the austerity legislation took no small amount of shouting and cajoling.
“Don’t you understand!” shouted parliament speaker Arseniy Yatsenyuk during parliament’s debate on Oct. 31. “Someone will get $16.5 billion, but it’s not going to be Ukraine if you don’t stop arguing.”
President Victor Yushchenko signed the bill into law on Nov. 3. Kyiv agreed to all IMF conditions, except for a freeze in the minimum wage, according to Oleksandr Shlapak, deputy head of the presidential secretariat.
The IMF was expected to consider the 24-month standby loan on Nov. 5 in Washington, D.C.
The stabilization package, which runs to 2011, envisions the creation of a stabilization fund and increased guarantees on bank deposits to Hr 100,000, and will help recapitalize banks.
Plans are also under way for a zero-deficit 2009 budget, which is expected to mean cutbacks in social spending and financial assistance for the poor.
“While the conditions imposed by the IMF will, in some cases, have unpleasant short-term consequences, in the long-term, Ukraine should benefit from the assistance package,” said Arch Puddington, director of research at New York-based Freedom House, a non-governmental organization that promotes economic and political freedoms. “The IMF’s [initial] decision, however, suggests a measure of faith in Ukraine’s long-term economic prospects and in its long-term political future.”
The short-term pains Ukrainians will face are lower wages, 35-percent-higher heating bills starting Dec. 1, less access to credit and a weaker currency – making it difficult to repay loans denominated in other currencies. The sliding hryvnia will also make imports more expensive.
“It’s crucial that wage increases [and other social spending] stop in order to halt spiraling inflation and help stabilize the country macro-economically,” said Ricardo Giucci, leader of the German Advisory Group, a private institute that advises Ukraine’s government.
Giucci said the crisis poses a great opportunity for implementing long-overdue economic reforms. While in the past, foreign capital poured into the country, today foreign investment can only be attracted by improving the investment climate. And given the difficult economic and financial situation, reforms can be passed quicker than usual, as shown by the swift actions of the government and parliament to adopt anti-crisis measures.
In the medium term, a zero-budget deficit could help reign in inflation, said Anastasiya Golovach, an analyst at Renaissance Capital in Kyiv. Golovach said cutting social spending is positive news for the market, since the past three years have seen increases in nominal wages by an average of 30 percent annually (and by about 17 percent in real wages). This happened due to government moves in light of frequent elections, which contributed to inflation.
The newly approved stabilization fund is meant to boost liquidity, replenish bank capital and help finance public investment programs. Funding for the stabilization fund is expected to come from privatization revenues and sale of government bonds.
Infrastructure development can become the first step toward a more-balanced economy if it lays the foundation for more structural economic changes.
“Infrastructure is positive,” said Edward Hugh, a Barcelona-based economist. “But it needs to form part of an ongoing process. Structural export drivers like green-field investments, assembly industries, factories, high-tech clusters, investments for tourism, whatever, need to follow, as well as a more intensive leveraging of the substantial agricultural resources Ukraine undoubtedly has. A financial-services-driven, construction-and-steel-based economy simply isn’t going to pass muster in the current global environment.”
But analysts stress that for this export-led dream to come true, relative prices need to be right, which means businesses in Ukraine need to be competitive. That means undoing all the damage done by the recent inflation and getting the exchange rate on the hryvnia right.
Experts acknowledged that Ukraine’s undiversified economy still puts the country in a very risky situation. The nation is heavily dependent on one export – steel – the value of which has plummeted this year. International demand is so low, Ukraine’s output dropped by half in October, year-on-year.
Ukraine is also heavily dependent on imports of increasingly expensive natural gas from Russia.
The final version of the package provides a boost to the agricultural sector by allowing agricultural enterprises not to pay value-added tax if they use the money to replenish their working capital or make further investments.
And the National Bank of Ukraine tightened trading rules at the interbank currency exchange to reduce the currency volatility and make its desired hryvnia rate more easily defendable.
There are a number of IMF recommendations still waiting to be approved, however. An Alfa-Bank statement said canceling the moratorium on the sale of agricultural lands as advised by the IMF will bring in foreign direct investment to the sector widely believed to be the savior of Ukraine’s still-undiversified economy. Also, strict control over consumer goods imports is required to keep the country’s balance healthy.
The IMF wants Ukraine to have “strong monetary and prudent fiscal policies,” said Ceyla Pazarbasiogan, head of the lender’s mission to Ukraine, on Oct. 29. Specific budget strictures could come after the IMF votes on the Ukraine loan expected on Nov. 5.
