Ukraine’s economy is caught in a deep and long-lasting recession. Unemployment is up. This year’s gross domestic product is expected to decline at least 13 percent. Tight credit and declining household incomes, along with sluggish global demand, point to a slow recovery ahead.
Economies are in a synchronized recession, including Ukraine’s trade and credit partners. However, a greater dimension of Ukraine’s recession, if considered from an international perspective, points to the long-lasting failure of the local authorities in making the domestic economy more flexible.
The problems of the global economic architecture have been actively discussed by policymakers of the G20, the group of 20 large industrial nations. The result should be a smoother path of the global economy in the future. Ukraine, of course, is not part of the G20, which is not necessarily bad news. In fact, Ukraine’s exclusion creates the right opportunity for the nation’s authorities to concentrate solely on the domestic economy.
Numerous problems have been mounting and remain unsolved in and outside of government. In our view, urgent action is required in the following areas:
• Ukrainian politicians have to shrug off populism and unite in order to have wide political support for sound policymaking, which will be publicly unpopular in the beginning. But ultimately its results will lead to sustainable economic recovery.
• A string of populist measures undertaken by authorities have heightened skepticism. Thanks to more than $10 billion in assistance to date from the International Monetary Fund, an even deeper economic downturn has been averted. Hence, restoration of confidence among private investors, local and foreign, should be a priority for Ukraine’s authorities.
• Cooperation with the IMF should be strong. The recent failure of Ukraine’s government to increase state-regulated natural gas tariffs for household consumers – a condition for the last loan tranche from the IMF – poses a threat to Ukraine’s relations with the fund. The nation’s creditworthiness is at stake, increasing the risk of continued currency devaluation.
• Deregulation of state-regulated tariffs should take place to increase energy efficiency. Household consumption of natural gas has not yet felt the full extent of the rise to market prices. The authorities continue to allow the loss-making operations of state-owned energy company Naftogaz, which has been absorbing all natural gas price increases since 2006.
• The central bank should complete its shift towards controlling inflation. Much rhetoric has been espoused by politicians about inflation. But, in reality, their actions fueled it. An annual inflation rate of 15 percent or more erodes trust in the currency and spawns dollarization, another distortion.
• Authorities should allow more flexibility of the market exchange rate. They should no longer try to support a fixed rate. This is populism in its purest form. Letting the currency float will help balance the country’s trade balance and current account balance.
• Action is long overdue to improve the country’s business climate and to fight corruption.
• On foreign policy, Ukraine’s authorities should be flexible and gain more cooperation with key heavyweights, which will help trade and investment. The divisive issue of NATO membership should be put aside for awhile. As for European Union membership, we believe this will happen sooner if authorities adopt all EU procedures and standards and adhere to them. This would disarm opponents of EU enlargement to the east and allow Ukraine’s EU membership advocates win the battle.
We understand the temptation to play the populist card is irresistible ahead of elections. But, given the critical condition of the Ukrainian economy, we believe that Ukraine’s leaders simply must reject populist remedies. They must capably demonstrate the statesmanship needed to pull the economy out of crisis and place it on the path of sustainable recovery. The crisis is a serious challenge. It is also an opportunity to decisively break with the past. We believe that the Ukrainian people, who have seen where populism has led, are ready to take up that challenge.
Vlad Sobell is a senior economist at Daiwa Securities SMBC Europe in London. He can be reached at Vlad.Sobell@daiwasmbc.co.uk. Alexander Valchyshen is head of research at Investment Capital Ukraine in Kyiv and a member of the executive committee of the Ukrainian Society of Financial Analysts. He can be reached at Alexander.Valchyshen@investcapital.com.ua.