Powerful external forces will drive and constrain Ukraine’s economic development both during and after the COVID-19 pandemic. Ultimately, however, domestic political and institutional developments — notably the strength of the political commitment to structural reform — will determine success or failure.
External drivers of Ukraine’s economic performance.
The rest of the world impacts on Ukraine’s economic performance through trade flows, through remittances and through capital flows, both foreign direct investment and portfolio capital flows.
The global economic environment will for quite a while be worse than we anticipated before the coronavirus hit. The International Monetary Fund expects, in April 2020, global real gross domestic product in 2020 to shrink by 3 percent. In January 2020, the IMF’s forecast for 2020 real GDP growth had been 3.3 percent.
This would make the COVID-19 pandemic the worst recession since the Great Depression of the 1930s and far worse than the great financial crisis of 2008-2010 when global real GDP growth reached a low 0f -0.1 percent in 2009. But in the IMF’s forecast, the pain is rather short-lived. Growth for 2021 is projected to rebound to 5.8 percent. Over the two years, 2020 and 2021, this would still leave a cumulative output loss (relative to the January 2020 projections) of around $9 trillion. Other forecasts are in the same ballpark.
All these forecasts assume that, globally, there will be a steady exit from lockdown during the summer of 2020 and that there will be no significant second wave of infections calling for the renewed imposition of social distancing measures. I consider these forecasts to be on the optimistic side. The IMF’s April 2020 projections for real GDP growth of Ukraine are -5.2 percent for 2020 and 4.2 percent for 2021. Again, I consider these numbers to be on the optimistic side.
Ukraine’s domestic production is heavily export-dependent. In 2018 Ukraine exports of goods and services were 45.21% of GDP. Fortunately for Ukraine, its main commodity exports, including metals and food have not seen the collapse in prices that other commodities, including petroleum products, have experienced. Also in 2018, Ukraine’s imports of goods and services were 53.81% of GDP.
The country could support this large excess of imports over exports because of large net remittances from abroad. Last year Ukraine received annual remittances of around $12 billion or just under 10% of GDP. These remittances are likely to take at least a 20 percent hit, if they follow the global pattern predicted by the World Bank and are unlikely to return in full, even after the pandemic has become history, making for a painful external adjustment.
FDI is also likely to get at least a temporary hit from the COVID-19 crisis. Domestic laws, rules, regulations, and agreements are, however, much more important in shaping the volume and destination of FDI.
Domestic drivers of Ukraine’s economic performance
Despite the obvious importance of external economic conditions, Ukraine’s economic success or failure during the coming years will be overwhelmingly home-made.
First, there is the key issue of a controlled, well-managed escape from Covid-19 and the lockdown.
Second, there is the problem of striking the right fiscal and monetary policy balance while the economy is recovering from turmoil and beyond.
Third, there is the key question of doubling down on key structural reforms, without which Ukraine’s economic growth prospects will remain mediocre.
Managing COVID-19 pandemic
As regards getting rid of the coronavirus shackles, testing, contact tracing, and selective isolation or quarantine are key.
Like everyone else, I hope for an effective vaccine or a cure, but I am not holding my breath.
Two kinds of tests are key. They are serologic or antibody tests and polymerase chain reaction or PCR tests.
The antibody test hopes for a positive antibody response. If it is indeed the case that a positive antibody test implies that a person has at least temporary immunity and is at least temporarily non-infectious, this person can rejoin the labor force without the constraints of social distancing.
The PCR test is one for infectiousness – whether a person has the disease and is capable of passing it on to others. It is key that both the infected persons and their contacts be isolated from contact with non-infected persons.
The more effective the testing for infectiousness, the contract tracing and the quarantining of the sources of the infection and their contacts are, the easier it will be to relax the social distancing and the return to normal work activities for the rest of the population – those who are susceptible to the disease but not infectious.
Smart containment following well-designed PCR tests, together with antibody tests can minimize the output losses, unemployment, and bankruptcies associated with the COVID-19 pandemic.
Challenges aside from COVID-19
Even if the coronavirus is eventually vanquished this way, the country will still face material macroeconomic stability and structural reform challenges.
On the fiscal side, the governments can fill gaps in coverage of the social safety net by expanding existing programs and using other delivery instruments. The IMF’s Fiscal Affairs Department recommends that for emerging markets these include mobile phone networks and in-kind provision of goods and services—especially health, food, and transportation—to reach people most in need or currently left out.
Reduce gray sector
Ukraine has an informal sector that is equal in size to at least 30 percent of GDP and likely a larger share of employment. It would be highly desirable both to reduce the size of the informal sector and to ensure that those who remain part of it are covered by a progressive social safety net.
Infrastructure investment
Infrastructure investment, including significant investment in the electric grid and distribution network, is also likely to require material public sector investment, as do health care and climate change. Given the right incentive framework, including a proven ability of the state to enter into long-term contractual agreements on utility pricing and to honor those agreements, domestic and foreign private investment can reduce the fiscal burden.
Utility pricing
Failure to charge the full long-run marginal social cost for key utilities like electricity and water could delay necessary infrastructure investment by years. That means including decommissioning costs in the tariffs of nuclear power plants and carbon emissions costs in the tariffs of other non-renewable sources of energy. Social issues should be addressed using fiscal means.
Agricultural land market
Creating a properly functioning market in agricultural land could greatly boost productivity in the agricultural sector.
Rule of law
Judicial reform, culminating in a transparent and independent judiciary and impartial law enforcement, is a necessary condition for successful and enduring structural economic reforms.
After 30 mostly wasted years, Ukraine still has the human capital – skills, talent, and technical know-how – to launch itself on a multi-decade path of sustained growth at annual rates of 5 percent to 7 percent.
Institutional and political weakness should not stand if the way of such a generational transformation.
Willem H. Buiter is a visiting professor of international and public affairs at Columbia University in New York and a member of the Economic Development Council of Ukraine.
