Ukraine’s government is making some progress.
But much more needs to be done
EVEN before the Russian invasion of the east
of the country last year, the task of reforming Ukraine’s economy was daunting.
Its people are poorer than they were when the Soviet Union ended (see chart 1).
Corruption pervades Ukrainian life. The traffic police demand bribes at random
and newspapers carry advertisements for companies that will forge exam papers
for you. To this set of chronic problems, the war has added acute ones: the
destruction of much of the country’s industrial base, spooked investors and a
balance-of-payments crisis. If Ukraine is to build a stable economy, it must
fix the public finances, shake up the all-important gas sector and stamp down
on corruption against the backdrop of an unresolved conflict.
Ukraine’s public debt is around 100% of GDP,
much of it denominated in foreign currency. Already unsustainable, its debt
burden is on an upward path: in the first quarter of 2015, Ukrainian GDP fell
by almost 18% year on year. With nearly $6 billion of foreign debt falling due
in the next year, but foreign-exchange reserves of around $10 billion, Ukraine
has little room for manoeuvre. Despite the central bank offering interest rates
of 30%—the world’s highest—the hryvnia, Ukraine’s currency, is shaky. If it
falls, servicing foreign debt will become even trickier.
The IMF, with which Ukraine agreed a bail-out
deal in March, has been clear about what is needed to make the country’s debts
sustainable. It assumes that the government in Kiev will write off $15.3
billion of debt and interest by 2018, and that it will have reduced its
public-debt-to-GDP ratio to about 70% of GDP by 2020. The goal is to reduce
debt repayments in any given year to no more than 10% of GDP.
To achieve this, Ukraine must cut a deal with
the holders of its debt. Negotiations are going badly. The creditors are trying
to get the government to agree only to maturity extensions. Ukraine wants to
reduce the total amount of debt it owes, as well as pushing back repayment
dates. It looks increasingly likely that Ukraine will fail to reach an
agreement by June, which could delay the disbursement of a badly needed $2.5
billion loan from the IMF.
Even in the face of obstinate creditors, says
the IMF, all is not lost. It hopes that tax rises and spending cuts will help
make Ukraine’s debt sustainable. As much as half of the economy operates out of
the reach of the taxman: tackling this would boost revenues. Ukraine’s big
shadow economy is partly down to its high payroll taxes (ie, those that are
levied on workers). Low “tax morale” plays a role, too. People see little point
in paying their share, since public services are poor and corruption pervasive.
VAT evasion is rampant.
The government is acting. It has introduced
an electronic VAT system, for instance, which will make evasion more difficult.
Payroll-tax breaks should also help to bring more firms out of the shadows. The
State Fiscal Service reported in April that it had received about 3,000
applications to take advantage of a tax amnesty—whereby people make an honest
tax declaration in exchange for a waiver from penalties—though that boosted
revenues by just $12m. Some taxes have risen. The maximum rate of
personal-income tax has moved from 17% to 20%. This seems to be paying off:
overall tax revenues are rising.
The government is also making tough decisions
on spending. Anders Aslund of the Atlantic Council, a think-tank, says that the
government has cut the cost of Ukraine’s pension system from 18% to 14% of GDP,
mainly by changing the way that payouts rise and removing perks enjoyed by the
old Soviet elite. (The biggest reform to pensions, raising the retirement age,
has been kicked into the long grass.) Spending on education and health care has
seen big drops, and a fifth of civil servants are being fired. In the first
quarter of this year, state spending in real terms was 17% lower than the year
before, leading to a budget surplus (see chart 2).
The government can also save money by
reforming the gas sector, the second of its big tasks. It is a huge fiscal
hole: in 2014 the state monopoly, Naftogaz, ran a deficit worth 5.7% of
Ukraine’s GDP. An opaque system of subsidies is to blame. For years, it ensured
that Ukrainian households received gas at one-fifth of its cost. That boosted
disposable incomes for many (though not for the very poorest, who are cut off
altogether from the gas network), but it was also an avenue for graft. Many
grew rich by buying gas at the household rate, then selling it on at industrial
prices.
The current government, in contrast to
predecessors, is making a serious effort to shake things up. On April 9th the
parliament passed EU -inspired legislation to
“unbundle” Naftogaz—splitting it up into separate production, transit, storage
and supply firms. Once implemented, consumers will be able to choose their gas
supplier, a radical change.
To close Naftogaz’s deficit, the government
is increasing the household price of gas fourfold. Ukrainians will not really
feel the pain until November, when they see the first bill of the winter. To
offset the hardship, the government and the IMF say that spending on social
programmes will see “an increase of 30% compared to 2014”. These figures are in
nominal terms, however; with inflation running at 60%, social spending is
probably falling in real (ie, inflation-adjusted) terms.
In other areas, reform is more sluggish. The
stations used by Naftogaz to measure imports are inside Russia, meaning that no
one is sure how much gas really enters Ukraine. Although the Ukrainian
authorities insist that the flow is closely monitored, others fear there is
huge scope for malpractice. A senior EU official dealing with energy believes
that each year up to €200m ($222m) worth of gas may go astray. Ukraine’s
foreign allies have repeatedly urged it to install meters on the border, so far
to no avail.
Graft is everywhere. A list of the world’s
most corrupt states, compiled by Transparency International, a pressure group,
puts the country at 142nd—little better than the Central African Republic. The
government has made much progress in one hotbed of corruption, public
procurement, by closing loopholes and making it more transparent. But another
flagship policy, an anti-corruption bureau, worries some. A 190-country study
by Alina Mungiu-Pippidi and colleagues at the Hertie School of Governance, in Germany,
shows that dedicated anti-corruption institutions typically fail. That is
usually because the bureau itself ends up becoming a target for corruption and
political influence.
Corruption also festers in Ukraine’s legal
system. The courts use a mixture of a modern Western civil code and a
Soviet-inspired economic code. This creates problems, says Daniel Bilak of CMS
Cameron McKenna, a law firm, since civil law in general, and commercial law in
particular, require certainty and predictability in their application. Judges
can choose which code to apply in business disputes, which makes the law
confusing and opens the door to bribes. Some reform has begun, however,
including making land-registry records available online, and judges are being
more closely scrutinised.
This government has the most ambitious
economic programme in Ukraine’s short history. But one area beyond its control
is the situation in the east of the country. Vladimir Putin, the Russian
president, has the power to heighten the conflict there at any time, doing
further damage to the economy. That is not a comfortable position for any
country to be in.
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