Thursday, 12 December

Political news rapidly displaced economic news from the information space and almost no one paid attention to the alarming symptoms that have appeared in the economy of Ukraine. According to the results of the first four months of this year, the state budget revenues did not catch up with the planned figures, although the NBU has already transferred all 47.6 billion UAH of its obligations to the state treasury for this year, and promised to transfer additional 17 billion UAH to the state during the year. It is the payment of the NBU that allowed the budget revenue to be at least 95% and accumulate a record balance for the Treasury single account started in May, but the NBU is not the whole economy and the National Bank cannot support the state every month. To maintain stability, it is necessary for the business to work actively, and problems have arisen with it. According to the NBU, the growth rate in the first quarter slowed to 2.4% (that is, to the level of 2017), and this figure is unlikely to improve significantly by the end of the year.

Now, according to the Ministry of Finance, the state budget revenues are under-fulfilled for a number of compelling reasons: VAT revenues were less than planned (since the national currency exchange rate “lags behind” the planned 29.3 UAH/USD), the import volumes, brought into the country, are also lower than expected. Also, at the end of the second quarter, the payment of corporate profits has been postponed (because the relevant standard could only be approved by the Government on April 26).

The main driving force behind the development of the economy is the consumer demand of the population. However, its growth will continue to slow down due to lower growth rates of real household incomes ‒ salaries, pension payments, as well as remittances from abroad.

The effect of last year’s record harvest, unfortunately, dried up. Of course, the contribution of the agricultural sector to GDP remained positive, but to a greater extent due to the increase in livestock production. In parallel, growth rates in the industry are declining, and not only in the energy sector, which worked halfway through warm weather but also in processing. In particular, a significant drop in the chemical industry, metallurgy, and other sectors continued for most of the first quarter. It is partly connected with planned repair work at some enterprises, and partly with the regular bans on the importation of certain types of products into the Russian Federation (boilers, turbines, agricultural machinery, electrical equipment, etc.). And if the first obstacle to growth is temporary, then the second is, if not constant, then long-term. Of course, the question remains open, why Ukrainian businessmen, despite the war with the Russian Federation, have not yet found alternative markets for themselves, but their mistakes will now affect state revenues.

What is even worse, with income shortfalls, the State budget expenditures only grow, and quite noticeably, by almost 13% in the first quarter alone. The state spending on pensions was bigger than last year, because in January they were paid in full, and in past years, part of January pensions was financed in advance in December. Also, pension expenses for certain groups of pensioners increased due to indexation, additional one-time supplements and an increase in pensions for the military. Government spending on current transfers almost doubled, capital spending on infrastructure projects and, of course, debt servicing costs (through external borrowing made at the end of 2018) grew.

The state budget deficit in the first quarter amounted to 26.2 billion UAH, and the consolidated budget ‒ 89 billion UAH. These are bad indicators, given that this is only the beginning of the fiscal year. Therefore, we have a disappointing picture: state budget revenues are falling, while expenses are rising. And if there are a lot of factors that can accelerate the further growth of state spending, then there are not many prerequisites for income growth.

The export of goods, which allows Ukraine to bring foreign currency into the country, grew by 8% in the first quarter. But the world prices for a part of our export goods are falling, and the economies of our countries-trading partners have also slowed growth. Therefore, for example, with a significant increase in the physical volumes of oil exports, the cost benefits from its sale were lower than expected. Fortunately, the export of meat increased significantly (by 21%), mainly due to the supply of Ukrainian chicken to Saudi Arabia, which helped increase sales of our food products. But at the same time, sales of metallurgy products (by 7.5%) and chemical products (by 18%) to other countries decreased, and the rate of sales of iron ore slowed down.

Import growth also slowed down (by 6.2%). This has a positive effect on the balance of payments of Ukraine and allows accumulating a portion of the currency that exporters bring into the country. But this is not enough since decline mainly occurred due to the reduction in energy exports, and not consumer goods.

In parallel, changes in Ukrainian consumer demand are recorded, on which Ukraine’s GDP growth has been determining for the second year in a row. Food expenses, which traditionally are the largest part of total Ukrainian expenses, are decreasing. The costs of excisable tobacco and alcohol, transport, health care, and education were also lower. That is, most of the goods and services produced in Ukraine. But Ukrainian expenses for imported products and services are growing ‒ clothes and shoes, household goods, leisure. Of course, it is good that the Ukrainians, due to the growth of their incomes, have switched from survival mode to normal consumption. But for Government finances, such a change in the consumer behavior can have negative consequences, since it stimulates an increase in imports, it does not bring currency into the country, but washes it away, because each subsequent supply of goods requires the importer to buy foreign currency in the domestic market.

Without the development and support of domestic producers and at least partial import substitution, the problem cannot be solved, but this cannot be done with real GDP growth rates and the actual lack of foreign investment. Therefore, in addition to a balanced policy of implementing the state budget and a moderate increase in government spending, if revenues grow at a slower pace, the authorities need to encourage investment and support domestic business, if not directly, then at least indirectly. Otherwise, there may not be enough currency for all. But so far, the winner of the presidential race only promises business meetings, while meeting with anyone except for entrepreneurs.

To finance the growing budget deficit and repay both domestic and foreign debt, the Ministry of Finance is actively attracting new loans. You can live in debt, and countries often live by just such a model, but you only need to accumulate debts if there is an additional resource for returning them, without increasing domestic production and exporting loans raised to finance previous loans sooner or later lead the country to the brink of default.

Therefore, it would be desirable that export volumes grow faster than imports, or domestic production actively develops. The National Bank of Ukraine expects growth in exports of goods in 2019–2021 to slow down to 2–3% (compared to 9% in 2018). This is due to both low external demand and lower commodity prices. This year, the high volumes of agricultural products, which, thanks to a record harvest of corn and sunflower, will be the main export drivers. But every year there will be no record harvests. The growth rate of non-energy imports will also fall, but not as significantly as exports ‒ up to 5-6%, that is, Ukraine’s dependence on foreign goods will continue in the future.

Moreover, according to the expectations of experts this year, the growth of remittances from labor migrants, who in recent years have become a powerful source of currency inflows into the country, will slow down. There are two reasons, on the one hand, economic activity in the EU countries is decreasing and the Euro Zone expects the stagnation. On the other hand, incomes in Ukraine are growing, the labor market already feels a personnel shortage and is ready to offer better conditions for applicants and more vacancies, to encourage some “commuters” (those, who go to work in other countries for up to 90 days) stay at home.

Accordingly, the balance of payments deficit will persist and IMF funds still remain the main source of replenishment of Ukraine’s international reserves. This is one of the main risks facing the new Government, because among the requirements of the fund, which should be fulfilled to continue the program, is reforming the state fiscal service by dividing it into two separate bodies, but the creation of the customs service is blocked in the courts and so far this problem is not solved. Another cornerstone in relations with the IMF is the introduction of a tax on capital withdrawn, on which the team of the President-elect insists. The Fund is so tirelessly repeating that despite the macroeconomic stabilization, the Ukrainian economy is still far from the state when it can afford tax experiments. It is difficult to disagree with the fund because the production of a new tax instead of a profit tax threatens the budget with a hole of 40 billion UAH in the first two years of reform. Given the rapidly growing budget deficit of this year and the lack of reliable sources of its financing, it may really better not to risk. No less sensitive for the IMF is “PrivatBank issue”. Its nationalization, in the opinion of the foundation, was the right and justified step that saved the country’s banking sector from a possible collapse. It is clear that the denationalization of the bank, in which each subsequent judicial decision, adopted in favor of the former owners of the bank, is rapidly bringing us closer, will stop Ukraine’s cooperation with the foundation, if not finally, then for a long time.

Of course, Ukraine could lend money not from the IMF, but from private lenders, but even if they risk investing in a country that does not comply with the IMF program, we will have to pay a lot. Realizing this, the Ministry of Finance so far uses every opportunity to raise funds on the domestic market, but as we explained above, this is a rather limited resource.

An additional risk is the Parliamentary elections to be held this fall. It is likely that the struggle for the electorate will lead to an increase in budgetary expenditures of a social nature through electoral initiatives by politicians, such as a sharp rise in social standards, in particular, the minimum wage. Accordingly, the state budget deficit will be even greater. As incomes will grow faster than production and productivity will increase, the inflation, which was successfully managed to curb only at the end of last year, will also rise. Therefore, it would not be superfluous for at least a part of high officials to distract from politics and look at the economy, and for a new team of reformers, who came along with the new President at least to announce the priorities and directions for future change.

By Valentyna Yushchenko

Leave A Reply