Macroeconomic situation of Ukraine

Transcription

1 Macroeconomic situation of Ukraine Małgorzata Jakubiak Center for Social and Economic Research The text is based on the study The sources of economic growth in Ukraine after 1998 currency crisis and the country s prospects (edited by Marek Dąbrowski and Małgorzata Jakubiak, with contributions from M. Antczak, A. Boichanka, V. Dubrovskiy, I. Golodniuk, Y. Kuz myn, A. Myślińska, J. H. Shirmer, M. Tomczyńska) and uses some of its outcomes. The sources of economic growth in Ukraine after 1998 currency crisis and the country s prospects was prepared in 2002 by CASE and CASE-Ukraine for the World Bank, and is available at the CASE website (CASE Report No. 55).

2 1. Introduction This paper presents the outlook of current macroeconomic situation of Ukraine, the analysis of factors which stood behind the economic growth of the period, and projections for the next two years. The study also points at certain inefficiencies or barriers which at the moment seem to have adverse effects for future economic growth. The general conclusion is that Ukraine should use the growth momentum and proceed with a set of necessary reforms. At the same time, given the current state of political debate, any radical moves in the sphere of economic policy do not seem very probable, at least in the short run. It lowers the prospects for stable and gradual development in the longer term. 2. Current economic situation After the fast economic expansion of the first half of 2002, the slowdown of rates of economic growth was visible in towards the end of the year. The full year growth was 4.1%. One year earlier, in 2001, the Ukrainian GDP grew astonishingly by 9.2%. Industry, which grew by 14.2% in 2001, expanded in 2002 by 7%. Production in agriculture increased in 2002 by 1.9% only compared with 10.2% growth one year earlier. Falling prices of agricultural products led to the continuation of consumer price deflation in the summer and autumn months of At the end of the year, the influence of the low food prices was still reflected in the low consumer price index, hence the consumer price deflation of -0.6% yoy recorded in December. However, as the prices of grain have been mounting from the beginning of 2003, and the results of monetary expansion of 2002 became apparent, CPI inflation on the yearly basis is already 4.3% in March. The year 2002 privatisation plans were not met, which undermines overall investment climate in Ukraine. Lower budget revenues resulting partly from deflation and partly from bad planning or bad tax collection did not result in budget deficit, due to cuts in spending. As a result of rising political tensions, the attention has shifted away from much needed structural reforms, and probably the situation will not change much at least until the autumn of 2003.

3 3. Third year of economic growth in Ukraine This section provides the account of Ukraine s economic growth of It starts from the description of the dynamics of aggregates on the demand side of the economy, then refers to changes in monetary and exchange policies, fiscal policy, developments on the labour market, and to the reduction in unregistered economic activity. The year 2002 was the third consecutive year of Ukraine s economic growth. It should be remembered, that Ukraine was the last among transition countries to show recovery. The fall in GDP lasted from the declaration of sovereignty to Actually, the first signs of recovery showed in the 2 nd half of 1997, and in the first half of The upwards trends rapidly reversed in September 1998, following the Russian crisis. The crisis brought severe contraction of real activity in Domestic demand fell by over 6 percent. Trade volumes also decreased. However, the devaluation of hryvnia, that made import fall by nearly 17% in 1999, led also to an import substitution. As a result, domestic demand rebounded in Figure 1 Real GDP in Ukraine (1991 = 100) Source: NBU and Ukraine State Statistics Committee Decomposition of growth trends by the components of global demand shows that the 6% economic growth of the year 2000 was primarily driven by a surge in exports and growing consumption. The 9% growth recorded in the following year was primarily driven by domestic demand. Consumption that accounts for nearly 60% of Ukrainian GDP started to rise in the last quarter of But it was at the beginning of 2000, when household consumption jumped by over 9 percent following more than 10 percent rise in real incomes. Relatively high, although

4 decreasing, rates of growth of consumption prevailed through 2000 and first half of This again was caused by growing wages. Investment that stayed at the same level in real terms in 1999, have recorded very high rates of growth since the last quarter of Real growth rate of investment in fixed assets did not fall below 12% through 2000, and according to preliminary estimates was 11.0% in Such high rates of growth were the reason that investment was giving the highest growth impulse to the growth of domestic demand in When we look at the gross investment data, it comes out that the highest growth rates in 2001 were recorded in transport and communication (23%) and manufacturing (almost 20%), while the growth of gross investment into mining (15%), construction (14%), and energy (9%) sectors were slower. Taking into account the share of each of these sectors in the value added, one can conclude that the highest contributors into the growth of gross investment in 2001 were manufacturing, transport and communication sectors. However, these are only gross data, so it is not clear how much of these amounts can be attributed to net investment in each sector. Even though net investment data are not obtainable, high rates of growth of investment in manufacturing (assuming that not all of this can be attributable to the metallurgy) seems to be promising. Government purchases were still falling in 2000, following the same trend as in the previous years. This was probably the result of higher public spending discipline and limited budgetary resources. A combination of various factors made export grow very fast, and allowed for trade surplus. Among these factors were: effects of the devaluation of hryvnia, favorable conditions on Ukraine s traditional export markets, and indirect subsidizing of the metallurgical sector. Exports surged by over 20% at the beginning of 2000, recorded a real growth of nearly 14% for the whole year, and gave a strong growth impulse to the economy. Growth of export slowed down in 2001, as the above mentioned positive conditions started to weaken. Import rebounded in 2000 as well, by 17.5%, and by 12% in 2001, as a result of growing consumer demand. However, trade surpluses have been recorded until the end of 2002.

5 Figure 2 Growth of real GDP and its components, (in percent) * Consumption Goverment Purchases Investment Export Import GDP Source: Source: State Statistic Committee of Ukraine Note: * - CASE estimates Low inflation recorded by the end of 2001 (6 percent on the annual basis in December 2001) and in the first months of 2002 can be attributable to the increase in the demand for money. The trust of economic agents and society into national currency and monetary policy conducted by the central bank increased visibly in 2001, thus allowing for the accommodation of the expansionary monetary policy of 2001 and early 2002 without the pass-through on inflation. The low inflation, and even the deflation of summer 2002, was possible also due to the supply shock good weather conditions and abundant supply of agricultural products made prices for food fall. The National Bank of Ukraine had therefore luck sharp, unexpected rise in demand for money combined with the supply-side shock helped in disinflation, although the NBU has been extending credit on a large scale. The situation is depicted on Figure 3, where the growing money supply of 2002 is combined with disinflation. Table 1 Inflation and monetary aggregates in Ukraine in CPI PPI Monetary base Currency in circulation (M0) Broad money (M3) y/y y/y UAH mil. y/y UAH mil. y/y UAH mil. y/y Source: NBU data Note: CPI and PPI are end-year percentage changes

6 Figure 3 Growth of monetary base and inflation, yoy changes Monetary base CPI 0-10 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Source: own calculations based on NBU and MinEcon data The post-crisis real devaluation and hence real depreciation of hryvnia was behind the 1999 contraction in imports and enhanced the expansion of Ukrainian exports. This real depreciation played a role of unintended expenditures-switching policy, which resulted in the decline of consumer imports in 1999 and allowed for the growth of food and light industries. Producer imports (mainly energy supplies) were not affected by the exchange rate dynamics as the prices for Russian and Turkmen oil and gas have been set independently of the prevailing exchange rates. The initial growth impulse of Ukrainian exports depreciation of national currency was soon (2000) coupled with favourable conditions on external markets. The most positively affected was traditional Ukrainian exports black metallurgy. However, these conditions worsened substantially in 2001, and the continued expansion of the metallurgical sector was possible due to subsidies, which in turn resulted in creating market distortions, implementation of anti-dumping procedures abroad, and most probably, in the future burden for the state budget. Finally, real appreciation of hryvnia in 2000 and 2001 demonstrated that future economic growth in Ukraine would depend more on improvements in productivity than on price advantages due to a real depreciation as it was observed earlier.

7 Figure 4 Nominal exchange rate of hryvnia against US dollar in Jan-98 Jan-99 Jan-00 Jan-01 Source: NBU data Note: Increase denotes depreciation. Nominal stability of the exchange rate of the period stood behind the real appreciation of domestic currency. The stable hryvnia contributed to the increase of confidence to domestic money. The NBU could keep the exchange rate of hryvnia practically unchanged due to the large trade surpluses (positive current account), and inflow of foreign loans (hence NBU accumulated large foreign exchange reserves) There were visible improvements in the sphere of fiscal policy. For the first time in years, Ukrainian government started to implement reliable budgets. Low fiscal deficits were attained, despite or may be even due to - the cut-off from foreign financing. Higher than expected tax revenues in 2000 (collected as a result of the revival of economic activity) made possible for the Yushchenko government to repay nearly all social arrears. The Budget Code regulating the division of responsibilities and sources of revenues between central and local governments was adopted in The multi-year budgeting started to be effective from The new multi-year approach should improve the process of medium-term planning based on consistent economic and social strategies. New, simplified taxation for small enterprises started to give fruits. During in there was a growth in the number of registered enterprises, the rise in the budget revenues, and costs of running a small firm went down. However, despite all this positive developments, there are still many bad practices in the sphere of fiscal policy. The existence of numerous tax privileges, persistent subsidies and the continuation of writing-off tax arrears can serve as examples.

8 Table 2 Ukrainian Fiscal Statistics in , percent of GDP Jun-Aug 2002 Consolidated budget revenues Consolidated budget expenditure Fiscal balance Budget balance without privatization receipts Public debt Source: Ministry of Finance, Ministry of Economy, CASE-Ukraine Ukrainian Economic Outlook. Labour market adjustments in the aftermath of the 1998 crisis followed the pattern typical for a CIS economy of the 1990s. Decline in employment was significantly smaller than the fall in production and labour demand. These were mainly movements of wages that absorbed the shock and the catch-up that followed. As a result, the ratio of people employed to the working age population remained practically unchanged. The structure of employment has not changed significantly during The number of employed 1 to the working age population was gradually falling throughout , and was unresponsive to changes in overall economic conditions. Employment in agriculture still accounts nearly for 30% of official total employment, and employment in industry has a slightly higher share. The rest of employment is accounted for services and people working in other sectors of the economy. Unemployment rate that stabilized in , decreased a little in 2001, and according to the employment office records, was 3.7% at the end of However, findings from the Labour Force Survey suggest that the true unemployment rate is much higher, and that in 2001 it was on average above 10%. The still existing discrepancy between the two numbers indicates the persistence of hidden unemployment and shadow labour market. The hidden unemployment may have various forms, such as shortened work days, unpaid leaves, and partial employment. The unemployment benefit - although increased from 50 UAH per month on average in 1999 to UAH in 2001 (which is less than 16 USD, without taking into account purchasing power differences) is still very low, and it does not create enough incentives to become registered as unemployed. Instead, people still prefer to be registered as employed, benefit from the employed status, and use their free time to engage in unofficial activities. Data on unemployment suggest that the significant part of the population supplements its official income with the secondary, informal job, revenues from which are often higher than from the registered occupation. 1 officially registered

9 The other important issue associated with Ukrainian labour market is still persistent labour migration. It was estimated, that the total number of labour migrants from Ukraine was no smaller than one million of persons in 2000, which was equal to 4.3% of the economically active population (aged 15-70). The majority of migrants declared to hold no constant work in Ukraine at the time of their migration, and only 7% of them were on unpaid leave. The migrants were mainly young people with some working experience (30-34 age group was most frequently represented), with secondary education, and coming from rural areas. More than one half of them travelled to Western and Central Europe (among them 1/3 to Poland, then to the Czech Republic and Italy), and over 1/3 to Russia (mainly older workers). There were signs indicating that the so called shadow economy decreased in One of these signs is a decrease in the size of unreported incomes of the population in It probably reflects the decline of unregistered economic activity in the household sector. If we compare total incomes of the population with household consumption, it turns out that registered incomes are significantly lower than the value of consumption. This situation occurs because people do not report all their incomes, but these amounts are nevertheless counted when being spent, as household consumption expenditure. Therefore, if we estimate household savings, and add it to the household consumption, we obtain the estimate of the disposable income of households, which can be then compared with total incomes of the population as reported by the State Statistic Committee. This difference between the approximation of disposable incomes of the population and reported incomes is shown on Figure 5 The income gap, expressed in terms of household consumption, was falling up to 1998, grew in the post-crisis year of 1999, and narrowed again in Thus, the unregistered economic activity of the household sector decreased in 2000 as compared to the previous period.

10 Figure 5 Difference between estimated disposable incomes and reported incomes of population, in percent of official consumption of households, % 25% 20% 15% 10% 5% 0% Source: CASE estimates on the basis of data from State Statistics Committee of Ukraine and NBU Moreover, there is evidence that there was a decrease in capital flight in 2000, as domestic investors perceived investment climate of 2000 as promising. However, the picture of economic development hold by domestic investors deteriorated in the following year which was reflected in the BOP statistics despite the continuation of economic growth registered in the country. These observations lead to the conclusion that shadow economy started to shrink in 2000, but the positive developments were somehow hampered by the uncertainties related to the economic policies of There was also a decrease in rent seeking activities, as measured by the fall in barter transactions and arrears to the budget in But it is not clear what were the exact reasons for it, since the official statistics do not difference the write-offs and the true repayment of arrears. Next years should show whether this trend of less rent seeking will continue or whether it was just a one-time phenomenon. 4. Factors of growth The economic growth observed in Ukraine for the last three years was caused by the combination of factors. First of all, macroeconomic situation of the 1 st half of 1998 made it clear that the decline potential had been already exhausted. The effects of economic reforms undertaken in 1990s finally began to give their fruits in 2000, after the currency crisis. An example of such a reform can be the introduction of simplified taxation, which was responsible for moving part of the unregistered economic activity to the official sector. This created positive fiscal impulse, although of the one-off influence. Limiting barter was another example.

11 Secondly, it should be stressed that the majority of these factors of growth had temporary or windfall character. This means that their impact on economic development is no longer in place, and the subsequent moves in the field of deregulation, elimination of corruption etc. should follow. There were also factors with long-term positive effects on the economy, like privatization, and the development of the financial sector. The financial crisis of 1998 and its consequences paradoxically created growth impulses (also of the one-off nature). Real depreciation of the national currency played a role of the unintended expenditure-switching policy, lowering consumer import demand, shifting consumers preferences towards the domestic production and thus giving a rise to the sectors producing first-needs commodities like food and light industry. Cheaper hryvnia and high world prices for metals (traditional Ukrainian export sector) plus economic growth in Russia were responsible for the booming export. Being cut-off from foreign borrowing imposed hard budget constraints, thus having a disciplining and deregulating character. The government of Yushchenko had a positive role in implementing reliable budget, repayment of wage and pension arrears, increased cash payments in the energy sector etc. However, fiscal discipline worsened in 2001, and some moves in this sphere even undermined earlier achievements. Positive changes of this type depend on the political will of the government, and can be easily reversed. 5. Impediments for sustainable growth At the moment there are still many obstacles for sustainable economic growth. The low level and negligible inflows of FDI are a sign of an unfavourable investment climate. The slow down of the sale of state-owned enterprises further undermines investors confidence. Fiscal policy lacks transparency, tax system is full of loopholes, and entrepreneurs complain about unpredictability of government policy in this area. The level of financial intermediation remains low which hampers further re-monetization and the transparency of economic transactions. Finally, the agricultural sector needs reforms. Bad investment climate The low level and negligible inflows of FDI almost exclusively related to privatization show that although the country recorded three years of impressive growth, the economic situation of Ukraine is still regarded as unstable by foreign investors. Inflows of foreign direct investment fell in 2002 by 20% in comparison to 2001, while short-term capital outflows

12 (probably indicating capital flight) increased substantially. The necessity of getting more FDI is especially important, when we consider that the positive relation between the extent of privatization and growth was visible in all industrial sectors, with the exception of fuel and energy. Refraining from the sale of some stated-owned assets despite earlier announcements in 2000, 2001, and in 2002 (after unexpected increase in privatization receipts in 1999) gives mixed signals about the government will. For this reason the decision of not privatizing Ukrtelekom and energy distribution companies in cannot be regarded as positive. The suspension of the sale of several high-profile enterprises in 2001 (including 49.9% stake in Ukrtelekom, for which government expected to collect about half of the total privatization receipts planned for 2001) and some oblenergos was the main factor behind the collection of less than half of planned privatization receipts, which caused a decrease in total revenues and fiscal deficit. The energy sector requires special attention the signs of increased payment discipline observed in 2000, partially reversed in The payments for electrical energy stabilised at a much higher level than before, but still significant part of energy sales is paid in barter or not paid at all. Still in 2000 the majority of energy-related new legislation was directed to support of energy consumption, while there was not so many new legislation acts related to energy saving or to hardening of budget constraints. The energy sector is subject to rent-seeking activities and strong lobbying pressure. Weaknesses of the tax system General weakness of the Ukrainian tax system still poses problems and has serious adverse impact on the budget (as total tax revenues constitute nearly 70 percent of all budget revenues). During total tax revenues, expressed in percent of GDP, were decreasing, despite rapid economic growth. When we look at the real change of tax revenues of the consolidated budget deflated by the GDP deflator it comes out that real tax revenues fell by nearly 5 percent in 2000, yet rose by over 7 percent in However, this real growth of tax revenues in 2001 took place almost exclusively due to the improvement of personal income tax collection. The figures for the year 2001 probably reflect some positive changes in the sphere of tax policy that happened before. Such as introduction of simplified taxation for small and medium enterprises and elimination of special tax treatment for selected companies. However, the lack

13 of sustainability in the sphere of fiscal policy makes one cautious about predictions of significant improvement in the tax collection in Ukraine. Corporate income tax receipts were falling in real terms both in 2000 and in It was the effect of continuous prevalence of the numerous tax privileges, such as tax exemptions for agricultural producers or the famous experiment for enterprises of the metallurgical sector. According to the law on experiment adopted in July 1999, metal factories received many implicit subsidies, and the rate of corporate profit tax for them was established at 9% (vs. 30% for the majority of other enterprises). To be eligible to participate in the experiment, the metallurgical enterprise had to meet two out of three requirements: 1) produce not less than 2% of the goods of metallurgical industry; 2) have the assets worn out at least by half; 3) export not less than 8% of the goods it produces. The poorest collection was observed in the value-added tax. During the government was unable to collect planned amounts. The VAT to GDP ratio declined over time from 6.2 percent in 1998 to 5 percent in 2001, and VAT receipts fell in real terms by over 12% in 2000, and were almost unchanged one year later 2. It should be remembered that VAT constitute one third of tax revenues and one fifth of total consolidated budget revenues. The broad tax amnesty enacted in 2001, implicitly enhanced non-payment of this tax during the course of the year and the accumulation of new arrears. The authorities argued that the tax debt forgiveness was supposed to free the economy form the financial burden of the overdue taxes. However, this move rather worsened tax discipline and resulted in the decline in budget revenues. Only receipts from personal income tax were following a different trend, and reflected positive developments in the economy during Personal income tax collection increased from 3.7% of GDP in 2000 to 4.2% of GDP in PIT receipts rose by 9% and by 26% in real terms in 2000 and in 2001, respectively. The majority of this can be attributable to the introduction of simplified taxation for physical persons. The implementation of the Tax Code accepted already in 2001 is therefore crucial for the future fiscal stance. The drafted Tax Code reduces number of tax categories, lowers corporate income tax and VAT rates, decreases the number of tax brackets of the personal income tax, etc. By lowering tax burden and elimination of the numerous loopholes and exemptions this code is supposed to increase the transparency of the fiscal policy and lower high 2 Deflated by GDP deflator.

14 administrative costs of the present system. However, it has not been implemented so far. The delay weakens government s confidence and the effects of the implementation at some later date may be different than planned. Tax and regulatory barriers concerning larger firms still remain very complicated, and the exposure to corruption and strong lobbying pressure is high. The accumulation of VAT refund arrears in 2001 (at about ½ percent of GDP) has been posing a threat, being another factor weakening the government s confidence. However, it is perceived that these arrears will be gradually repaid, if not until the end of 2002, then in early 2003, following the obligation toward the IMF. Low level of financial intermediation Despite all the positive developments in the financial sector that took place during resulting from growing competition and ceasing of some sources of speculative profits the level of financial intermediation still remains very low. Notwithstanding the decrease in the perception of risk of banking operations, better allocations of credits, and the reduction in problem loans, banks and other financial institutions still operate in the hostile environment. As a result, the relative size of the Ukrainian banking system is low by international standards. Banking assets to GDP ratio stays at about 20% (compared with around 60% in Estonia or over 300% in Germany). Assets of the non-bank financial institutions (such as investment and pension funds or insurance companies) constitute around 1% of GDP in Ukraine (19% in Hungary, 15% in Poland, 72% in Germany). The size of the stock market is negligible. There is a need to put serious effort to reduce negative effects of non-transparency, weak access to information, insufficient protection of property rights, additional costs of financial operations imposed by the state administration, large size of shadow economy and the tolerance of persistent non-monetary transactions. Uncertain future of agricultural sector Finally, it is clear that agriculture cannot expand without substantial reforms. The growth of agriculture in (steaming from good weather conditions and some easily reversible policies) did not create foundations for the positive tendencies in Ukrainian agriculture to continue. This was already reflected in the 2002 data. Agriculture managed to grow by 1.9% only, and this growth was predominantly the result of an increase in animal production. Production of cereals deteriorated in Hopefully, the land-market reform will soon bring some fruits, but we must still wait for its effects.

15 Good weather was responsible for the agricultural growth of The mechanism of growth which took place one year later was more complex and included both the influence of economic policies (liberalization of prices for some products and privatisation and development of the competitive market in agricultural inputs and outputs) and good weather. Two other factors helped to increase agricultural output higher transportation costs and the devaluation of hryvnia by making agricultural imports more costly. Although there have been improvements in agricultural policy during 2001 in refraining from excessive regulation at the grain market for example the whole sector remains exposed to regulative pressure. The over-regulation and the lack of will to effectively change the system of ownership up to 1999 caused very slow adaptation of agriculture to the changing market and social conditions. At the moment, the agricultural sector suffers from high production and very high transportation costs. Ukraine has a very inefficient system of input supply and transportation chains. At the same time it suffers from the lack of funds for the necessary investment in the infrastructure. And it is agreed that without the necessary radical reforming of agriculture, the sector is unable to generate enough means to invest, thus lowering the chances for the continuation of the growth of the agricultural output. In 2001, despite the growth of , agricultural production was still below 70% of agricultural output of And the situation has not changed much in Here, much depends on the government policy towards this sector. Today, it is hard to asses which direction country leaders will chose the continuation of agricultural reforms or the return to state s interventionism. 6. Future prospects 4 It should be remembered that making any long- or even medium-term forecasts for an economy such as Ukraine is exceptionally risky. The country underwent radical changes, went through the prolonged recession that began in the last years of the Soviet Union, and finally started to grow. But since the base for this growth does not seem to be very stable, or of the long-term nature and given the mixed outlook when considering past economic 3 according to the official statistics 4 The forecasts presented in this section were calculated in mid-2002, with the information available for that period. Although the tendencies shown by the projections are still actual, some of its assumptions and outcomes may no longer be correct.

16 policies, it is difficult to assess what tendency will prevail in the future the inertial or the reform-oriented one. However, the outlook for the next two years will not change much. This is for the set of reasons, but mainly because some positive changes that happened in are irreversible. The growth impulse gave rise to the sectors of the economy in which Ukraine has probably a comparative advantage, and their development will most probably continue. Some positive changes in the sphere of fiscal policies and legislation seem impossible to be overturned easily. Higher confidence to the central bank and to the government already demonstrated itself in the higher demand for cash transactions, and financial sector is developing slowly but steadily. In addition, higher incomes of the population will stimulate domestic demand for some time. Nevertheless, it is worth to consider two possible policy scenarios for the close future. They are broadly similar when considering their short-run outcomes. However, their consequences for the future of the economy are different. If the ruling elite decide to support present economic recovery by the next round of necessary reforms, then these reforms can create a basis for sustainable growth. It is clear that there is still lot to be done in the sphere of tax reform, legislation, reduction of state intervention, improvement of transparency, refraining from stop-and-go economic policies, enforcement of the property or shareholders rights, and so on. As examples of other transitional, yet more successful economies show 5, only the strong commitment to reforms can assure the transition to a relatively well functioning market economy. However, if the chance is to be missed, economic potential will not be used, and the growth will not continue in the long-term. And we can observe the cyclical patter of prosperity and crises of the Latin American type of the previous decades. The first, some reform, scenario assumes that there will be a progress in the field of regulations that improve investment climate and in the sphere of fiscal policy. Banking system will see a slow but gradual improvement. Ukraine s external position will remain stable and manageable during Economic growth in Russia (strong financial and trade links) will slow down. As a result, Ukrainian GDP will continue to grow both in 2002 and in However, its growth rates will decelerate, as the role of net exports as a growth engine will weaken and further expansion of domestic demand will occur at a slower rate. The 5 Central Europe and the Baltics

17 deceleration of the growth of investment in fixed assets has been already visible in the first quarter of 2002, when the growth rate was 9.6% yoy, compared to 23.7% yoy one year earlier. At the same time, real wages and incomes of the population continue to grow indicating that the growth of consumption can outperform the growth of investment for the whole Figure 6 Past and forecasted growth of real GDP, , in percent reform scenario status quo * 2002f 2003f Source: State Statistic Committee of Ukraine, CASE forecasts Note: * - estimate; f forecast It is assumed that fiscal policy will be more expansionary under the status quo than in the reform scenario. Budget deficit is assumed to be higher in 2002 and in Additional deficit is to be financed by increased emissions of treasury bills. In comparison with the baseline scenario, increased purchases of treasury bills by the central bank will result in faster growth of monetary aggregates, which in turn will lead to higher inflation. Real growth of GDP in 2002 will be slightly higher due to enlarged government consumption. However, adverse effects of greater inflation will start to prevail in the next year, and the economic growth will decline. Higher domestic demand will stimulate growth of imports, which will worsen a bit current account and decrease gross reserves. [0]The above conclusions regarding economic growth of the year 2003 were written in mid Now, when more information is available, the growth forecasts should be revised slightly upwards. With current higher prices of oil, continued Russia s economic expansion in 2002, and other factors, the economic growth of the years should be around 4%.

18 The incoming presidential elections would probably lead to increased public spending, which together with the NBU trying to continue depreciation pressures on hryvnia in order to boost exports should create additional inflationary pressure. However, the consumer price inflation should not go beyond 5% in 2003 and probably also in Concluding remarks Ukraine should address the obstacles for growth listed in the section 5. Primarily, high bureaucratic and regulatory barriers should be reduced. The energy sector requires special attention, as the predominant source of the rent seeking. The privatisation process ought to be continued, and there is a need for transparent and clear fiscal policy. There is a need to address problems in the agriculture how to change present unsustainable agricultural taxes without causing a shock to agriculture, invest in obsolete infrastructure, and at the same time resist to the temptation of state interventionism. In spite of limiting these impediments, Ukraine should continue its efforts towards joining WTO. Trade and capital flows constitute an important part of Ukrainian GDP, thus the country can profit from lower trade barriers and from having a possibility to defend its national interests within WTO. As a producer of relatively simple commodities, Ukraine can therefore reduce its exposure to external shocks. In the long term, the advantage of being a member of WTO will demonstrate itself in lower prices. Uncertainty about trading conditions should be reduced in the medium-term, thus enhancing more transparency (clear information about policies, rules and regulations), and hopefully there will be a reduction in antidumping procedures due to multilateral mechanisms of WTO. This last fact less losses due to discriminative measures should help exportoriented industries.