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Democracy Watch, 2011 - Issue 16

05-31-2011 08:09 AM CET | Business, Economy, Finances, Banking & Insurance

Press release from: People First Foundation

Ukrainian economy stumbles towards a slow recovery

The first months of 2011 have shown signs of a slow recovery for the Ukrainian economy. Industrial production has grown by 10.5% as of January 2011 compared to January 2010. The harvest volume this autumn is expected to increase up to 42 million tons. The national budget surplus for January-February 2011 accounts for 4.1 billion UAH (0.5 billion USD) owing to increased taxes, reduced expenses and an increase in the demand for raw materials on the world markets. The combination of the aforementioned factors as well as other positive developments have assured 4-4.5% GDP growth in Ukraine in 2011.

Ukraine’s macroeconomic performance has continued to improve since the beginning of the year. The metallurgy and engineering industries have been the most successful, compensating for slower growth rates in the chemical and agricultural sectors. The growth rates for February 2011, compared to January 2011, are the following: 16.5% growth in engineering, including 19.8% and 14.5% growth in the production of transport and machinery / equipment, respectively, 16.3% growth of the wood-working industry, 14.4% in the FMCG sector, 7.7% in the pulp and paper sector and 3.4% growth for the food industry. At the same time there was a decline in several industries: extractive industry (by 6.5%), generation and distribution of electrical energy, gas and water (by 2%) as well as in coke and petroleum industry (by 1.9%).

The global boom in steel prices raised the growth of metallurgy production to 17.4% in February 2011 compared to 13.3% in January 2011. The export of engineering products to Russia has increased up to 30.1% compared to the same period last year. The growth of the chemical industry peaked at 28.5% in January 2011 but dropped down to 17.4% in February 2011. The preparations for Euro-2012 stimulated development in the construction sector with growth of 6.1% as of January-February 2011. The relatively low growth of this year’s budget expenditures (by 13% compared to 2010) allowed the government to increase the wages of particular public sector employees (education and health care workers) in apparent response to the protests which started in the second half of the previous year. The baking sector has also demonstrated some signs of improvement. 'Naftogaz' has finally returned all 12.1 billion cubic meters of gas to 'RosUkrEnergo' according to the ruling of the Stockholm arbitration court.

Despite the gradual return to growth, the economy of Ukraine still faces many problems. The government’s low level of commitment to the implementation of reforms caused the IMF to defer negotiations over the next tranche of loan funding until June-July 2011. The rate of inflation is still growing. The government is yet to decide on a priority economic area between free trade with the European Union and a customs union with Russia, Byelorussia and Kazakhstan. The growth of world oil prices negatively affects the prices of oil-products in Ukraine, resulting in a the rise of the cost of transport services as well as municipal services (electricity bill has increased by 15% as of 1st April 2011, gas and heating bills - by 20% and 26%, respectively, since the middle of April 2011, tariffs for telecommunication services have increased by 10-35%). All of the aforementioned factors undermine the purchasing power of the population. Another problem is the sudden 90% increase in imports in February 2011 compared to February 2010, tipping the import-export balance 1.1 billion dollars further into Ukraine’s disfavour.

The fact that the Ukrainian population purchased 3.3 billion dollars in currency trading during the first three months of 2011 is indicative of the amassed capital of the ‘shadow economy' and the lack of public confidence in the future of the nation. The number of business owners and registered small and medium sized businesses has dropped by 30% compared to the first three months of 2010 as a result of the new tax legislation. Attempting to address this problem Verkhovna Rada opted to simplify the procedure of opening a business and give legal entities the right to establish a statutory fund of any size and in any number needed to start a business. But these measures have not been enough to remedy the situation and help the small and medium sized businesses suffering from the new tax code.

NBU Governor Serhiy Arbuzov commented on the IMF tranche saying that Ukraine expected to receive a double tranche from IMF in the amount of 3 billion dollars following the results of the first half of the year. But in order to receive this tranche the Ukrainian government are obligated to meet specific IMF requirements concerning the implementation of pension reforms, increase of tariffs, settlement of the VAT debt, grain quotas, etc. The National Bank of Ukraine however, is one of the few institutions to fully responded to the IMF conditional agreement requirements.

The Ukrainian government has voiced its intention to sign a settlement agreement with Vanco Prykerchenska Ltd., a requirement of initiating joint projects in Black Sea, which will come as good news for foreign investors. Although Prime-Minister Azarov predicts that it would take at least 10 years to develop the production of oil and gas in the Black Sea.

In summery a favourable environment in world markets and more considered approach to government activity in 2011 has assured a slow and slight recovery of the national economy. Any further progress will require substantial political will from those managing the country, professionalism in the government, a genuine fight against corruption and abuse of power together with renewed respect for democratic principles and norms. The economic policy of the government and President still faces numerous risks due to deteriorating living conditions with potential protests, the potential for a new wave of world economic crises and Ukraine’s vulnerability manifest in an unstable and misbalanced national budget.

People First Comment:

Whilst the government should be congratulated for what looks like an economic turn around questions need to be asked as to the real causes of the apparent growth and the cost in social terms. Most certainly the upturn in world demand for commodities such as steel, chemicals and grain has enabled the government to show a large rise in exports but whether this is due to government policy or simply current circumstance is open to debate. Similarly the government’s statistics are rather odd as the growth rate is calculated in comparison with the crisis months and January of this year that includes a minimum two-week celebration of Orthodox Christmas and is therefore an economic anomaly

For economic growth to be sustainable we cannot just consider the figures. It is good that commodity exporting companies are able to cash in on growing world demand but this does not put food on the kitchen table for the majority or put children through school. Whilst export companies are expanding the SME sector seems to be doing exactly the opposite. The number of companies on the tax register has fallen dramatically over the past year. This may be because the tax authorities are being more efficient in prosecuting tax evaders or that they are simply milking the sector to death forcing entrepreneurs into the grey and black economies.

Certainly the tax authorities have become much more assertive in their bid to stamp out evasion and improve collection but some of their methods verge on extortion and human rights violation. Many SME owners are complaining about excessive and illegal demands that have no bearing on the reality of their businesses. One business owner recently reported to People First that the whole attitude of the tax police has changed. “In the past they would call to make an appointment and we would have a reasonable discussion, now they just barge in and make all sorts of demands based on hear say and rumour and sometimes this happens two or three times a month. It really is very short sighted and does nothing to build faith in the system.”

Another unprecedented policy is the writing off of commercial company debts to the State when the company is owned by people close to the authorities: a commercial debt of over $3 billion owed to Naftogaz was simply written off whilst the general public watch interest rates rise with no right off at all. Such policies can only breed public discontent.

Some fight but most just give up and plan their exit from Ukraine. One measure of this is the number of parents now seeking to join their children who are being educated abroad. In the past it was just the children of the middle class and wealthy, now it is whole family units and few will ever come back. In the last year Ukraine has become one of the top five countries in the world where the population is prepared to pack their bags and leave in search of a more equitable and secure future.

Whilst the current policies may ensure success for the commodity exporters and a higher than previous level of revenue collection they are very short term in outlook. Tax collection the world over is an issue for all governments and many systems have been tried and tested. In Georgia for example the tax levels were reduced, corruption was virtually eradicated and the state started to supply real levels of service and as a result State revenue levels have increased by 672% over the past 6 years and the people are happy about it.

But if you pay taxes and see nothing for it then eventually you have to question what you are paying for. Similarly simply increasing the efficiency of the tax collection system in an environment where the banks are not lending is a sure recipe to guarantee that you kill off the SME sector and that is nothing more than a self defeating philosophy in every sense of the word.

Quote of the week:

Every political system is an accumulation of habits, customs, prejudices, and principles that have survived a long process of trial and error and of ceaseless response to changing circumstances. If the system works well on the whole, it is a lucky accident – the luckiest, indeed, that can befall a society.

Edward C. Banfield
American political scientist

Democracy Watch is the weekly monitor of the People First Foundation and serves to raise public awareness of how government and parliamentary action is impacting upon Ukrainian democracy and democratic due process. The information is copyright free and may be reproduced but we ask that any comments are reproduced in full and with reference to the People First Foundation.

The People First Foundation recognise and appreciate the support of Ivan Matieshin in the production of Democracy Watch.

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