Ti­mothy Ash: A macroe­co­nomic look at Ukraine’s fi­nan­cial sys­tem

Kyiv Post Legal Quarterly - - Contents - By Ti­mothy Ash


a start­ing point, a plus is that the econ­omy is grow­ing, with sec­ond quar­ter real gross do­mes­tic prod­uct growth re­vised up to 3.8 per­cent year-over-year, from 3.1 per­cent in the first quar­ter, and from full year growth of around 2.5 per­cent for 2017. With some pre-elec­tion pump prim­ing ex­pected, the In­ter­na­tional Mone­tary Fund and World Bank fore­casts for full year growth of around 3.5 per­cent in 2018 don’t look that un­re­al­is­tic.


The real GDP growth of around 3.5 per­cent is fair but hardly stel­lar, and given the low Ukrainian base and cheap hryv­nia, and com­pared with some of its peers in emerg­ing Europe it is per­haps a lit­tle dis­ap­point­ing.

Ukraine therein comes in the mid­dle of the pack. Ex­pla­na­tions might lie with the drag of Rus­sia's con­tin­ued war in east­ern Ukraine, but also slow progress still in rein­ing in cor­rup­tion, which makes for a chal­leng­ing, al­beit

im­prov­ing busi­ness en­vi­ron­ment, with for­eign and do­mes­tic in­vest­ment con­tin­u­ing to lag. Per­haps we can also add in the loss of growth po­ten­tial from the con­tin­ued still large out-mi­gra­tion of young, skilled Ukraini­ans — pre­dom­i­nantly to Europe (over 1 mil­lion in Poland) and ask why so many still chose to mi­grate, and per­haps therein the link is back to cor­rup­tion, and slow progress in chang­ing how busi­ness is done in Ukraine.

De­layed IMF

Growth is also be­ing held back by the now long de­lay in get­ting the IMF pro­gram back on track. This has stalled the in­flow of much needed IMF and other of­fi­cial cred­its — per­haps to the tune of $6–7 bil­lion (4–5 per­cent of GDP). Cap­i­tal in­flows have been lim­ited, and ar­guably en­sur­ing greater de­pre­ci­a­tion pres­sure on the hryv­nia, and higher Na­tional Bank of Ukraine and mar­ket pol­icy rates as a re­sult. This has ul­ti­mately fed back into lim­it­ing real GDP growth and rais­ing the price of credit to the econ­omy.

But the long de­lay in get­ting IMF and of­fi­cial fi­nanc­ing back on track also cre­ates a missed op­por­tu­nity for be­ing able to sell Ukraine as a re­form suc­cess story to in­vestors. In­stead, Ukraine ap­pears in the head­lines for the wrong rea­sons — de­lays with the IMF.

In­fla­tion has sur­prised on the up­side. Af­ter hit­ting sin­gle dig­its in 2016, the con­sumer price in­dex pushed back into the mid-teens in 2017. But a com­mend­ably or­tho­dox and tight mone­tary stance from the cen­tral bank has at least brought some light on the in­fla­tion front with the con­sumer price in­dex drop­ping to just 8.9 per­cent in Au­gust.

Fu­ture trends in in­fla­tion will likely be de­ter­mined again by whether the gov­ern­ment can se­cure the re­sump­tion of IMF lend­ing. Sea­son­al­ity and a ten­dency for for­eign ex­change de­mand to pick up through elec­tions, plus emerg­ing mar­ket for­eign ex­change weak­ness, might see more weak­en­ing pres­sure over the near term — which could be stemmed by a con­fi­dence boost from the re­lease of IMF and re­lated cred­its.

Fis­cal per­for­mance has shown some im­prove­ment over the course of the year. In­deed, at one point the deficit had seemed set to ex­ceed the IMF’S tar­get of 2.5 per­cent of GDP by as much as 1 per­cent of GDP. But per­haps due to im­proved GDP growth, rev­enues have bucked up, while the Fi­nance Min­istry seems to have reined in bud­get spend­ing.

De­lays in pri­va­ti­za­tion, re­duced Na­tional Bank of Ukraine profit trans­fers, and also lim­ited mar­ket ac­cess, again be­cause of stalled IMF lend­ing, have strained the min­istry’s cash bal­ance and forced a more pru­dent fis­cal stance than would oth­er­wise per­haps have been main­tained. But the Fi­nance Min­istry’s trea­sury cash bal­ance is not much above Hr 20 bil­lion at present, and that just does not seem enough to en­able cov­er­age of the weight of debt ser­vice now loom­ing — with­out the se­cu­rity of cheap IMF fund­ing and then also the cheaper mar­ket ac­cess that that would fa­cil­i­tate.

One sil­ver lin­ing from the large num­bers of Ukraini­ans now work­ing over­seas is that re­mit­tances have con­tin­ued to in­crease. So much so that the NBU has re­vised es­ti­mates for re­mit­tance flows up by sev­eral bil­lion dol­lars per year for the pe­riod since 2015 and to over $9 bil­lion in 2017, and likely some­thing sim­i­lar, or higher, for 2018.

The stock of pub­lic sec­tor debt has flat­lined around $75 bil­lion for the past year, and with real for­eign ex­change ap­pre­ci­a­tion, the ra­tio of pub­lic sec­tor debt to GDP has fallen much more rapidly than had been as­sumed by the IMF and oth­ers, to around 63 per­cent, from a peak of over 90 per­cent in 2015. The ra­tio of gross ex­ter­nal debt to GDP has also fallen be­low 100 per­cent for the first time in years. Im­prove­ments in both ra­tios sug­gest re­duced vul­ner­a­bil­ity in the con­text of a chal­leng­ing en­vi­ron­ment around emerg­ing mar­kets as global fi­nanc­ing con­di­tions tighten.

But vul­ner­a­bil­ity re­mains and the an­swer is to bol­ster for­eign ex­change re­serves by kick­start­ing IMF lend­ing, which would then help gain mar­ket ac­cess — specif­i­cally now the long-de­layed Eu­robond mar­ket ac­cess.

It is prob­a­bly fairly clear that while there have been mean­ing­ful im­prove­ments in the macroe­co­nomic per­for­mance of the Ukrainian econ­omy over the past year, per­for­mance could be much bet­ter, and vul­ner­a­bil­i­ties re­main.

And therein now so much rests on Ukraine man­ag­ing to get IMF lend­ing back on track.

In­deed, it seems key to en­sur­ing Ukraine can se­curely fi­nance it­self through elec­tions, and hence that the hryv­nia and in­fla­tion re­main well-an­chored.

In­deed, some of the huge re­form achieve­ments made since 2014 could so eas­ily now un­wind if the right de­ci­sions are not now taken.

And those that ar­gue that Ukraine has al­ter­na­tives to IMF fi­nanc­ing are sim­ply not be­ing re­al­is­tic. With stresses around Ar­gentina, Brazil, In­dia, Rus­sia, South Africa, et al.— they are be­ing out­right cava­lier in ap­proach.

There are some real pos­i­tive signs of macroe­co­nomic im­prove­ment, let’s hope these are not put at risk now by pop­ulist choices in the run-up to elec­tions.

Why do so many young, skilled Ukraini­ans go abroad? Cor­rup­tion and slow progress in chang­ing how busi­ness is done in Ukraine ap­pear to be the cul­prits.


Prime Min­is­ter Volodymyr Groys­man (R) wel­comes the In­ter­na­tional Mone­tary Fund's Ron van Rooden dur­ing their meet­ing on Feb. 2 in Kyiv.

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