Ukraine

1
Ukraines Economic Prospects and Priorities for
Reform

• Martin Raiser, Economic Advisor
• World Bank

2
The Macro-Context Strengths and Risks

• Strong fundamentals (public debt 14 of GDP, low
  fiscal and current account deficits)
• Regionally competitive exchange rate and wages
• Improved transparency in corporate sector
• WTO accession and EU FTA anchors for reform
• Increasing investor interest (FDI up gt 5 of GDP)
• Huge, under-served domestic market finance,
  housing, consumer durables, retail etc.

• Rising inflation
• Growing external imbalances
• Credit boom may hide underlying credit risks
• Limited degree of export diversification and
  vulnerability to terms of trade shock (gas ?
  metals ?)
• Laggard in structural reform and un-tested
  financial regulatory framework
• Political instability and short election cycles
  populist spending promises

3
A Risk Fairly Priced?

• Gradual re-pricing since May 07
• Reflects shift in perceptions of political risks
  after dissolution of parliament
• Now broadly in line with other BB- sovereigns

4
Why Did Macro Performance Hold Up So Well So Far?

• Underutilized capacity what goes down must come
  up (to some extent)
• Luck strong metal price growth offsets gas price
  shock EURO and Ruble strength against the US
  keep real effective exchange rate in check
• Clever budgeting indexation of social payments
  and wages to CPI, but budget revenues grow in
  line with GDP deflator aggregate fiscal impact
  more restrained than appears from the approved
  budget
• But this benign constellation cannot continue
  forever gt signs of strain and imbalances emerging

5
Real effective exchange rate remains under
control for now
6
GDP still driven by steel prices
7
Indexation rules help the budget
8
But rising imbalances, driven by private sector
9
The price of a quasi-peg
10
Medium-term Economic Prospects in the Era of
Globalization

• Two World Views
• De-coupling and European Convergence gt Ukraine
  inevitably will catch-up and fast because
  emerging markets are no longer considered risky
• The Four-Speed World gt only fast reformers in
  emerging markets benefit long-term from
  globalization
• Ukraine can benefit regardless of which view is
  right but only if it reforms

11
The European Convergence Path

• Ukraine can finance 4-6 GDP current account
  deficit
• Ukraines dollar wages (US250 av) roughly in
  balance with relative GDP level
• Medium-term trend is for moderate real exchange
  rate appreciation around 1.75 US wage growth
  for every 1 GDP growth
• Note all competitors appreciating at similar if
  not faster pace!

12
Reform Challenges

• Avoid fiscal populism at this stage in the
  cycle Ukraine should aim for fiscal surpluses
• Improve the Investment Climate and Governance
• Improve the quality of public services (health
  and education)
• Increase public investment in infrastructure
• Reform the legal and judicial system to protect
  property and contract rights

13
Investment climate Governance diagnostics

• Ranked 139th of 175 in Doing Business
• Ranked 73th of 131 in WEF Competitiveness
• Lagging lower middle income av. in rule of law
  and ctrl of corruption

14
Public sector reform and social inclusion
diagnostics

• Public wage bill 10 of GDP (incl in kind) EU
  8.8, CIS 5
• SOE employment 12.5 - EU8 4, CIS 9
• Public investment 2 of GDP EU 5, Asia 8-10
• Little improvement in service quality despite
  high spending
• Poverty is declining but people do not feel their
  lives have improved

15
Economic reform the politicians dilemma

• Not much choice when it comes to economic model
• All three major parties supported basic
  market-oriented policy platform during elections
• WTO and EU integration are strong anchors
• Not much hope for immediate quick wins
• Strong recent growth record may suggest reforms
  are not needed
• Institutional reforms take longer to bear fruit
• Not much public support for the long-haul of
  structural reforms
• Redistribution through re-privatization and
  tighter tax enforcement sounds attractive but
  track record suggests that it may not work

16
Reforms and Performance During Transition
Ukraine may still be at point A
Growth path 2
Income level
Growth path 1
B
The growth impact of reform
A
t
17
The Expectations of the Population

• EBRD/World Bank Life in Transition Survey
• 42 market economy preferable, 33 planned
  economy preferable
• Only 15 economic situation better than 1989 (CIS
  30, EU8 26)
• 80 think state should guarantee employment and
  low prices (CIS 80, EU8 65)
• 38 dissatisfied with health services (CIS 32,
  EU8 25)
• Close to 50 completely distrust political
  institutions (CIS 25, EU 30)
• People expect state to take social responsibility
  but have little trust that it will

18
Economic reform strategy

• Focus attention on a few selected issues
• Use interests of large domestic capital to build
  reform coalition -gt access to finance markets
  requires improved governance and business climate
• Focus on public service delivery to build support
  for economic reform in the population
• Try to avoid politicizing reform remember
  there are no alternative economic models

19
Prioritizing Reforms World Bank proposals

• Quick Wins
• Enact a new Law on State Procurement (opposition
  to reform is small losses to the budget are
  huge)
• Pass the Joint Stock Company law (key signal to
  investors)
• Adopt a realistic 2008 budget (avoid
  macro-overheating and adjust peoples
  expectations while going is good)
• Opportunities
• Use FTA negotiations to push deregulation agenda
• EURO 2012 as an opportunity to renew government
  infrastructure investment
• Strengthen financial market regulators while
  markets are benign (dont wait until they are
  tested by investors)

20
Prioritizing Reforms Long Term Economic and
Social Reform Challenges

• Reduce tax burden and reform tax administration
  gt new tax code, but existing drafts need more
  work!
• Push ahead with pension reform
• Reform financing of social services as a key to
  improve quality
• Continue raising energy tariffs to full cost
  recovery levels
• Re-launch privatization competitively and
  transparently
• Reform the land market start with auctioning
  urban real estate competitively
• Reform public administration and the judiciary

21
What it all adds up to WB Base Case (Oct 07)

• ToT weakening in 2008-2010 lower growth and
  larger external deficits
• As revenue growth declines, fiscal policy will
  tighten to prevent widening deficits
• Ukraine retains access to international capital
  markets and investment-led growth continues (at
  somewhat lower rates)
• Reforms will continue at gradual, sometimes
  inconsistent pace faster growth in 09-10 if
  reforms accelerate
• Quarterly updates on www.worldbank.org.ua

22
WB Base Case