Why Ukraine must act now to implement an anti-crisis plan

The current global economic crisis is unprecedented and the recovery is likely to be slower than many had hoped.  For Ukraine, the crisis has hit at a difficult time, politically, as the country looks towards presidential elections. Yet, the country cannot wait to tackle the crisis until a clear political mandate emerges from the polls. It needs to find enough compromise to take a comprehensive set of measures to withstand the crisis and enable recovery. The next session of parliament starting April 13 offers the opportunity to take one step in that direction. It should not be squandered.   

In October 2008, Ukraine was among the first countries to correctly seek and rapidly receive large scale financial assistance, from the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development as well as scaled up technical assistance from a range of bilateral donors. Since then, some positive steps have been taken, but a lot remains to be done to implement a coherent package to deal with the crisis. At the outset, it is important to get expectations right: Ukraine is likely to suffer a deep recession. Given external imbalances and the lack of access to capital markets muddling through is not a viable strategy.

An anti-crisis action plan for Ukraine needs to contain four key elements: (i) adequate and continued implementation of macroeconomic policies under the program supported by the IMF, (ii) the re-orientation of budget spending towards growth enhancing investments in public infrastructure to support the real sector and employment, coupled with efforts to mobilize  resources for the protection of the poor and vulnerable, (iii) a clear strategy to protect depositors and rehabilitate the banking sector, and (iv) reforms to enable business entry and attract private investment. All these elements are closely inter-linked and are mutually reinforcing. Effective implementation of these elements will require the Government, the Presidency, and the National Bank of Ukraine to work closely together, and it will require support in parliament. Taking decisive first steps in these areas will help stabilize market expectations, ensure continued assistance from the International Financial Institutions and mobilize additional support from bilateral creditors.  With the IMF mission returning to Kyiv there are now good prospects for progress on the first dimension. Below, we outline the key challenges in the other three areas that would complement and support prudent macroeconomic policies and are at the core of the World Bank’s dialogue with the authorities.

On the fiscal side, Ukraine shares with many other emerging markets the predicament of the absence of financing to close a large fiscal gap.  Based on World Bank assumptions for growth, inflation and resulting tax revenues, we believe the underlying fiscal deficit in the 2009 budget is significantly larger than the 3% of GDP assumed in the budget law,  without counting the costs of bank recapitalization. Measures adopted by parliament on March 31 contribute to closing this gap by some 0.6% of GDP. Additional measures to be considered by parliament, in particular to address the growing imbalance in the pension fund, could add another 0.3%. These steps would signal Ukraine’s willingness to tackle its fiscal problems and could unlock external financing. More fiscal measures may be needed and in our view there is significant scope in Ukraine’s budget to reduce non-targeted spending and wasteful subsidies and tax exemptions to inefficient producers and wealthy consumers. But at this stage doing something is what counts. Parliament should support the proposed additional measures.

In the banking sector, the diagnostics for the largest banks have revealed significant capital shortfalls. Encouragingly, many private shareholders, including western banks have already started to recapitalize their banks. For systemically important banks whose shareholders are unwilling or unable to recapitalize, the state has a role to play. The process by which the government would acquire control in these banks, ensure deposits are safe and tax payers’ money is spent prudently is now being elaborated. Its implementation will require consistent collaboration between NBU and the Government and its success will depend on careful design and communication to the public. At the same time, insolvent banks that are not eligible for recapitalization need to be intervened fast to prevent the loss of confidence and the risk of contagion for the rest of the system. To do this job, NBU requires a larger arsenal of resolution tools that would allow depositors and good assets to be transferred to viable banks whilst carving out bad assets for subsequent liquidation, and existing shareholders to be written down in accordance with current capital valuations. To be able to do this, the legislation needs to be amended – this should be urgently considered by parliament.

 Finally, the re-launching of structural reforms is critical for Ukraine to come out of this crisis in a robust and competitive position. Ukraine can no longer rely on cheap money to finance the modernization of its old industrial sector. Many projects that were viable before the crisis may no longer be so after it. Thus Ukraine will need to go through a period of accelerated structural change. For this it needs to lower barriers for businesses to enter and exit, so that existing resources can be reallocated. Ukraine will need to set appropriate incentives for business to innovate and modernize through a predictable tax and regulatory system, through appropriate pricing policies for energy and other public services and resist the temptation to slow structural change through subsidies and tax breaks. And – as importantly – Ukraine will need to modernize its public services to become more efficient and to deliver better quality. The structural reform agenda is long. However, in the short-run, a few critical pieces of legislation could go a long way to set the stage for an early recovery. Legislation now before parliament would reduce the number of permits and lower minimum capital requirements for private businesses. The government has also prepared a new law on public procurement that signals Ukraine’s commitment to international standards of competition, whilst saving the state large amounts of money. This legislation should be adopted.

 The international crisis has exposed the risks inherent in the growth model Ukraine followed during the boom years, as in many other countries in the region.  Ukraine deserves international assistance to cope with the huge shocks that have unhinged this growth model. But to benefit from such assistance and emerge from the crisis with its economy poised for a return to sustained growth, Ukraine needs to accept and to tackle its own problems and shortcomings. There is no time to wait.