Ukraine: between ambitious plans and the harsh reality

The Ukrainian government has presented a strategy of economic development for the next five years, which assumes rapid GDP growth. However, if this plan is successfully implemented, then a significant part of state revenues will go to foreign creditors, as a kind of “penalty for development”.
Ukraine: between ambitious plans and the harsh reality

Kiev, Ukraine (©Dave Collier, CC BY-SA 2.0)

The key objectives of the new development strategy, presented at the beginning of October 2019 by the Ukrainian government, include expanding Ukraine’s GDP by 40 per cent, creating one million of new jobs, and attracting USD50bn in new foreign direct investments (FDIs).

The government’s plans include a revolutionary expansion of the transport infrastructure, the repair of 24,000 kilometers of Ukrainian roads, active development of railways, and the construction of five deep-water ports and 15 airports.

According to the official declarations, soon, “every Ukrainian citizen will be guaranteed a subsistence level income, the environmental pollution will be reduced by at least 20 per cent, and the negative demographic trends will be reversed as a result of which the number of newly born citizens and those returning to the country will exceed the number of those who are dying and going abroad,” said the Prime Minister of Ukraine Oleksiy Honcharuk.

Plan to increase GDP by 40 per cent in 5 years

According to the Finance Minister Oksana Markarova, achieving 40 per cent GDP growth in five years is a realistic target. “That’s growth of 7 per cent annually over the next five years — an objective that is difficult, but achievable if we liberalize the agricultural land market and carry out privatization,” commented Ms. Markarova.

Other factors that are supposed to contribute to rapid economic growth include positive changes in the investment climate and the influx of new investments. However, the Ukrainian authorities very frequently use the term “investments” when referring to money spent on the purchase of government bonds, which ultimately constitute new debts incurred by the government. This means that in reality, we are not talking about stable economic growth based on strong foundations, but about the inflow of cash from the sale of the remaining state-owned property and about new loans incurred by the government, which will eventually have to be repaid.

“The growth of Ukraine’s real GDP by 40 per cent in five years is theoretically possible, but in reality it would require an economic miracle,” said Maria Repko from the Kiev-based Centre for Economic Strategy. According to the analyst Evgenia Akhtyrko, such growth cannot be achieved on the basis of the existing assets. She believes that Ukraine would need an avalanche of new economic projects with high rates of return and high added value.

Analysts are less optimistic

The declared target of 40 per cent GDP growth is contradicted by the macroeconomic forecast for the next three years. According to that projection, GDP growth will reach 17.8 per cent in the optimistic scenario and 12 per cent in the pessimistic scenario.

Ukraine’s economic performance in recent years is not encouraging either. Experts are pointing out that the last time when Ukraine’s GDP grew by more than 5 per cent y/y, was in 2011. Back then, however, the country was not involved in a war, and the economy was in much better condition than it is right now. Moreover, the economy was getting an additional boost associated with the investments related to the preparations for the Euro 2012 football tournament.

The Ukrainian analysts are also skeptical about Ukraine’s ability to attract USD50bn in investment and point out, that in recent years the country only managed to bring in USD2.5bn in FDIs annually. Additionally, this was mostly investment in the financial sector, rather than non-financial ones.

It is also unclear whether it would be possible to create the promised one million new jobs. On the one hand, there are approximately 300 thousand registered unemployed people, and employers are already complaining about the shortage of available workers. On the other hand, the creation of that many jobs would require huge investments in the manufacturing sector. There is a big question mark hanging over both sides of this equation.

“It is not clear how such figures are to be achieved. It would be good if the government provided an economic model to back up these objectives. At the moment it is not clear where the government wants to find the 15-20 growth stimulators enabling such a rate of growth in our economy, which is currently oriented on the exports of raw materials,” commented the economist Alexey Kushch.

Lack of funding is inhibiting growth

Vladimir Dubrovsky from CASE Ukraine believes that the assumptions presented by the government are merely a collection of political slogans and have no practical application. There are no clear deadlines or principles that the government will follow in order to achieve its goals. The economist notes that despite previous declarations, the presented program does not include any ground-breaking reforms aside from the liberalization of the agricultural land market.

It is not clear in what way and using what measures the government wants to achieve the parameters indicated in the program. Previous practice shows that if GDP is to grow by a certain value in a given year, then it is necessary to attract a corresponding amount of investments. For example, if we want to achieve GDP growth of 6-7 per cent, then we need USD6-7bn in FDIs every year.

Meanwhile, in the past year the value of FDIs was approximately USD2bn. If we expect an impetus for growth from the agricultural land market, then we should keep in mind that the legislation on the land market is scheduled to enter into force in October 2020. “This means that it will not have any impact this year and that the initial effects will only be felt in 2021,” said the economist Andriy Novak.

The abandoned development plan of President Poroshenko

It’s questionable whether the government’s program could be successfully implemented, especially if we compare the previous development plans with the economic results actually achieved by Ukraine. In 2015 the then-President Petro Poroshenko announced a plan for the complete reconstruction of Ukraine’s economy, known as the “Ukraine 2020 Sustainable Development Strategy”.

The plan assumed that by 2020 Ukraine would move up from 96th place to a spot within the top thirty in the World Bank’s “Doing Business” ranking; that Ukraine’s credit rating according to the Standard & Poor’s scale would improve from CCC to BBB; that Ukraine would move up from 84th place to a position within the top forty in The Global Competitiveness Index; that GDP per capita would increase to USD16,000; that the maximum budget deficit would fall from 10.1 per cent to 3 per cent of GDP; and that the total debt of the state would decrease from 67.7 per cent to 60 per cent of GDP. Foreign direct investments were supposed to increase by a total of USD40bn in the years 2015-2020. Ukraine was also supposed to move up from 144th place, occupied at the time, to the top fifty of the classified countries in Transparency International’s Corruption Perceptions Index.

Since then, Ukraine has managed to slightly improve its credit rating — its long-term rating is B- and its short-term rating is B, and to reduce the budget deficit. Direct debt and state-guaranteed debt is still above 60 per cent of GDP, in September 2019 approached the level of 67 per cent of GDP. In 2018, nominal GDP per capita was only USD3,100, which is over five times less than previously planned.

The Ukrainian economy is not competitive

In 2018, Ukraine improved its position in the Doing Business ranking, moving from the 71st to 64th place. Progress has been made in areas such as the protection of minority shareholders’ rights, dealing with construction permits, getting a connection to the electric grid, trading across borders, and the registration of property.

At the same time the World Bank has lowered its assessment of the Ukrainian tax system and the ability of companies to enforce debt (in the case of the latter indicator Ukraine ranks the 146th among 190 countries included in the ranking). And even though it has moved up by 48 spots since 2014, it is still very far away from the previously planned place among the top thirty countries.

In the Global Competitiveness Index Ukraine currently occupies a distant 83rd place, and has only managed to move up one spot during the past five years, instead of the planned jump of more than 40 places.

Meanwhile, in the latest Corruption Perception Index prepared by Transparency International Ukraine was ranked at a distant 120th place, tying with Liberia, Mali and Malawi. The only country in the Central and East Europe with a lower score than Ukraine was Russia.

Penalty for development

However, even if Ukraine actually manages to implement the recently presented development plan, then it will receive a kind of “penalty for growth”. In 2015, the Ukrainian government reached an agreement with foreign creditors concerning debt restructuring. In accordance with this agreement the Ukrainian authorities undertook to pay to the creditors a certain share of the country’s GDP. In the case of GDP growth in the range of 3-4 per cent per year, the payments will amount to 15 per cent of the surplus growth over 3 per cent, and for GDP growth higher than 4 per cent per year the payments will amount to 40 per cent of the surplus value. In the case of GDP growth of less than 3 per cent per year the country will not have to pay any “penalty for development”.

According to the World Bank, in 2018, Ukraine’s GDP exceeded the base level of USD125.4bn, which served as the threshold triggering these provisions. This means that in the case of any large-scale privatization effort, Ukraine will simply be giving away state-owned assets for free, as a large part of the revenues obtained from such sales will have to be paid out to the creditors.

If we were to compare the obligations resulting from the aforementioned agreement with the World Bank’s estimates concerning the projected GDP growth of 2 per cent, then in the event of sales of state-owned agricultural land — seen by the government as one of the pillars of growth — millions of hectares of Ukrainian “chernozem” soils would be given away for next to nothing, because most of the revenues would go to the creditors.

In this situation, in the long run it could be more profitable for Ukraine to simply lease out the state-owned enterprises and to effectively implement a moratorium on the sales of state-owned property until the expiration of the 2015 agreement with the creditors.

The Ukrainian government does see the necessity of paying a “penalty for growth” as a problem. “Fearing economic growth, because it would mean that we have to honor our commitments, is an inadequate approach. Our aim should be to grow at such a fast rate, so that the repayment of obligations towards our international partners is no longer a problem,” stated Prime Minister Oleksiy Honcharuk in reference to the objections raised by the economists.

Kiev, Ukraine (©Dave Collier, CC BY-SA 2.0)

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