The Tymoshenko government’s policy leads to a worsening of the economic situation!

Facts

The State Statistics Committee published data on the economic growth over January – April of 2008. The cumulative growth rates of GDP continue to lag behind last year’s indices. For 4 months of 2008 real GDP has risen by 6.2% relatively to the same period of the previous year. The GDP growth over the same period over the past year was 7.9%.

Notwithstanding maintenance of relatively high dynamics of the economic growth, its quality raises questions. High inflation and lack of structural reforms, which should be initiated by the coalition and government, undermine future prospects for the growth.

In May several authoritative international organizations warned the government about increasing macroeconomic imbalances. Fitch international rating agency deteriorated a prognosis of Ukraine’s ratings from “positive” to “stable”.

The IMF published a regular half-year review “Prospects for development of regional economy: Europe”. In report – for a period of 2008 - 2009 – Ukraine’s macroeconomic prognosis was considerably worsened.

Comments

Key factors of the GDP growth in January – April of 2008:

A rise in cumulative total tax receipts. Over January-April of 2008 an increase amounted 9.7% year-to-year. It was achieved through (a) extending import tax receipts (VAT, excises, import duty) and (b) abolishing bill of exchange VAT on import.

An increase in value added in trade, which is boosted by internal consumer demand given steep acceleration of people’s income growth (+46.8% over the first quarter of 2008).

The leveling of value added growth dynamics in the manufacturing industry in April after a slowdown in March of 2008.

Factors of the economic growth are unstable:

In the future months a reduction of trade contribution to GDP is likely to occur if the Tymoshenko government imposes planned restrictions on mark-ups of distribution networks.

A decrease in tax contribution to GDP is expected. Since May 16, 2008 the lowered rates of import duties have become valid in Ukraine following the actual entry into the WTO. A reduction of import tax receipts is expected in the future months. It is impossible to compensate them by increasing internal taxes.
Owing to amplified attempts of manual regulation of prices for agricultural products, the agricultural producers could not take advantage of the opportunity of growing prices on world markets and prospects of good harvest in 2008. The contribution of agriculture to the economic growth will remain slight.

A negative signal is continuing reduction of value added in building. By 4 months’ results value added in building diminished by 2.7%. The growth dynamics in building reveal the oppression of investment activity as a factor of long-term economic growth. According to the State Statistics Committee data, over the first quarter of 2008 investment growth in fixed assets fell to 10.4% (comparing to 32.2% over the same period in 2007). A slowdown in investment dynamics is accounted for a number of factors:

Businessmen’s expectations are worsening. According to the National Bank of Ukraine data, an estimate of prospects of the economic situation for the next 12 months deteriorated from (-17.1%) in the 4th quarter of 2007 to (-25.1%) in the 1st quarter of 2008.

The privatization prospects are uncertain under conditions of political instability. The ownership revision (Dniproenergo) and non-fulfillment of contract obligations (Vanco) raises risks of investing in Ukraine.

The cost of investments is growing because the NBU toughened the monetary policy and raised interest rates.

Prices on house building market are “overheated”, and the market itself pending their decline following a curtailment of mortgage crediting by commercial banks.

Thus, the factors of the economic growth in short-term perspective are unstable and their embodiment generates negative effects such as aggravating structural imbalances. The GDP growth is ensured by trade and taxes on imported commodities, which will flood Ukraine in reply to consumer demand warmed-up by wages and social payments. A negative signal is continuing slump in value added in building and general slowdown in investment dynamics.

Risks of development in short-term period are being amplified in the light of increasing inflation and the authorities’ inability to initiate reforms necessary for maintaining steady growth dynamics. According to Fitch press-release, worsening of prognosis for Ukraine’s ratings is attributed to:

Aggravating macroeconomic risks, primarily, on the part of inflation (30.2% measured on the annual basis, April, 2008) and growing deficit of the current transactions account (7.5% of GDP, the 2008 prognosis).

Uncertain measures within a framework of the budget and tax policy and the monetary and credit policy taken by the authorities (by the government and NBU) for minimization of the indicated risks.

Fitch bluntly states about lack of clear-cut anti-inflationary strategy from the authorities’ part, which “would help to avoid the risk of high level of inflation being retained in the Ukrainian economy and would be a positive factor for ratings”. In particular:

The budgetary policy maintains an expansionist focus. The government does not show its resoluteness to reduce the 2008 budget deficit. Appropriate amendments to the law on budget remain unapproved. An expected budget deficit will exceed 1% of GDP.

The NBU conducts poor explanatory work on the prospects of the currency policy. Hryvnia revaluation on cash and inter-bank markets falls short of prognosis figures of the monetary policy for 2008. Given that economic agents do not comprehend the mechanism used for currency formation, such policy diminishes current anti-inflationary effect of hryvnia reinforcement.

The IMF experts says about a possible pessimistic scenario of Ukraine’s economic development. According to the Fund’s estimations, Ukraine’s economic growth rate will slow down from 7.6% in 2007 to 4.2% in 2009. It is one of the worst scenarios of growth for the developing countries on the European continent (after Croatia). Given a steep slowdown in the growth rates, the IMF warns about would-be “hard landing” of the Ukrainian economy, which is usually connected with overheated demand and accompanied with ailing consequences such as increasing inflation, strengthening of the real exchange rate, loss in world competitiveness, setback in production and the necessity of steep cut in budget spending.

As the IMF experts say, consequences for the Ukrainian economy could turn out to be much worse due to the authorities’ inability to initiate and implement necessary structural reforms.
Worsening of prognoses for development by independent international experts is a clear signal for the government about the existence of considerable risks of further deterioration of the macroeconomic situation in Ukraine.