September 2020, Vol. 247, No. 9


Part 2: Background of the Ukraine’s Mega-Challenges

By Gordon Feller, Eurasia Correspondent

Editor’s note: This is the second of two articles on  Ukraine’s $260 million effort to upgrade and expand its gas transmission networks focuses on stability and growth within the country as a whole and its relationship to the pricing of natural gas.

Since 2014, Ukraine has undertaken considerable reforms to reinforce macroeconomic stability and bolster the foundations of growth. After a significant contraction in 2014-2015, economic growth has picked up (2.4% in 2016-2017, 3.5% in 2018-2019). However, higher sustained economic growth is needed to deliver a durable improvement in living standards. 

While moderate poverty declined to 16.8% in 2018 from a peak of 27% during the crisis in 2015, it remains above the pre-crisis level (14.1% in 2013). The Ukrainian economy continues to be driven by domestic consumption and agriculture. The export structure remains concentrated in basic commodities rather than higher value-added products integrated with global value chains.

Investment and productivity have yet to rise to levels needed to support strong and sustained economic growth (fixed investment remained at 17% of GDP in 2018, while FDI remained at 2%).  

Key structural reforms in the social and energy sectors have helped reduce current expenditures and public debt. During the crisis of 2014-2015, fiscal adjustment was accomplished through the energy tariff reform to close the quasi-fiscal deficit and a nominal freeze on wages, pensions and social assistance despite high inflation.  

As a result, the overall fiscal deficit was reduced from 10% of GDP in 2014 to 2.3% in 2016. The reform of energy pricing, primarily for natural gas, was the most important contributor to the reduction of public expenditures between 2014 and 2016.   

From 2016 onward, significant further reforms were implemented in the social sectors (pensions, housing utility subsidies and health). The goal was to promote fiscal sustainability. As a result, spending on social benefits declined from 16.3% of GDP in 2016 to 14.8% in 2019.  

On the revenue side, performance has improved modestly with the economic recovery. Tax revenues increased from 33% GDP in 2016 to 34.4% in 2019.  Overall, the fiscal deficit was maintained at about 2% GDP in the last three years, with a primary surplus of 1.2% GDP in 2018. Public and publicly guaranteed debt declined from 81% in 2016 to an estimated 51% in 2019. 

The political transition in 2019 has provided the new Ukrainian authorities an unprecedented mandate and opportunity to address the obstacles to economic growth and advance major economic reforms. President  Zelensky was elected in April 2019 with a large majority of the vote. Subsequently, the President’s Servant of the People party won a majority of seats in the July 2019 parliamentary election.  

The new Government, which took office in August 2019, presented its five-year program to Parliament in October, setting ambitious aspirational goals for the next five years, in particular with regard to GDP growth acceleration, attraction of foreign direct investment (FDI), development of infrastructure, job creation, poverty reduction and improvement in public services.  

The program also outlines key reform priorities, including opening the agricultural land market, de-monopolization by unbundling the two largest state-owned monopolies, Naftogaz and Ukrainian Railways, and making further progress in strengthening nascent anticorruption institutions. 

In the short term, growth is expected to remain robust at around 3.6% on average by 2021, but with significant economic, fiscal and social fragility. Political uncertainty and vested interests undermine the reform agenda and the investment process.  

The fiscal deficit has been maintained at under 2.5% of GDP for four years in a row (2016-2019), while public current expenditures have declined from 46% of GDP in 2013 to an estimated 37% in 2019. At the same time, Ukraine faces sizable debt repayments in 2020-2021, with about 8% of GDP ($11 billion) per year needed to repay public debt and finance the fiscal deficit.  

The authorities plan to finance about 40% of this from external sources (horizon of five years or more), with the rest raised domestically (with maturity up to two years). To raise the necessary external financing at affordable terms and exit the cycle of rolling over public debt during the next three years, it will be important to deliver on the pending reform agenda, maintain prudent macro-economic management and secure financing from international development partners.  

Further ambitious structural reforms will be critical to achieving sustained higher growth. With powerful vested interests standing in the way of reforms, building a coalition among reformers in government, Ukrainian civil society and international development partners around key reforms has been critical to their progress. Financing and technical support from the World Bank occurs in close coordination with the IMF, EU, U.S. Treasury, USAID, the U.K. and other bilateral partners. 

Lack of competition and weak institutional governance have been identified as major impediments to investment, productivity and growth by the “Ukraine Growth Study,” which was completed in 2019, a World Bank report said. An anticompetitive environment in key sectors distorts markets and serves as a barrier to entry and investment.  

 It can also facilitate state capture by oligarchs and high levels of corruption, further undermining investor confidence. In this context, the promotion of institutional reforms, transparency and competition in infrastructure sectors with a large footprint of state-owned enterprises (energy and transport) can help promote investment and efficiency in important parts of the economy.  

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