Imports: the measuring stick of the li ving standard

Export dynamics last year were very low: 6.7 percent. In all the years of independence they were lower only in 1995 (2.6 percent). The other years were marked by more dynamic growth or decline. Export dynamics decreased mostly during the period before the one- time boosting of the hryvnia by 2.7 percent. The commodity balance deficit and the attendant drop in the current account surplus from 6.8 to 2.2 billion dollars were more than compensated by the hard currency influx stemming from the increase in the financial account surplus (up to 8 billion compared to the 4 million dollar deficit in 2004). At the same time, there was logic to the stabilization of the exchange rate at UAH 5.05/USD 1.00 after April 21. In other words, the monthly balance of commodities and services had a deficit beginning in June.

Therefore, export problems should not be attributed to the National Bank’s inadequate level of exchange protectionism. They are rooted in the fluctuations of world trade dynamics as well as internal circumstances. For this reason one should consider the hypothesis circulating in government circles and among independent experts that the decrease in last year’s export indicator was partly caused by the counteraction of the tax authorities, who targeted attempts to make false claims to obtain VAT refunds. In 2004 this artificially raised real export indices.

However, last year, just like in 2003-2004, exports increased faster than the GDP, industry, and investments. But in 2005 domestic demand, not external, was the main stimulus of economic growth. Whereas in 2004, for example, the GDP rose by 12.1 percent and exports by 37 percent - i.e., 25.1 percent faster — in 2005 exports rose faster than the GDP by a mere 4.3 percent. In contrast, nominal per capita income went up by 38 percent in 2005, i.e., 31.3 percent faster than exports. In 2004, exports rose 15 percent faster than nominal income (37 percent compared to 22 percent). At the same time, the role of such a domestic demand component as investments was noticeably smaller in the structure of growth factors. In 2004 fixed capital investments increased by 28 percent and in the first nine months by 3.4 percent.

Machine building and metallurgy have made the largest contribution to the slowdown in exports. Whereas in 2004 exports of machines, equipment, vehicles, and instruments were the most dynamic among all commodity groups (+55.6 percent), last year the dynamics were negative (-18 percent). The reasons for the depressions in machine-building exports should be sought in both the problems within the industry and the drop in external demand on the main markets, especially in the countries that recently joined the EU. But the point is not only reduced demand but also the worsening of the overall situation in the industry, which is holding back the possibilities to increase the demand for its products. The export potential for machine building is under certain pressure from challenges that are typical of the industry: rising metal prices, increasing transportation and energy supply costs, and labor productivity, which is lagging behind wages.

Machine building is badly in need of both domestic and foreign investments. Since the start of the year foreign investments have increased by a mere 2.3 percent (less than the total amount in Ukraine: 2.7 percent); domestic investments in fixed capital have dropped by 6.1 percent, although in 2004 they were up by 20.4 percent. This decline in investment activity corresponds to export reductions. The cancellation of benefits in this sector, especially in the auto industry, has also had an effect on the export potential.

Metallurgy has increased its exports by only 1 billion compared to 4.5 billion dollars in 2004. The reason is not only the standstill in world prices. This industry has worn-out assets that must be modernized. In addition, metallurgy was overheated in 2004, and 2005 saw the beginning of a sales crisis. Overproduction became especially noticeable in the middle of the second quarter. Leading enterprises launched reconstruction, which had an effect on the industry’s supply potential on both domestic and foreign markets. As a result, the industry finished 2005 in a state of recession, with output dropping by 1.5 percent between January and December. In terms of comparable prices, metal exports were negative in 2005; this reflected the industry’s critical condition and affected the coke byproduct industry (-13.4 percent) which is closely connected with foreign and domestic market demand for metals.

Construction was one of two industries that registered a decline in the production of gross value added. As with machine building, this investment-generating industry passed into a mode of initial overcooling in connection with a decline in investment activity.

The process of slowing down foreign demand has been underway in Europe for the past two years, and it can be only partially explained by the hryvnia exchange rate rising with regard to the euro. In 2004, nominal devaluation amounted to 8.3 percent, and in 2005 it was replaced by revaluation: 17.26 percent. However, in both cases the decline of Europe’s export ratio was on a close level: 3.4 percent. Therefore, these processes were influenced to a greater extent by weakening foreign demand in this region in connection with the depressed economic situation and drop in demand, including for Ukrainian machine-building products.

This is confirmed by the fact that the revaluation of the hryvnia to the ruble by 8.25 percent, compared to 5.62 percent in 2004, did not prevent the increase of Russia’s share in Ukrainian exports in 2005. Therefore, the braking impact of the rising price of exports in this region gave way to a factor of increasing foreign demand in connection with the economic growth rate that proved considerably higher than in Europe. At the same time, it should be acknowledged that the expansion of exports to this region was to some extent facilitated by the revaluation of the hryvnia, which was two times lower to the ruble than to the euro (8.25 percent vs. 17.26 percent).

Another fundamental factor that influenced the formation of a greater balance of the current account of the balance of payments was the stabilization of import dynamics. Over the past three years the growth of imports of goods and services has stayed firmly above 20 percent, although in 2005 the gap between it and exports was the largest in the last three years (20.8 percent vs. 6.7 percent). Therefore, statements about the decisive impact of last year’s revaluation on the acceleration of imports lack reliable arguments. It increased even in the absence of changes in the exchange rate.

In addition, the trend of maintaining high import dynamics, which has been noted over the past three years, is a positive one. Certain efforts must be made to overcome the stereotype, deeply imbedded in the mentality of this society, that the predominant import dynamics are an undoubtedly negative phenomenon. It is necessary to change the attitude to this fact as something unwelcome. Export is not an end in itself but a means of obtaining resources for the end consumer, including those of imported origin.

Ukraine badly needs investment imports to modernize its economy. Imports also support economic growth by meeting consumer demand. Stuart Chase developed a common-sense formula: what we produce as a nation, plus what we import, minus what we export, is the measuring stick of a living standard. Nor should we forget the fathers of political economy. John Stuart Mill wrote that imports, not exports, secure a country’s well-being, provided full employment is secured by other means. This well-being is reflected in the level of consumption by its citizens of both domestic and imported products.

Unlike the situation with exports, the influence of last year’s strengthening of the hryvnia on the acceleration of imports is undeniable, although, as we have mentioned, it was not decisive. Imports from Europe, given the twice greater revaluation of the hryvnia to the euro than to the Russian ruble, increased by 2.5 billion dollars, and only by 1 billion dollars from Russia (1.7 billion dollars from CIS countries). At the same time, one should not reduce everything to the exchange rate support of imports. With a four-times smaller revaluation of the hryvnia to the dollar (4.8 percent vs. 17.2 percent), imports from Asia rose by 1.9 billion dollars.

Imports in 2005 helped ease inflationary pressure. We know that consumer prices increased by 2 percent less than last year. Since September there has been a certain decrease in the consumer price index on meat and sugar, and the prices of a number of other goods are stabilizing. To a considerable extent this was facilitated by a tangible increase in food imports. While food imports in 2004 dropped by 12.2 percent, last year they went up by 40.6 percent (twice faster than all imports), or by 0.8 billion dollars. The imports of industrial goods rose three times faster: 54.3 percent vs. 17.5 percent in 2004. This phenomenon is conveniently described as «deflation import.» This was absolutely justified as an anti-inflation measure, which reckoned with the record growth of nominal per capita income (38 percent) with a slowdown in the growth rates of national commodity supply (GDP dynamics: 2.4 percent).

High activity of investment imports has also been maintained: 29 percent vs. 36.2 percent in 2004. In absolute terms, the growth in imports of machines, equipment, vehicles, and instruments (2.3 billion dollars) was even higher than last year (2 billion dollars). In 2004, machine-building import dynamics exceeded overall indices by 8.3 percent, compared to 8.2 percent last year. In conditions of weakened investment activity and a decline in domestic machine building, imports of such products played an important role in supporting economic growth and avoiding recession.

It should be noted that last year’s import growth rate was partially achieved owing to some achievements concerning its legalization in the course of implementing the program «A Stop to Contraband.» But imports could have been higher and not slowed down their dynamic if there had been better interaction between the Verkhovna Rada and the government in terms of coordinating the terms and conditions of WTO membership and adopting pertinent laws.

Divergent trends in the movement of exports and imports have resulted in the reduction of surplus in the current operations account that once again showed a positive balance (2,184 billion dollars), but 4.62 billion dollars less than in 2004. The latter, however, does not indicate a decline in the economic growth rate; in 2003, when the GDP rose by 9.6 percent, the current account surplus (2.9 billion dollars) surpassed last year’s (2.2 billion) by only 700 million dollars.

Normalization of the current account balance made it possible to relatively slow down the unproductive emission for the purchase of hard currency and lower the potential of inflationary pressure on the economy.

Therefore, every effort should be made to counteract the widespread stereotype of the desirability of a super-high positive balance in the current account, particularly the trade balance. If someone wants to further strengthen the Ukrainian currency (with all the pluses and minuses of this phenomenon), then the excessive expansion of exports and another increase in the positive trade balance will favor this. However, that is hardly desirable, if you consider the possible inflationary consequences that would stem from the monetarization of the current account surplus. Nor can a profound sterilization of the money supply be a good alternative, as this causes a rise in interest rates and slows down economic growth and the gross domestic product, the nation’s aggregate income.