It is generally known that the current budget program was approved allowing for a certain concealed deficit of over 7% GDP. The exhausted Ukrainian economy will not sustain this, and the situation must be corrected forthwith, something the previous Ukrainian Parliament was unable to accomplish.
The reader is reminded that the macroeconomic model now in use was initiated in October 1994 when Ukraine was gripped by the previous year’s world record hyperinflation (10,256%). There was no choice under the circumstances except a rigid monetary policy; there were no other tools with which to quickly overcome it while deepening market reforms. Those in charge reckoned that a 2-2.5% monthly inflation rate would suffice to start stabilizing the economy and securing its growth. A stand which answered the principal economic theory postulates and tallied with the experience of Central and Eastern European countries. In Poland, Hungary, and several other post-socialist countries economic growth began with a 35-40% annual inflation rate. In Ukraine, this level was achieved in 1996, by applying very strict emission procedures. In 1997, it was slightly over 10%, but the low-inflation-production-increment vehicle just did not work. GDP decline continued last year (-3.2%).
What caused this situation?
There are many reasons. Mostly the absence of deep-going reforms in the financial sphere, which, combined with the existing monetary system, determines the macroeconomic situation. In 1994-96, the consolidated budget deficit was lowered noticeably - from 8.9% to 4.9% of GDP. This, however, was not due to structural government finance adjustments, but to restrictions of certain disbursements.
Personally, I would not attribute all the negative consequences to the government. Budget reforms are possible only when the executive and legislative branches cooperate closely and effectively. There is simply no other alternative. In Ukraine the situation is unfortunately precisely the opposite. Last year the two branches’ confrontation reached its apex, blocking an extremely important package of bills concerning reforms in the state fiscal system and the budget was approved half a year later than scheduled. All this could not but affect budget deficit; it reached a critical level: 6.7% of GDP. Actually, the sharpening of the financial crisis, surpassing by far 1995-96 indices, has assumed a systemic character, embracing government and private business entities.
How is the 1997 budget deficit dangerous for the economy? Or perhaps its hazards are overstated?
To answer this, one must concentrate primarily on the qualitative changes in the vehicles servicing this deficit. Until recently, it was completely recompensed by the National Bank’s credit emission, i.e., by way of levying an unconditional inflation tax, with the main burden resting on the lower-paid strata and persons with fixed incomes. In this sense the budget deficit was a formal value. Its being financed was guaranteed by printing-press money. Thus, in 1992, with budget deficit reaching 13.8%, this technique secured the financing of 36.3% budget expenses - or 692.2 billion karbovantsi. BY way of comparison, budget returns from other sources, particularly the VAT, constituted 486.7 billion krb., and company income tax revenues totaled 279.1 billion krb.
Over the past few years budget deficit financing has been placed on a more civilized footing, using the stock market. In 1995, NBU loans covered 81.4% consolidated budget deficit, and 33.9% in 1996. In 1997, this type of financing was stopped for the first time. What happened next was only to be expected. Ukraine’s financial market parameters turned out insufficient to cover the 1997 budget deficit of over Hr 5.1 billion. Hence the exorbitant budget borrowing rates (the latter are known to be formed on the stock market according to the laws of supply and demand).
This particular circumstance should not be attributed to the world financial crisis. Before this crisis broke out, in July 1997, the Finance Ministry borrowed at 29%, compared to 13% in Russia, 12% in Azerbaijan, and 3% in Lithuania. The Asian crisis served merely to aggravate the existing situation. Over the past six years Ukraine’s borrowing rate has jumped to 50% with the classical debt pyramid effect. In 1996, internal government bonds were estimated at Hr 3.7 billion; in 1997 it was Hr 11.3 billion. As of April 1, 1998, the sum total of government domestic bonds (mostly short-term obligations) was in excess of Hr 13 billion. As a result, government borrowings on the stock market turned from a crisis-softening factor into its opposite, causing further dramatic complications.
Another thing was alarming. The economic space has de facto been divided into two spheres: monetary capital turnover actually servicing the budget deficit and consuming basic state financial resources through its self-growth vehicles, and the real sector currently denied budget subsidies. In 1994, with its soaring inflation, commercial bank long-term loans made up 11.3% of their bond portfolios. In 1997, it showed a decline (which it shouldn’t have normally), registering 10.6%.
The NBU discount rate has actually lost its regulatory function, despite gradually declining from 300% (October 1994) to 17% (November 1997). Commercial bank interest rates were now determined by state borrowing rates on the stock market.
These processes could not help but affect the enterprises’ economic condition. While 12% of industrial entities were officially recognized as unprofitable in 1995, the figure rose to 30% in 1996 and almost 50% in 1997. In agribusiness, the respective indices were +10% in 1995; -11% in 1996, and -24% in 1997, meaning that not only enterprises but also whole sectors were piling up red ink. Credit liabilities rose over 1.5 times in 1997.
The conclusion is obvious: unless there are radical changes in financial policy, the stabilizing processes in the production sector seen this year will be frustrated for want of credit resources and because of low profitability. By 1999, the economy could well enter another phase of critical decline; GDP is estimated at +0.5% in 1998, but will probably register -2-3% in 1999.
In fact, the President’s message to Parliament, on the need to effect priority changes in the budget program this year, lower the deficit to 2.5% of GDP and 1-1.5% the following year, was warranted precisely by the aforementioned circumstances. Ukraine must channel subsidies into the real sector at all costs. And the only way to do so is getting our foreign government debt increment under strict control, thus stopping the ongoing budget (debt-accumulating) chronic crisis, which, if allowed any further, will become irreversible. The validity of this inference is corroborated by the experience of certain countries. The alarming factor is that the reality of this menace does not seem fully understood.
It is generally known that the current budget program was approved allowing for a certain concealed deficit of over 7% GDP. The exhausted Ukrainian economy will not sustain this, and the situation must be corrected forthwith, something the previous Ukrainian Parliament was unable to accomplish.
I understand the full complexity of all these tasks, and that it is impossible to solve them given the current laws, without deep-going corrections in the relevant budget expenditures and without invalidating numerous tax benefits (official findings testify that these benefits are unacceptable in any civilized country anywhere in the world). This was precisely why President Kuchma addressed the new Parliament, calling for cooperation and a joint quest for ways to solve the budget problems accumulated over the years. One should also consider that this problem will face any new government, notwithstanding the color of the flag it waves.
Some propose to solve budget problems using moderate inflation as a kind of lubricant. I am positive that this approach is wrong. The only way out of the current financial situation is to further strengthen the national currency. Thus the President’s message to Parliament proposes to further lower predicted inflation to 8-7% in 1999, subsequently reaching 5-6%. This is very important from the standpoint of protecting people’s incomes and stimulating the investment process.
At the same time, monetary instruments can no longer be relied upon as the only way to contain inflation. The macroeconomic policy built on this principle has long been exhausted. Further lowering the inflation rate must ensue from structural reforms and their stabilizing effect on the socioeconomic system (financial sector included, of course). Moreover, there is the pressing issue of tangibly increasing the economy’s monetary level, which is perhaps the lowest in Ukraine of all the transition economy states. Some progress was made here last year when the GDP monetarization level reached almost 14%. This is not enough and the process must be expedited. Very much so. There are considerable reserves to be used. In 1997, barter deals in the economic sphere grew from 32 to 42.5%. Such transactions should be given monetary content, and the same applies to replacing money surrogates. It also has very broad capabilities of significantly raising the level of GDP monetarization without causing inflation. This needs to be faced seriously. It is an extraordinarily serious problems.
The money supply structure and the proportion of it outside the banking system are also disconcerting. This subject has been discussed for the past four years and the situation has gone from bad to worse. It is impossible to foster economic growth at the existing GDP monetarization level, with literally every second hryvnia being used in transactions outside bank accounts.
Certain adjustments also have to be made in exchange rate policy. In 1996-97, inflation was 39.7% and 10.1%. respectively. Ukraine’s current payments balance was -2.8% and -2.7% of GDP, with the hryvnia exchange rate (mainly reflecting these parameters) remaining practically unaltered. NBU official statistics read that 1998’s artificial revaluation of the hryvnia amounts to 9.6%. This factor actually explains the lowering exports and deteriorating performance in the relevant sectors, which is very dangerous for Ukraine.
Proceeding from all this, Ukraine needs a more flexible exchange rate policy. This means, primarily, a policy of foreign exchange inflation, to be kept on a parity basis. Such a policy would balance the interests of exporters and importers, and would best answer the logic of economic growth. At the same time, such an approach would not go counter to any of the measures designed to stabilize the national currency. In fact, adjustments in inflation and currency exchange rates, along the currency corridor determined for this year, are underway. I am personally convinced that the previous declaration of this policy was not a destructive element (as some try to portray it). To the contrary, it was a manifestation of respect for the market operator, a vehicle designed to formulate their rational expectations, something which should be respected at all times.
Finally, the President’s message contains one more basic macroeconomic position, the two directional orientation of his financial stabilization program. Here measures are stipulated aimed at not only restructuring budget expenditures, but also at substantially lessening the tax burden, thus stimulating production, legalizing the economy, and expanding the tax basis. However, solving these particular problems largely depends on the extent of coordinated efforts between the government and Parliament. I am convinced that restructuring budget expense items and lowering the tax burden must be solved in what is currently termed as a “package” approach - i.e., comprehensively. This is something that must be clearly understood. The program proposed by the President is geared to resolutely lower the tax burden, something one and all have been anxiously expecting. However, this cannot be accomplished in what engineers call an off-line mode. Coordinated steps must be taken. Something we are all eager to see.
Photo by Leonid Bakka, The Day:
Anatoly Halchynsky
Editor’s Note:
We hope that Mr. Halchynsky’s article, authored by one of the fathers of Ukrainian economic reforms and the Presidential Administration’s economic trendsetter, will prompt a variety of comments and suggestions. We hereby invite political figures, statesmen, scientists, and journalists to join this discussion of effective corrections in the current reforms. We wish also to remind of the unavoidable restrictions to be levied by any periodical, in terms of space: any contribution will be welcome subject to the condition that its size does not exceed 200 standard newspaper lines — 6,000 characters or 3 kilobytes.







