How can we sustain our economic independence?

The following interview is part of our newspaper’s plan to acquaint readers with the views of two ministers of the economy — one from the real cabinet and the other from the “shadow cabinet,” which is composed of opposition members. Both of them were sent identical questions. The minister from the Party of Regions-based shadow government, Iryna Akimova, quickly found the time to speak to The Day (the obstruction of parliament may have helped), while Ukraine’s Minister of the Economy Bohdan Danylyshyn was too busy with meetings, trips, and more meetings to talk to the press. But we are determined to talk him into granting us an interview. It will probably take place once things improve in the country. We are sure this will happen very soon.

THE SALVOS OF TODAY’S AURORA

Do you believe in the possibility that there will be a breakthrough in Ukraine’s economy in 2008, and what is the main prerequisite for this?

“What we need is an absolutely realistic and rational approach to the economic policy. This means there should be macroeconomic stability, meaning low inflation as well as a good investment climate, while social programs should fit in with the economic potential. If these conditions were maintained or improved, we could really expect a major step forward in the field of economic reforms. But the current tendency is just the reverse: inflation is on the rise, while the government is making the opposite effort, which seems to be speeding up rather than slowing down inflation. The growing social spending does not, unfortunately, meet the budget’s potential. Furthermore, the social spending growth rate essentially exceeds the growth of labor efficiency. And if things continue this way, I think any economic breakthrough is out of the question. Sustained political stability is also important. So we can hardly expect a breakthrough in economic reforms and in the national economy as a whole in 2008.”

Is the government’s anti- inflation program working? It is said to be producing results already. Do you think the government will manage to maintain a one-digit inflation rate?

“All the media have reported that some kind of anti-inflation program has been drawn up and is being discussed at the Cabinet of Ministers. You can judge it only by secondary sources, so you can’t possible comment on it without seeing the text itself. As to whether or not it works, we will see by the current inflation figures. In January they reached an all-time high of about 3 percent. The same month saw an abrupt 4-percent rise in the price of food which, as you know, accounts for 52 percent of the consumer basket used for assessing the inflation index. What else pushed up inflation in January? There were mass-scale lump-sum social payouts in December. Some of them were of a ‘planned’ nature: you know that bonuses are usually paid out in December, and last December they were up by an average 13 percent compared to November. There was a massive UAH 7.7 billion current expenditures payout from the state budget. This money was withdrawn from treasury accounts because the Tymoshenko government was just beginning to carry out these social payments. And the result? There was not and could not be an abrupt rise in the supply of food on the market from both national and foreign producers. On the other hand, large-scale payouts brought up consumer demand. Since prices on competing markets are regulated by demand and supply, prices naturally went up.”

A NEED FOR COORDINATION

“I’d like to say a few words about the anti-inflation program. Its first premise is the effective performance of the National Bank. The NBU pursued a more austere monetary policy in January. Accordingly, the rate of basic inflation, for which the National Bank is responsible, is relatively low and essentially lower than that of non-basic inflation, for which the cabinet is supposed to be responsible. All other conditions being equal, the success of anti-inflation measures depends on a number of key factors. The first one is clear-cut coordination of fiscal and monetary policies. In other words, if the National Bank begins to effectively combat inflation, its activities should be supported with very cautious spending of budgetary funds, i.e., an austere fiscal policy. This condition is not being observed today. Therefore, it is too early to say that the National Bank and the cabinet are really coordinating their actions. Here is another characteristic example. The National Bank is trying to make sure that commercial banks run a lesser risk when they offer private credits. This is being achieved by, among other things, increasing the reservation rate, which reduces risks to the banking system. This is an absolutely normal and civilized form of regulation. And what is the government doing right now? It is trying to launch a program of so-called cheap mortgages, which dramatically increase risks for commercial banks. The implementation of this scheme may increase the demand for housing and then prices. This is what I call a lack of coordination. The cabinet is in fact hindering the NBU from pursuing a rational monetary policy and combating inflation.

“Another factor that is very important for a successful anti- inflation policy is the National Bank’s real independence. This has been widely discussed in the past three years, and it is possible to achieve it. First of all, it is about depoliticizing the central bank management and forbidding various political party activists to serve on its chief executive bodies. On the other hand, one must clearly define the National Bank’s goal as maintaining the stability of prices, not of the exchange rate. This requirement remains unfulfilled, and it is difficult to say to what extent the coalition is prepared to do this. In any case, it would be interesting to read the anti-inflation program when it materializes and see the viewpoint of our opponents on this matter.

“And, finally, the third point. Unless labor efficiency surpasses the growth of social expenditures, I think it will be very difficult to believe in any drop in inflation. External factors will also come into play, such as the growing demand and prices for farm produce on world markets. But this plays a secondary role compared to our domestic factors. I do not think it will be possible to keep a lower than 10-percent inflation rate in 2008, which also coincides with the viewpoint of major international organizations. You know that the World Bank has increased its inflation outlook for Ukraine to 13.6 percent, while the National Bank forecast a 14-percent inflation rate. These figures are much more realistic in the event that there is no additional upsurge of social expenditures.”

WE WERE NOT ASKED

When the government, including the Ministry of the Economy, worked on the anti- inflation program, did it consult or take into account the viewpoint of the shadow cabinet?

“There were no direct consultations, but when the shadow government was discussing the inflation growth problem the week before last, it pointed out the risks hidden in the coalition government’s program and its first actions. So if the government had been interested in the opinion of the shadow cabinet, it could have familiarized itself with the materials we discussed and taken them into account while drawing up the anti-inflation scheme. There were also special hearings in the parliamentary finance committee — first with the committee members alone and then with experts, public figures, and even students. It was about the risks that Ukraine is now encountering and ways to overcome them. The shadow government’s voice could have been heard, of course, but there have been no direct consultation so far.”

A recent survey showed that even Ukraine’s eastern regions know absolutely nothing about the shadow cabinet’s activities. Could you comment on this? Is this your mistake or is the press simply ignoring the opposition government?

“It must be a two-way process, and I find it hard to put the blame on somebody. I think it would be more correct to say that the shadow cabinet has not yet fully used its potential to work with the public, and it should intensify this process. What is being done today? You may have noticed that the Party of Region’s Web site has a separate link called the ‘Shadow Cabinet.’ As long as the shadow cabinet does not have its own site, this link will be functioning. There, you can see minutes of meetings and decisions made by the shadow cabinet. Recently comments by some of the shadow government members started being posted. The shadow ministry of the economy conducts daily monitoring of the coalition government’s performance in the economic field. This monitoring will include all important events, in our view. We will be determining their importance by concrete deeds, not intentions, and will try to comment on them in detail. My fellow members of the shadow cabinet and I expect queries from the media. We are planning to hold a roundtable debate shortly on the most important matters, and naturally, we will invite the press and civic organizations. It will be primarily about the coalition government’s program and the way it is being implemented. The government is also supposed to submit a new draft budget in the nearest future, and I still hope to see the anti-inflation program. This will also be a point to discuss at this roundtable. You were right to note that many regions are unaware of the shadow cabinet’s activities, so we are planning to hold a series of regional roundtable debates in order to present the shadow cabinet’s goals and share our views on the situation in Ukraine and the prospects for its development.”

WITHER GOEST THOU?

There was a very high inflation rate in January, but the government says it will be much lower in February. What factors are affecting this process now?

“I agree that the inflation rate may be slightly lower in February. First of all, there is such a thing as seasonal fluctuations and, second, there is also what is known as the ‘base effect’.”

Is it only the base at work here, or do you also notice any results of the government’s work?

“I have already talked about the role of the National Bank. It can do a lot by pursuing a more austere monetary policy, but this will not be done in February because of time lags. As a rule, monetary measures show an effect three to four, and sometimes even six, quarters later. In other words, we will see the results of what the National Bank is now doing in mid-2009 at best. And this is one more reason to claim that inflation will not be lower than 10 percent this year. Whatever the NBU may be doing now, this will affect inflation in 2009, not 2008. The Tymoshenko government has not adopted any anti-inflationary measures, but only made widely-announced intentions. One of the latter is to increase the administrative regulation of prices for foods as well as fuel and lubricants. At the same time, Savings Bank depositors began to receive compensation en masse. In other words, the demand for money is always on the rise. At the same time, utility charges have not been revised yet, but they will be. In terms of statistics, this will also affect the attempt to curb inflation. But as soon as these charges begin to be revised (I emphasize that this is absolutely inevitable and has already begun in some places, following the gas price hike), we are most likely to see a big increases in prices.”

The increasing price index has a positive effect on the GDP growth, doesn’t it?

“You have to be very careful about terms here. An increasing price index affects the growth of the nominal, but not the real, GDP. So, in nominal terms, GDP figures will be growing.”

Again, because of the inflation factor...

“Naturally.”

And this allows the government to say that it intends to increase the nominal GDP outlook by 3.6 percent in 2008?

“Yes.”

VERBAL DEFENSE

But why is the inflation outlook not being revised in this case?

“This is a good question that should be addressed to the coalition government. Both Ukrainian and international experts consider the inflation outlook of 9.6 percent as unrealistic. They have already said as much, but the government is leaving the inflation outlook unchanged. We could wish this figure to be lower than 10 percent, but we should be realists and alter the macroeconomic targets because this question also has a social aspect. If the nominal rate of inflation is not being upwardly revised, it is not necessary to revise the subsistence level, which should grow in real terms, but it will not be able to catch up with rising inflation. If this outlook is not being revised, one need not increase the related payouts, such as minimum pensions. Experts have calculated that if, instead of the projected 9.6 percent, inflation is at least 12.5 percent in 2008 — which is also an underrated figure — pensioners who receive a minimum pension will lose an average of 170 hryvnias a year. This is what will happen if the real inflation rate is ignored.”

This also seems to have a small positive aspect: the government is showing that it is able to curb inflation, which psychologically plays in its favor and positively affects outlooks.

“I think a blatantly underrated inflation forecast is most likely to play in favor of increased, rather than reduced, inflation expectations. These expectations are shaped primarily by information about the past period. In other words, if there were factors pushing inflation up in the past few months, especially the last two, no reasonable consumer will ever believe that these factors will just stop working. Besides, if he sees that the government’s actions are at variance with the intentions it declared in its program, this may cause him to be even more distrustful. In addition, inflation outlooks are often shaped not only and not so much by statements of the executive branch, i.e., the cabinet, as by the opinion of the National Bank, the body that in charge of the monetary policy. And it has been making quite realistic forecasts. This is why I do not think that the actual cheating of the public by means of underrated inflation forecasts can really bring down inflation expectations.”

I cannot help reminding you that your government did not revise the inflation outlook either.

“Point taken. I think any government tends to keep to a conservative outlook in this matter. But I’d like to emphasize one thing. The external factors that began to affect inflation, such as price changes on world markets and information on farming crops in Ukraine, emerged in the second half of the year. So it was impossible to take them into account early in the year.”

ABOUT RULES AGAIN

National Security and Defense Council Secretary Raisa Bohatyriova claims that “the most dangerous tendency today is the attempt to upset the balance of political interests and, as a result, changes in the rules of the economic game.” Do you agree with this statement? What do you think it can lead to? After all, business always demands stable rules from the authorities. How will business react to these changes?

“If by ‘upsetting the political balance’ she means the never-ending confrontation in parliament, it is true that the continuing interruption in parliament’s proceedings is not, of course, conducive to making laws that are aimed at improving the investment climate and further encouraging the business sector to invest in and develop the economy of Ukraine. On the other hand, let us look at the tendencies that emerged in the previous two years or, to be more exact, late in 2004, which signaled the beginning of a permanent period of political instability. At the time, experts and businessmen expressed the opinion that this would definitely affect the development of business in Ukraine. But what happened in the idle parliament, when the trouble was caused by none other than the current coalition? The answer is that, even though the parliament was disabled, the rules of the game remained unchanged, which the business community accepted positively. A stabilized legislative sector allowed the country to attract more domestic and foreign investments. You know that the influx of foreign investments reached an all-time high in 2007. What is the main message of all this? What business expects is relative stability of the rules of the game even if they are bad in principle and have a lot of shortcomings. But when political instability drags on, this will naturally have negative consequences. So it is in my interests and those of my colleagues to resolve the current political conflict and begin positive legislative work.”

But maybe it would be good to continue this kind of stable period so that the economy goes up again?

“I repeat: there can only be a short-term positive effect of stable rules of the game in conditions of political instability. But if nothing occurs or improves for a long time and political instability is always on the rise, this tendency will not work. I can explain this with a concrete example. Such a thing as business climate comprises a lot of factors: tax pressure on businesses, regulatory pressure, overall macroeconomic stability, observance of property rights, etc. As long as the property right is not called into question, business will be developing because it gets adapted and finds proper mechanisms even if the tax law is bad and the rules of the game are intact. Whether these mechanisms are good or bad is another question, but it still finds them. When a new political factor of instability enters and threatens to infringe property rights, business will answer by an abrupt drop in activity. For example, this was the result of the past attempts to revise privatization contracts.

“Political instability also adds uncertainty to the taxation policy. Another example is the ban on using bills of exchange as payment for the import VAT. In this case, the already available business adaptation mechanisms do not work, and new ones have to be thought up. Naturally, the first reaction will be a drop in business outlooks, which, according to a National Bank poll, did happen. The January outlooks are in the negative. Shrinking investments will be the next step.”

But can this result in a situation where the government will earn additional revenues by banning bill-of-exchange settlements and, at the same time, will slow down industrial growth?

“A slow-down effect is quite possible as a result of these violations of the rules of the game because this washes out operational funds and circulating capital. In these conditions it is difficult to make decisions, especially if they concern future investments, when current operations have to be financed. It is too bad that this factor can work for quite a long time because it is more difficult to restore undermined trust in the government than simply to continue observing bad but stable rules of the game.”

SUBJECTIVE BILLIONS

The 2008 budget allocates money in line with governmental target-oriented programs. Do you think this is the right fund distribution mechanism?

“The distribution of funds among specific target-oriented programs can only be reasonable if the country has a clearly-defined goal and its leaders know what to do. This is called medium-term planning and programming. Priorities should be supported, at least for the medium term, by medium-term budgetary planning: then the budget can annually allocate certain funds for a target-oriented program that fits in with our medium-term priorities. In this case, ideally, even if the political elite has changed, the country will be basically moving towards the same priorities. Since medium-term budgetary planning is still on the level of ideas rather than practical realization, today it is difficult to expect a rational distribution of funds among target-oriented programs. There will always be an element of subjectivism or lobbying on the part of certain groups, even if the bulk of these programs really serve the interests of the country’s development.

“Now let’s look at this process from a different angle. There are priorities that are contained, albeit covertly, in the current government’s program. One of them is increasing energy effectiveness and reducing energy consumption in the economy. This is very important against the backdrop of the constantly rising oil and gas prices: this should be the number-one priority. It can be found in the government’s program and should be duly reflected in the state budget. But, in comparison to the draft submitted by the Yanukovych government, the Tymoshenko cabinet has drastically cut budgetary expenses for energy-saving programs. The same applies to the money that is aimed at reforming the housing and utilities sector, which is also of paramount importance to people’s well-being and the state as a whole. Can this be called rational distribution of governmental funds? I would answer in the negative. The point is that some program priorities, once widely advertised and serving as the basis of an election campaign, are not in fact being supported by concrete budgetary measures.”

PLANNING AND REFUNDING

Your government once tried to introduce medium-term planning. Did it fail or was there not enough time to do this?

“Frankly speaking, it was not the Yanukovych government that began to develop medium-term planning. The previous cabinets also made similar attempts. But this is quite a difficult thing to do, especially in a country where political elites are constantly replacing one another. It is very difficult in this case to make a joint effort to map out a medium-term program, which in a way will be binding on all sides even if there is some kind of common vision of the prospects and instruments to achieve them with. As long as the political situation in Ukraine is unstable, it will be very difficult to introduce the system of medium-term budgetary planning.”

The government will be trying to restrict foreign crediting of public-sector companies, but it does not seem to be overly concerned about the growth of borrowing in the corporate sector, particularly on the part of banks that are obviously not going to curtail consumer crediting and which favor the restoration of the long-term refunding of commercial banks in connection with the liquidity crisis on international markets. Do you support these demands?

“There is no such thing as long- term refunding in international practice. Commercial banks are always refunded in the short term. There is a rational grain in this. A commercial bank is an organization that is supposed to carry risks in crediting the household and industrial sectors. It should take these risks into account, because if it doesn’t, it will face consequences, such as poor financial results or even bankruptcy. This is what many commercial banks in the world experience. This raises the question: what do we want when we prompt banks to run the higher risks of crediting — I mean cheap housing schemes, i.e., virtual cheap credits at 4 to 6 percent interest, while the real interest rate today is at least 16 percent? Where are we leading this country to? To ensure refunding with National Bank funds? This will just mean accommodation of the budget deficit and an additional impulse to inflationary pressure. This is why I think that long-term refunding schemes are out of place here, especially when inflationary pressure is already rather high. The National Bank is aware of this, judging by its latest measures to increase the reservation rate.”

How do you think Ukraine’s banking system will bear the financial crisis on world markets?

“There are no great fears with regard to the negative effect of the world crisis on Ukraine’s banking system. Quite a large part of Ukraine’s banking sector is already working with foreign capital. So to some extent the risks are falling on the shoulders of our foreign partners, thereby cushioning the negative effect for Ukraine. So I don’t see any reason why the banking system should experience a big external shock.”

“What do you think of the prospects of creating a state development bank and a land bank in Ukraine?

“These ideas look very nice from the outside. People say: we have to increase investments by establishing these kinds of institutions. I have always been rather skeptical about them. To start with, we should know exactly what we want to achieve and to what extent the instrument for achieving this goal is correct. In my view, we now have good opportunities for more active investment activity on the part of private capital. The banking sector is thriving. But why should we, instead of developing private businesses, create new state-run monsters that will always be synonyms for the opaque distribution of funds and inefficiency? I think the development of private capital is the main direction. So a development bank is hardly the best idea.”

STANDING STILL NOT A GOOD IDEA

Do you expect that the moratorium on land sales in Ukraine will be lifted by Jan. 1, 2009?

Yes, I do and actively support this. We should finish the work on the land cadastre and all related draft laws as soon as possible. During one year the country should finally lift this moratorium and allow the land market to function without restraint. Yes, there may be many procedural problems that will periodically arise, but if we do not lift the moratorium, we will be just dragging our feet and standing still.”

Do you think that the National Bank is going to pursue a more volatile and flexible exchange-rate policy? Experts have differing views. Does your personal analysis suggest that the national currency should be devalued or revalued?

“I am not going to speculate on the exchange-rate policy; I consider it politically incorrect to do so. Monetary policy matters should be absolutely separate from pure politics because this is the National Bank’s preserve. This is a very delicate function because it is connected with changes in inflation outlooks. This is why I can only judge about the intentions that have been made public by the National Bank and say to what extent they are reasonable, fair, and correct. The NBU has been doing intensive preparatory work in the past two or three years to introduce inflation targeting. Obviously, such things cannot be done in a day or even one month. But this work is being done, and I think it is correct. As one of the steps to introduce inflation targeting, the National Bank announced that it had supported the International Monetary Fund idea about a gradual increase of exchange rate volatility within certain limits. The latter are quite large, and if the bank chooses to gradually allow the hryvnia to float between 4.95 and 5.25, this will be a big step forward. In this case, I fully support the central bank’s attitude and hope that no political perturbations will affect this.

Another thing: in the fourth quarter of 2007 the National Bank began to pursue a more austere monetary policy. One could criticize the NBU for its too soft monetary policy in 2006 and the first half of 2007, but in the second half, especially in the fourth quarter and in January 2008 it has showed itself as a very responsible agent. This is commendable. All I would like to wish the National Bank now is that it should coordinate the monetary policy with the government in a real sense, not virtually, as it is doing now.”

INFLATIONARY ADDITIVE

What effect will the gas agreements reached during President Viktor Yushchenko’s visit to Moscow have on Ukraine’s economy? Do you think that Russia made some concessions during the negotiations not out of altruism but because the Ukrainian side either showed some important trump cards or made some equally important economic or even political concessions?

“The question is what kind of concessions there were and whether Russia received any equivalent compensation. The main thing is that Ukraine is increasingly aware of the simple truth that it must pay on time and in full according to its commitments. A better payment discipline is absolutely inevitable, no matter how hard this is, and the result of these talks is prompting us to meet our payment obligations.

“How can I assess the short-term gains that result from establishing a fixed price for gas in the first six months of this year in exchange for Gazprom’s easier access to our domestic market of energy resources? I think there can be two ways to think about this. Until now, all the governments and the entire political elite of Ukraine were very wary of Russian capital’s easier access to our domestic market. I think we will have to reckon with this trend in the nearest future, and it may have both positive and negative aspects because, unfortunately, gas has always been not just an economic problem but also an instrument of political pressure. So, on the whole, one can say that these talks resulted in certain concessions on Ukraine’s part, and we will have to work very long and hard with their consequences. Ukraine should brace itself for even higher gas prices, and the schedule of this price hike may not always be in Ukraine’s favor. The only way to retain economic independence is to adapt domestic consumers to the new, higher, gas prices, implement an energy-saving policy in the public sector, provide budgetary social incentives, and price-adaptation mechanisms as fast as possible.”

How many percentage points will the new gas price add to the inflation rate?

“An estimated 2 to 3 percent by the end of the year.”

Did we take this into account when we were estimating our outlooks? With due account of this percentage, what is your inflation forecast for this year?

“13 to 14 percent.”

That sounds rather optimistic.

“Yes, that’s my optimistic forecast.”

Even Poroshenko mentioned 16 percent.

“I am more inclined to support the World Bank’s viewpoint. Of course, this will also depend on the amplitude of social payouts. But, I say again that my forecast is rather optimistic. I do not believe that inflation can be lower than 14 percent. It can be higher but not lower.”