Getting rid of economic archaisms

Volodymyr LANOVY, Ph.D. in Economics, president of Market Reforms Center, deserves to be called one of the leading Ukrainian practicing economists. He held various state offices, such as the Minister of Economy, advisor to the President of Ukraine, MP, etc., in which he mastered and implemented in real life various economic models and approaches. The Day has asked Lanovy about the policies Ukraine should pursue in 2010, the reforms that need to be implemented, and the best areas to channel budget money into.

In your opinion, what kind of model for the post-crisis development of the economy has to be built to prevent the same kind of situation from happening again?

“The economy will become powerful if millions of people get interested in opening their own business in its different fields. The task of the post-crisis Ukraine is to offer new goods on international markets. I personally have not seen any new Ukrainian goods, such as cell phones or airplanes, appear after a year of crisis. We had no breakthrough in creating innovative high-quality goods that would help Ukraine to carve out new niches on international markets. That is why the state now has to help the small business in all possible ways rather than emphasize a few priorities. The year 2010 is the time to stake on inventiveness, business activity, and building modern intellectual economy.

“On the other hand, the problem of upgrading equipment in the industrial, energy, transport, and agricultural sectors is already long overdue. There is a need for a complex state target program that would include new approaches to collecting taxes, amortization, customs regulation, purchasing know-how technologies, attracting long-term international loans, etc.”

What mechanisms of economic stimulation should be reflected in the budget in order to cause the GDP rate to grow and avoid provoking inflation?

“A deep economic crisis cannot be overcome by means of some distributive or regulatory mechanisms. Certain expenditures have to be earmarked in the budget including expenditures on implementing some serious changes in major industry spheres, the development of the accompanying infrastructure (big transport systems, communications, energy objects, ports, and airports), and making Internet available to every family. Instead of being a resource-providing appendage, in the future Ukraine has to be a state that generates innovative ideas, technologies, and models, just like Japan is doing now. Unlike Japan, we have natural resources, which are our potential for success, but we keep ignoring it or putting it aside until later. In my opinion, the greatest part of budget money has to be spent on creating an economic platform for an innovational leap.

“The present budget project does not contain such an investment component. Instead, for unknown reasons, they plan to spend 50 billion hryvnias on bank recapitalization. Why are they so generous, and why is there no explanation exactly what this money will be used for?

“If we want to see new technologies in Ukraine in five or six years from now, there have to be expenditures on these long-term tasks in the 2010 budget. The government have to invest into such risky but promising R&D projects on partnership conditions with private investors, in particular commercial banks. It also sure has to completely change financing education and finally realize the program to modernize the healthcare system. The state has to invest into creating laboratories, producing medications and medical equipment, and founding pharmaceutical and diagnostic complexes and centers.

“Another task for the government is the social support for citizens and unemployment rate control. If this is not done, society degrades, crime spreads, and it all leads to moral and intellectual abyss. The needs of social and humanitarian development should receive from 7 to 10 percent of GDP. To stimulate GDP growth in the long-term perspective, we need to reform the taxation system to make it facilitate business development and foster energy saving.”

In your opinion, is it better to boost the economy by stimulating consumer demand directly or via the banking system?

“Stimulating consumer demand is a wrong method for an economy. It is only possible to stimulate consumers when domestic production is absolutely flexible toward the demand, which means it can react to the demand increase right away. However, this is a utopia. For example, yesterday you bought a kilogram of apples and tomorrow you will be given more money, and you will decide you want two kilograms. But it is impossible to grow twice as many apples in a day. There will be a deficit of apples, the salesmen will buy more apples abroad, imports will increase, and it will lead to the balance of payments deficit. This will devaluate the national currency.

“It means that such consumer demand stimulation only undermines the value of money and weakens the economy. In my opinion, it makes sense to develop domestic market by encouraging production instead of providing consumers with more money. Therefore, the government has to stimulate the growth of the number of effective consumers on the domestic market. Then there will be no inflation.”

What do you think about reinvigorating the economy by way of refinancing provided by the National Bank of Ukraine?

“The imperfection of the banking system refinancing, in particular using the pawn method and auctions for money emission distribution, create a possibility for artificial monetization of the economy and undermining its monetary system. This is exactly what happened in the last few months of 2008. The excessive amount of issued hryvnias, a total of more than 100 billion, which were given to commercial banks undermined the exchange rate, the paying capacity of economic agents, and devalued tangible assets. It led to the loss of credit worthiness of the entire banking system and the mass capital outflow abroad.

“That is why refinancing banks the way it is being done now is extremely ruinous. Besides, these methods channel new credits into the sphere with accumulated passive funds, like real estate or plots of land, and old products stocked in a great number in warehouses. For structural reforms to take place, credits have to be channeled into new spheres and growing market segments.”

In your opinion, what should the new principle for refinancing banks be?

“We have to finally get rid of the wrong thought that the National Bank is the bank that provides credits to other banks. It is not the main moneylender in the country. What has been created in Ukraine is a mixture of the old Soviet approach, when the money simply printed, and the predatory capitalistic model of its distribution among financial oligarchs. Its reformation should involve monetary emission to the secondary gold and currency markets and state-guaranteed debt securities. Those banks that have these instruments will receive centralized refinancing. Credit institutions will find other resources of refinancing on the interbank debt market and the deposit market through the mechanism of subordinated debt, and other market sources.

“At the same time, the National Bank of Ukraine (NBU) has to transformed into a reserve bank. It means that banks’ obligatory reserve funds have to stay on special accounts in the NBU and will be used to provide individual reorganization aid to the institutions that have lost their liquidity.”

What steps should the banks take to win back people’s trust?

“When there is a 20-percent inflation rate and the bank offers only a 19-percent interest rate on deposits, not one person with knowledge of economics will wait to make purchases and instead put his money on a deposit account. Banks won’t be able to win people’s trust back again without inflation reduction, minimization of financial risks, and stabilization of the hryvnia’s exchange rate. The indefiniteness of the monetary policy (the NBU Council has not defined any macro-financial reference points in the 2010 budget), negative experience with inflation and devaluation, and Ukrainian citizens’ memories will slow down the process of restoring trust.”

The hryvnia is strengthening now. What is your forecast about what will happen to the national currency in 2010?

“Ukraine has enough currency reserves (about USD 26 billion) to make up the possible payments deficit. There are no objective reasons now for the hryvnia rate to go down because of lack of dollars. It will continue to be like this only if there is no exchange rate revaluation as the Cabinet of Ministers wants to have it. (They used the rate of 7.5 hryvnias for one dollar for the Law on the 2010 State Budget.)

“I want to mention one more factor of the hryvnia’s stability. In the past two or three months the situation on the Ukraine’s currency exchange market calmed down as a result of the NBU taking measures aimed at reducing the amount of money in circulation and suspending banks refinancing. The National Bank is also very cautious about offers from the government to buy public bonds. If such monetary politics is continued, the hryvnia’s stability will be maintained.

“However, we can’t be sure that there won’t be any sudden changes or manipulations with currency that would result in exchange rate fluctuations – something we saw in the past years. That is why we need a goal-oriented and predictable monetary policy. In my opinion, it has to contain such components as the moderate, slow exchange rate devaluation, the NBU’s obligatory currency interventions on the market if the exchange rate exceeds its permitted deviation (three to four kopecks), stimulation of exports and foreign currency earnings, etc. It would be good to borrow quite a few things from China’s experience in credit and currency control. However, Ukraine’s goal perspective is a European model of monetary integration. We should begin implementing it.”