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The last hurdle for Ukraine’s recovery

Sep 21,2017 - Last updated at Sep 21,2017

Ukraine’s capital abounds with signs of hope and anarchy. The country has experienced an impressive economic turnaround, but corruption remains rife. 

President Petro Poroshenko’s administration has stabilised public finances, but failed to rein in clientelism.

The question now is whether any judicial and legal reforms that Poroshenko undertakes can establish the conditions for strong, sustained economic growth.

Since concluding a loan agreement with the government in March 2015, the International Monetary Fund (IMF)has followed through with four substantial disbursements. 

But on a recent visit, IMF First Deputy Managing Director David Lipton warned that there are risks of Ukraine “going backwards”.

Ukraine’s problems are not macroeconomic. The government’s current finance minister, Oleksandr Danyliuk, is an avowed free marketeer with a strong record of economic management, as was his predecessor, Natalie Jaresko.

According to the IMF, Ukraine’s public expenditures in 2014 totalled 53 per cent of GDP, but had fallen to 40 per cent of GDP by 2016. And in just one year, from 2014 to 2015, Ukraine slashed its budget deficit from 10 per cent of GDP to a mere 2 per cent. It is now on track to maintain a deficit of around 3 per cent of GDP in the coming years.

Moreover, thanks to improvements in the tax system, state revenues increased by 30 per cent year on year in the first half of 2017, outpacing growth in expenditures. As a result, the government had a balanced budget in January-June.

In April, the IMF projected that Ukraine’s public debt would stand at 91 per cent of GDP at the end of 2017; but the government has already brought its debt down to 81 per cent of GDP.

This progress will likely continue as growth strengthens and Ukraine’s currency, the hryvnia, appreciates.

Ukraine owes much of its economic strength today to Valeriya Hontareva, the former chair of the central bank who cleaned up the banking sector over the past three years. 

Under Hontareva, the National Bank of Ukraine shut down half of the country’s 180 banks, most of which were corrupt — if not outright criminal — operations. And now that the restructuring is almost complete, lending is set to take off.

Typically, when a country gets its domestic finances in order, its external finances improve, too. 

Ukraine’s foreign-exchange reserves have been a major cause of concern since 2014; but today, they stand at a reassuring $18 billion — equal to about 3.5 months of current imports.

Better still, the hryvnia has strengthened by 6 per cent against the dollar this year. This has boosted GDP and reduced the public debt, which is predominantly held in international currencies.

At the same time, Ukraine is undergoing a relatively fast “de-dollarisation”, such that hryvnia-denominated bank deposits are now growing faster than those in foreign currencies.

Ukraine has the three essential ingredients for strong, sound growth. In the first half of 2017, the European Union-Ukraine Deep and Comprehensive Free Trade Area took effect, and Ukraine’s exports skyrocketed by 25 per cent, far outpacing import growth.

Moreover, Ukraine has strong investment and consumption growth. In the first half of this year, construction surged by 24 per cent, and retail sales increased by 8 per cent.

But while the IMF has projected 2.9 per cent GDP growth for 2017 — and annual growth of 4 per cent by 2020 — annualised growth in the first half of this year was just 2.5 per cent. There are a few reasons why Ukraine’s newfound financial stability has not yet led to a stronger growth takeoff.

For starters, the fighting in eastern Ukraine has disrupted the agricultural sector, the leading source of growth for the last decade. 

But, more important, Ukraine’s “animal spirits” may be suppressed, because its entrepreneurs see little point in trying to compete with oligarchs who remain able to rig the economy in their favour.

Over the past three years, the government has started (with a shove from the IMF) to combat corruption in a systematic way, including by unifying energy prices and introducing a transparent electronic procurement system for most public purchases.

And so far, more than 100,000 public officials have publicly disclosed their incomes and assets in a display of transparency that rivals Scandinavian countries.

But the government’s failure to uphold the rule of law remains a serious problem. Previously, domestic businesses and foreign investors worried that the tax authorities were abusing their power. 

But in March, Ukraine’s anticorruption bureau arrested the country’s tax chief, Roman Nasirov. 

Now, the biggest cause for concern is the prosecutor general’s office and the security services. 

Both are under the president’s control, and both have come to be widely regarded as predatory state agencies.

It is hoped that judicial reforms currently in the works will check executive authority, secure property rights, and thus encourage growth. But it is already clear that more will be needed.

In July, Poroshenko stripped the citizenship of Mikhail Saakashvili, the former president of Georgia whom Poroshenko invited to Ukraine and appointed governor of Odessa in 2015.

Poroshenko’s decision, carried out by decree and without due process, is legally dubious, and Saakashvili, rather than accepting his fate, has used his denationalisation to galvanise Ukrainian civil society. 

This month, he and the Ukrainian opposition leader Yuliya Tymoshenko entered Ukraine from Poland without going through passport control.

By inviting prosecution, Saakashvili has gained a platform from which he can criticise Ukraine’s justice system and Poroshenko’s neglect of the rule of law.

The IMF’s demand that the Ukrainian government establish an independent anticorruption court to investigate, prosecute, and punish dishonest public officials remains unfulfilled. 

But if Ukraine is to continue on the road to recovery, it will have to demonstrate that no one — not even the president — is above the law.

 

 

The writer is a senior fellow at the Atlantic Council in Washington, DC, and the author of “Ukraine: What Went Wrong and How to Fix It”. ©Project Syndicate, 2017. www.project-syndicate.org

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