Reforms in Ukraine Should Go On

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Instability is a common feature of Ukrainian politics. To some degree it is a price of democracy: Ukraine changed five elected leaders over 25 years of the independence, which is the largest number among CIS states. However, average Ukrainian government rarely lasted over one-two years as it lost majority in the Parliament or was ousted by the President. On top of this, in last ten years Ukraine went through two ”Maidans” that led to change in country’s leadership. Ukraine may find itself with new Government in the very near future. Frequent government changes do not help the country as there is little to ensure continuity in government policies. Budget planning is done on a single-year basis, senior civil servants are frequently replaced along with politically appointed Ministers. Strategic planning exercises are rarely seen to the end and even if they do often they are often ignored by new governments. As a result, each new Government that comes to power starts from scratch in many areas.

Ukrainian Constitution prohibits the Parliament from dismissing the Prime Minister for a year after the Government’s program is approved. As this job protection came close to the end in November and December 2015, two junior coalition members (namely, Batkivshchyna and Samopomich) called for the Government reshuffle. Even before, the coalition was fractious and the Government frequently had to rely on votes for MP’s outside the coalition to get laws passed. As negotiations on government reshuffle came nowhere a number of MPs called for Government’s resignation.

The confrontation between the Government and the Verkhovna Rada came to a head in February 2016. The Parliament declared the Government’s performance unsatisfactory but failed to get enough votes for no-confidence motion. Prolonged political instability resulted in further delays for third tranche of the IMF loan (which was initially scheduled for the end of 2015) and might also lead to postponed assistance from other international donors. It also slowed down the implementation of required reforms. If instability would continue for longer than a few months it may threaten macroeconomic stability. It has already contributed to higher volatility of the exchange rate, which may increase further if Ukraine loses access to external funding for prolonged period. This may also result in higher inflation. Thus, the immediate concern is settling the question of who should be the Prime Minister. This should help reduce uncertainty, preserve stability in the economy and prevent worsening of short-term economic prospects. However, economic recovery and medium-term growth prospects will depend on continued reforms. Ukraine will also have to work to modernize production capacity and replace aging equipment, revitalize infrastructure, and increase productivity.

The agenda for the reforms is long but over the last two years progress was made in many areas. The Government should continue efforts to increase efficiency of public spending and improve fairness of tax system. This includes more fair distribution of social contributions and personal income taxation (including wage de-shadowing) as well as introduction of means-tested social welfare assistance. The housing and utility subsidies should be revised to add incentive for energy efficiency. We think that the major taxes should remain effective. In particular, the Government should increase efficiency of EPT rather than substitute it with the tax on redistributed profit. The exporters should receive VAT refunds within reasonable time. Besides, the Government should continue moves for more open and inclusive public procurement.

The energy reform should continue. Increase in tariffs has already produced results in the form of massive reduction of the Naftogaz’s deficit and the reduction of inefficient energy consumption. This helped to stabilize energy grid in winter and reduce reliance on imported gas from Russia. However, reduction in energy subsidies should be coupled with increasing efficiency of local utilities and continued protection of the vulnerable consumers. Recent reduction in world energy prices may help to ease the process.

The reform of state-owned entities should be finally completed. In particular, the Government should restart the privatization process as soon as possible and complete sale of most companies (except for strategic ones) within period of three years. At the same time, the corporate management of state-owned companies should be efficient while fulfilling public policy objectives. For this, the Government should finally complete competitions for the appointment of directors at these companies.

The deregulation and technical regulation reform removed a number of obstacles for doing business in the country. However, the EU-Ukraine Association Agreement requires efficient market supervision from Ukrainian authorities to ensure EU market access for Ukrainian companies. Moreover, a degree of government intervention is still needed to ensure safety, protect environment and reach other public policy goals. Continued reform of law and justice system is needed to make sure that laws are faithfully executed, enforce contracts and remove the spectre of corruption. Without these crucial steps simplification of procedures and removal of regulations will have little effect on business climate.

Equally important for economic recovery is ensuring that Ukraine has human and physical capital to develop new goods and produce them. This would require efforts on revitalizing transport infrastructure, successful financial sector reform that will help to channel savings to most efficient investments, science and education reform that will produce qualified workforce and intellectual property needed to compete in global marketplace. The Government should also ensure development of small and medium companies, which require better access to the financing.

Administrative reform should result in nimble and well-paid civil service with focus on policymaking functions, while most administrative services would be devolved to the local authorities as well as the revision of functions of most central executive entities. As a result, number of civil servants will decline. At the same time, those servants that remain at work should receive substantial increase in wages after check of their competences, which would reduce corruption.

To sum up, political instability is not good for economy. In the short-term, the clarity on who governs in Ukraine is needed to maintain fragile macroeconomic stabilization. In the medium term, the main cost of political crisis is loss of continuity and delay or derailment of reforms needed for economic recovery. On the bright side, reforms now have more momentum than at any time over the last fifteen years. If political crisis is resolved in the nearest future and current progress is continued Ukraine may be ready to return to growth over the next few years.

In the future Ukraine should make sure that economic policy and reform agenda would be more insulated from political instability. This can be ensured only if efficient and effective medium term planning is introduced. This relates not only to the implementation of full-scale medium-term budget expenditure framework, but also approval of clear-cut medium-term program with clearly defined policy priorities. This would increase transparency and predictability of Ukraine’s development, which would increase its investment attractiveness. The Government should introduce promised reforms, which would improve business climate and attracted required foreign and domestic investments to the country.

The article was published on March 11, 2016 as a Highlight of the Month in the Issue #3 (185) of Monthly Economic Monitor of Ukraine (http://www.ier.com.ua/en/publications/regular_products/monthly_economic_monitoring?pid=5199)

Oleksandra Betliy
Vitaliy Kravchuk
The Institute for Economic Research and Policy Consulting - Kiev