Ukraine: Making Strategic Choices for Sustained Growth

Challenge

Ukraine has long been thought to be performing below its potential, lagging behind its Central European neighbors and facing serious governance and institutional weaknesses. Because of strong demand for Ukraine’s traditional products (metallurgy, machinery, chemicals), however, economic growth averaged 7.5 percent per year from 2000 to 2007, the fiscal deficit was a low 2 percent of GDP, foreign capital was flowing in, and public debt was low. Due to high social spending and the buoyant economy, poverty had fallen sharply. Ukraine became a member of the World Trade Organization (WTO) in 2008, but later that year, long built-up vulnerabilities and accumulating macro-imbalances resulted in a severe triple crisis. Markets reacted quickly, and by end-2008, Ukraine was shut out of international capital markets, suffering losses in reserves and bank deposits and sharp drops in fiscal revenues and exports, especially steel, its major export. The bottom was reached in mid-2009, when GDP shrank by 14.8 percent year-on-year, one of the most significant drops among middle-income countries. Although Ukraine’s growth resumed in the aftermath of the crisis, uneven reform implementation impedes its prospects. Weaker global growth, volatility in the Eurozone, and disruptions in global financial markets further complicate the situation. More ambitious reforms, including fiscal consolidation and energy and banking sector reform, are needed to address vulnerabilities and reduce risks, while deeper structural reforms are required to sustain medium-term growth and help realize Ukraine’s substantial growth potential.

Solution

Bank engagement in Ukraine is guided by the 2012–16 Country Partnership Strategy (CPS), which has two pillars: first, improving public services and finances, aiming for more effective fiscal management, better targeted social assistance spending, and more efficient service delivery; and second, improving the business climate to unlock economic potential, aiming to enhance the business environment and physical infrastructure, reduce the cost of doing business, and create a policy framework to attract investment in agriculture.

In line with the two pillars, the Bank focused on growth and competitiveness, business climate improvements, and investment promotion, and on strengthening public institutions and policies and improving the use of public resources. The Bank, along with the International Monetary Fund (IMF) and other partners, provided extraordinary support to stabilize the banking system and address underlying vulnerabilities. The Bank also supported large infrastructure operations (transport and energy) and helped advance the reform agenda. Analytical work was directed toward core government priorities (competitiveness and energy) and the Bank’s advocacy list (health, demographics, social issues). The International Finance Corporation (IFC) focused on advisory services and investments in the real and financial sectors.

Results

Important results achieved include:

• by 2012, a one-stop-shop model for the administration of social programs was implemented in 753 out of 756 local welfare offices, reducing processing time for benefit applications from 4.5 hours in 2006 to 1.4 hours in 2012. It has also allowed staff to process 50 percent more benefits per month;
  
• improvements in tax administration resulted in a reduction of tax compliance costs and contributed to the improved ranking of Ukraine in Doing Business 2013: (i) establishment of an automated call center allowed taxpayers to obtain information by phone or e-mail and reduced contact with tax officials. Total number of consultations provided by the call center increased from zero in 2007 to 495,000 in 2012; (ii) introduction of a risk-based audit cut the share of enterprises subject to audit from 3.7 percent in 2007 to 0.7 percent in 2012; (iii) introduction of e-filing in 2012 reduced time for tax compliance by 25 percent;
  
• the Rural Land Titling project helped establish a foundation for transparent land market operations by supporting the issuance of 6.8 million rural land titles and the development of a publicly available electronic cadastral system, which reduced time to register a land plot from typically over one month under the previous system to a current average time of less than one hour;
  
• the road upgrading works funded by the Road and Safety Improvement project significantly improved the riding quality on the M-03 road between Boryspil and Lubny. By mid-January 2013, about 74 kilometers of road sections were completed and open for traffic. Road safety works to eliminate the black spots have started, and once finished, expect to reduce fatalities in road accidents from eight to six victims per 10,000 vehicles;
  
• the Ukraine Hydropower Rehabilitation project helped rehabilitate 53 hydropower units in four hydroelectric plants between 2006 and 2012. The capacity of the rehabilitated hydroelectric plants increased by roughly 116 megawatts in 2012, bringing additional reliable, affordable, and environmentally acceptable energy to the people and contributing to increased energy security in Ukraine.

Bank Group Contribution

Since Ukraine joined the World Bank Group in 1992, commitments have totaled US$7 billion for 40 operations. The Bank’s portfolio consists of 10 active projects with total commitments of US$2.04 billion. Portfolio performance has been improving due to joint efforts by the Bank and its Ukrainian counterparts. Ukraine ended FY12 with a historically high disbursement rate of 25.6 percent. IFC to date has invested a total of US$943 million to about 30 clients in Ukraine, while the outstanding gross exposure of the Multilateral Investment Guarantee Agency (MIGA) totals US$1 billion. The CPS envisages financial assistance in urban infrastructure, energy, and social assistance, while structural reforms and governance remain at the core of the analytical program. The Bank’s analytical activities also focus on fiscal, tax, and public financial management (PFM), agriculture, business regulations, and private sector development. Several technical assistance activities build the basis for new lending in the municipal and energy sectors and social reforms.

The contribution and role of trust funds (TFs) to Ukraine’s program (totaling US$18.9 million) have increased. TF activities are supporting numerous CPS priorities, including PFM (capital budgeting, public-private partnerships [PPPs], quasi-fiscal activities, public procurement), municipal services, health sector reforms, and energy. The largest TFs include:

• partnership for Market Readiness (PMR) in Ukraine (US$5.35 million) to create the local carbon market;
  
• Swedish TF for Urban Infrastructure Project (US$5.86 million) to strengthen the capacity of the municipal services sector;
  
• Hydropower Rehabilitation Proto-Carbon Finance Project (US$6.98 million) to reduce carbon emissions through the rehabilitation of hydropower plants.

Partners

Significant efforts to form strong partnerships have been made in previous years. The World Bank Group, with the IMF and the European Union (EU), provided support to stabilize the banking system and address underlying vulnerabilities in the crisis response. Cooperation between international financial institutions (IFIs) in the energy sector, under the aegis of the Brussels Declaration, allowed the partners to agree on an IFI-European Commission (EC) list of key structural reforms promoting IFI investment in the gas sector. Joint advocacy has also been made with the EC on public procurement, with the European Bank for Reconstruction and Development (EBRD) and the IMF on grain quotas and agricultural market interventions, with the U.S. Agency for International Development (USAID) on transparency in capital markets, and with the United Nations (UN) on health sector issues. Partnerships on key policy issues, technical assistance, and advice continue with the IMF, EU, EBRD, European Investment Bank (EIB), USAID, and bilateral donors. In particular, the Bank continues close coordination on policy matrices under the IMF program and EU sector budget support. The ramped-up demand for good governance activities resulted in strong cooperation with the International Renaissance Foundation and USAID. If the Eurozone crisis deepens, cooperation across the World Bank Group and with other IFIs would be strengthened further to maximize impact. The World Bank Group is currently engaged in dialogue with the EBRD, EIB, and IMF on a coordinated response to a possible new crisis.

Moving Forward

To sustain growth into the future, the CPS argues that Ukraine’s biggest challenges would be to:

1. increase its international competitiveness,
2. improve the quality of public services and the efficiency of public finance, and
3. tackle governance weaknesses.

The CPS will continue investments in public infrastructure (transport, energy efficiency), and policy reform dialogue will remain at the core of the strategy to help secure sound public finances, strengthen Ukraine’s energy sector, and reduce financial sector vulnerabilities. To improve its public services, Ukraine needs to spend not more, but more effectively, and the CPS will focus on enhancements in public spending and public financial management overall. Governance remains a key topic of Bank engagement, and although there is consensus in Ukraine that poor governance is a serious problem, there is not yet agreement on the specific reforms needed. The Bank will therefore aim to strengthen the demand for good governance by working with a broad group of stakeholders.

The World Bank is also committed to responding to new challenges in the partnership with middle-income countries like Ukraine: utilizing development knowledge to help craft specific local development solutions, cooperating with other partners to enhance the impact of the Bank’s work, tackling governance weaknesses that are obstacles to sustained growth, and harnessing Ukraine’s potential contribution to pressing global problems such as the food crisis.