Can Ukraine Avert a Financial Meltdown?

Cash-strapped Ukraine had drifted to the brink of an economic crisis by mid-June. While the budget deficit swelled, the wage and pension arrears further accumulated, provoking angry strike action from miners. The country’s payment obligation to foreign investors surged to a dangerous level. The legislative process has been paralyzed for months following the March election, as the parliament (Verkhovna Rada), dominated by leftists and centrist opposition, was unable to elect the speaker who is extremely powerful politically in Ukraine. Finally, in early July a prominent figure of the opposition, Oleksandr Tkachenko received the necessary votes. That makes him a likely candidate to contest the presidential elections in the summer of 1999.

Some major highlights of the present economic situation are as follows:

• The government’s already large debt is expanding as a consequence of sizable budget deficits. In the first four months of 1998 budgetary revenues amounted to 4.1 billion hryvnias (against a full-year target of 21.1 billion hryvnias), while debt-servicing and repayment costs were 4.7 billion hryvnias. The revenue-collection shortfall so far this year as a result of tax evasion and delayed privatization initiatives is estimated at more than 5 billion hryvnias. Prime Minister Valery Pustovoitenko acknowledged that privatization receipts from January to May were 214 million hryvnias, against a full-year target of more than 1 billion hryvnias.
• The short-term obligations of the government are fast increasing. The budget deficit has been financed primarily through the selling of treasury bills (T-bills). In 1996 investors held T-bills with a total value of about $1.9 billion. In 1997 the government’s obligation increased to $5.6 billion and in April 1998, to $6.5 billion. The government has to redeem about $4.5 billion hryvnias worth of bonds within nine months; and $500 million worth of T-bills matured in June. Also, the interest rate is high and yields on treasury bills of various maturities are currently at 60 percent.

Foreign investors—who held half of Ukraine’s treasury bills last year—are increasingly selling their holdings. They have been purchasing only 10 to 25 percent of the securities in recent months. Their exodus from the T-bill market has already forced the National Bank to spend $1 billion to prevent the hryvnia from falling. The money comes from borrowing on the overseas capital markets. After borrowing more than $1 billion recently, the government is now planning to raise another $2.5 billion to pay off mature T-bills and foreign debt in the next three months. Ukraine’s foreign debt has reached $12 billion, compared to $450 million in 1994.

• The government’s huge financing needs crowd out the "real economy’s" capital needs. There is an acute shortage of credit. In 1997 commercial banks provided less long-term loans to enterprises than in 1994, when inflation was still rampant. (At least inflation has been constrained; in 1998 it lingers below 10 percent.) The maturity of most long-term loans is limited to one year and the loan recipients are usually forced to put up collateral worth 20 percent more than what they borrow. About 30 percent of bank profits come from nonlending activities—mostly trading—and the rest mostly come from short-term loans to favored customers.
• In 1997 Ukraine’s GDP fell by 3.2 percent—the GDP has fallen by 60 percent since 1991. Finally, in the first five months of 1998 it showed a 0.1 percent growth, compared to the same period last year. The GDP now stands at 35.7 billion hryvnias. While 12 percent of industrial units were officially recognized as unprofitable in 1995, the figure rose to 30 percent in 1996 and 45 percent in 1997. In January–May 1998 the number of loss-making companies grew to 51 percent of the total.
• At the end of last year bad loans were estimated to account for 21 percent of the total assets of Ukraine’s 30 largest banks, even using Ukrainian accounting standards. Bad debts at the three largest banks were even more significant, forming about one-third of the loans issued by Ukraina Bank and Oschadbank and 19 percent of Ukrsotsbank’s portfolio. Ukraina Bank has been the primary cash conduit for Ukraine’s large collective farms and agribusinesses. The bank’s shaky finances reflect the continuous decline of the agricultural sector since 1990.
• The omnipresence of corruption has been criticized recently by Professor James Mace, consultant to the Kyiv-based Deni (Day) newspaper. "Lawmakers openly sell their votes. The Interior Ministry has not solved a single big case like a political or big-business murder. Humanitarian aid is openly sold in almost every bazaar. The secret police agent spying on you can actually come up, introduce himself, and complain about how poorly he is paid. And nothing whatsoever can be done about it given the poverty that breeds corruption," he lamented. According to an IFC survey small business owners receive a visit from a Ukraine government inspector once every four days. Given that the loss of any of the 36 licenses and permits needed to run a business would spell closure, most Ukrainians take these official "courtesy calls" very seriously. The state-sponsored meddling could be one reason why most of Ukraine’s economy is run off the books and out of sight.
• The shadow economy has reached 60 percent of GDP, Ukraine’s tax chief acknowledged in mid-June. Mykola Azarov, head of the State Tax Service, estimated the size of the shadow economy at between $13 billion and $15 billion, with the vast majority of commerce conducted in dollars. Only $3 billion of the total is kept in hryvnia." The withdrawal of money from the legal economy into the shadow economy is continuing," Azarov told the daily Facti. The existence of the shadow economy has hampered tax collection and has deepened the federal budget deficit. Tax arrears for the five months of 1998 stood at 25 percent for value-added tax, 15 percent for excises, and 87 percent for rental payments for oil and gas extraction and transit pumping of natural gas. More than 40 percent of all transactions in the economy are made through barter.
• Wage and pension payments arrears remain high. Wage arrears continue to grow and are estimated at $2 billion. Strikes by some 12,500 miners nationwide halted around one-third of the country’s coal mines, cutting national coal production by some 35 percent since the beginning of the year. Miner organizers estimate total wage arrears to miners across the country at 2.21 billion hryvnias ($1.1 billion). The miners are owed on average eight months in back wages, according to the Coal Industry Ministry. According to World Bank calculations, the average production cost of Ukrainian coal is about $50 a ton, compared with a world market price of $35. The industry is also caught in a web of inter-enterprise debt. Only four of Ukraine’s 250-odd mines are profitable at present. At most, 50 of the bigger ones have a future if they shape up. But making the mines profitable would cause social tensions. In the eastern province of Donetsk, coal mining supports 13 percent of the workforce. The government recently provided some funds to coal-producing regions and promised to give an additional 600 million hryvna allocated by parliament to help the miners.

At the beginning of June pension arrears stood at 1.6 billion hryvnias ($800 million). Elderly people in eastern Ukraine who have not received pension payments for five months have been offered free coffins as an alternative, Facti reported.

Presidential Measures

On June 19 Ukrainian President Leonid Kuchma signed 15 emergency economic decrees aimed at raising revenues, cutting expenditures, and stimulating production. He warned the country’s parliament, which was too paralyzed to act while heavy international borrowing was nearing a critical mark, that a crisis could undermine the stability of the hryvnia.

The Presidential Decrees include:

• Halving the obligatory payments by employers (of their workers’ salaries) to 5 percent to go to a special government fund dealing with the consequences of the 1986 Chernobyl nuclear disaster.
• Unifying the agricultural production tax (10 such taxes existed previously).
• Allocating some 1.25 billion hryvnia ($625 million) in state funds to pay wages, pensions, and social benefits;
• Allowing the government to introduce new excise and import tariffs.
• Restructuring or canceling debts by agricultural enterprises.
• Setting up "special economic zones" in the coal-producing Donetsk region.
• Lowering the current 20 percent value-added tax and simplifying tax procedures for small businesses.

The president’s latest decrees will be submitted as draft laws to parliament and will add to the stack of 42 draft bills languishing in the parliament’s in-box. (The Ukrainian Constitution forbids the president from issuing decrees that contradict legislation. Many of Kuchma’s economic decrees, including the latest ones, can be challenged on those grounds.)

The new measures were announced soon after the latest mission from the IMF started its consultations in Kyiv on June 15. In July 1997 the Fund refused to grant a three-year, Extended Fund Facility (EFF) loan worth $2.5–3 billion, instead awarding the one-year standby facility. But even that standby’s disbursement was suspended after Kiev ran a budget deficit of almost 6.0 percent of GDP in the first quarter of 1998. The target set in the 1998 budget is 2.3 percent of GDP. The IMF has repeatedly faulted Ukraine for not implementing meaningful economic reforms, including sweeping privatization and structural economic changes.

"Ukraine is doing a better job of managing its economy and might qualify for a resumption of aid from the International Monetary Fund," First Deputy Managing Director Stanley Fischer was quoted as saying on June 21. Negotiations were focusing on a $2 billion EFF loan and the resumption of a $542 million standby credit. Fischer said that there are still some technical problems and that the final decision on the EFF loan will be made in late July.