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2 April

“Ukraine’s economy can’t grow as long as we don’t change the role of the enforcement agencies”

Finance Minister about reforming the State Fiscal Service and other challenges facing Ukraine’s domestic economy

Interviewed by Lyubomyr Shavalyuk

So far, there’ve been more talk and scandals around reforming the State Fiscal Service (SFS) than actual results. What are your thoughts on that?

— Back in 2016, right after I was appointed, I evaluated the reform of the SFS, which had been going on for more than a year, and gave it negative marks. There were plenty of nice-looking reports, lots of numbers and many lauded ‘victories,’ but in reality the situation on the ground had not changed at all. Corruption reigned and pressure on business continued. When you look at reports like that, you get the false impression that things are so great that nothing needs to be done.

But the key point is what taxpayers think of the way the SFS has changed. According to a poll of the business community published recently by the American Chamber of Commerce, the SFS was #2 for corruption after the courts. In other words, we can talk all we want about reforms, but this is what those who directly work with the Service on a daily basis had to say about it.

This means we have to look beyond statistics that are being massaged, beyond the standard clichés about how good everything is. For instance, let’s take a look at those aspects that can’t possibly be successful without reforms. Have new people come in? No. Has the level of influence of lobbying groups gone down? No. I would even say that it has increased. Do you want to know why? Because one year ago, when we managed to introduce a transparent register for VAT refunds against enormous resistance, someone lost a few billion. We completely removed certain people from the VAT refund process, which now takes place completely transparently and automatically. Any attempt to abuse this system is now immediately apparent. And those folks who lost out are trying to compensate their losses in other areas, where they still have some leverage.

What is your game plan for this reform?

We’re going to continue changing the way the SFS operates but the key here is to change the people. That means starting with a transparent competition to select the management of this agency. Now that [ex-SFS director accused of corruption and arrested in March 2017 Roman] Nasirov has finally been fired, we have both the opportunity and the duty to run a proper competition. In this respect, I have already organized a few meetings, both internal ones and ones with members of the SFS reform project’s supervisory board. This board includes five ambassadors—of the US, Canada, Germany, Sweden and the EU—, representatives of the IMF, the EBRD and the Business Ombudsman Council. Representatives of partner countries and IFIs have also been engaged in different processes. For instance, they played an active role in coming up with approaches to selecting managers at major state corporations.

As you know, when the Naftogaz Ukrainy board members quit, this led to a lot of concern, including at Naftogaz itself. The situation had to be resolved very quickly. Worries about the fate of this company were justified, as it’s very large.

But let’s look at the SFS. If we look at it like an enterprise, its indicators are several times larger than those of the state. For instance, the SFS collected taxes and duties worth over UAH 840 billion in 2017 alone. Yet its activities influence the level of corruption and the business climate in the country and, in the end, competition. Obviously if one company in a sector pays taxes and its neighbor does not, this damages the competitiveness of the sector. That’s why we can’t take a purely formal approach to selecting the SFS management. This competition should restore some trust in the organization. But to achieve this, we have to engage the community as much as possible. Without this kind of approach, there will never be any confidence not only in the chosen managers but in the very reform of the Service.

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There’s another important point. If we just do things pro forma, in the best case we will hire people who are properly qualified, have managerial skills and so on. So what do you think? Can a person who worked 10-15 years in the SFS or even in the private sector, like Nasirov, might meet these requirements? I think that they certainly won’t be the worst candidate on the list. But what they will be missing is honesty. Because the worst option for us will be to hire a smart manager with really strong contacts and great communication skills but inclined to corruption. That kind of pro forma selection will be correct, but nothing will have changed.

Transforming the SFS into a transparent service agency is the #1 reform for Ukraine. This one aspect affects the business climate, and that means the country’s investment appeal and economic growth. So everyone who’s interested in this should take part in the transparent selection of the State Fiscal Service management and keep a close eye on the process.

The SFS reform plan goes like this. After a number of Cabinet resolutions were canceled [by the Government on January 11; the resolutions referred to the reorganization of the SFS structure, the appointment of new people and final abolition of the tax police] we will once again submit them to the Cabinet and they should get a new lease on life. I’m confident my colleagues will support them. Changes in the structure of the Service and the selection of new staff will help diminish the likelihood of corruption and will cut off the interest groups that currently control some aspects of the Fiscal Service’s work.

There have been precedents where competitive hiring has turned into a farce, such as in the case of UkrSpirt, the alcohol monopoly. How possible is it that this could happen again?

— It’s quite possible. Look at how the process works. There’s a [competition] commission, we’re supposedly taking all the right steps, we’re including external experts to ensure trust in the process, and afterwards we feel insulted when they see a scam going on and turn their backs, saying that they don’t want anything to do with it.

Right now, the premier is setting up a new group for selecting managers in line with recommendations from our partners and based on government proposals. In other words, we are re-launching the process of selecting managers for state enterprises and are applying a new approach to it.

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At the same time, we have to get going with privatization. The 2018 Budget anticipates UAH 22.5bn in revenues from privatization, so I hope that Ukraine will be able to get this process going. I’ve already met with people from the EBRD and a number of investment banks to think about how to launch privatization, given that next year is a double election year.

I remember an example from my own investment days: when you look at the prospects for investing in different countries, you always consider the political situation. This is normal global practice. And when elections are looming, they often say: “Let’s wait and see what happens after the election.” I’m sure this will be happening in a lot of financial centers this time as well, and it will be very difficult to persuade investors to put their capital into something before these elections. This factor needs to be taken into account, but that’s not a reason for us to stop the process. Otherwise those who are sitting at state enterprises will continue to manage them poorly, to siphon off assets and to work against the national interest. It’s Ukrainians who will feel the loss of tens of billions of hryvnia every year because of this.

Let’s assume that the SFS hires new people who are reform-minded. How far will this go to restore confidence in the Service?

— This is a necessary but insufficient condition. A good deal will also depend on tax policy as well. It has to be aimed at eliminating potential sources of corruption, like the launch of the automatic register of VAT refunds or the “one-stop shop” at Customs. Both the Tax and Customs Codes need to be understandable and not allow for a variety of interpretations. This means changing laws, which is a task for the Finance Ministry, which establishes policy, and the Government and Rada.

Yet another important element in restoring trust is streamlining procedures at the SFS, because the simpler they are, the less they demand of taxpayers and the fewer opportunities officials have at various stages to interfere in commercial activities. And that reduces corruption risks enormously.

One very important change that MinFin initiated last year was the “one-stop shop.” This is a revolutionary step for us as it forces all state agencies, such as the State Consumer Product Service, the State Environmental Inspection, the State Border Service, and the SFS, which control goods on the customs territory of Ukraine, to work as a single unit. So, for goods to enter Ukraine, a business needs to only deal with the government in electronic form. Right now, businesses are being sold a story that there’s no state but there is Customs that exists as a separate entity, with border guards, ecologists, phytosanitary services and so on. They say, “We at Customs have done our job and you’ll just have to go look elsewhere to find the other oversight agencies. That’s not our problem.”

That’s why economic growth is at such a slow pace here. If we behave this way towards those who help our economy develop, we get the result we deserve. I’m certain that people in all agencies who are officially—and occasionally unofficially—engaged in oversight all get their cut and they will definitely insist on maintaining the existing system. We’re against this, and launching a “one-stop shop” will go a long way to resolving this problem.

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Last year, we launched a pilot project on a voluntary basis. As of February 1, 2018, our “one-stop shop” became mandatory for all agencies across the country, with some provisions for a transition period. This has required major changes in the way all these agencies operate. When things got stuck, we were forced to call these agencies together at the ministry, to work out a common vision and resolve issues that they were unable for some reason to resolve between them on their own.

What do we see today? Built-in interdependence. Now it’s a lot harder to hide something because the documents have to be delivered on time—this applies to all documents for goods going through Customs are submitted in advance—, and by the time goods arrive at Customs, they are already registered with the various services. This has made it very difficult for a vehicle to jump through unnoticed or to skip one of the mandatory inspections. People who have been abusing the situation can already see that they will be caught, as everything is visible in the system now. Businesses are slowly starting to understand clearly who’s responsible for the process, what documents need to be submitted and how long the oversight will take, who’s responsible for any delays and whether there are grounds for them. We are monitoring this process and working to improve procedures all the time. Today, about 80% of all documents are being handled through the one-stop shop.

We have a few other initiatives as well, which we hope will be introduced at the legislative level so that Ukrainian business can continue to cooperate unimpeded with foreign partners and so that Ukraine doesn’t find itself on any black lists in Europe. For instance, by the end of this year, we hope to finish implementing the minimal requirements, that is the first four steps of the OECD plan to prevent tax base erosion and profit shifting (BEPS). This includes joining the MLI or multilateral instrument, which makes it possible to amend all bilateral agreements about dual taxation. I think that in the next while we will also implement this. In short, we’re tackling reforms from three angles: changing people at the SFS, streamlining SFS operations and procedures, and improving tax policies.

What impact will eliminating the tax police have on the reform of the SFS?

— This is another key issue, without which real reform will be impossible. The tax police have effectively been outside the law for over a year, but we’ve been unable to completely close them down. That’s because one of the MinFin resolutions canceled by the Government provided precisely for this. In other words, the tax police are now part of the SFS, but its activities are not recognized in law. Yet it continues to operate and to be funded out of the budget. Meanwhile, its staff has no incentive to work because they know that their department will soon be closed down. We really need to finish this process.

Why is eliminating the tax police so important to the reform of the SFS? Our goal is to transform the SFS into a service agency. That means that it cannot include a law enforcement unit, let alone one with the reputation that the current group has with business. This kind of “whip” has no place in the SFS and it should never even be an option to use it to put pressure on businesses. Once that is done, using the right approaches, people, processes and key performance indicators (KPI), we can look forward to the successful reform of the State Fiscal Service.

The tax police and its attacks on business should become a thing of the past. On the other hand, we do need a Financial Investigations Service (FIS) and this episode also reads like a detective story. In March 2017, the Government vetted a bill on setting up the FIS that had been drafted by the Finance Ministry together with other ministries and agencies, experts and business. Unfortunately, that’s as far as it got. Once this bill is passed, it will mean very serious changes, including the loss of influence of a number of enforcement agencies. Despite the fact that we have been an independent nation for so many years, our enforcers still play a very large role, not just in the economy, but in every aspect of the lives of our citizens. A far too large one. This is completely unacceptable for a democratic country.

Once there is an FIS, the function of investigating white-collar crimes against the state will be shifted from the SBU, the National Police and the Prosecutor General’s Office and the tax police will be eliminated altogether. The 15,000 people who work in these agencies today will be reduced to a maximum of 3,500. Most of them will be new individuals whose hiring will be based on very different principles and who will undergo special training. The experience of the current lot in this sphere is not needed at the FIS. We need people who can fight in a broad-based way with complicated financial crimes such as tax evasion, money-laundering, deliberately bankrupting banks and state enterprises, and so on.

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Ukraine’s economy can’t grow as long as we don’t change the role of the enforcement agencies. Do we need the SBU? Yes, very much, but as an oversight agency. Counterintelligence officers should have very high salaries, be professionally trained, and protect the country from foreign agents working against us—right now there are many of those. These people should be an elite force, but when they see next to them a huge department engaged in activities that are not its remit, interfering in all kinds of commercial processes on absolutely fictive grounds, and motivated by reasons that are all too obvious to everyone, this harms morale in the counterintelligence units and establishes a completely inappropriate image of the agency as a whole.

The same is true for other agencies, especially the Prosecutor General’s Office. Does it need to be powerful? Absolutely—in order for the country’s interests to be professionally defended in the courts, and for operational and investigative activities to be properly overseen. Absolutely not in order to put pressure on business and on civil society, to prevent the return of money that has been siphoned out of the banking system, and so on.

Currently, this division of spheres of influence is hampering the process of setting up a new, independent agency. So, yes, progress will not be easy, but all those who are trying to slow down this process need to start thinking about their country and not just their own narrow interests.

Right now there’s a lot of debate about how Ukraine should grow its economy. One side talks about a completely free market. The other side talks about the Asian tigers, where the state supports the establishment of its own transnational corporations and then lets the float freely on external markets. What do you think about this?

— I prefer the first model—an open market and competition. That’s my general position, especially with regard to Ukraine. First of all, historically, any kind of state interference led to corruption or was so incompetent that it hurt growth. Secondly, our state institutions are too weak. They need to be reformed long before we can even consider letting such institutions manage the country’s economy. So the only proper choice for Ukraine is a liberal one, maximum competition, and limited government influence over the economy.

One of the most significant impulses to Ukraine’s economy right now should become transparent privatization. For instance, for many years now, we’ve been debating land reform, but nothing’s been done. Today, those who say that Ukrainians are against land reform are simply manipulating the facts. Indeed, those who are gaining economic and political advantages from the moratorium are against reforms. These people spent years scare-mongering Ukrainians and those phobias have helped entire parties gain seats in the Verkhovna Rada, earn money and live a lot better than the farmers that they are supposedly trying to protect. Playing on such irrational thinking has turned out to be a pretty good business for them.

After all, reforms are not intended to satisfy those who have been living off ordinary Ukrainians who own land. A free land market is our chance to give the economy a real shot in the arm. For changes to be felt across the country, the economy has to be growing at 7-8%, and that’s quite impossible without land reform.

Agriculture is now one of the main drivers of the domestic economy. Ukraine has definite competitive advantages on world agricultural markets and it has been showing good results: #1 in the world for exports of oil, in the top 5 for creamery butter, among the top 10 exporters of food products to the EU, and among the top 10 exporters of flour in the world, and more. And this is despite the obstacles we have generated all by ourselves! The farm sector has lots of potential because of the situation on world markets. The question is, how should it be developed? Land reform is a big part of the answer to that. If the farm sector begins to develop, we can look forward to new jobs and more budget revenues. But right now there’s a moratorium and someone is paying for that: people get smaller salaries or pensions, while others can’t afford to pay for higher quality healthcare. The ban on the sale of farmland limits the growth of agribusinesses, it has a negative impact on the economy as a whole, and it reduces opportunities to cover public spending, especially for social services.

Our opponents say, “How much can you talk about agriculture. We need to develop high technology.” My take on that is that we should first figure out what’s happening with the most obvious things. How are these ‘market experts’ planning to generate something new? Through another moratorium? “OK, so, to develop high technologies, let’s institute a ban: you do whatever it is you do, but we won’t let you commercialize or sell it, because that will cheapen it. That’s how we plan to protect you.” If ‘specialists’ with this kind of approach try to develop other sectors of the economy, lots of folks will pack their bags and leave.

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It’s been 10 months since we’ve had a tranche from the IMF. Does the Government have a Plan B for generating the necessary reserve of hard currency, given how much we will have to pay out over 2018-2019?

— I think it’s too soon to talk about a Plan B. Our position is to continue cooperation with the IMF. Why is it that we could leave the program because we didn’t set up an Anti-Corruption Court? How will we explain how this happened? Because we don’t want to work with the IMF or we don’t want to fight corruption? Let’s not confuse causes and effects.

This is not going to be an easy year for us. Even if we survive it and make it to 2019, the country faces major payments on external debts that have accumulated in the last few years. Of course, the Ministry has the necessary instruments to regulate individual problems. And we are expanding our set, we’re increasing domestic bonds, and we’re generating opportunities for foreign investors to borrow in hryvnia. We’re doing a lot, but it’s not in order to say that we don’t need reforms of we can do just fine without the IMF. We’re doing it because such instruments should be available in any proper financial system.

The IMF program is also linked to the trust of foreign investors, a signal to them that we are taking on reforms. One thing that also needs to be understood: for the economy to grow much faster than now, serious investments are needed. Who generates new jobs, whether it’s an investor from Munich or from Mykolayiv, doesn’t matter. Unfortunately, it’s turned out that a lot of our local investors, who often acquired their businesses through dubious privatization deals, moved their profits offshore. That’s what we call a national investor? And then they come along and say, “Why do we need foreigners?” For Ukraine’s economy to grow, we need investments and investors who believe in the country, who want to honestly grow their business and pay their proper taxes. So we need to show them that Ukraine is moving forward with reforms.

And so we intend to do everything that’s needed so that Ukraine can successfully complete a cooperation program with the IMF for the first time in history. I think we will manage to launch the Anti-Corruption Court. This is one of the points in the memorandum, but this is not because the IMF needs it but because Ukrainians want it and it’s a key step in the transformation of our country.

As to the natural gas sector and rates, we’re looking for a solution there. More than 50% of Ukrainians are receiving subsidies from the government today and are socially protected. Raising rates will only increase the number of subsidized households and public spending on them. Yet given the way the system currently works, this won’t be compensated by profits from Naftogaz Ukrainy. More importantly: reforming the gas sector isn’t just about raising rates but about setting the necessary conditions for competition to grow in this market. We’re talking to the IMF about all these things in a comprehensive way and looking for the mechanism that will reduce the impact on ordinary folks as much as possible. We understand very well just how painful this issue is.

It’s also worth noting that quite a few of our hard currency payments are taking place using internal instruments and some of the payouts scheduled for 2018-2019 we plan to refinance on the domestic market, as the IMF program anticipates as well.

In addition to this, we have begun active operations with our external bonds. During the placement of eurobonds in September 2017, we replaced most of those that mature in 2019 with new 15-year bonds.

Bio

Oleksandr Danyliuk was born in Moldova in 1975. He graduated from Kyiv Polytechnic Institute with a degree in electrical engineering. He also graduated from the Kyiv Institute of Investment Management with degree in investment management, and an MBA from the Indiana University Business School in the US. Mr. Danyliuk worked in the investment business and consulting in Kyiv, Moscow and London. He was appointed Minister of Finance of Ukraine in April 2016.

Translated by Lidia Wolanskyj  

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