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29 November, 2011

Crisis of Vision

Even top government officials acknowledge the low quality of public administration in Ukraine. Their confessions are comically tragic

Global economic growth is expected to fall from 3.8% in 2010 to 3.2% in 2011, according to the latest report from the World Bank. In 2012, the trend will continue. Russia’s growth outlook appears even gloomier: it will slip from 4.7% to 4.1% (IMF) or from 4.5% to 3.7% (World Bank).

Meanwhile, the Ukrainian government seems to be turning a blind eye to these global trends, despite the fact that its foreign debt service payments will peak in 2013. The Ukrainian government is doing the opposite of what EU economists recommend as a way of handling the crisis.

The first and foremost requirement on all EU members is stringent control over spending, primarily with regard to administrative, rather than capital, expenditure. In contrast, Ukraine has been increasing administrative spending since 2009. For example, funding for the Prosecutor General’s Office has increased by 150% and for the Interior Ministry by 80%. The cost of presidential activities has nearly doubled. Worse still, the draft state budget for 2013 includes subsidies to Naftogaz and Ukrenergo to the tune of UAH 13 billion.

Another typical requirement in the EU is limiting the country’s debt burden. In Ukraine, the previous and current governments each borrowed $15 billion. Sooner or later, this money will have to be paid back. Ukraine’s sovereign and guaranteed debt will reach $62 billion (40% of GDP) by the end of 2011. The IMF set the critical level of our sovereign debt at 40% of GDP and in the summer of 2010, when this debt was at 36% of GDP, Deputy Prime Minister Serhiy Tihipko acknowledged that “this figure was critical for us.” And then what? To pay off its debts, Ukraine will spend UAH 89 billion in 2011 and nearly UAH 60 billion in 2012. With this in mind, one must remember that the country had a colossal negative foreign trade balance – $6.67 billion in January-July 2011.

Whether we like it or not, the stability of Ukraine’s national finances is directly dependent on IMF loans. Just like the German Bundestag decides whether Greece will default, the IMF plays that role for Ukraine.

Another EU demand is enhancing the quality of public administration, especially in the economic and financial sectors where a mistake may cost billions. For example, the EU suggests that Greece carry out a large-scale privatization program worth €50 billion by selling off key banks, electric energy monopolies, communications and gambling businesses. It is doubtful that Greece would sell its assets like Ukraine – through non-competitive procedures to a single bidder.

Even top government officials acknowledge the low quality of public administration in Ukraine. Their confessions sound comically tragic, because they could fix the situation if they wanted to. For example, First Deputy Prime Minister Andriy Kliuyev recently said: “The paradox is that Ukraine ranks high in international ratings in terms of its natural, labor and intellectual potential. But when it comes to managing these resources, we bring up the rear in all ratings.” For example, Ukrainian officials indulge in repeating that the country can potentially export 24 million tons of crops ($6-7 billion), but this summer, the government inexplicably introduced grain export quotas which badly damaged Ukrainian exports — and this at a time when global prices were topping out. Only after they fell did the pro-government majority in parliament lift the quotas. This policy caused at least UAH 10 billion in damages to agricultural producers and the country in general.

Yet another fundamental EU recommendation is improving the economic climate. Again, Ukraine is moving the other way: it slid from 149th to 152nd place in the 2012 Doing Business report by the World Bank and the International Financial Corporation to find itself in the uncomfortable company of Liberia (151) and Bolivia (153). In the 2011 Economic Freedom of the World rating, Ukraine ranked 125th among 141 countries, one position behind Senegal. The government’s talk of a radical improvement of the investment climate is a bluff. After implementing the Tax Code alone, the number of Ukrainians wanting to open their own businesses dropped by 67%. According to Ukraine’s National Bank, 30.5% of enterprises (down from 36%) believe their economic condition has improved.

A number of artificial monopolies have been set up in Ukraine most of which are utterly inefficient and are able to operate only because of very low wages and tax evasion. Excessive monopolization of the economy is not the same thing the EU criticized in Greece where 200 enterprises account for half of GDP.

The EU demands that Greece end unprecedented levels of tax evasion. For Ukraine, this is a two-edged weapon, but sometimes the figures are simply overwhelming. For example, the total volume of direct foreign investments in Donetsk Region is $2.2 billion, while $5 billion is withdrawn to Cyprus alone.

The EU members are paying more attention to managing the financial markets and bringing in stricter standards for banks, particularly regulations pertaining to equity capital. Since the onset of the crisis in 2008, financial institutions in Ukraine have shifted their problems to the state and by extension, to tax payers.

The EU recipes apply to Ukraine. Why not follow them and amend them to our situation?

The government is cashing in instead of cushioning the country against further crises


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