1998: THE YEAR IN REVIEW

Ukraine's economy: staving off collapse

Ukraine's economy showed evidence that an upswing might have begun in 1998, after some regions reported an increase in economic activity in mid-year. However, the onset of a financial and monetary crisis in late August caused by the crash of the Russian financial markets killed any expectations that a Ukrainian economic renaissance was imminent.

The year started with a Kuchma administration prognosis that Ukraine could achieve a 1 percent growth in GDP (gross domestic product) - the first upward swing of economic indicators since independence in 1991 - if Ukraine held strictly to austerity programs and kept the budget deficit to a minimum.

However, a report issued by the United Nations Development Program predicted that the quality of life in Ukraine would continue to decline. The annual Human Development Report, which analyzes living standards, the labor market and welfare provisions, concluded that life expectancy in Ukraine would continue to fall and education and public health standards would worsen as the GDP continued to drop. The study's human development index ranked Ukraine 95th among the 175 countries it surveyed.

At the beginning of 1998, Ukraine was already feeling the aftershocks of the collapse of Asian markets, which had been spreading slowly around the world since Thailand's economy had collapsed in mid-1997.

On January 3, Prime Minister Valerii Pustovoitenko announced that his government would focus its efforts in 1998 on reducing the shadow economy in Ukraine, which accounts for some 43 percent of the country's GDP and which Mr. Pustovoitenko called the major reason for the shortfall in Ukraine's annual budget receipts.

Budget shortfalls had forced Ukraine to borrow money on the international bond market for the last two years, treasury notes that would become due in 1998 just as the financial crisis hit Ukraine.

Mr. Pustovoitenko steered clear of any mention of a new tax reform initiative to reduce the tax burden on businesses that have caused many firms to hide their profits, but emphasized the need for tighter control over tax payments and to holding "chronic tax dodgers" criminally responsible. In 1997 Ukraine collected merely 76.1 percent of its projected tax revenues.

Mr. Pustovoitenko also called for strengthening anti-smuggling measures, the use of indirect excise taxes, and the development of trust among corporations and individuals in Ukraine's banking-credit system.

A little more than two weeks later President Leonid Kuchma announced an economic austerity program to fend off tremors from the Southeast Asian economic collapse, after international investors began to quit the Ukrainian treasury bond market, increasing concerns of a looming financial crisis in the country.

The announcement, made on national television, directed the government to cut expenses to reduce the projected 1998 budget deficit from 3.7 percent to 2.2 percent and to reduce the number of government workers by 20 percent. The president said he thought that the two moves, along with aggressive tax collections and an ambitious privatization program, would give Ukraine the hard currency it needed to honor its treasury note obligations.

Anatolii Halchynskyi, President Kuchma's senior economic advisor, said on January 20: "The financial situation of the state is close to critical."

That same day the chairman of the National Bank of Ukraine, Viktor Yuschenko, announced a new currency corridor for Ukraine, a fluctuation band for the Ukrainian currency that the state bank supports and which is supposed to assure foreign investors of the hryvnia's stability. The parameters, which had stood at 1.75 to 1.95 hrv per U.S. dollar, were raised to 1.8 hrv to 2.25 hrv after the NBU failed to support the hryvnia in November 1997 with the onset of panic selling as a result of the Asian market collapse.

The president's administration continued to move strongly to stimulate interest in Ukraine's economy, which had been all but abandoned by foreign investors in the second half of 1997 and had seen a decline in new business registrations by Ukrainian commercial interests. On February 3 President Kuchma signed a second series of presidential decrees to lessen the burden of government regulation and audits, and to establish a fixed tax for small business.

U.S. representatives to the Kuchma-Gore Commission, meeting in Kyiv on February 5-6, applauded Ukraine's efforts to overcome the financial crisis that was threatening the country. "At a time of international financial instability, Ukraine recognized the need to move boldly," said Jan Kalicki, head of the U.S. delegation. However, he noted that barriers to foreign trade and investment still existed, namely, the need to undergo basic economic structural reform and to more strongly support the rule of law.

Ukraine received some hope that it would be able to obtain the money to stave off economic catastrophe and to re-pay its growing international debt when the International Monetary Fund told a high-level Ukrainian delegation in Washington on January 22 that it was ready to negotiate a long-term Extended Fund Facility (EFF) loan program with Kyiv. Ukraine's Vice Prime Minister for Economic Reform Serhii Tyhypko said the figure the two sides were considering approaches $3 billion and hoped an agreement could be worked out by April.

The IMF also agreed to extend to Ukraine a $49 million tranche of the old stand-by agreement, which had been due in December but held up by the IMF. The stand-by program had not been working well for Ukraine since its inception in August 1997 because the country had failed to meet IMF reform guidelines several times, causing delays in disbursements.

On March 14, an IMF delegation again left Ukraine without approving an expected $50 million tranche because Kyiv had failed to maintain agreed-upon financial indicators, which presidential economic advisor Valerii Lytvytskyi said was associated with problems regarding "the implementation of a mechanism to manage spending and the revival of the bond market."

As negotiations continued with the IMF, and with Ukraine for all intents and purposes having abandoned its effort to receive the stand-by loans, renowned international economist Jeffrey Sachs said in Kyiv on June 15 that if Ukraine was denied a new loan program by the IMF the country would be left in dire financial straits.

"The financial situation in this country and the problems facing the government are very intricate, and it's going to be extremely difficult to draw other funds given the situation that has emerged on the international markets," said Mr. Sachs.

The Harvard University professor explained that Ukraine would have a difficult time meeting the 87 requirements that the IMF has listed, and that the international lender should ease its conditions.

While Mr. Sachs spoke, an IMF delegation was meeting in Kyiv with Ukrainian officials on the EFF agreement that Ukraine had requested. Among the sticking points were the IMF's demands for an accelerated and more transparent privatization process, and wider structural reforms in the economy.

A little over six months after negotiations began, the IMF agreed to a $2.26 billion three-year EFF credit arrangement, based on Ukraine sticking to a stringent economic reform program. Among those demands: rationalize the tax structure and reduce tax burdens on business; strengthen financial and monetary institutions; launch administrative reform and rationalize the size of the budget structure; adopt transparent privatization procedures; reduce government intervention in economic activities; reform the energy and agricultural sectors.

On July 31 the IMF mission head said in Kyiv that the economic decrees issued by President Kuchma in the first half of 1998 had gone a long way in improving the business climate in the country and creating conditions for economic growth.

Ukraine received a first tranche of $257 million during the first week of September, after the IMF's board of directors approved the EFF agreement in Washington.

A week later the World Bank, which had made loans worth nearly $1 billion available on the condition that the IMF approve the EFF, announced four loans for Ukraine.

In the September 15 announcement, World Bank officials said they had committed $949.6 million in loans to Ukraine's economic reform effort - $300 million earmarked for continued enterprise privatization and restructuring the securities market; $300 million for banking reform; $300 million for coal and agricultural sector reform; with the remaining money to be dedicated to environmental concerns.

The first two World Bank loans were loosely structured to be available for budgetary use and balance of payments support. Ukraine received the first installment of $260 million three days later.

The European Union followed suit on October 16, extending to Ukraine a $182.5 million balance of payments loan and $203 million for the Chornobyl Shelter Fund that it had promised Ukraine, which had been tied to the approval of the IMF loan. The loan was offered while President Kuchma was in Vienna to meet with European Union leaders and to ask for associate membership for Ukraine. EU officials, while proposing closer economic ties with Ukraine, stopped short of offering associate status.

The money from the IMF, the World Bank and the EU came at a most opportune time for Ukraine as it attempted to deal with the collapse of the Russian economy in August, which included the need to make immediate payments on treasury notes that had come due and to contain a dramatic slide in the hryvnia's value.

Since the beginning of September the hryvnia had fallen 18 percent against the U.S. dollar and would continue to slide until November when its value would stabilize at 3.42 hryvnia to the dollar, a loss of some 75 percent of its value against the U.S. dollar.

The same day the IMF approved the EFF, the National Bank of Ukraine affected a de facto devaluation of the national currency when the hryvnia was allowed to drop below the currency band that had been set in January for 1998. The bank's chairman announced a new band on September 4 that would allow the currency to float between 2.5 and 3.5 hrv to the dollar.

Ukraine had spent millions in foreign currency trying to keep the hryvnia stable as first the Asian and then the Russian crises caused the hryvnia to tumble. By September 9 Ukraine's foreign currency reserves, which had stood at $2.34 billion in January, had fallen to between $860 million and $890 million (U.S.).

With the free fall of Russia's economy, one still closely tied to Ukraine's, Kyiv prepared for the worst. On September 7 President Kuchma sent an economic crisis package of 36 bills to the Verkhovna Rada for immediate approval. Two days later he called an emergency meeting of his top economic officials to examine the state of Ukraine's economy and what further measures were needed to avert a meltdown of Ukraine's economy, as had already occurred in Russia.

On September 14 the government announced two emergency steps to keep hard currency in the country. First, it decreed that Ukrainian banks must keep 75 percent of their currency holdings in hryvni. Then it announced it was restructuring the repayment of matured, short-term government domestic loan bonds to foreign creditors at a 20 percent rate and converting the outstanding debt into long-term treasury notes. It said that 75 percent of foreign holders of Ukrainian treasury notes had agreed to the deal.

After strong protests from Ukrainian banks regarding the first decree, the government lowered the required hryvnia reserve to 50 percent.

On September 23 the president of the Association of Ukrainian Banks, Oleksander Suhoniako, said Ukrainian banks had lost some $800 million as a direct result of the financial and business crisis in Russia, and that the major financial threat in Ukraine was to the country's banking system.

Ihor Yukhnovsky, a national deputy and member of President Kuchma's Supreme Economic Council, speaking at a separate press conference two days earlier, agreed. "The financial problem in Ukraine is the 1.7 billion hrv that the Ministry of Finance currently owes the commercial banks of Ukraine," said Mr. Yukhnovsky.

With the hryvnia continuing to fall, Chairman Yuschenko of the NBU faced increasing pressure to resign.

First, his staunch and protracted support of the hryvnia with scarce foreign reserves was criticized by President Kuchma. Then, on October 16, a routine annual report by the NBU chairman before the Verkhovna Rada turned into a protracted two-day debate on the bank's investment procedures, which ended with the formation of a parliamentary investigative commission to look into the matter.

The president, stymied repeatedly in his attempt to get economic and structural reforms completed and Ukraine out of its financial crunch, turned to the Verkhovna Rada on November 19 in a major policy address called a "non-regular state of the nation address" to get the parliamentary body to act on the dozens of pieces of legislation that the president and the Cabinet of Ministers had sent for approval in 1998. Many of the bills were part of a bloc of economic decrees the president had issued beginning June 18 to maneuver around a Verkhovna Rada frozen by its inability to elect a chairman.

The president called on the Verkhovna Rada to work with the executive branch of power to lift the nation out of the economic crisis, to refrain from calling for monetary emission to pay back wages and pensions and to approve a realistic budget.

The Ukrainian budget for 1999 had been sent to the Verkhovna Rada in mid-October, only to be rejected and returned because the economic indicators didn't reflect the financial realities in the country in the aftermath of the financial crisis. Upon its return, the Budget Committee, chaired by Yuliia Tymoshenko of the oppositionist Hromada Party, rewrote part of the budget and presented a balanced budget that a majority of the national deputies called unrealistic. The Budget Committee had raised expenditure levels over that proposed by the Cabinet of Ministers by 33 percent, while calling for a 5.5 billion hrv monetary emission to cover shortfalls in the revenue side and balance the budget.

Although the plan was rejected by the full Parliament on first reading on December 3, it was subsequently approved on December 9 and sent back to committee for reconciliation with the Cabinet of Ministers proposal.

The IMF, which on November 4, had issued the second tranche of the new EFF, some $78 million, said in mid-December that because of concerns regarding the 1999 Ukrainian budget it would hold off the next scheduled tranche until after it had analyzed the final bill - a process it said could be completed by February 1999. Meanwhile Verkhovna Rada Chairman Oleksander Tkachenko assured everyone that Ukraine would have a budget for 1999 by December 25.

In an otherwise bleak economic year for Ukraine in 1998, a few bright moments did exist.

First there was the signing of a 10-year comprehensive economic cooperation pact on February 20 between Ukraine and Russia, with the goal of doubling trade between the two countries by 2007. However, as with any treaty between Moscow and Kyiv, the agreements brought with them criticism. The Ukrainian media and opposition politicians painted the series of agreements as the selling out of Ukrainian national interests and the first step to re-integration with Moscow. National Deputy Serhii Teriokhin called it "the Belarusification of Ukraine."

Then, on May 9-12, Ukraine successfully hosted the board of governors meeting and business forum of the European Bank for Reconstruction and Development (EBRD), during which nearly 4,500 guests gathered in Kyiv from around Europe. There were no criticisms of Ukraine - only expressions of delight over the beauty of Kyiv and a changed perception of what Ukraine had to offer Europe.

Ukraine had wanted the convention to be a watershed for changing investor interest in Ukraine. Therefore, it included an exhibition of Ukraine's economic and business potential in the three-day affair. Ukraine's Vice Prime Minister for Economic Reform Tyhypko said that Ukraine succeeded in attracting interest. "Many were here for the first time and were amazed by what they saw," said Mr. Tyhypko.

Ukraine also scored points with the international community through its effort in organizing the Black Sea Economic Cooperation Organization, an 11-member body for the development of cooperation in the fields of transport, energy, communications and ecology, which was officially formed on June 4 in Yalta.

Finally, Ukraine maintained high hopes that it could become a player in the movement of oil from the rich fields found in Azerbaijan to Western and Central Europe. Ukrainian officials returned from a two-day conference in the Azerbaijani capital of Baku on September 8, where Ukraine presented its plan for the transport of oil to the West, convinced that this was the best plan presented.

It would take Azeri oil by rail to the Georgian Black Sea city of Supsa and transport it to the Odesa oil terminal, where the black gold would move via pipeline to the Ukrainian city of Brody and then on to Poland, the Baltic Sea and Western Europe.

Azerbaijan, which had said it would decide on which of three proposed routing plans it would choose by November, has delayed the decision as an oil glut and depressed prices have decreased the viability of all the projects.

Copyright © The Ukrainian Weekly, December 27, 1998, No. 52, Vol. LXVI

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