1999: THE YEAR IN REVIEW: Ukraine's economy: few improvements (12/26/99)

1999: THE YEAR IN REVIEW

Ukraine's economy: few improvements

For all of President Leonid Kuchma's foreign policy achievements and his success in the elections, he could claim few improvements in the economy in 1999. For Ukraine, it was more of the same: continued stagnation, a slowly devaluating currency, rising unemployment and little movement on reforms.

But the president gave some hope after his re-election to another five-year term that the economic situation may finally begin to change when he announced the reinvigoration of comprehensive economic reforms, which he and his ministers said would be deep and radical.

The president claimed throughout the year that the major obstacle to completing economic reforms was the Verkhovna Rada. In March, while hosting a wide-ranging forum on Ukraine's economic future dubbed "Ukraine 2010," the president called on cooperation between the legislative and executive branches of government. "Economic transformation should never become a matter for political barter," said Mr. Kuchma. But in a presidential election year it could be no other way, with the leftist-dominated Parliament putting up obstacles to the president's proposals at every chance.

The Ukraine 2010 conference, a gathering of the major economic players in Ukraine held March 10-11, attempted to spell out long-term economic objectives for the country. It announced a three-stage development process that would lift Ukraine to political stability by 2010. In the first stage, the years 1999-2000, the announced goal was to achieve economic stability and halt industrial decline. In the next phase, from 2000 to 2006, Ukraine would begin to see economic growth that would reach 6-7 percent, which would eventually rise to 8 percent as Ukraine entered the final stage of its economic revival.

Prime Minister Valerii Pustovoitenko said the basis for the market transformations must be a stable currency and low inflation. He announced that the government expected to lower inflation to 10-12 percent in 2000 and to 5 percent by 2006.

The year began on a high note for Ukraine, when the Verkhovna Rada passed the 1999 budget with hours to go to the New Year. For the Verkhovna Rada, which has had trouble agreeing on most everything since it was elected in March 1998 and which did not pass the 1998 budget until six months into the fiscal year, that was a major accomplishment.

It took 20 votes before the national deputies could manage to eke out a bare majority of 226 votes - and only after some figures were adjusted to assuage leftist legislators who were holding out for more financing for social spending. The budget called for expenditures of 25.14 billion hrv ($7.2 billion) against revenues of 23.9 billion hrv, a deficit that fell within the 1 percent framework that the International Monetary Fund had strongly urged.

Seeking further support from the IMF, Prime Minister Pustovoitenko traveled to Washington on February 2 to meet with IMF officials regarding the continuation of the Extended Fund Facility program, by which Ukraine is to receive some $2.6 billion in financial credits through 2001. Mr. Pustovoitenko needed to show IMF officials that Ukraine was making the effort to meet the agreed-upon economic and reform parameters. Mr. Pustovoitenko also wanted to ensure that the IMF was ready to extend the next tranche of money, desperately needed in the first quarter of 1999, when Ukraine was scheduled to begin repaying short-term treasury notes it had issued in the 1996-1998 period and IMF loans extended prior to the EFF agreement.

Simultaneously, President Kuchma met with IMF Director Michel Camdessus and other international bankers at the World Economic Forum, held annually in Davos, Switzerland, where he discussed continued financing of Ukraine's beleaguered economy and the problems Ukraine was having reaching targeted goals for administrative reform and revenue collection.

After stalling for two months, the IMF finally agreed to resume the EFF program with Ukraine at the end of March, the first payment since the previous September. By June the IMF had granted Ukraine $965 million in long-term credits.

At a CIS Economic Forum in St. Petersburg on June 15, Mr. Pustovoitenko announced that he would ask the IMF for a debt-forgiveness program in conjunction with a June 12 decision by the Group of Seven most industrialized states to forgive debt incurred by the 36 poorest countries of the world. Mr. Pustovoitenko met with IMF Director Camdessus at the forum, which ended with no decision on Ukraine's request.

The agricultural sector of Ukraine - once called the breadbasket of Europe and later of the Soviet Union - continued its drastic decline in 1999, mostly because it remained stalled in an administrative quagmire between the old Communist system and half-hearted and uncompleted economic reforms. Since 1991 harvest yields have fallen steadily. In January the Ministry of Agriculture announced that the country harvested just 26.5 million tons of grain in the prior year, down by about 25 percent from 1997. Soviet era harvests generally had stood at about 50 million tons. Although the agricultural ministry blamed the poor crop on drought and the financial crisis in neighboring Russia, a private agricultural consultant laid it elsewhere.

"The results expose the absence of market reforms in Ukraine and the Ukrainian Agriculture Ministry's misguided policies," said Serhii Feofilov of Kyiv-based UkrAgroConsult.

In 1999 the Ukrainian currency, the hryvnia, also had trouble keeping pace with its past performance, which never has been much to speak of. On February 9 Vice Prime Minister of Economic Reforms Serhii Tyhypko introduced a new currency corridor for the hryvnia after it reached the upper limits of the past trading band, which was 2.5 hrv to 3.5 hrv to the U.S. dollar. At the time the hryvnia was trading at 3.4 hrv to the dollar.

While pegging the new corridor at 3.4 hrv to 4.6 hrv to the dollar, Mr. Tyhypko said he expected to eventually liberalize the currency, but that the new currency corridor would remain for the duration of 1999.

In fact, the hryvnia stayed within the corridor only through the first half of the year, but with little artificial support from the National Bank of Ukraine. At the beginning of August it suddenly plunged by 20 percent in a two-week span as an unexpected countrywide gasoline shortage caused a minor panic among consumers and then currency traders. NBU Chairman Viktor Yuschenko announced on August 11 that he would not enter the market to prop up the hryvnia unless the situation turned critical. Eventually, however, the NBU did make a limited intervention.

Pavlo Haidutskyi, President Kuchma's economic advisor, said the oil crisis ensued from the sudden demand for oil products as the harvest season went into full swing. He said that market forces should have replenished the depleted reserves, but that trading companies had refused to sell oil products in Ukraine because they could not get the price they wanted after a government subsidy of import tariffs expired.

On July 31, with many filling stations closed for lack of gasoline, and those working offering a liter of gas for nearly $2, President Kuchma dismissed his First Vice Prime Minister Volodymyr Kuratchenko. While a bewildered Mr. Kuratchenko maintained that he did not understand the reason for his dismissal, the president said the reason was obvious.

"Somebody should be responsible for the fuel and energy complex," said Mr. Kuchma.

Eventually Ukraine bought some 11 million tons of oil in Greece and Azerbaijan to replace depleted reserves and bring gas prices down.

Two months later, as the presidential elections drew near, the hryvnia began to devalue again and eventually wound up outside the currency corridor. Mr. Yuschenko announced that he would again let the currency float, while emphasizing that he expected that it would return within the currency corridor, which it never did. By the end of the year, the value of the hryvnia had fallen to 5 hrv to a U.S. dollar. On December 3 President Kuchma said that Ukraine's hard currency reserves did not allow it to continue to support the hryvnia and that it would most likely be allowed to float freely in the next year.

Mr. Yuschenko, widely respected by international bankers but less so by the leftist Ukrainian Parliament, nearly lost his NBU chairmanship on May 6-7 when a parliamentary committee accused him of financial misdealing in the handling of Ukraine's hard currency reserves.

The Verkhovna Rada's Banking Committee accused Ukraine's chief banker of a questionable and highly risky deposit of $580 million into a Cypriot bank, considered an off-shore tax haven. It said the NBU could not account for $85 million, and accused the central bank of insufficient transparency and too much independence. Mr. Yuschenko defended his bank's policies during a hearing of the full parliamentary body, while explaining that "there are no losses," and that he had independent audits to prove that all the money was accounted for.

Two votes on the matter showed that a majority of the national deputies did not agree with the Banking Budget Committee's proposal to remove Mr. Yuschenko. Some four months later, the NBU chairman went out of his way to announce that all the invested money plus profits had been returned from Cyprus.

The Verkhovna Rada continued to block and stall economic reforms and almost any of President Kuchma's economic initiatives in 1999, including a new privatization effort and a proposal that would have allowed for the sale of agricultural lands.

President Kuchma showed his frustration with the Parliament on April 21 when he accused it of intentionally not passing needed reform bills and turning itself into a leftist rostrum in the run-up to the presidential elections.

Two months later, with no additional parliamentary cooperation evident and his Constitutional mandate to issue economic reforms via decree expiring, President Kuchma issued 39 presidential orders in a two-week span.

In a Constitution Day address to the nation on June 28, the president derided the country's Parliament for its paralysis and political populism, and announced that he had issued the decrees to revitalize the economy.

"A country cannot be a prisoner of parliamentary passivity in the legislative process caused by the lack of desire to create a legal basis for the economy," said Mr. Kuchma.

Mr. Haidutskyi, the president's economic advisor, said most of the executive orders were replicas of bills that had languished in the Verkhovna Rada - some for more than a year.

"It was simply no longer possible to wait for the Verkhovna Rada to act," said Mr. Haidutskyi.

Many of the decrees were politically motivated - after all it was the beginning of the campaign season - but others, such as a simple, one-time tax for small businesses, increased pensions for farmers, a graduated tax for new businesses, and an increase in the tax on alcohol, tobacco and mobile telephones, were considered necessary by many experts.

Although in 1999 Ukraine failed again to collect the tax revenues projected in the budget, Prime Minister Pustovoitenko aggressively hounded the State Tax Administration to meet targets. In April, after the tax inspectors met merely 82 percent of their first quarter goal, the prime minister ordered salaries cut until levels were met. On April 9 he announced that the overall tax debt to the government had risen to 13.9 billion hrv.

Ukraine's revenue shortfall posed problems for the country not only in the repayment of loans and treasury notes, but in its handling of the debt owed to Russia for oil and gas.

Prime Minister Pustovoitenko met with Russian Prime Minister Sergei Stepashin in Kyiv on July 16, to discuss the 25 percent decline in trade between the two countries in the last year, and Ukraine's increasing indebtedness to Russia for oil and gas. The two sides could not agree on the exact size of the debt because Kyiv insisted that it was not responsible for money owed by private Ukrainian firms. They did agree, however, on a general guideline for repayment.

After Prime Minister Stepashin abruptly left office in August, his replacement, Vladimir Putin, continued talks on the subject with his Ukrainian counterpart in Moscow. In late August Ukraine agreed to repay in commodities what the two sides finally determined to be a $1 billion debt.

First Vice Prime Minister Anatolii Kinakh, who had replaced Mr. Kuratchenko after the gasoline crisis, said on August 28 that Ukrainian strategic bombers would be part of the deal after it was determined that Ukraine's disarmament treaties were not affected.

Foreign trade turnover in Ukraine continued to grow in Ukraine in 1999, albeit at a molasses-like drip. On November 25 the Ministry of Foreign Trade announced that in the first nine months of 1999, Ukraine had imported $10.9 billion, while exporting $8.9 billion, a trade turnover of $19.8 billion, which left Ukraine with a $2 billion trade deficit. The numbers were a slight improvement over 1998.

The agricultural industry also experienced some rare good news as well with the release of numbers that showed that grain exports had nearly doubled over the previous year in the January to September time-frame, reaching 4.6 million tons, as compared to 2.3 tons in 1998.

The ministry predicted that in 2000 trade turnover would increase sharply to reach $29.6 million.

However, the government continued to struggle to obtain repayment of credits it had issued to Ukrainian firms to cover international loans on which they were at risk of defaulting. November figures released by the Cabinet of Ministers showed that the government was owed nearly 227.4 million hrv (more than $54 million) by private Ukrainian businesses.

In September, PriceWaterhouseCooper, a leading international auditing firm and the Ukrainian Investment Newspaper announced Ukraine's largest state-controlled companies of 1998. Leading the pack was the now reorganized and semi-privatized UkrGazProm with gross revenues of 15 billion hrv, followed by UkrTeleKom with 2.5 billion hrv and KryvorizhStal with 2.1 hrv in gross income.

By the end of November Ukraine had recorded a surprising 3.8 percent gain in industrial output over 1998, chiefly due to a strong November showing of 9.9 percent, compared to a 1.6 percent average increase for the previous 10 months.

Other economic indicators showed that Ukraine's economy appeared to be stabilizing. While National Bank Reserves remained at between $1.1 to $1.2 billion, inflation stayed under control. In November the government reported a slight increase in inflation, at 2.9 percent, the highest monthly increase in 1999. Nonetheless, the annual figure remained a respectable 14.5 percent.

The budget, as always, became another point of contention between the executive and legislative branches as the fiscal year, which parallels the calendar year in Ukraine, ended.

Back in June several members of the Verkhovna Rada Budget Committee had joined with the Ministry of Finance to develop a general budget outline and to smooth over potential points of disagreement. But when the Verkhovna Rada received the draft budget for 2000 on October 7 the squabbles began.

The Cabinet of Ministers' budget for the first time ever proposed a budget surplus, chiefly due to the insistence of the IMF, which said the surplus was needed to cover scheduled loan repayments next year in the amount of $3 billion. That however, did not suit Verkhovna Rada Budget Committee Chairwoman Yulia Tymoshenko, who called the financial document unrealistic. She also argued that the government's projected 2 percent growth in the country's GDP in 2000 was inflated and should be closer to 1 percent. Meanwhile, as always, leftist national deputies cried out that social protection programs were being ignored.

The national deputies managed to pass the budget in its first reading on November 18, but only after they made extensive changes, including elimination of the surplus. The parliamentarians boosted appropriations for social safety net programs and raised total budget expenditures to 40.75 billion hrv. The original budget presented by the Cabinet of Ministers called for a budget surplus of 554,000 hrv, with outlays pegged at 38.6 billion hrv and revenue at 38 billion hrv. The budget was returned to the Cabinet of Ministers, which was to reconcile the differing figures. But Vice Prime Minister Tyhypko said on November 29 that the changes were unworkable. He suggested that the government would not compromise as it had done in the past and ruin the first chance for a responsible budget for the country.

Mr. Tyhypko's confrontational tone echoed a new assertiveness found in the government with the re-election of the president. In the immediate days after his landslide victory, Mr. Kuchma spoke out for reinvigorated and radical economic reforms and ordered his ministers to develop a 100-day program to get the executive moving in the right direction.

In his inauguration speech he mentioned the need to radically alter the budget and tax systems, intensify agriculture and land reform, and overhaul the administrative-bureaucratic system, which should include substantial personnel cuts.

He explained that the large bureaucratic machine in Ukraine, a remnant of the old Communist administrative command system, had to be taken apart, which meant deep and far-reaching administrative reforms and consolidation, to include a better balance between local and central governments.

"Today the administrative-bureaucratic hybrid that has developed is increasingly at odds with the practices and responsibilities of the democratization of the life of the state and society, and the development of market relations," said President Kuchma.

He said the streamlining would produce another, secondary, but perhaps even more beneficial result: less fertile ground for corruption to continue to thrive. He asserted that an integrated battle against corruption was required to maintain Ukraine's national security interests.

The first tangible result of the president's fired up reform program occurred on December 3, when he issued a presidential decree on agricultural sector reform, which liquidated collective farms and called on the establishment of individual and corporate farms and for the development of legal enforcement structures to ensure an open and voluntary system. It also called on the legalization of the sale of land to be used for agriculture.

The new impetus given economic reforms at the end of 1999 did not sway the IMF immediately and convince it to give Ukraine much-needed, additional credits. As Vice Prime Minister Tyhypko explained on December 2, the international finance organization would no longer be satisfied with either promises or plans.

"Now we must show that we are implementing what we have promised," said Mr. Tyhypko.

On September 7 the IMF had authorized the disbursement of an additional $184 million under the EFF framework, which was suspended at the end of that month after several economic indicators, as well as the NBU hard currency reserves did not meet IMF requirements.

This time Ukraine hoped to convince the IMF mission, which arrived in Ukraine on December 1 and was to remain until IMF Director Camdessus arrived in mid-December, that through its new aggressive stance on economic reforms it would meet IMF requirements to receive a $300 million tranche in January 2000.

The head of the IMF mission to Kyiv, John Odling-Smee, said it would be up to Ukraine to prove that it had qualified for more IMF money.

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