Ukraine's economy continues to grow in first months of 2002 (03/31/02)

Ukraine's economy continues to grow in first months of 2002

by Roman Woronowycz
Kyiv Press Bureau

KYIV - Ukraine's economy has continued to grow, albeit at a slower pace, in the first months of 2002 - even as skeptics keep insisting that the numbers aren't accurate or the expansion is artificial.

Overall the economy has improved dramatically in the last two years recovering more than 50 percent of the decline of the previous eight years. Salaries have increased by nearly a quarter since the economy hit bottom in 1998.

That does not mean, however, that everything is on the up-and-up and will necessarily continue in that direction. To sustain economic growth, which has resulted in a 15 percent increase in the country's GDP since 2000, Kyiv must soon get around to radical tax reform, and foreign investment must be given more incentives to enter the country. But even if all goes well, no one expects Ukraine to reach European levels of prosperity for at least another decade or more.

The economic figures for the first two months of 2002 continue to show a strident economic expansion, although not as robust as in previous months. In January the economy rose by 3.6 percent over 2001, while the February rate was even better, at an even 4 percent.

Volodymyr Sidenko, director of economic programs at the Razumkov Ukrainian Center for Economic and Political Studies, said the hot Ukrainian economy should avoid the effects of world recession and that growth would continue through 2002 at least.

"I believe the overall tempo will be positive, around 5 percent for the year, but only if the world economy begins to grow by the second half of the year. If it doesn't do so, which some experts are predicting, then there will be no more than 3 percent growth," explained Mr. Sidenko.

The noted economist, who previously served as a presidential advisor, said the past economic gains were driven by manufacturing, and especially the metallurgy sector. He said that because the metal and steel industry in Ukraine is export driven, the U.S. import restrictions in world steel could help limit the growth rate of the Ukrainian economy as well, but not for the apparent reason.

He explained that the amount of Ukrainian steel exported to the U.S. had fallen in the last two years anyway, due to U.S. quotas and anti-dumping investigations. However, Ukraine's exports to other countries could be affected by increased competition in those markets from firms looking to recoup their own trade losses in the United States.

A key reason that Mr. Sidenko is bullish on the Ukrainian economy is because he has evidence that money hauled out of the country into foreign and offshore accounts in the 1990s is beginning to return at an increasing rate. That capital is usually immediately invested in order to assure that it is "legalized."

There are several reasons for the return of capital, not the least of which is the fact that in the last two years, and especially since September 11, new banking laws and international standards in the fight against corruption and terrorism have forced shadowy banks and off-shore havens to make their banking procedures more transparent.

"Many Ukrainian businessmen have come to believe that it is safer and easier to keep their money in Ukraine," explained Mr. Sidenko.

Inflation and an unstable currency, two reasons Ukrainian businesses preferred to cart their money out of the country in earlier days, has been brought under control as well. The 2001 inflation rate was 6.1 percent and 2002 forecasts are for a similar figure. The currency, once in constant devaluation, has not wavered by more than 1 percent for two years now.

Mr. Sidenko suggested that some deflationary tendencies exist in Ukraine today, especially in the energy sector, but emphasized that inflation would have to be watched carefully, especially with salaries on the rise.

In the last year, partly for political reasons and partly because a hot economy has given the government more revenues, salaries have risen by 21.4 percent and pensions have increased by 25 percent. While nobody is expecting a surge of uncontrolled consumer spending anytime soon, mostly because the actual salaries are still woefully below the poverty levels of most Western countries, the raises could increase inflationary pressure on basic food staples. An overly optimistic 2002 government budget also could bring inflationary pressure.

The job market, however, remains very weak and improvements largely parallel the wage hikes in the sectors where they are occurring. Mr. Sidenko explained that the construction boom in Ukraine has not only caused wages to rise, but has created a disproportionate number of the new work places. He said that there is reason to believe that the strong performance of the textile industry and food sector in the last two years could lead to dynamic expansion of employment opportunities in those areas of the economy in the next year as well.

He said he is bullish also on eventual strong growth in the computer industry and still believes that, when the investment climate in Ukraine finally improves multinational computer hardware and software companies would invest here to utilize the trained and inexpensive work force that exists.

Foreign investment, or the lack of it, is one of the issues that still could limit the Ukrainian market from reaching its full potential. The other problem is the unresolved issue of tax reform. Last year Russia restructured its tax system, which reduced the ceiling on taxes to merely 13 percent. The move should not only spur investment in that country and create new businesses and job opportunities, but it could further dampen the investment atmosphere for the Ukrainian market.

Jorge Intriago, vice president of the European Business Association in Kyiv and a tax expert for PriceWaterhouseCoopers, said that if Kyiv doesn't legislate serious tax reform this year, recent economic gains could be lost.

"There is a 40 percent profit tax on businesses here," explained Mr. Intriago. "Even though it is more difficult to do business in Russia, I would prefer to build my factory there simply because the tax rate is lower."

Mr. Intriago said he believes that tax reform will occur in Ukraine in 2002 after the new Parliament is seated, although he couldn't say for certain whether the new tax code would be what businesses were looking for.

Mr. Intriago also criticized the pace of structural reforms in Ukraine. He explained that while there is much legislation on the books that is investor- and business-friendly, much of it has not been implemented. He said Ukraine also still lacks corporate governance legislation, which is essential for foreign investors looking to form companies in Ukraine.

"I have to send my Ukrainian attorneys to Russia for conferences on corporate governance, a law Russia has," explained Mr. Intriago. "Here it is not yet even on the table."

Mr. Intriago, like Mr. Sidenko, remains bullish on Ukraine, however. The European Business Association official said that figures on the level of foreign investment in Ukraine are misleading and that more foreign businesses are interested in the country than the numbers suggested. While the official rate of foreign investment in Ukraine fell last year, Mr. Intriago said he had seen an increase in the amount of foreign business projects in the country, which he said was the most he had observed except for the banner 1997 year. That year, prior to the onset of the Russian financial crisis, which destroyed foreign investor interest in the NIS, the Ukrainian economy had been on the verge of a similar economic boom.

Mr. Intriago said that foreign investors in Ukraine tend to initiate projects with borrowed money instead of their own capital, a byproduct of the perceived higher risk of investing here. That type of investment does not show up in economic figures on new investment capital.

However, once the companies are established and confidence in the market develops, real capital tends to follow the initial debt investment. Mr. Intriago believes that within a couple of years that strategy will be reflected in higher foreign investment numbers on Ukraine.

The business expert also agreed with Mr. Sidenko that economic growth will continue in 2002, although at reduced levels from the torrid pace of last year, and that inflation will remain under control. He concurred that domestic capital today found in foreign banks would increasingly continue to return to the country, driving the economic expansion further.

While both experts said they believe that Ukraine is moving towards Europe in its business prospects and opportunities, they also concurred that it would be difficult for Ukraine to reach Europe's level of economic development as soon as state leaders in Ukraine were predicting. President Leonid Kuchma recently stated that he had set a goal of about 2011 for entering the European Union.

Mr. Sidenko said that today Ukraine's per capita GDP is only about 15-16 percent of the European average, and only about 25 percent of one of its poorest nations, Greece.

He said that to reach European levels Ukraine would need to attain a per capita GDP level of $12,000-$13,000 (U.S.), about where the Czech Republic stands today. He said that to reach that mark by 2011 would require a 400 percent increase in Ukraine's current GDP, which amounted to an average annual increase of approximately 10 percent, or an economy on fire for a decade at world record levels.

"I think that the rate of growth needed to get to Europe by 2011 is a fantasy," said Mr. Sidenko. "I believe that until 2015, perhaps a bit earlier, we will still be climbing out of the depths. We are currently only halfway out of the hole."

Mr. Intriago, meanwhile, agreed that even 2015 was an optimistic date and said that today Ukraine was at least a decade behind its western neighbor, Poland, in economic development and five years behind Russia. He added, however, that Ukraine would have an advantage over Russia in future development because it could count on more direct support from Europe and the West.

"This is the last frontier. Russia will always be Russia, and Ukraine is strategically important to Europe," explained Mr. Intriago.

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