Columbia University is site of forum on Ukraine's economic prospects (06/12/05)

Columbia University is site of forum on Ukraine's economic prospects

by Margarita Mesonzhnik

NEW YORK - The Columbia University Ukrainian Studies Program, together with the Ukraine-US Business Networking Series: Forum II on April 1 hosted representatives of the Ukrainian government for the panel discussion "Ukraine's Economic Prospects following the Orange Revolution."

The panelists included: Roman Zvarych (minister of justice), Volodymyr Shandra (minister of industry), Yurii Yekhanurov (chair of the Parliamentary Committee on Industry), Valerii Asadchev (vice-chair of Parliamentary Budgetary Committee) Volodymyr Maistryshyn (Parliamentary Budgetary Committee) and Oleksander Hudyma (Parliamentary Committee on Energy Policy).

The Ukrainian officials reiterated the liberal economic agenda of the new Ukrainian government: business liberalization and deregulation, foreign trade liberalization, a strong legal system, the elimination of corruption, and corporate and public governance.

Not surprisingly, the Columbia discussions centered around the structural reforms that are required to take place expeditiously and resolutely. Yet, the upcoming parliamentary elections of March 2006 leave the new government with a short window of opportunity for the implementation of reform. At the same time they impose greater demands to maneuver carefully so as not to destroy political capital with decisions that are likely to entail popular disappointment. In addition, some key economic fundamentals for Ukraine continue to weaken. In particular, the growth in the price of steel exports, which accounts for a quarter of Ukraine's GDP, is expected to slow in 2005.

As a result of these economic and political pressures, the new government must strike a difficult balance that might endanger the liberal stance of its economic agenda.

One of the two key factors forcing the government to take on a more short-term-oriented policy is the upcoming political reform, the key element of which is transforming Ukraine into a parliamentary republic. The changes enacted into Ukraine's constitution in December 2004 in the famous deal that cleared the way for Viktor Yushchenko's re-election will transfer to the parliament the president's power to nominate the prime minister, a significant portion of the Cabinet and regional governors. The reform is expected to be implemented by either September or December of this year. Either way, gaining the pro-presidential majority in the March 2006 parliamentary elections is nearly as important as the presidential elections of 2004.

Another key factor on the economics front is the fact that troubling consequences of the electoral crisis of late 2004 are already visible. Ukraine's economic expansion slowed more sharply in the first months of 2005 than had generally been expected. After growing by 12 percent in 2004, economic growth slowed to only 5 percent on annual basis year-to-date. In the short term, the macroeconomic picture remains at best mixed. The imports in the Ukrainian gross domestic product constitute 60 percent of the total. The great economic growth of the recent past was driven primarily by the favorable developments in the main export markets. First, 40 percent of the Ukrainian exports are composed of steel and other metals. The price for steel has been rising steadily in the past three years, almost doubling during that period for some product lines. Although the prices are projected to continue to rise, the rate of the increases is projected to slow, which will have a significant impact on the Ukrainian economy.

Second, 20 percent of exports are directed to Russia, where economic growth fueled the demand for Ukrainian products. Russian demand is projected to grow steadily in the short term. All in all, economic growth is likely to be cut in half in the current year.

The core of the economic agenda promised in Mr. Yushchenko's electoral platform was focused on business liberalization and stability in the fiscal and monetary policies. Indeed, the first major step on the economic reform path - the adoption of the 2005 budget - was a major step in introducing a greater fiscal discipline. The new budget eliminated tax privileges and special tax zones thus, significantly reducing the budget deficit.

However, a slew of recent decisions taken primarily under the leadership of Prime Minister Yulia Tymoshenko seem to run counter to the direction announced under the Orange Revolution platform, and bear a greater socialist inclination.

Ukraine inherited a social spending program that the state could ill afford. In 2004, the former prime minister, Viktor Yanukovych, in a move to secure more votes in the upcoming elections, doubled the social spending. Surprisingly, however, on March 9, Ms. Tymoshenko announced that she would again raise the average pensions and public sector salaries by 24 percent and by 57 percent, respectively, by the end of the year. The result was predictable: the inflation jumped to 15 percent. The full effects of the increased social spending on the inflation and the budget are still to be seen.

The tools that the government has chosen in curbing the inflation are also reminiscent of those used in the past under the centrally managed economic regime. Last month, Ms. Tymoshenko's Cabinet imposed price caps on gasoline and meat prices. Fuel and meat shortages ensued almost immediately.

As part of his electoral campaign, Mr. Yushchenko demanded that privatizations that were carried out without due commercial and legal considerations be reverted. The infamous case of Kryvorizhstal, a steel mill sold to an investment consortium right before the elections for an amount that was at least three times below the market value of the asset, was the catalyst for the re-privatization program.

The highly debated and long-awaited program has yet to be announced, but what has been seen from Ms. Tymoshenko so far is not encouraging. At first, the prime minister entertained the idea of re-privatizing over 3,000 enterprises. Mr. Yushchenko quickly dismissed the plan, and the list was shortened to a manageable 30 to 40 enterprises. Ms. Tymoshenko believed that Kryvorizhstal, and some other larger companies, should remain state-owned - an idea that is hardly supported by the abysmal operations of the state-owned enterprises elsewhere and particularly in the former Soviet Union.

According to Ms. Tymoshenko, one of the proposed ways to deal with the aforementioned fuel crisis will be the creation of several hundred state-owned gasoline stations, in contrast to the international practice of keeping the gasoline supply in private ownership. The unclear re-privatization plan, coupled with signs that the new government appears to favor a greater role for the state, created a decision paralysis not only on the part of foreign businesses, but also the domestic players who traditionally tended to dismiss such political instability. Needless to say, little of the $7 billion in direct foreign investment promised for 2005 at the World Economic Forum in Davos, Switzerland, has been realized.

Despite the attempts to deny the ideological differences between Prime Minister Tymoshenko and President Yushchenko, so far many of the decisions pushed by the head of the Cabinet have taken a socialist approach in contrast to the liberal stance traditionally advocated by Mr. Yushchenko.

The desire of the new government to keep approval ratings at a level sufficient to win in the upcoming 2006 elections is undoubtedly sensible. Let's not forget that the electoral base in Ukraine is divided, with a sizable 40 percent plus support for opposition leaders coming from the East. Yet, it is now clear that the rush to secure election victory so far has stymied true economic reforms. Going forward, the situation is complicated by the political reforms due later in 2005. The direct beneficiary of the constitutional reform is Ms. Tymoshenko, who will see her powers as prime minister strengthened significantly after the reform takes place. In turn, the position of Mr. Yushchenko as president will give him less room to defend his proven free-market economic outlook.

The question, however, remains whether the current policy adequately takes into account the risk of a departure from the economic reform mandate expressed by Ukraine's new leaders at the Columbia panel.

Margarita Mesonzhnik, a native of Donetsk, Ukraine, is currently a master of international affairs student at Columbia University's School of International and Public Affairs (SIPA). Her area of specialization is international energy business and policy, and international economic policy. Ms. Mesonzhnik graduated from Boston University with a degree in finance and economics. She subsequently worked in the energy sector for three years both in the U.S. and Russia.

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