On the May’30 2017 Round Table “Challenges and risks of crises expansion in Ukraine and economic policy measure to overcome”, organised by the Razumkov centre was held in Kyiv, Conference hall of the Natsionalny hotel. The event was attended by more than 70 leading Ukrainian economic and financial experts from public and non-government institutions.
Vasyl Yurchyshyn, director of the economic programs for Razumkov Centre, presented publication The main Conclusions and recommendations for the economic policy find below.
1. Ukraine is gradually emerging from a protracted deep crisis, however a number of macroeconomic imbalances and institutional contradictions indicate the likely intensification of negative pressure that could destroy the stabilization process in the country. This pressure can manifest and be activated in Ukraine in a politically difficult 2019, when the elections of the President and the Parliament should take place, as well as the formation of the new government, which will be accompanied by unfavorable external challenges (in particular, the continuation of Russian aggression in the East of Ukraine), and by spreading and deepening internal oppositions between the leading political forces.
At the same time, during this period there is a tendency for socio-economic problems to accumulate. Between such problems, one can expect reducing welfare, low economic dynamics, worsening external balances due to poor competitiveness, loss of solvency, as a result of increasing external debts. In conditions of weak institutional capacity of reforms, all the above may compromise the achievement of sustainable economic growth and development.
2. Among the contemporary geoeconomical and geopolitical processes, the decisive role belongs to the implementation (and consequently to its impact on most of the world) of the new economic policy of the USA, whose characteristics will be as follows: higher growth of the US economy (compared with the main EU countries and Japan), increase of the interest rate (faster pace compared with the dynamics of the European Central Bank and the Bank of Japan), dollar appreciation on world markets, strengthening the position of the US banks and companies in the global financial markets.
The biggest global influences, resulting from monetary, fiscal and structural transformations in the US, are likely to take place in the second half of 2018 - the first half of 2019. Increasing interest rates and fiscal expansion / stimulus in the United States will strengthen capital inflowing to the US markets, which, in its turn, may enhance global trade and currency imbalances.
It will also mean increasing profitability on international borrowing markets. This will lead, from one side, to growing cost of borrowing and increased debt pressure, especially for countries with unstable institutions and economies, and from the other side, to significantly reduced investor interest (for both direct and portfolio investments) for politically and economically unsteady countries (such as Ukraine).
3. The change in the US policy regarding its increased protectionism and the "divorce" between the UK and the EU (Brexit) will lead to a significant reorientation of trade flows from the "traditional markets" to new rather productive and absorbing markets. In such circumstances, new niches for "third" countries are likely to emerge, if they can offer more favorable price conditions. However, additional limits or even reduced demand for products of "third" countries are equally likely, which could bring a significant export loss for Ukraine as one of the least competitive countries in Europe.
The main processes related to Brexit, are likely to be completed in 2019 (as well as fiscal changes in the US), and this is the time of probable acceleration of structural changes in the European developed countries (i.e. formation of new economic and institutional environment), which would also require changes in economic policies of the countries seeking to continue active partnerships with the updated EU and the UK. This fully applies to Ukraine, and one of the principal challenges for the country is looking for new formats of collaboration, especially with Great Britain in the consistent implementation of the perspective policy of free trade.
4. One of the important consequences of expanded protectionist measures and refusal of the USA to continue taking part in the Trans-Pacific partnership will (with high probability) be the loss of importance and authority by the World Trade Organization. This, in its turn, will slow the formation of agreed harmonized rules and procedures of international economic relations. Instead, it is likely that the tendency to the formation and strengthening of new structures and the integration of regional economic alliances will increase. Moreover, such alliances can quickly create preferential production, trade, investment and infrastructure networks. Although it will require additional costs that may not always be immediately available in emerging countries, however, finding these resources and integrating into such alliances turn out to be real prerequisites for "survival" of a country.
World experience proves – the more highly integrated are the markets in a region, the more attractive is this region for entry of further investmens, which, in its turn, expands competitive niches. That is undoubtedly due to the formation of aggregate demand in China’s economy, and further increases in its constituent economic factors, additional systemic changes in the impact on the development of other countries will occur. In this context, the geographical remoteness will be decreasing importance, while infrastructure and integration readiness will be becoming more and more significant. This fully applies to Ukraine, as well.
5. In new conditions the role of global leader of world trade will be consistently held by China, which continues to strengthen its own position in global trade and investment. However, although during the last decade the dynamics of the economic growth in emerging countries has significantly outpaced the dynamics of the economic growth in developed countries, such a difference in economic dynamics is also contradictory, since emerging countries still remain largely dependent on technological, innovation and financial resources of developed countries. This is why the sources of systemic changes in the global economy still mostly remain the largest developed countries (and their unions) - the USA, the UK, the EU, Japan and the others, whilst the Chinese economy, not yet established and institutionally strong, still belongs to emerging ones. Therefore, the development of international economic rules and standards does not seem to be simple and consistent, not only on the global level, but also for individual (regional) integration formations.
6. Although Ukraine needs to restore its investment potential and active attraction of foreign investments into the national economy, even more important is the accelerated integration (and, consequently, investments) of the country to world production, trade and financial networks that will allow Ukraine to sustain in global trends.
Without denying aspirations of Ukraine for European integration, it should be noted that in the coming decades the region that will play an increasingly greater role in the global labor market, forming value-added chains is the East Asian region. Therefore, for a country that would rather be an active participant in global economic processes, it is important to be involved in the transcontinental projects initiated by investors from East Asian countries.
As soon as possible, Ukraine should overcome weak infrastructure and integration capabilities, strengthen its positions in emerging markets, in particular its transport capacity and bringing it closer to the transport network of the CEE countries, as well as to expand trade and mutual investment, especially in view of the prospects of free trade zones between Ukraine and the EU, Canada, etc.
7. Another important impact of the economy of China on trade flows is the so-called terms of trade, which may affect the general economic dynamics of not only any individual country, but also partner countries. As far as Ukraine is concerned, the next 2-3 years are likely to be characterized by deterioration of terms of trade, which in 2018-2019 along with political tensions, might accelerate challenges and risks associated with the deterioration of the balances of payment structure, and, consequently, general macroeconomic balances (increase in trade and budget deficits, weakening capital inflow, increasing debt load, etc.).
Improving terms of trade is generally a positive factor for increasing the level of saving. The effect of income which is accelerated in exports expansion, allows using fewer resources to spend on imported goods, and at the same time, saving a larger share of disposable income. However, Ukraine should further distance itself from the impacts associated with external factors. In general, the higher the competitiveness and development of the country, the smaller the impact of terms of trade on its balance of payments, as is has been confirmed by practices in many countries. Therefore, for successful emerging European countries which manage to accelerate structural changes, and thus strengthen their competitiveness (in the context of the high competitive requirements of the EU), the fluctuations of the terms of trade index is not so valid.
8. In the coming years there will significant changes in the structure of global saving. It is noticeable that countries with high savings usually do not have any problems to access financial resources (primarily domestic ones), that allows them, among other factors, to maintain a high level of investment and sustainable economic dynamics.
An appropriate level of saving and positive trading conditions encourage FDI (foreign direct investments), since such macroeconomic "combination" (positive levels of savings and terms of trade) shows investors the prerequisites for further sustainable growth. The reverse is fair as well – FDI become factors for structural changes that enhance competitiveness, change the structure of the economy, renew export potential and export structure, which allows the country to find out new competitive niches, less dependent on terms of trade.
9. Interdependencies between current account of the balance of payments and monetary policy are often underestimated. However, monetary expansion is a positive factor for the acceleration of positive economic dynamics, which is an important factor in increasing savings, capital investment and FDI inflows. On one hand, they become a component for further fixed investments (by strengthening the macroeconomic environment of the country), and on the other hand, they improve current account financing (by narrowing the need for external financing), and thus reduce the risk of debt pressure.
Macroeconomic theory and experience of almost all countries clearly indicate that, first, the consistent expansion of money supply is indispensable for sustainable growth and development. Second, under any circumstance the deployment of macroeconomic imbalances, limiting and overcoming the crisis require appropriate monetary incentives. Recently, these "postulates" are unfortunately, ignored in Ukraine and an unreasonably restrictive monetary policy has been implemented. The immediate consequence and the result of such a policy are the systemic violations of lending – in fact, throughout the whole post-crisis period (after 2009) credits to the economy gradually decreased, whilst economic possibilities for many companies (lacking financial resources) deteriorated, which pushed the country further into stagnation.
10. In Ukraine, economic shocks are usually accompanied by investment, inflation and currency shocks and vice versa – depreciation of hryvnia was among the important causes of economic losses (decrease of GDP, accelerating inflation, deterioration of business and investment attractiveness). Although the "weak" hryvnia occasionally helped to improve the external balance, it nevertheless had only short-term impact and did not become a factor for sustainable recovery.
This is why only a prudent monetary policy (particularly in terms of clarity and transparency of the NBU) will help to preserve the purchasing power of the hryvnia and will serve as an essential factor in strengthening macroeconomic sustainability.
11. Whilst Ukraine has recently managed to postpone default risks, the country has only the next two years to secure reliable financial sources and fulfill its obligations on external debts. It should be emphasized that even an idea of default is unacceptable. Indeed, the example of Argentina in 2001 when the country failed to reach acceptable agreements with international creditors regarding restructuring its foreign debt payments (and therefore, it was obliged to declare default), resulted in 15 years, during which it was impossible for Argentina to have access to international capital markets. This is an important warning and an alarm for Ukraine regarding the priority for consistent and complete implementation of all issues as to external debts payments.
The situation with external financing is also complicated by the fact that in recent years Ukraine has had to make considerable efforts to fill international reserves. The current total external debt of Ukraine almost 2.5 times exceeds its exports value, and the short-term debt is three times higher than the gross foreign exchange reserves of the country. In other words, in the context of external debts, the existing gross international reserve of the country is extremely insufficient.
12. Given the current economic and financial instability, Ukraine has a significantly limited access to international resources, which makes it difficult to maintain macroeconomic and financial stability. Firstly, among sovereign CEE issuers, euro-bonds of Ukraine have the highest rate of return, which equally means that the risk is also the highest. The attractiveness of such bonds is, therefore, rather questionable.
Secondly, the possibility of refinancing bonds is largely dependent on geopolitical factors (including termination or limitation of the war activities in the East of Ukraine), as well as on the success of reforms (especially those related to public administration and governmental institutions, which have been recently rather unsatisfactory). The situation is complicated by the fact that already in 2017-2018, there will be a recovery of high demand for borrowed funds in emerging countries. The latter means that one should seriously consider such strategic limits while planning the participation of Ukraine in accessing loan resources (its demand will reach maximum values in 2019-2020). This also means a substantial increase of financial risks for the country during this period.
This situation is exacerbated by the fact that the IMF would normally stop providing financial assistance to any country six months before its important elections (to avoid accusations of politicization). Thus, starting autumn 2018, Ukraine might find itself without any financial support of international financial institutions and will have to rely on its own resources (external market sources of private creditors will be very expensive).
13. Other problem for Ukraine lies in failure to use the source, which in many countries has played an important role not only in financing the budget deficit but also served as a factor in structural changes in the economic environment – that of privatization. Successful privatization processes and investment expansion mutually increase each other’s effectiveness and efficiency. There is a positive correlation between FDI and success of privatization processes, so it is highly important to urgently restore and expand privatization in Ukraine.
14. Therefore, today and during at least the next two years, Ukraine faces critical risks associated with:
- decreasing export potential and weakening inclusion in the new competitive environments,
- low levels of savings and investments,
- worsening terms of trade and balance of payments,
- detachment from global integration and infrastructure projects,
- capital outflow,
- weakness of funding sources for fiscal and external trade deficits,
- increased cost for borrowed funds and deepening of debt pressure.
The economic recovery of the country therefore fully depends on how effectively Ukraine will manage to overcome the negative factors, elements and tendencies, by turning challenges into opportunities and using them for the country development.