Download Ukrainian Exchange Rate Policy: What Lies Ahead

Ukraine’s Economic Prospects
and Priorities for Reform
Martin Raiser, Economic Advisor
World Bank
The Macro-Context: Strengths and Risks
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Strong fundamentals (public
debt 14% of GDP, low fiscal
and current account
deficits)
Regionally competitive –
exchange rate and wages
Improved transparency in
corporate sector
WTO accession and EU
FTA anchors for reform
Increasing investor interest
(FDI up > 5% of GDP)
Huge, under-served
domestic market: finance,
housing, consumer
durables, retail etc.
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Rising inflation
Growing external
imbalances
Credit boom may hide
underlying credit risks
Limited degree of export
diversification and
vulnerability to terms of
trade shock (gas ↑;
metals ↓)
Laggard in structural reform
and un-tested financial
regulatory framework
Political instability and short
election cycles ~ populist
spending promises
A Risk Fairly Priced?
800

700
Philippines
Turkey
Ukraine
Uruguay
600

500
400
300
200

100
2007M9
2007M7
2007M5
2007M3
2007M1
2006M11
2006M9
2006M7
2006M5
2006M3
2006M1
2005M11
2005M9
2005M7
2005M5
2005M3
2005M1
2004M11
2004M9
2004M7
2004M5
2004M3
2004M1
0
Gradual repricing since
May ’07
Reflects shift in
perceptions of
political risks
after
dissolution of
parliament
Now broadly in
line with other
BB- sovereigns
Why Did Macro Performance Hold Up So
Well So Far?
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Underutilized capacity: what goes down must come
up (to some extent)
Luck: strong metal price growth offsets gas price
shock; EURO and Ruble strength against the US $
keep real effective exchange rate in check
Clever budgeting: indexation of social payments and
wages to CPI, but budget revenues grow in line with
GDP deflator – aggregate fiscal impact more
restrained than appears from the approved budget
But this benign constellation cannot continue forever
=> signs of strain and imbalances emerging
2007M06
2007M01
2006M08
2006M03
2005M10
2005M05
2004M12
2004M07
2004M02
2003M09
2003M04
2002M11
2002M06
150
2002M01
2001M08
2001M03
2000M10
2000M05
1999M12
1999M07
1999M02
1998M09
1998M04
1997M11
1997M06
1997M01
Real effective exchange rate
remains under control for now
160
Real Effective Exchange Rate
140
130
120
110
100
90
80
2007q3
2007q2
2007q1
2006q4
2006q3
12%
2006q2
2006q1
2005q4
2005q3
2005q2
2005q1
2004q4
2004q3
2004q2
2004q1
2003q4
2003q3
2003q2
2003q1
2002q4
2002q3
2002q2
2002q1
GDP still driven by steel prices
16%
100%
14%
GDP y/y
80%
EU steel y/y
60%
10%
40%
8%
20%
6%
4%
0%
2%
-20%
0%
-40%
Indexation rules help the budget
30
GDP deflator, % change
25
CPI, % change eop
20
15
10
5
0
2002
-5
2003
2004
2005
2006
2007F
But rising imbalances, driven by private
sector
12
10
Current Account Balance, % GDP
8
Fiscal balance, % GDP
6
4
2
0
-2
-4
-6
2002
2003
2004
2005
2006
2007F
The “price” of a quasi-peg
60
GDP deflator, % change
50
Monetary base, % change
40
30
20
10
0
2002
2003
2004
2005
2006
2007F
Medium-term Economic Prospects in the
Era of Globalization
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Two World Views:
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“De-coupling” and European Convergence =>
Ukraine inevitably will catch-up and fast because
emerging markets are no longer considered risky
The Four-Speed World => only fast reformers in
emerging markets benefit long-term from
globalization
Ukraine can benefit regardless of which view
is right – but only if it reforms
The European Convergence Path
2
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1
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0
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-1
-2
UKR 2005
UKR 2004
-3
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UKR 2000
-4
-5
-2
-1
0
Log per capita GDP (Index, EU25=0)
1
Ukraine can finance 4-6%
GDP current account deficit
Ukraine’s dollar wages
(US$250 av) roughly in
balance with relative GDP
level
Medium-term trend is for
moderate real exchange rate
appreciation – around 1.75%
US$ wage growth for every 1%
GDP growth
Note: all competitors
appreciating at similar if not
faster pace!
Reform Challenges
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Avoid fiscal populism – at this stage in the
cycle Ukraine should aim for fiscal surpluses
Improve the Investment Climate and
Governance
Improve the quality of public services (health
and education)
Increase public investment in infrastructure
Reform the legal and judicial system to
protect property and contract rights
Investment climate & Governance:
diagnostics
Ukraine, % rank
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Ranked 139th of
175 in Doing
Business
Ranked 73th of
131 in WEF
Competitiveness
Lagging lower
middle income av.
in rule of law and
ctrl of corruption
90
80
70
60
50
40
30
20
10
0
2006
2007
Doing Business
2006
2007
2005
2006
Competitiveness Index Control of Corruption
Public sector reform and social inclusion:
diagnostics
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Public wage bill ~ 10% of
GDP (incl in kind) – EU
8.8%, CIS 5%
SOE employment 12.5%
- EU8 4%, CIS 9%
Public investment 2% of
GDP – EU 5%, Asia 810%
Little improvement in
service quality despite
high spending
Poverty is declining but
people do not feel their
lives have improved
35%
Figure 1: Standard poverty rate in Ukraine: 2000-2005
(In percentage points; using the standard poverty line)
30%
Headcount Rate
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25%
20%
15%
10%
5%
0%
2000
2001
2002
2003
2004
Source: World Bank, computed from the Ukraine Living Conditions Survey
2005
Economic reform: the politicians’ dilemma
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Not much choice when it comes to economic model
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Not much hope for immediate quick wins
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All three major parties supported basic market-oriented
policy platform during elections
WTO and EU integration are strong anchors
Strong recent growth record may suggest reforms are not
needed
Institutional reforms take longer to bear fruit
Not much public support for the long-haul of
structural reforms
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Redistribution through re-privatization and tighter tax
enforcement sounds attractive but track record suggests
that it may not work
Reforms and Performance During Transition
Income level
Ukraine may still be at point “A”
B
The growth impact of reform
A
t
The Expectations of the Population
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EBRD/World Bank “Life in Transition Survey”
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42% market economy preferable, 33% planned economy
preferable
Only 15% economic situation better than 1989 (CIS 30%,
EU8 26%)
80% think state should guarantee employment and low
prices (CIS 80%, EU8 65%)
38% dissatisfied with health services (CIS 32%, EU8 25%)
Close to 50% completely distrust political institutions (CIS
25%, EU 30%)
People expect state to take social responsibility but
have little trust that it will
Economic reform strategy
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Focus attention on a few selected issues
Use interests of large domestic capital to build
reform coalition -> access to finance & markets
requires improved governance and business climate
Focus on public service delivery to build support for
economic reform in the population
Try to avoid politicizing reform – remember: there
are no alternative economic models
Prioritizing Reforms: World Bank
proposals
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Quick Wins:
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Enact a new Law on State Procurement (opposition to
reform is small; losses to the budget are huge)
Pass the Joint Stock Company law (key signal to investors)
Adopt a realistic 2008 budget (avoid macro-overheating
and adjust people’s expectations while going is good)
Opportunities:
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Use FTA negotiations to push deregulation agenda
EURO 2012 as an opportunity to renew government
infrastructure investment
Strengthen financial market regulators while markets are
benign (don’t wait until they are tested by investors)
Prioritizing Reforms: Long Term
Economic and Social Reform Challenges
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Reduce tax burden and reform tax administration =>
new tax code, but existing drafts need more work!
Push ahead with pension reform
Reform financing of social services as a key to
improve quality
Continue raising energy tariffs to full cost recovery
levels
Re-launch privatization – competitively and
transparently
Reform the land market – start with auctioning urban
real estate competitively
Reform public administration and the judiciary
What it all adds up to: WB Base Case (Oct
07)
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ToT weakening in 2008-2010 – lower growth and
larger external deficits
As revenue growth declines, fiscal policy will tighten
to prevent widening deficits
Ukraine retains access to international capital
markets and investment-led growth continues (at
somewhat lower rates)
Reforms will continue at gradual, sometimes
inconsistent pace – faster growth in 09-10 if reforms
accelerate
Quarterly updates on: www.worldbank.org.ua
WB Base Case