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Policy Briefing Series [PB/04/2012]y g [ ]
The Current Economic Slowdown Analysis and Policy RecommendationsAnalysis and Policy Recommendations
Robert Kirchner, Vitaliy Kravchuk, Oleksandra Betliy Veronika MovchanOleksandra Betliy, Veronika Movchan
German Advisory Group/IER
Berlin/Kyiv, July 2012
© German Advisory Group
Overview
1 Recent Economic Slowdown: Facts
2 S l t d A f P li R ti2 Selected Areas for Policy Reaction
3 Conclusions3 Conclusions
ContactsContacts
© German Advisory Group2
1. Recent Economic Slowdown: Facts
• Real GDP growth:
6
7 % yoy
4
5
2
3
0
1
2010
Q1
2010
Q2
2010
Q3
2010
Q4
2011
Q1
2011
Q2
2011
Q3
2011
Q4
2012
Q1
Source: Ukrstat
© German Advisory Group3
• Conclusion: Economic growth is slowing down
Real Economic Growth: Demand
20 p.p. contribution to real GDP growth change
10
15
0
5
-5
0
-15
-10
Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12Private final consumption Government consumption Gross fixed capital formation
Inventories Net exportsSource: own calculations, Ukrstat
© German Advisory Group4
• Conclusion: Real private final consumption delivers the main contribution to growth, while investments disappoint
Focus: Investments
20 Real gross fixed capital formation% yoy
10
15
5
-5
0Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12
Conclusions:-10
Source: Ukrstat
• Conclusions: • Recent slowdown of investment observable (1Q 2012) • Furthermore no strong recovery after crisis - real gross fixed
© German Advisory Group5
Furthermore, no strong recovery after crisis real gross fixed capital formation in 2012 is estimated to reach only 58.4% of 2007 level
Real Economic Growth: Supply7
p.p. contribution to real GDP change
5
6
3
4
1
2
-1
0Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12
Agriculture Manufacturing Other sectorsS l l ti Uk t t
• Conclusions: • Growth of manufacturing sectors (primarily export-oriented) decelerated due to
Source: own calculations, Ukrstat
© German Advisory Group6
weak external demand• Agriculture contributed the most to economic growth in 2011 due to record harvest
Price Developments
30 % yoy
20
25
10
15
5
10
0
Jan‐10
Mar‐10
May‐10
Jul‐1
0
Sep‐10
Nov‐10
Jan‐11
Mar‐11
May‐11
Jul‐1
1
Sep‐11
Nov‐11
Jan‐12
Mar‐12
May‐12
• Conclusion: Deceleration of price dynamics point
PPI Core CPI
© German Advisory Group7
p y pto weakening domestic demand
Labor Market Developments
10
Unemployment rate (ILO)%
9
10 %
8
6
7
5
Q1
Q2
Q3
Q4
C l i L b k t i k
2010 2011 2012Source: Ukrstat
© German Advisory Group8
• Conclusion: Labour market remains weak –unemployment rate is still higher than before the crisis
Assessment
• The economy shows clear signs of a slowdownThe economy shows clear signs of a slowdown• External demand is weak, and expected to remain
so for the time being due to a number of external grisks– Escalation of Eurozone debt-crisis– Further fall in commodity-prices (in particular steel)– Slowdown of world economy
China’s economy cooling off– China s economy cooling off
• Domestic demand is mainly led by consumption; investments are relatively weakinvestments are relatively weak
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2. Selected Areas for Policy Reaction
• The slowdown raises the question how policy makers should react, with the objective of stimulating economic growth
Whi h i t t i ht b d t ti l t k i• Which instruments might be used to stimulate weakening growth, in particular via demand components (relevant in the short term) and the supply side (more long term)?the short term) and the supply side (more long term)?
• We analyse instruments in the following policy areas:a Monetary and Exchange Rate Policya. Monetary and Exchange Rate Policyb. Fiscal Policyc. Financial Sector Policyd. Investment Climate e. Trade Policy and Regional Integration
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a. Monetary and Exchange Rate Policy
• Observation I: UAH has recently appreciated relative to y ppother regional currencies due to its tight link to the USD:
Nominal exchange rates vs. USD, (indexed)g ( )
110
120 depreciation
100
80
90
1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2
11.01.2011
11.02.2011
11.03.2011
11.04.2011
11.05.2011
11.06.2011
11.07.2011
11.08.2011
11.09.2011
11.10.2011
11.11.2011
11.12.2011
11.01.2012
11.02.2012
11.03.2012
11.04.2012
11.05.2012
11.06.2012
© German Advisory Group11
UAH/USD TRY/USD RUB/USD PLN/USD
Source: ECB, NBU
• Observation II: NBU is forced to keep a tight p gmonetary policy stance in order to defend UAH peg under current circumstances
30
35% p.a.
Kyiv-Prime (1 month)
20
25
10
15
0
5
1.20
10
1.20
10
1.20
10
1.20
11
1.20
11
1.20
11
1.20
11
1.20
11
1.20
11
1.20
12
1.20
12
1.20
12
© German Advisory Group12
7.1
9.1
11.1 1.1
3.1
5.1
7.1
9.1
11.1 1.1
3.1
5.1
Source: AYA securities
• Observation III: This has a negative influence on the i th b ki t h l di i threcovery in the banking sector, where lending is rather
weak and lending rates still high:
15
20
6
8 % p.a. % of GDP
102
4
0
5
2
0
9Q1
9Q2
9Q3
9Q4
0Q1
0Q2
0Q3
0Q4
1Q1
1Q2
1Q3
1Q4
2Q1
0‐2
2009
2009
2009
2009
2010
2010
2010
2010
2011
2011
2011
2011
2012
Real interest rate (lhs) Lending volume (rhs)
© German Advisory Group13
Note: Real interest rate is derived from nominal interest rate on loans to nonfinancial corporations in national currency with maturity of 1-5 years and inflation expectations from the NBU enterprise survey, lending volume reflects loans issued over the quarter as % of GDPSource: own calculations, NBU
Assessment
• More FX flexibility would be beneficial in the current• More FX flexibility would be beneficial in the current situation, as:
• The currently very tight monetary policy might be• The currently very tight monetary policy might be relaxed, supporting lending and investments
• This might contribute to an improvement in netThis might contribute to an improvement in net exports/the current account deficit
• Currently no fundamental need for hugeCurrently, no fundamental need for huge devaluation - this should limit expected depreciation
• Gradual approach necessary as dollarization is stillGradual approach necessary as dollarization is still high and hedging markets not functioning properly
• See PB 01/2012 for further information
© German Advisory Group14
See PB 01/2012 for further information
b. Fiscal Policy
• In terms of analysing the potential impact of fiscal policy on economic growth we distinguish 2 issues here:growth, we distinguish 2 issues here:
1. (Classical) deficit spending2. Changing the structure of expenditures towards higher efficiency and g g p g y
growth-supporting measures • Regarding issue 1, we see no room in the short term for a loosening of fiscal policy in order to stimulate growth; there is no alternative to thefiscal policy in order to stimulate growth; there is no alternative to the continuation of fiscal consolidation that started in 2010
• Discussion “growth versus austerity” to some extent similar to EurozoneO th t t i t d t ( t l) fi li it f• On the contrary, restricted access to (external) finance limits room for
manoeuver for government, as the pool of domestic savings is limited • Furthermore, it competes with private business for financial resources, and keeps their borrowing costs high (i.e. crowding out is a real issue)
• Conclusion: Currently no room for deficit spending; on the contrary, fiscal consolidation needs to continue
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• Regarding issue 2, fiscal policy can make an important contribution to stimulating economic growth in the long term by changing theto stimulating economic growth in the long term by changing the structure of expenditure towards higher public investments, which is right now strongly biased towards current expenditures 40
5.44.3
2.2 2.8
3.2
25
30
35
40 % of GDP
Capital fiscal expenditures in Ukraine were lower than 10% of
26.0 28.331.4 32.1
28.5
10
15
20
25 Ukraine were lower than 10% of total spending or 4% of GDP during recent years, while in emerging economies they
0
5
10
2007 2008 2009 2010 2011
accounted on average for 14% of total government spending or 4.4% of GDP
C l i Ch i th dit t t i
Capital consolidated fiscal expendituresCurrent consolidated fiscal expenditures
Source: State Treasury, Ukrstat
© German Advisory Group16
• Conclusion: Changing the expenditure structure may give an important boost to economic growth in the long term
Assessment
• In light of the evident financing pressures, and the risk ofIn light of the evident financing pressures, and the risk of crowding out private investments, the government should target as short-term measure mainly to “cut fat” in expenditure; some tax exemptions could be revised to ensure additional revenues
• This would lead to a decrease in funding needs, which would help the private sector to attract more financial resources andhelp the private sector to attract more financial resources and facilitate investment
• A change in expenditure towards more public investments isA change in expenditure towards more public investments is needed from a long-term perspective. However, this requires a number of accompanying reforms like utility tariff increases
• The Government should also promote PPP in energy and utility sectors, which would ensure additional investments
i t th b k d f t i t d fi l di
© German Advisory Group17
against the background of restricted fiscal spending
c. Financial Sector Policy
• Banking sector has not fully recovered from the crisis this• Banking sector has not fully recovered from the crisis, this process is still very weak and fragile
• This creates problems for the transmission of monetary policy p y p yimpulses to the economy and keeps financing costs high and investment at a low level
B f thi bl i t l d l l l f l di ill• Before this problem is not solved, a low level of lending will prevail and no significant support for investments and the real economy eco o y
• Financial sector reforms thus needs to stimulate the recovery in the banking sector, which will in turn support investments and economic growth
• Many individual problems exist, but the still high level of non-performing loans (NPL) is a major drag on new lending
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performing loans (NPL) is a major drag on new lending
Assessment
• Clearing the high burden of NPLs from the banking system is a diti f t ti l dinecessary precondition for restarting new lending
• Over the last several years, legislation related to debt collection was revised significantly in favor of lenders. In 2013 new g ybankruptcy law will become effective, which will also remove some obstacles to bad debt collection. Still, it is unclear if changes in law will translate to better debt collectionchanges in law will translate to better debt collection
• In the longer term, initiatives to make lending a safer process must be a key priority for the authorities, as this will help to achieve t bilit d th i th b ki t thi th tstability and growth in the banking sector, something that was
missing before the crisis• An important institutional feature to lower interest rates and p
improve access to credit (e.g. for SMEs) are credit bureaus, whose activities should be improved
• See our policy papers PP/02/2011 and PP/04/2012 for further
© German Advisory Group19
• See our policy papers PP/02/2011 and PP/04/2012 for further recommendations and suggestions
d. Investment Climate
• Sluggish development of private investment (of both domestic gg (and foreign origin) not just an issue of high financing costs and more moderate long-term economic growth after the crisis
B i d i t t li t k f t f i t t• Business and investment climate a key factor for investment decisions. Here, some worrying tendencies:• Despite ambitious plans, a number of indicators (e.g. “Doing Business”Despite ambitious plans, a number of indicators (e.g. Doing Business
by the World Bank, where Ukraine dropped from 149th to 152nd place) signal a deterioration over the last years. This is supported by results of the IER Business Tendency surveythe IER Business Tendency survey
• Net FDI inflows in Jan-May 2012 were significantly lower than in 2011 (USD 1.8 bn vs USD 2.8 bn)
• Conclusion: Improving the investment climate could deliver an important boost to investments and economic growth
© German Advisory Group20
Assessment
• General areas where action is needed:• Regulatory reform should be continued to ease the cost
of Doing business, including full introduction of one-stop-shops for receiving licenses and permissions
• Tax administration should be transparent and fair to taxpayers (VAT should be refunded in time and in full, advanced EPT payments as well as presumptive EPT payment should be stopped)payment should be stopped)
• Start-ups should be promoted (see PB/02/2011)• Some of these measures do not cost anything; on the• Some of these measures do not cost anything; on the
contrary, they may even save public resources• Specific recommendations regarding FDI attraction and
© German Advisory Group21
• Specific recommendations regarding FDI attraction and the role of the promotion agency see PB/05/2012
е. Trade Policy and Regional Integration
• Trade policy is not an instrument of macroeconomic p ystabilisation policy, but used during the crisis 2008/2009
• Currently, draft law No.9241 (passed in first reading) suggests to increase duties up to the level allowed by the WTO in order to increase fiscal revenues and support domestic production in certain sectorsdomestic production in certain sectors
• The draft is not fully compatible with the WTO as some of proposed tariff rates exceed the WTO bound levelproposed tariff rates exceed the WTO bound level
• The draft concerns about 10% of Ukraine’s imports or USD 8 4 bn (2011) and would increase the weighted averageUSD 8.4 bn (2011) and would increase the weighted average import tariff rate for these products from 1.8% to 7.3%.
• Most affected trade partners: EU (48%), China (10%)
© German Advisory Group22
ost a ected t ade pa t e s U ( 8%), C a ( 0%)
Expected impact:• Potential increase in fiscal revenues (depending on elasticity of demand) • Reduction of official imports, which could improve the CA balance• Unclear impact on domestic production:Unclear impact on domestic production:
• Selected goods are not produced domestically • At least 40% of involved imports are products used in domestic supply chain
as raw/semi-processed products, thus cost of domestic production increasesas raw/semi processed products, thus cost of domestic production increases or import substitution occurs with unclear quality effect
• 38% of involved imports are machinery building products thus higher tariff rates could negatively affect capital expendituresg y p p
• Negative impact on domestic consumers as tariff increase will be eventually passed through to consumer prices
• Additional trade risks in case other countries follow similar steps/retaliateAdditional trade risks in case other countries follow similar steps/retaliate• Conclusion: Not the right instrument to stimulate economic growth,
as many risks are associated with such a move. A liberal trade regime is beneficial for the economy and should be thus kept
© German Advisory Group
regime is beneficial for the economy and should be thus kept
• Rather than moving towards more protectionism, Ukraine g pshould instead push ahead with the DCFTA with the EU (as part of the broader Association Agreement)
• This fundamental step would serve as a reform and modernisation anchor in several sectors of the economy, and extend well beyond bilateral trade flows:extend well beyond bilateral trade flows:
• Extensive regulatory approximation (Procurement, Competition Policy,…)p y, )
• Increase in FDI inflows to be expected as a result of a better domestic investment climate (link to previous point)
• Improved access to markets of the third countries through harmonization of standards with the EU
© German Advisory Group24
Assessment
• The currently discussed No 9241 is in our view the wrongThe currently discussed No.9241 is in our view the wrong instrument to support economic growth; increased protectionism will be of little help to overcome the challenges Ukraine currently faces
• A measure that would undoubtedly have a positive long-term impact on economic welfare and growth in Ukraine (through different channels) would be the signing/ratification of the DCFTA with the EU (as part of the broader Associationof the DCFTA with the EU (as part of the broader Association Agreement)
© German Advisory Group25
3. Conclusions
A slowdown of the economy is clearly underway, driven mainly by weak external demand
Key question: How to respond in order to stimulate economic growth?growth?
In the short-term, authorities should focus on boosting private investment, which is way below its pre-crisis level, through , y p , gdifferent instruments: A more flexible exchange rate that would help to soften
t li d th t l dimonetary policy and thus support lending A tight fiscal policy that prevents crowding out Improvements in the investment climate Improvements in the investment climate
A gradual FX flexibilisation would at the same time contribute to an improvement in net exports
© German Advisory Group26
an improvement in net exports
I th l t th b t d b In the longer term, growth can be a supported by increasing mainly the supply-side of the economy:
A fiscal policy shift towards public investments instead of A fiscal policy shift towards public investments instead of the prevailing current expenditure
A financial sector reform that fixes the situation in the A financial sector reform that fixes the situation in the banking sector and contributes to sector stability and growth and supports the real economy g pp y
A trade/regional integration policy that follows Ukraine’s liberal trade policy heritage and uses the DCFTA as a main reform anchor for modernising Ukraine’s economy
© German Advisory Group27
Contacts
Robert [email protected] [email protected] Betliybetliy@ier kiev [email protected] [email protected]@
German Advisory Groupc/o BE Berlin Economics GmbHc/o BE Berlin Economics GmbHSchillerstr. 59, D-10627 BerlinTel: +49 30 / 20 61 34 64 0 Fax: +49 30 / 20 61 34 64 9
© German Advisory Group28
Fax: 49 30 / 20 61 34 64 9 E-mail: [email protected]
