Ukraine - International University of Japan · Net exports 1.1 Principal exports 2002 % of total Principal imports 2002 % of total Metals 39.7 Minerals 41.5 Minerals 12.5 Electronics

Country Report April 2003

Ukraine

April 2003

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Ukraine at a glance: 2003-04

OVERVIEWTension between supporters and opponents of the president, Leonid Kuchma,will ensure further political instability—particularly with the approach of thepresidential election due by late 2004. The opposition will continue to launchperiodic street protests, but will suffer from problems of disunity. Pro-presidential groups are likely to retain a nominal majority in parliament.However, this will prove insufficiently stable to ensure a calmer politicalenvironment. Nothing more than gradual progress on reform is likely, althoughno significant backsliding is expected. Combined with a relatively sound mixof fiscal and monetary policy, this will permit annual real GDP growth of4-4.5% in 2003-04. The sound policy mix should also limit the expected rise ininflation, and thereby curtail the extent of real currency appreciation. Thecurrent-account surplus will shrink, as strong domestic demand sucks ininvestment- and consumption-related imports.

Key changes from last month

Political outlook• The protests held on March 9th attracted tens of thousands of anti-Kuchma

demonstrators. However, as expected, they failed to generate the momentumneeded to endanger Mr Kuchma’s political survival.

Economic policy outlook• The parliament has recently succeeded in approving specific tax changes

and passing anti-money laundering legislation. The Economist IntelligenceUnit still expects generally disappointing legislative progress, however,given the lack of a stable parliamentary majority and ongoing signs oflegislative gridlock.

Economic forecast• Inflation rates for the first two months of 2003 are in line with our forecast

for a return to moderate, single-digit annual inflation this year. The 7% realGDP growth recorded year on year in January-February came from aparticularly low base. We expect the rate of growth to slow over theremainder of the year.

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ISSN 1356-4129

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Ukraine 1

Country Report April 2003 www.eiu.com © The Economist Intelligence Unit Limited 2003

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2003-047 Political outlook9 Economic policy outlook10 Economic forecast

13 The political scene

18 Economic policy

23 The domestic economy23 Output and demand24 Employment, wages and prices27 Financial indicators30 Sectoral trends

33 Foreign trade and payments

List of tables10 International assumptions summary11 Gross domestic product by expenditure12 Forecast summary22 Main economic policy indicators23 Real GDP24 Gross value added24 Consumer confidence index25 Consumer prices25 Earnings and arrears, Jan 200326 Average monthly wages, Jan 200328 Commercial-bank lending and deposits31 Industrial output32 Agricultural sector32 Main macroeconomic indicators33 Merchandise trade34 Direction of trade, 200235 Composition of trade, 200236 Balance of payments37 Foreign direct investment stock, 200238 Main external indicators

2 Ukraine


List of figures13 Gross domestic product13 Consumer price inflation19 Consolidated budget balance26 Arrears28 Exchange rates and inflation29 Interest rates and inflation37 International reserves and current-account balance

Ukraine 3


Summary April 2003

Ukraine’s political scene will remain polarised and tense at least until thepresident, Leonid Kuchma, departs from office. His second and final term endsin late 2004. The pro-presidential groups’ monopoly of the political scene willfurther antagonise the opposition, leading to a high risk of new street protestsand political gridlock, and little chance of greater political efficacy. Fiscalimprovements and a generally appropriate monetary policy will ensure asufficiently sound basis for further macroeconomic stability. Annual real GDPgrowth will continue at around 4-4.5% in 2003-04, and annual inflation rateswill be in single digits. Gradual real currency appreciation, a narrow exportbase and rising import demand will reduce the current-account surplus.

Parliament remained polarised between supporters and opponents ofMr Kuchma during the first three months of 2003. This impeded legislativeeffectiveness and raised political tension, particularly as the opposition carriedthrough with plans to resume countrywide street demonstrations in earlyMarch, and the debate over constitutional amendments heated up. Theopposition showed signs of greater unity, but failed to develop significantmomentum. Ukraine sent anti-chemical warfare units to Kuwait, but remainsisolated from the West. This has forced Mr Kuchma to re-emphasise ties withRussia and the Commonwealth of Independent States (CIS).

Slow reform progress has delayed agreement on new IMF lending. Byapproving significant minimum wage increases for 2003, parliament opened upa sizeable hole in the recently passed budget. Tax reforms have picked up pace,but further delays appear likely. Last-minute adoption of legislation required tocombat money-laundering has eased international sanctions. The NationalBank of Ukraine (NBU, the central bank) has stepped up its campaign againstcapital flight and has loosened currency controls.

Real GDP growth accelerated to around 7% year on year in January-February.The steel sector continued to recover. Growth in agricultural output alsostrengthened, but grain prospects remain poor owing to inclement weather.Real wages continued to rise strongly, and moderate year-on-year inflationreturned. The currency stayed stable, and bank deposits are up sharply.

The merchandise trade surplus rose to almost US$1bn in 2002 as a result ofstrong export growth. Steel and grain exports have risen substantially, andexports to Russia have revived. The current-account surplus rose to a recordUS$3.2bn. Although negotiations over Ukraine’s accession to the World TradeOrganisation (WTO) have made progress, the government has pushed back itstarget date for membership to 2004. Foreign direct investment (FDI) remainslow by regional comparison.

Editors: Stuart Hensel (editor); Dafne Ter-Sakarian (consulting editor)Editorial closing date: April 4th 2003

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2003-04

Economic policy

The domestic economy

Foreign trade and payments

The political scene

4 Ukraine


Political structure

Ukraine

A new constitution was approved by the Verkhovna Rada on June 28th 1996

Verkhovna Rada (Supreme Council—parliament), a unicameral assembly of 450 deputies

March 31st 2002 (parliamentary); October 31st and November 14th 1999 (presidential)

President, currently Leonid Kuchma, elected in November 1999; next presidential electiondue by October 2004

Led by the prime minister, currently Viktor Yanukovych, appointed in November 2002

Our Ukraine (OU) (101 seats), Communist Party of Ukraine (CPU) (60 seats), People’sPower (19 seats), Yuliya Tymoshenko’s Bloc (18 seats), Socialist Party of Ukraine (SPU) (20seats), Party of Entrepreneurs-Labour Ukraine (42 seats), Democratic Initiatives (22 seats),Ukraine’s Agrarians (16 seats); the Popular Democratic Party (PDP) (16 seats), Regions ofUkraine (43 seats); Social Democratic Party of Ukraine-united (SDPU-u) (38 seats),European Choice (20 seats), People’s Choice (15 seats)

Prime minister Viktor YanukovychFirst deputy prime minister & minister of finance Mykola AzarovDeputy prime minister Vitaly HaidukDeputy prime minister for humanitarian policy Dmytro TabachnykDeputy prime minister for the agricultural sector Ivan Kyrylenko

Agricultural policy Serhy RyzhukDefence Volodymyr ShkidchenkoEconomy & European integration Valery KhoroshkovskyEducation Vasyl KremenForeign affairs Anatoly ZlenkoFuel & energy Serhy YermilovHealth Andry PidayevInternal Affairs Yury SmyrnovJustice Oleksandr LavrynovychLabour & social policy Mykhaylo PapiyevTransport Heorhy Kyrpa

Volodymyr Lytvyn

Serhy Tyhypko

(vacant)

Official name

Legal system

National legislature

National elections

Head of state

National government

Main political factions inparliament

Cabinet of Ministers (StateCouncil)

Chairman of parliament

Central bank governor

State Property Fund chairman

Key ministers

Ukraine 5


Economic structure

Annual indicators1998 a 1999 a 2000a 2001 a 2002 a

GDP at market prices (HRN bn) 102.6 130.4 170.1 204.2 265.8 b

GDP (US$ bn) 41.9 31.6 31.3 38.0 49.9 b

Real GDP growth (%) -1.9 -0.2 5.9 9.1 4.6Consumer price inflation (av; %) 10.6 22.7 28.2 12.0 0.8Population (m) 49.9 49.5 49.0 48.7 b 48.3 b

Exports of goods fob (US$ m) 13,699 13,189 15,722 17,091 18,669Imports of goods fob (US$ m) -16,283 -12,945 -14,943 -16,893 -17,959

Current-account balance (US$ m) -1,296 1,658 1,481 1,402 3,173Foreign-exchange reserves excl gold (US$ m) 761 1,046 1,353 2,955 4,241Total external debt (US$ bn) 13.1 13.9 12.2 12.4 b 14.4 b

Debt-service ratio, paid (%) 11.4 16.4 18.6 10.4 b 9.5 b

Exchange rate (av) HRN:US$ 2.45 4.13 5.44 5.37 5.33

a Actual. b Economist Intelligence Unit estimates.

Origin of gross domestic product 2001 % of total Components of gross domestic product 1999 % of totalAgriculture 23.4 Private consumption 58.6Industry 41.5 Public consumption 18.5

Services 35.1 Net fixed investment 19.4Increase in stocks -0.1

Net exports 1.1

Principal exports 2002 % of total Principal imports 2002 % of totalMetals 39.7 Minerals 41.5Minerals 12.5 Electronics 14.7

Electronics 9.8 Chemicals 8.1Chemicals 7.8 Transport equipment 6.0Vegetables 6.2 Metals 4.8

Main destinations of exports 2002 % of total Main origins of imports 2002 % of totalRussia 17.8 Russia 37.2Turkey 6.9 Turkmenistan 11.1Italy 4.6 Germany 9.8

Germany 4.2 US 2.8China 3.9 Poland 3.2

6 Ukraine


Quarterly indicators2001 20021 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Consolidated government finance (HRN m)Revenue 12,177 13,193 13,848 15,717 12,689 15,108 15,747 17,268Expenditure 10,853 13,157 13,828 17,690 12,028 14,402 14,391 18,264Balance 1,324 36 20 -1,973 661 706 1,356 -996OutputReal GDP (% change, year on year)a 8.2 9.9 10.5 9.1 4.1 4.4 4.3 4.1Industrial production index (% change, year on

year)b 17.8 18.8 16.7 14.2 5.9 5.9 6.2 7.0Employment, wages and pricesUnemployment rate (% of the labour force) 4.2 4.0 3.6 3.6 3.9 3.8 3.7 3.7Average nominal monthly gross wages (HRN) 266.0 303.2 327.7 349.5 334.8 364.0 393.1 412.0Average nominal monthly gross wages (% change,

year on year) 37.1 40.5 33.7 29.8 25.8 20.0 20.0 17.9Consumer prices (1995=100) 400.1 410.4 405.6 410.7 414.9 413.7 401.9 408.6Consumer prices (% change, year on year) 19.4 14.5 8.9 6.1 3.7 0.8 -0.9 -0.5Producer prices, industrial (1995=100) 319.0 319.4 320.0 318.8 317.9 326.4 335.4 336.7Producer prices, industrial (% change, year on

year) 15.6 10.1 7.0 2.7 -0.3 2.2 4.8 5.6Financial indicatorsExchange rate HRN:US$ (av) 5.43 5.41 5.35 5.30 5.32 5.33 5.33 5.33Exchange rate HRN:US$ (end-period) 5.42 5.38 5.33 5.30 5.32 5.33 5.33 5.33Deposit rate (av; %) 9.8 11.0 12.0 11.2 9.3 8.0 7.7 6.7Lending rate (av; %) 35.6 32.3 31.1 30.1 28.9 26.0 24.1 22.4Money market rate (av; %) 5.9 21.4 22.3 16.7 9.1 5.4 3.6 4.0M1 (end-period; HRN bn) 21,191 23,848 25,912 29,796 30,315 32,574 36,600 40,451M1 (% change, year on year) 44.0 39.0 43.4 43.1 43.1 36.6 41.2 35.8M2 (end-period; HRN bn) 32,531 36,552 39,292 45,186 47,032 51,056 57,618 64,322M2 (% change, year on year) 38.4 37.4 38.8 43.0 44.6 39.7 46.6 42.3PFTS Stockmarket index (end-period; Oct 1st

1997=100) 58.5 49.5 48.3 44.5 45.6 61.7 53.1 57.3Foreign trade (US$ m)Exports fob 4,040 4,385 4,192 4,474 4,030 4,449 4,814 4,664Imports cif -3,872 -4,105 -4,229 -4,687 -3,893 -4,391 -4,643 -4,050Trade balance 168 280 -37 -213 137 58 171 614

Balance of payments (US$ m)Merchandise trade balance fob-fob 168 280 -37 -213 137 58 171 n/aServices balance 51 23 223 118 260 232 234 n/aIncome balance -169 -135 -164 -199 -137 -148 -173 n/aNet transfer payments 239 377 390 450 462 458 531 n/aCurrent-account balance 289 545 412 156 722 600 763 n/aReserves excl gold (end-period) 1,396 1,731 2,578 2,955 2,962 3,245 3,899 4,241

a Calculated on cumulative basis from beginning of each year. Data for 2002 do not reflect recent revisions to full-year data. b Calculated oncumulative basis from beginning of each year; seasonally adjusted.

Sources: Ukrainian Economic Trends; IMF, International Financial Statistics; Ministry for the Economy and European Integration; Standard & Poor’s, Emerging Stock Markets Review.

Ukraine 7


Outlook for 2003-04

Political outlook

Political uncertainty in Ukraine remains high and is unlikely to diminishsignificantly during the Economist Intelligence Unit’s 2003-04 forecast period.This reflects the presence of a divisive and compromised president, LeonidKuchma, at the centre of Ukraine’s political life, and the intensifying struggle tosucceed him in the presidential election due by late 2004. Mr Kuchma isconstitutionally not permitted to seek a third presidential mandate, and willfocus instead on ensuring the electoral victory of a loyal successor able toguarantee his immunity from prosecution once he leaves office. However, withno such candidate yet in sight, Mr Kuchma will also need to concentrate onshoring up his own position, to ensure that he can hold on to power until theend of his term or else extend his period in office if all else fails. This willrequire a hardline stance with regard to his opponents and a concerted focus onjuggling the interests of his allies—which will preclude any possibility thatpolitical tensions might ease.

Mr Kuchma continues to dominate the political scene, but has yet to recoverfully from charges of serious abuses of power, most of which stem from therelease of various secretly recorded audio tapes of presidential conversationsover the past two years. Even if no new allegations emerge, the existingcharges against Mr Kuchma—and his heavy-handed push to dominate allbranches of power in order to insulate himself from calls for his ouster—willensure that the political scene remains deeply polarised. This will bringrenewed anti-Kuchma street protests and will add even further to thedisruptions that are already expected to interrupt the working of parliament.Although pro-presidential groups in parliament enjoy a narrow majority, theyare internally divided and face a sizeable opposition. This will limit any chancethat stable voting patterns might emerge, particularly as all sides will focusincreasingly on their electoral strategies.

In this difficult political environment, the prime minister, Viktor Yanukovych,will have only limited room for manoeuvre. He is constrained by the powerfulrole that Mr Kuchma has carved out for himself in cabinet affairs, and by hisown lack of a broad support base in parliament. His position and policies willdepend on the cohesion of the pro-presidential majority in parliament, in whicha number of rival interests are represented, and which might disintegrate in therun-up to the election. These various constraints are reflected in the vaguenessof the government action plan unveiled earlier this year, and Mr Yanukovych’srole is likely to be that of a caretaker until the presidential election.

The approach of the presidential election campaign will place particular strainon the cohesion of the pro-presidential majority in parliament, as its variousconstituent units will identify their own preferred candidates and will need tocompete for the presidential administration’s backing. Moreover, it is likely thatno obvious pro-Kuchma candidate will emerge, which will only add further tothe political scene’s uncertainty. None of the most likely pro-presidential

Domestic politics

Election watch

8 Ukraine


candidates, including Mr Yanukovych, the speaker of parliament, VolodymyrLytvyn, and the head of the presidential administration, Viktor Medvedchuk,enjoys more than 5% support among voters. By contrast, the Our Ukraineleader and reformist former prime minister, Viktor Yushchenko, continues toenjoy the support of almost one-quarter of Ukraine’s voters and remains by farthe favourite to succeed Mr Kuchma.

The likelihood that the pro-Kuchma camp will fail to produce a candidatecapable of matching Mr Yushchenko’s appeal suggests a number of possiblescenarios—most of which carry negative implications in terms of politicalstability. Most obviously, the Kuchma administration is not above an all-outabuse of administrative resources or resorting to electoral fraud in an effort tosecure a favourable outcome. Somewhat less destabilising is the possibility of alast-minute push on constitutional amendments to reduce the powers of thepresidency. However, this would further distract attention from all otherlegislative priorities, without actually guaranteeing greater political efficacy inthe future. More destabilising would be a push for constitutional amendmentsdesigned to prolong Mr Kuchma’s term in office. Proposals that Mr Kuchmaforwarded to parliament in early March hint at this sort of a strategy, whichwould significantly escalate political tension if implemented. Finally, the lack ofa strong pro-Kuchma candidate also raises the possibility of an accommodationbetween the pro-presidential camp—or parts of it at least—and Mr Yushchenko.The possibility of this will increase if Mr Kuchma eventually alienates parts ofhis camp by spurning their preferred candidates.

The risks to Mr Yushchenko’s candidacy are nevertheless numerous. He isunlikely to enjoy the united support of anti-Kuchma forces in thepresidential election. Although it is uncertain whether Ms Tymoshenko andMr Yushchenko will co-operate, it seems even more unlikely that theCommunist Party of Ukraine (CPU) will back a candidate supported by thereformist forces. The closer the presidential election draws, the more apparentthe ideological cracks in the opposition camp will become. EvenMr Yushchenko’s ability to keep his parliamentary faction intact is not assured,given the authorities’ ability to exert pressure on individual deputies, anddisagreements among Mr Yushchenko’s supporters, many of whom criticise hisreluctance to join the more vocal opposition.

Rhetorically, at least, Ukraine will remain committed to the goals of integrationwith NATO and the EU. However, domestic politics already override anddetermine Ukraine’s foreign policy moves, and no consistent foreign policy islikely to emerge until after the 2004 presidential election at the very earliest.Until then, no significant improvement in the relationship with the West willbe possible, and Mr Kuchma will continue to be isolated internationally. TheEuropean Commission and individual EU member states have alreadyexplicitly ruled out Ukrainian membership of the EU for the foreseeablefuture, and the NATO-Ukraine Action Plan released in January 2003 does notmap out any concrete steps towards reaching Ukraine’s long-term goal ofNATO membership.

International relations

Ukraine 9


Economic policy outlook

Ukraine’s reform progress has lost considerable momentum over the past yearas a result of repeated bouts of political turmoil. Reform progress will remainfitful during the 2003-04 forecast period, particularly given the high risk offurther political in-fighting in the run-up to the 2004 presidential election.These political distractions will bring delays in key policy areas, including taxreform, coal sector restructuring and privatisation in the energy and telecom-munications sectors. The risk that Ukraine might actually reverse the reformsachieved since early 2000—or halt further progress completely—neverthelessremains relatively low. The left wing in parliament has been weakened, andthe reformist Our Ukraine faction is by far the largest group in parliament.It will continue on occasion to vote with pro-presidential groups to passreform legislation.

Notwithstanding the government’s frequent reliance on expendituresequestration and an only gradual increase in revenue collection, the fiscalstance has improved in recent years. Notwithstanding the budgetary looseninganticipated in 2003-04, the fiscal stance is expected to continue to benefit fromthe gradual accumulation of fiscal reforms. However, difficulties in budgetformulation and implementation will continue, producing a shortfall in profittax proceeds, as well as financing problems related to privatisation andmultilateral inflows.

The possibility exists that the fiscal stance will benefit from the long-awaitedpassage of a new tax code, which parliament hopes to approve by mid-2003.However, there is a significant risk that parliament will fail to approve the newcode in time for consideration of the draft 2004 budget, or that a new tax codemight fail—at least initially—to broaden the tax base enough to compensate forlower tax rates. Plans to cut income tax starting from 2004—in line with the billpassed by parliament on second reading in March 2003—might similarlyprompt a fall in municipal revenue. An additional risk is that of moderate fiscalloosening ahead of the campaign for the presidential election due by late 2004.Combined with greater access to financing on the commercial bond markets,this could raise the annual budget deficit to around 2.5% of GDP by 2004, upfrom the 1% deficit we forecast in 2003.

The National Bank of Ukraine (NBU, the central bank) announced in late 2002that it is to target slower money supply growth in response to risinginflationary pressures. Nevertheless, monetary policy will remain relativelyloose, as the NBU will continue to prioritise further increases in internationalreserves and will attempt to sustain the economy’s recovery. Moreover, thepossibility that monetary policy will loosen further has increased as a result ofthe appointment of a new NBU chairman, Serhy Tyhypko, in late 2002.Mr Tyhypko has denied plans for any sharp shift in policy to help exporters,but has signalled a greater willingness to facilitate commercial bank lending tothe real sector, and has begun the process of liberalising currency controls.

Policy trends

Monetary policy

Fiscal policy

10 Ukraine


Economic forecast

International assumptions summary(% unless otherwise indicated)

2001 2002 2003 2004Real GDP growthWorld 2.1 2.9 3.1 3.9OECD 0.8 1.8 1.8 2.5EU 1.4 0.9 1.2 2.1Exchange rates¥:US$ 121.5 125.3 120.3 121.5US$:€ 0.90 0.95 1.12 1.11SDR:US$ 0.79 0.77 0.72 0.72Financial indicators¥ 2-month private bill rate 0.2 0.1 0.1 0.1US$ 3-month commercial paper rate 3.6 1.7 1.3 3.1Commodity pricesOil (Brent; US$/b) 24.5 25.0 25.3 19.5Gold (US$/troy oz) 271.1 309.8 325.5 290.0Food, feedstuffs & beverages (% change in US$

terms) -1.9 12.7 5.8 3.0Industrial raw materials (% change in US$ terms) -9.7 2.2 11.7 3.2

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

We expect the global economy to improve gradually after a sluggish startduring the first half of 2003. However, the economic recovery in the EU willprove considerably weaker than in the US. Russia, which remains Ukraine’slargest export market, will see real GDP growth dip in 2003 but should avoid asharper slowdown with the help of firm oil prices and sustained consumptiondemand. Annual Russian GDP growth is expected to recover to around 4% in2004, in line with the strengthening external outlook.

The prospects for Ukraine’s terms of trade are broadly favourable. Export pricesfor steel, which accounts for over 30% of Ukraine’s export revenue, are expectedto rise by almost 15% between 2002 and 2004. We assume that the rise in oilprices related to the war between the US and Iraq, will prove temporary, andthat oil prices will drop back fairly rapidly below US$20/barrel. The mainthreats to this forecast would be a sharper than expected correction in the USeconomy’s imbalances—which would slow US growth markedly and affectEuropean economies—and uncertainty about the consequences of war in Iraq.This could result in a sharper and more prolonged rise in oil prices than wecurrently anticipate.

International assumptions

Ukraine 11


Gross domestic product by expenditure(HRN m at constant 1995 prices; % change year on year in brackets unless otherwise indicated)

2001a 2002 b 2003c 2004c

Private consumption 29,426 30,780 31,662 32,865(5.5) (4.6) (2.9) (3.8)

Public consumption 9,539 9,825 10,169 10,627(2.1) (3.0) (3.5) (4.5)

Gross fixed investment 13,613 14,294 15,151 15,909(9.4) (5.0) (6.0) (5.0)

Final domestic demand 52,578 54,899 56,983 59,401(5.8) (4.4) (3.8) (4.2)

Stockbuilding 107 100 100 200(2.1)d (0.0) d (0.0)d (0.2)d

Total domestic demand 52,685 54,999 57,083 59,601(8.1) (4.4) (3.8) (4.4)

Exports of goods & services 31,439b 33,775 36,326 38,920(17.0)b (7.4) (7.6) (7.1)

Imports of goods & services -30,388b -32,451 -34,833 -37,328(15.3)b (6.8) (7.3) (7.2)

GDP 53,834 56,322 58,575 61,193(9.1) (4.6) a (4.0) (4.5)

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.d Contribution to real GDP growth.

Annual real GDP growth is unlikely to exceed 4-4.5% during the 2003-04 forecastperiod, even with the help of improved external demand and moderateelection-related policy loosening. The industrial sector is not expected to benefitfrom the real depreciation and considerable excess capacity that helped to drivegrowth in 2000-01, and insufficient restructuring has limited thecompetitiveness of vital sectors such as steel. Agricultural growth will also bemoderate, if only because of the strengthening base period used in year-on-yearcomparisons. Slow reform of the financial sector—and below-potential inflowsof foreign direct investment (FDI)—will also constrain growth. Finally, Ukraine’sreliance on metals remains a cause for concern, given international pressurefrom competitors insisting that Ukraine cut exports. Although this is mitigatedto some degree by continued growth in services and the increasing importanceof non-steel manufacturing, the economy will still reorient only slowly from itsexcessive reliance on low value-added sales to traditional markets.

The unprecedented consumer price deflation experienced in 2002 will give wayto moderate inflation in 2003-04. Inflation in 2002 had been contained by aparticularly sharp drop in food prices, and by price caps introduced before theMarch 2002 parliamentary election. Neither of these factors is likely to apply in2003. Instead, oil prices are expected to spike during the first half of the year, andthe currency is likely to weaken at a greater pace than in 2002. With the fiscal-monetary mix expected to loosen further with the approach of the presidentialelection, inflation is expected to reach 10% by end-2004. However, the risk of areturn to even higher inflation rates—as seen in the late 1990s—remains minimal.

The hryvnya’s stability against the US dollar over the past year has reflected therecord current-account surplus, continued macroeconomic stability and NBU

Economic growth

Inflation

Exchange rates

12 Ukraine


currency controls, which include a requirement that exporters sell 50% of theirhard-currency earnings. The hryvnya is expected to depreciate more quicklyagainst the US dollar over the forecast period, as a result of a reduced current-account surplus, rising debt-service costs and a somewhat looser fiscal-monetary policy mix. This will translate into further real effective currencydepreciation in 2003. In 2004 the rise in inflation will bring a return to realcurrency appreciation.

Even if a return to the extreme currency instability of past years appearsunlikely, the risk of greater than expected nominal currency depreciationagainst the US dollar has increased with the change in leadership at the NBU—particularly as Mr Tyhypko has come out in favour of abolishing the 50%surrender requirement. Even though he has indicated that he would delay thisstep until after implementing a variety of measures designed to curb capitalflight, the efficacy of these alternative measures is uncertain, such that theconsequences of easing currency controls are difficult to gauge.

Ukraine’s current account registered a record surplus of US$3.2bn in 2002, andwill remain in surplus in 2003 and 2004. However, this surplus is expected todecline over time as rising domestic demand pushes up consumption- andinvestment-related imports. These imports are expected to lower the current-account surplus to around US$1.8bn (2.7% of GDP) by 2004. Ukraine’s narrowexport base—and the extent of trade barriers faced in leading markets for majorexports such as steel—brings significant risks. However, these are cushioned bythe sizeable transit payments received from Russian oil and gas exporters, as wellas by rising remittances from Ukrainians working abroad. Similarly, the risk ofhigher than expected oil import prices would be mitigated, at least partly, by anincrease in demand for Ukrainian machinery and steel imports from Russia’senergy sector.

Forecast summary(% unless otherwise indicated)

2001a 2002 a 2003b 2004b

Real GDP growth 9.1 4.6 4.0 4.5Industrial production growth 14.0 7.0 5.5 4.0

Gross fixed investment growth 9.4 5.0 c 6.0 5.0Unemployment rate (av) 3.9 3.8 4.3 4.6

Consumer price inflation (av) 12.0 0.8 5.5 9.0Consumer price inflation (year-end) 6.1 -0.6 8.5 10.0Commercial-bank lending rate 32.3 25.4 24.5 24.0

Consolidated government balance (% of GDP) -0.3 0.6 c -1.0 -1.5Exports of goods fob (US$ bn) 17.1 18.7 20.5 21.8

Imports of goods fob (US$ bn) 16.9 18.0 20.3 21.7Current-account balance (US$ bn) 1.4 3.2 2.3 1.8Current-account balance (% of GDP) 3.7 6.4 c 4.0 2.7

External debt (year-end; US$ bn) 12.4c 14.4 c 15.6 16.2Exchange rate HRN:US$ (av) 5.37 5.33 5.40 5.60

Exchange rate HRN:¥100 (av) 4.42 4.25 4.49 4.61Exchange rate HRN:€ (year-end) 4.67 5.60 6.22 6.26

Exchange rate HRN:SDR (year-end) 6.66 7.25 7.67 7.87

a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates.

External sector

Ukraine 13


The political scene

The president, Leonid Kuchma, remains firmly at the centre of political powerin Ukraine, despite the serious allegations that have haunted him over the pasttwo years. In order to remain in power, Mr Kuchma has needed to subordinateall other considerations to the imperative of his own political survival. This hasaffected almost all aspects of domestic politics and foreign policy, which haveinevitably been drawn into Mr Kuchma’s personal political fight, and into thebroader struggle being waged by political elites over the presidential succession.

Mr Kuchma has taken a keen interest in shaping the outcome of thepresidential election due by October 2004. His interest is even greater thanmight otherwise have been expected were he not faced with such an array ofdamaging charges. Almost all of the allegations that he faces stem from secretlyrecorded audio tapes that first surfaced in late 2000. Mr Kuchma’s opponentsclaim that these tapes contain details of presidential conversations showingserious abuses of power by the president and his entourage. The latest blow toMr Kuchma’s international reputation came in September 2002, when the USgovernment declared, on the basis of these secret recordings, that it believedMr Kuchma to have personally authorised the sale of radar systems to Iraq indefiance of UN sanctions (January 2003, page 19).

Mr Kuchma has denied all of the charges against him and has so faroutmanoeuvred his opponents. He has even managed to bolster his positionsince late 2002, despite facing a vociferous anti-presidential campaign inparliament and large-scale public demonstrations across the country. In order todo so, Mr Kuchma has relied on the divide-and-rule tactics that have servedhim well in the past, and has prioritised above all else the need to insulatehimself from new impeachment threats or other outright challenges to his rule.His decision to reshuffle the cabinet in November 2002, for instance, clearlyreflected personal political considerations rather than any desire to bring newmomentum to policymaking (January 2003, pages 16-17). The reshuffle wasdriven by Mr Kuchma’s need to appease the various interests represented

Political stability and efficacycontinue to suffer

Mr Kuchma’s manoeuvringdominates politics

14 Ukraine


among pro-presidential groups in parliament, and to tie them more closely tohis administration by handing them greater power within the executive branch.

Mr Kuchma’s single-minded focus on his own political survival has exacted atoll in terms of political stability and efficacy. His push to keep his own allies onboard, and to secure a pro-presidential majority in parliament, has alienated theopposition and polarised politics without bringing any noticeable improvementin political effectiveness. Leaders of the opposition factions have resented thepressure put on their deputies to defect to the pro-Kuchma camp, and in lateDecember were furious at attempts to strip the opposition of its control of keyparliamentary committees (January 2003, page 18). As a result of thesedivisions, the prime minister, Viktor Yanukovych, enjoys only limited room formanoeuvre. Only the most pressing economic bills have managed to securemajority support in parliament, such as the 2003 budget in late December andthe legislation to combat money-laundering passed in early February.

The political skirmishes of recent months have underlined the neglect ofinstitution-building during the Kuchma years. Ukraine’s political parties remainunconsolidated, and political elites still see a clear incentive to try to shape thecountry’s nascent political institutions to serve their own parochial interests.The shape both of the electoral code and of the institutional balance of power,for instance, remain the subject of furious debate. This has distracted attentionfrom pressing reform issues, and, more generally, has perpetuated the sense ofchronic upheaval characteristic of Ukrainian politics in recent years.

The struggle over the shape of the electoral system came to a head most recentlyon February 20th, when parliament defeated a proposal to base the electoralsystem entirely on proportional voting and party lists, in place of the currentmixed electoral system. Under the present system, parliament consists ofdeputies elected partly through party lists and partly through majoritarian ballotin single-member constituencies. In the February 20th vote, the bulk of pro-presidential deputies reconfirmed their desire to maintain a mixed system.These deputies represent factions that are closely linked to powerful oligarchicbusiness groups, and the reasons for their support for the status quo are largelyself-interested: their oligarch-linked groups lack well-developed party structures,but enjoy the political and media connections needed to dominate majoritariancontests, as was readily apparent in the March 2002 parliamentary election(April 2002, page 15). Those who supported reforms in the February 20th votedid so for similarly clear reasons, as they calculated that their well-developedparty structures would enable them to benefit the most from party-list voting.They included not only the four opposition factions, but also the pro-presidentialSocial Democratic Party of Ukraine-united (SDPU-u). Notwithstanding currentsigns of serious strain within its leadership, the SDPU-u has done more than anyother pro-Kuchma group in terms of political party development, and is nowpossibly the best-developed political party in Ukraine.

The outcome of the vote on the electoral code underlined the risk of furtherparliamentary gridlock in the lead-up to the presidential election. At one level,the vote bodes poorly for the fate of other aspects of the opposition’s politicalreform agenda, not to mention its hopes for a successful vote in parliament to

Debate over the institutionalframework continues

Electoral code vote confirmspotential for further gridlock

Ukraine 15


impeach the president: on key issues damaging to oligarchic interests, pro-presidential factions are still able to cobble together a blocking majority.However, the recent vote on the electoral code should also serve as a warningto the pro-presidential majority. The narrowness of the vote, the defection ofthe SDPU-u and the unity of the opposition suggest that its own legislativeinitiatives might be similarly hamstrung.

This could prove particularly serious for Mr Kuchma as he renews efforts toreshape the balance of institutional powers through constitutionalamendments. On March 6th Mr Kuchma submitted draft amendments to theparliament, several of which corresponded to the results of the controversialreferendum held in April 2000 (April 2000, page 15). For instance, thepresidential draft envisages the introduction of a bicameral parliamentconsisting of a 300-seat assembly elected on a proportional basis and an 81-seathouse of appointed regional representatives. The draft further stipulates thatparliamentarians, local deputies and the president would all be elected for five-year terms in elections in March, September and December of the same year.The parliament would have the right to appoint the prime minister, and thepresident would be able to dissolve the parliament.

Mr Kuchma’s renewed interest in Ukraine’s institutional architecture hints at hisstruggle to identify a suitable loyalist candidate able to win the presidentialelection in 2004. With no candidate in sight, Mr Kuchma is aware of the needto keep his other options open. Through constitutional amendments, he mighthope to introduce an institutional balance of power that best serves his owninterests. Even more importantly, he might hope to convince parliament tolengthen his term in office, with the rationale that his proposed constitutionalamendments called for presidential and parliamentary elections to besynchronised in 2006. However, it is likely that the changes proposed byMr Kuchma would still leave the current uneasy balance between the executiveand the legislature intact, and would do little to address the fundamentalweaknesses that currently impede the political system’s efficacy. Moreover,Mr Kuchma’s proposal has attracted concerted criticism from oppositionleaders, who deride it as a last-ditch attempt to prolong his term in office, andwho see it as a precursor to further legislative initiatives designed to benefit thepresident. Pro-Kuchma deputies have already registered with parliament acontroversial proposal to provide legal guarantees, immunity and a taxamnesty for the Ukrainian president beyond his term of office. Mr Kuchma’slatest initiative has so far met with only muted support from within his owncamp, and has prompted a united response from the opposition, at leastrelative to past performance.

As Mr Kuchma’s proposed amendments came only days before the start of anew round of anti-Kuchma protests—scheduled to begin on March 9th—theywere widely seen as an attempt to co-opt the opposition’s message of politicalreform. His initial call for sweeping reforms in late August 2002 had also comeonly shortly before the scheduled resumption of anti-Kuchma protests in mid-September. In advance of those earlier demonstrations, Mr Kuchma hadappeared moderately more successful at driving a wedge between the disparate

Mr Kuchma’s constitutionalplan attracts opposition ire

Opposition launches protestsand tries to limit divisions

16 Ukraine


opposition groups—with the popular former prime minister, Viktor Yushchenko,lending only belated and half-hearted support in early September to the protestmovement organised by more vocal parts of the opposition. Mr Yushchenko’sOur Ukraine (OU) bloc proved more willing to back the March 9th protests,which succeeded in mobilising tens of thousands of protesters in Kiev and inover 100 other cities throughout the country.

The latest anti-Kuchma demonstrations nevertheless suffered from the sameproblems that had afflicted previous attempts by the opposition to develop anysort of momentum—widespread apathy, restricted media access and activeinterference by the authorities. In addition, the opposition had still not fullymanaged to overcome its own internal divisions. A resolution published byparticipants of the Kiev protest on March 9th underlined this point. It called notonly for an early presidential election, but also for the release of politicalprisoners, an end to censorship, equal access to the media, an increase in wagesand a halt to utility price rises. This all-encompassing list reflects the uneasycoexistence of right-wing, pro-market and pro-independence groups on one sideof the opposition, and anti-market and pro-Russian groups on the other.

The opposition’s differences extend to tactics as well. The core of the opposition,centred on the Socialist Party of Ukraine (SPU) and the Yuliya Tymoshenko Bloc(BYT), is overtly anti-Kuchma and supports far more confrontational tactics thanthe conciliatory ones favoured by Mr Yushchenko. His uneasy middle-of-the-road stance reflects his particular position as the early (and overwhelming)favourite in the presidential election due by October 2004. Mr Yushchenko’sparamount concern is to preserve intact his OU support base until the start ofthe actual election campaign, and to dissuade the authorities from movingdecisively to marginalise him. Nevertheless, since the start of the yearMr Yushchenko has appeared more willing to identify himself with theopposition mainstream. In addition to his decision to participate in the March9th rally, Mr Yushchenko has generally been more outspoken, as seen by hisstrongly worded statement in February, addressed to Mr Kuchma,Mr Yanukovych and the parliamentary speaker, Volodymyr Lytvyn, in which heaccused the authorities of intimidating and attacking the political opposition.

The Kuchma administration’s domestic political problems have inevitablyspilled over into the international arena. This reflects both the negative reactionof Western governments to the charges faced by Mr Kuchma, and, increasingly,electoral considerations on the part of the Ukrainian administration. Ukraine’saccommodating stance on the war in Iraq has at least helped to patch uprelations with the US government, which has shunned Mr Kuchma as a resultof suspicions over radar sales to Iraq. Ukraine has deployed a specialised anti-chemical warfare unit to Kuwait, and in early April was listed by the US as partof its coalition against Iraq. However, it is unlikely that relations will improvesignificantly while Mr Kuchma remains in power, and the US has announcedthat it will reduce assistance to Ukraine under the Freedom Support Act fromUS$155m in 2003 to US$94m in 2004.

Mr Yushchenko comes a littlecloser to the opposition core

Relations with the West arefrosty despite stance on Iraq

Ukraine 17


Mr Kuchma’s isolation has forced him to re-emphasise relations with Russiaand with the Commonwealth of Independent States (CIS). In late JanuaryMr Kuchma joined his Russian counterpart, Vladimir Putin, in Kiev to sign along-awaited border treaty. During the same visit Mr Putin handed Mr Kuchmaanother important life-line, when he backed Mr Kuchma’s election as chairmanof the CIS Heads of State Council. In late February the two leaders joined theircounterparts from Belarus and Kazakhstan in confirming their intention toestablish a common free-trade zone. This latest initiative is based on the modelof the EU and envisages a commission, independent of national governments,overseeing the implementation of the free-trade area. This latest venture willalmost certainly run into similar difficulties to the ones faced by previous CISintegration efforts. All four of the presidents who backed the latest proposalhave their own domestic agenda. Of the four, Ukraine is possibly the leastreliable partner politically, not least because of inherent tension between apotential EU-Ukraine free-trade agreement and a CIS free-trade zone.Mr Kuchma’s current support for the CIS is therefore best understood as afunction of his isolation from the West and his lack of a support base at home.Through his renewed CIS activism, Mr Kuchma probably hopes to positionhimself favourably for the forthcoming presidential election campaign. Byadopting a pro-CIS course, a Kuchma-backed candidate would be in a positionto outflank the Communist Party of Ukraine (CPU) and to complicate efforts byMr Yushchenko, who has close ties with the West, to appeal to the populouseastern regions on the border with Russia.

As seen with the deployment of units to Kuwait, the Kuchma administrationstill hopes that it can regain some of the confidence that it had lost amongWestern governments as a result of the recent scandals. The Ukrainian Ministryof Foreign Affairs was therefore quick to declare that Mr Kuchma’s new post atthe CIS would not alter Ukraine’s foreign-policy priority of integration intoNATO and the EU. In a similar vein, only days after his appointment to the CISpresidency, Mr Kuchma established a State Council for Issues of European andEuro-Atlantic Integration, designed to co-ordinate implementation of stepstowards EU and NATO membership. The Council will be headed by thepresident and will consist of the prime minister, the head of the NationalSecurity Council, the foreign minister, several government officials and, on anoptional basis, the parliamentary speaker.

The EU is almost certain to look for more concrete signs than this of Ukraine’scommitment to closer integration, including evidence of the political willneeded to tackle a wide range of political and economic reforms. In mid-Marchthe EU spelled out in greater detail its latest plans for relations withneighbouring countries that are not in a position to join the EU any time soon.According to these latest proposals, the EU and its neighbours would negotiatebilateral action plans—the implementation of which would then decide theextent of EU concessions possible. Although this proposal holds out thepossibility of greater trade concessions than are currently available underUkraine’s existing arrangements with the EU, the Ukrainian government hasreacted negatively, on the basis that the EU has not provided sufficientconfirmation of the possibility of eventual membership.

Mr Kuchma is elected Chair ofthe CIS Heads of State Council

A new council emerges toco-ordinate integration efforts

18 Ukraine


Economic policy

After months of negotiations the IMF has yet to agree to a framework for a newlending programme to replace the one that expired in September 2002. Thegovernment still hopes that the IMF will eventually agree to a precautionarystand-by facility involving credits of around US$600m-800m over a period offrom three to five years. However, it has so far failed to ease a number of theFund’s outstanding concerns, or even to prevent the emergence of newdisputes. During its latest mission to Ukraine in late February, for instance, theFund drew attention to continued distortions in the tax system, insufficienttransparency in the privatisation process, and unfunded plans to boost public-sector wages and to preserve social privileges. The IMF also repeated long-standing concerns over Ukraine’s under-developed banking sector, and issuednewer warnings about aspects of the monetary and re-financing policies of theNational Bank of Ukraine (NBU, the central bank).

The Fund remains particularly critical of the government’s inability to deal withthe large volume of value-added-tax (VAT) refunds that it owes to exporters.The IMF has stressed its concerns over the VAT issue for more than a year,including in the final months of the last lending programme in mid-2002, whenthe VAT issue scuppered any chance of a final disbursement. The IMF insiststhat the government reduce outstanding VAT arrears by at least HRN1.7bn(US$315m) in 2003, with a view to liquidating the total stock of arrears(HRN6.5bn) by mid-2004. This presents a daunting challenge for thegovernment. Although changes to the relevant legislation—particularly theintroduction of simplified procedures for calculating VAT liabilities in late2002—have improved the situation, Ukrainian policymakers have yet to addressthe distortions that result from the inadequacies of Ukraine’s tax and legalsystems. Poor budget planning, persistent distortions in fund allocation andwidespread tax privileges have compounded the problem, by forcing thegovernment to under-finance VAT reimbursements in order to compensate. Inparticular, policymakers continue to resist pressure to cancel the numerous VAT-related tax privileges enjoyed by producers of automobiles, aircraft and militaryequipment, and in sectors such as agriculture and housing construction. TheIMF estimates that these privileges amount to as much as one-third of totalbudget revenue.

Ukraine’s chronic budget planning problems resurfaced most recently duringthe debate to approve the 2003 budget. The haste with which parliamentpassed the 2003 budget in December has resulted in a significant mismatchbetween budget provisions and the budget-defining laws approved at the sametime. Most noticeably, on the eve of the final reading of the budget, parliamentapproved measures to boost the minimum monthly wage from HRN165(US$30) to HRN237 as of January 1st. As this promised to open up a significantHRN9.8bn hole in the budget, the government at first called on parliament toback down, before then accepting a compromise in which parliament agreed todelay the full wage increase until July 2003. The initial wage rise effective fromthe start of the year was limited to increasing the minimum wage to HRN185.Even this still left a significant hole in the government’s budget, which neither

Slow reforms bring furtherdelays to multilateral lending

VAT debt arrears remain acause for concern

Unfunded wage rises threaten2003 budget implementation

Ukraine 19


the cabinet nor parliament has so far wanted to address. This reluctancereflects, at least in part, the enormous political difficulty posed by re-calculatingthe budget and making offsetting cuts elsewhere. The budget planning processfor 2003 remains unfinished as a result, and the government has been forcedonce again to resort to ad hoc budget management.

The fiscal situation in Ukraine is further complicated by slow progress on taxreform. The single most important reform—passage of a new tax code—hasremained stuck in parliament since 2001. Since the start of 2003 parliamentarydeputies have at least begun to make some headway on amending the specifictax laws needed to underpin the new code. The reform of the corporate profittax system has made progress, with the president, Leonid Kuchma, signing anew law in early January that will enter into effect at the start of 2004. Thenew law indirectly reduces the corporate profit tax rate from 30% to 25%, byraising depreciation rates and by introducing quarterly (as opposed to monthly)advance tax payments. In mid-March parliament then turned its sights toincome tax reforms, approving in a second reading a draft law that differsconsiderably from previous versions. Most importantly, it abandons plans for arange of income tax rates varying from 10% to 20%, and introduces a flat tax of13% for all but the highest levels of income, similar to the law adopted in 2001in Russia. However, parliament still needs to address a host of specific normsand procedures during the third and final reading of this bill in April, and therisk of delays in finalising income tax reform remains high.

According to Mykola Azarov, the first deputy prime minister and financeminister, the government has set itself an ambitious timetable for reforming thetax system. It hopes shortly to conclude revisions to the income tax legislation,and then to reduce the rate for VAT from 20% to 15%. It needs to complete thisreform process by the start of July in order for the 2004 budget to benefit. In thelight of past difficulties and the tense political environment, this schedule looksunrealistic. Revenue planning and implementation are therefore likely onceagain to emerge as a problem in 2004 as well.

Ukraine’s difficulties with revenue planning have been readily apparent overthe past year, with the government grossly misjudging the scale of multilateral

Some progress is made onincome and profit tax reform

Privatisation woes in 2002prompt more realistic planning

20 Ukraine


and privatisation-related financing inflows available (January 2003, pages 21-23).After fulfilling only around 10% of its HRN5.6bn privatisation revenue target in2002, the government has adopted a far more conservative projection ofHRN2.1bn in privatisation inflows in 2003. In so doing, it has faced criticismfrom parliamentarians, who felt that the target could be doubled through theinclusion of a number of major sales that the government had cautiously notincluded in its assumptions. Given the experience of past years, thegovernment’s caution appears well founded, with proceeds from privatisationsales over the first two months of 2003 actually corresponding roughly to plan—a rare occurrence for Ukraine in recent years.

The State Property Fund (SPF) has attracted much of the criticism for thefailures of past privatisation efforts, and in late February its long-serving head,Oleksandr Bondar, tendered his resignation. The SPF has faced consistentpressure from vested political and business interests keen to control the process,and has been criticised for problems ranging from a lack of generaltransparency to unrealistic asking prices. The most recent major sale—that inmid-March of a 25% stake in the Mariupol-based metallurgical giant Azovstal—came only after a year of trying and a significant reduction in the asking price.

This pattern is likely to be repeated in forthcoming sales of minority stakes inlarge government-owned assets. Most immediately, the SPF will attempt tocomplete the proposed sale of 25% stakes in three power utilities(Prykarpattiaoblenergo, Lvivoblenergo and Chernigivoblenergo), as well as inthe Nikopol ferro-alloy and the Alchevsky metallurgical plants. All are plannedfor the second quarter of 2003. The government recently provided additionaldetails of its plans for the remainder of the year, including its intention to sell49% of another metals giant, the Dnipropetrovsk metallurgical plant, and a 39%stake in the chemical giant Krymsoda. Perhaps the most uncertainty surroundsthe largest anticipated sale in 2003—a majority stake in the state-owned oilcompany Ukrnafta. As the government’s 2003 privatisation programme countson a hefty US$200m from Ukrnafta’s sale, the SPF has already begun to lookfor potential substitute sales in the hopes of preventing a repeat of thefinancing shortfall seen in 2002.

Ukraine’s ability to attract investors and to prevent periodic financing problemshas suffered from image problems abroad—and from negative assessments byoutside bodies such as the Financial Action Task Force (FATF). In December2002 this anti-money-laundering watchdog called on its 29 member states toimpose sanctions on Ukraine. The FATF’s decision came as a blow to Ukrainianlawmakers, who had scrambled to pass satisfactory anti-money-launderinglegislation. Several FATF members imposed sanctions in January, including theUS, the UK, Canada, Sweden, Switzerland, Finland and Germany.

By early February a large number of Ukrainian banks were already reportingincreased transaction cost and delays in payments, as a result of special scrutinyof Ukraine-related monetary transactions. Faced with the risk that Ukrainiancorrespondent accounts might even be closed down altogether, parliamentredoubled its efforts in early February, when it amended the criminal code andto the criminal procedural code in order to stiffen penalties for

FATF sanctions are lifted butUkraine stays on the blacklist

Ukraine 21


money-laundering. The amendments came in the wake of a new law passed inDecember 2002, which lowered the threshold for financial transactionsrequiring monitoring—from HRN100,000 for cash payments and HRN300,000for non-cash payments to a unified HRN80,000 (about USD$15,000). On thebasis of these legislative improvements, the FATF finally agreed in mid-February to withdraw its call for sanctions. It has nevertheless still decided toleave Ukraine on its blacklist, until it sees signs of successful implementation.The first opportunity to revise Ukraine’s status will come at the FATF’s nextplenary meeting, scheduled for mid-June. The Ukrainian authorities haveapproached this target date with caution, and have factored into their planningthe possibility that Ukraine might stay blacklisted until the end of the year.

Thanks to the generally pro-active stance adopted by its new leadership, theNBU has been at the forefront of efforts to detect and monitor suspiciousfinancial operations. The new NBU chairman, Serhy Tyhypko, has generated aflurry of regulatory initiatives to combat money-laundering and capital flightsince his controversial approval in late December 2002 (January 2003, page 17).The NBU hopes to combine these initiatives with the partial liberalisation ofcurrency controls, but continues to insist that it will not significantly modify thegenerally appropriate monetary policy followed under the old leadership.

The policy changes that the NBU has introduced so far appear significant. Asfrom mid-February, all contracts between residents and non-residents involvingthe transfer of Ukrainian securities require licenses. According to the NBU, theseoperations represent the most widespread mechanism for the illegal export ofcapital: Ukrainian companies sell securities at a minimal price to a friendlyforeign-based entity, and then buy them back with hard currency at anoverstated price. The NBU hopes to block this mechanism by limiting the abilityof companies to buy hard currency on the interbank currency market for thepurpose of financing such operations. In another major step towards preventingoutflows of capital, the NBU also introduced, effective from February 27th, alicensing requirement for Ukrainian companies that seek to transfer sums ofmore than €50,000 (US$53,000) abroad for the purpose of paying for servicesrendered by non-residents. The only payments now exempt from this licensingrequirement are those for services rendered in banking, insurance (re-insurance),transport and communications. Although both of these measures will help toplug some existing capital-flight loopholes, others are almost certain to emergeas long as the underlying causes of capital flight remain.

The NBU hopes that its recent measures to combat capital flight will provesufficient to permit a greater degree of currency liberalisation. The central bankhas already proposed a number of changes to deregulate currency-marketoperations. Ukrainians are now allowed to take the equivalent of US$3,000 (upfrom a previous limit of US$1,000) out of the country without a declaration.The NBU has also simplified the process (and raised the limit) for funds thatUkrainians can transfer out of the country with an individual license from thecentral bank. The NBU now allows Ukrainians to take out currency loans fromnon-residents without special permission from the NBU, and to buy currencyon the interbank market for accounts on these loans. For companies, one of the

The new NBU leadership setsits targets on capital flight

The NBU has begun toliberalise the currency market

22 Ukraine


most significant novelties is the reduction (from five days to one day) of therequired delay in payments for import through LORO accounts (correspondentaccounts). Finally, the NBU has extended the duration of the trading session atthe interbank currency market, and has cancelled the requirement that banksobtain the central bank’s permission before borrowing from non-residents.

The requirement that exporters sell at least 50% of their hard-currency proceedson the interbank market—one of the NBU’s main means of controlling thesupply of hard currency—still remains firmly in place. After indicating in early2003 that it might scrap this requirement, the NBU has now indicated that theissue is off of its agenda for the time being. The NBU had first introduced asurrender requirement in the wake of the Russian rouble crisis in the late 1990s,and has kept it in place far longer than originally envisaged. The requirementremains most restrictive for exporters who are also large importers, as it forcesthem first to sell their proceeds before buying them back later at a loss. Bycontrast, most Ukrainian exporters tend to sell far more than 50% of theircurrency proceeds on the interbank market.

In addition to pushing for currency liberalisation, Mr Tyhypko has come out infavour of further monetary policy loosening in order to boost lending to thereal sector and to support the economy’s recovery. He has voiced support foradditional reductions in the refinancing rate (which has already fallen by20 percentage points over the past two years), as well as reductions in reserverequirements, which were last adjusted in the first half of 2002. However, theIMF has voiced concerns about some aspects of the NBU’s programme,particularly its plans to boost long-term lending to enterprises. The NBU’s plansinclude offering as much as HRN1.5bn to commercial banks at a favourableinterest rate, in the expectation that banks will then use this financing to creditlong-term infrastructure projects.

Main economic policy indicatorsJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Consolidated budget revenue (HRN m)2001 4,004 4,003 4,170 4,239 4,583 4,372 4,836 4,624 4,388 4,683 4,487 6,5472002 3,858 4,329 4,502 4,975 5,426 4,707 5,433 5,351 4,964 5,230 5,597 6,4412003 4,637 – – – – – – – – – – –Consolidated budget expenditure (HRN m)2001 2,599 3,588 4,665 4,070 4,452 4,636 4,520 4,893 4,416 4,447 5,121 8,1232002 2,476 4,194 5,358 5,072 4,363 4,967 4,948 4,793 4,651 4,668 5,054 8,5422003 3,186 – – – – – – – – – – –

Consolidated budget balance (HRN m)2001 1,404 415 -495 169 131 -264 317 -269 -28 237 -634 -1,5762002 1,382 135 -856 -96 1,062 -260 485 558 313 562 543 -2,1012003 1,451 – – – – – – – – – – –Exchange rate (av; HRN:US$)2001 5.433 5.430 5.421 5.418 5.414 5.401 5.371 5.347 5.339 5.310 5.287 5.2942002 5.313 5.321 5.322 5.327 5.328 5.329 5.329 5.329 5.330 5.330 5.3302003 5.333 5.334 – – – – – – – – – –Real effective exchange-rate index (CPI-based; Dec 1997=100)2001 69.2 70.2 71.1 72.6 73.5 75.1 74.1 72.3 71.9 72.7 74.4 75.12002 76.0 75.3 74.1 74.1 72.2 69.1 66.5 66.9 66.7 67.0 67.0 66.72003 65.7 – – – – – – – – – – –

Plans for further monetaryloosening remain in place

Ukraine 23


Main economic policy indicatorsJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

M2 (HRN m)2001 30,327 31,104 32,531 33,570 34,718 36,552 36,991 37,933 39,292 40,416 41,204 45,1862002 43,278 44,727 47,032 48,090 48,613 51,056 53,691 56,145 57,618 58,597 59,474 64,3222003 62,621 64,801 – – – – – – – – – –M2 (% change, year on year)2001 40.0 38.5 38.4 36.3 35.7 37.4 33.4 30.7 38.8 43.0 42.6 43.02002 42.7 43.8 44.6 43.3 40.0 39.7 45.1 48.0 46.6 45.0 44.3 42.32003 44.7 44.9 – – – – – – – – – –

Commercial bank lending rate (av; %)2001 37.4 35.6 33.8 33.0 31.7 32.1 31.1 31.7 30.6 30.5 30.2 29.62002 29.7 29.4 27.6 27.1 26.1 25.0 24.9 24.0 23.5 22.9 22.4 21.82003 18.6 17.6 – – – – – – – – – –Commercial bank deposit rate (av; %)2001 11.7 9.3 8.2 11.3 8.6 13.0 11.3 14.2 10.4 12.8 10.2 10.82002 10.1 9.2 8.6 8.1 7.8 8.2 7.9 7.6 7.6 7.0 6.1 6.92003 6.8 6.8 – – – – – – – – – –

Sources: IMF, International Financial Statistics; Ministry for the Economy and European Integration; Economist Intelligence Unit.

The domestic economy

Output and demandReal GDP(% change, year on year)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec2002Monthly 3.2 4.0 4.1 5.0 2.6 6.7 5.0 3.3 3.1 3.8 4.6 4.5Cumulativea 3.2 3.6 4.1 4.1 3.8 4.4 4.4 4.2 4.3 4.1 4.1 4.12003Monthly 7.7 6.7 – – – – – – – – – –Cumulativea 7.7 7.2 – – – – – – – – – –

a Since start of year. 2002 data do not include latest revisions.

Sources: State Committee of Statistics; Ministry for the Economy and European Integration; press reports.

The government has revised upwards its figures for real GDP growth in 2002(from 4.1% to 4.6%) and has reported an acceleration in growth over the firsttwo months of 2003. According to preliminary government data, cumulativegrowth in January-February exceeded 7% year on year. In part, this is afunction of a low base period established in early 2002, when the economyproved particularly sluggish owing to a sharp slump in the chemicals andmetallurgy sectors. Although these base-year considerations will dissipateover the remainder of the year, the government has recently adopted abullish stance by including an annual growth forecast of 5-6% in its draftaction plan for 2003, considerably higher than the 4.2% assumption includedin the 2003 budget.

Real GDP growth rose to 7% inJanuary-February 2003

24 Ukraine


Gross value added(% change, year on year)

2001 2002 2003Jan-Apr Jan-Jul Jan-Nov Jan-Apr Jan-Jul Jan-Nov Jan

Wholesale & retail trade 10.2 14.3 23.8 19.8 12.8 9.6 8.8

Agriculture, hunting & forestry 5.0 24.6 11.4 10.7 6.9 3.9 5.2Manufacturing 24.2 21.9 18.3 4.0 7.9 8.1 13.8

Education -0.1 0.2 0.3 1.3 1.3 1.1 0.9Construction 8.7 9.3 7.0 1.0 -2.6 -1.7 24.4Transport -0.5 0.2 0.2 0.9 1.5 2.2 8.3

Extractive industry 4.1 4.4 3.7 -0.2 0.5 1.9 3.9Electricity, gas & water 1.1 3.4 2.0 -0.9 -0.1 0.8 3.8

Note. Year-end 2002 data are not yet available.

Source: Ministry for the Economy and European Integration.

The robust growth registered during the first two months 2003 has benefitedfrom improved conditions abroad, which have helped to boost themanufacturing sector and compensated for slackening domestic demand.Buoyant domestic demand had previously been instrumental in driving theeconomy’s recovery, particularly once the initial boost provided by exports in2000 and the first part of 2001 had begun to lessen. However, the growth indomestic trade had decelerated steadily over the course of 2002, and in January2003 proved relatively modest (compared with the growth rates seen in 2001)at under 9% year on year. Despite this relative slowdown, domestic demand isunlikely to collapse, with construction activity rising 20% year on year duringthe first two months of 2003, and the most recent consumer confidence surveydata showing an upturn in late 2002. Similarly, the strong rise in deposits seenover the past two years (part of which represents deferred consumption in theabsence of access to greater consumer lending) suggests continued scope forconsumer demand.

Consumer confidence index2001 20021 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Index (June 2000=100) 80.7 83.2 94.0 94.9 90.9 95.3 88.8 93.4

Sources: International Centre for Policy Studies; GfK-USM.

Employment, wages and prices

Ukraine experienced unusually strong consumer price deflation in 2002, as aresult of a larger than normal decrease in food prices during the first half of theyear, and the imposition of price caps in advance of the March 2002 election(July 2002, page 26). This experience with deflation is unlikely to repeat itself in2003. Starting in the second half of last year, monthly consumer price increaseshave generally returned to the pattern of previous years. By February 2003,year-on-year inflation had risen to 2.5%, only moderately lower than during theyear-earlier period.

External upturn compensatesfor softening domestic demand

Year-on-year deflation givesway to moderate inflation

Ukraine 25


Consumer prices(% change, month on month)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec2002Food 1.5 -2.1 -1.0 2.2 -0.3 -3.2 -2.7 -0.7 0.2 0.7 1.1 2.2Non-food 0.0 0.1 -1.2 0.0 0.1 0.9 0.0 0.1 0.2 0.3 0.1 0.0Services 0.2 0.0 0.0 0.0 -0.4 0.5 0.5 0.9 0.4 0.9 0.3 0.1Total 1.0 -1.4 -0.7 1.4 -0.3 -1.8 -1.5 -0.2 0.2 0.7 0.7 1.42003Food 2.0 1.5 – – – – – – – – – –Non-food 0.1 0.0 – – – – – – – – – –Services 0.8 0.4 – – – – – – – – – –Total 1.5 1.1 – – – – – – – – – –

Sources: Ministry for the Economy and European Integration; press reports.

The return of moderate inflation in early 2003 was largely attributable to a 3.5%cumulative increase in food prices. Prices for services grew less strongly overthe first two months of the year (by 1.2%), and those of non-food goods rose byonly 0.1%. The rate of consumer price inflation in Ukraine is particularlyinfluenced by the situation on the grain, meat and milk markets, as foodproducts account for around 70% of the consumer basket. In particular, thegrain surplus that existed in 2002, as a result of record-high grain production, isunlikely to be repeated in 2003, given inclement weather conditions in the firstmonths of the year. Additional pressure on prices will come as the utility pricerise introduced at the start of the year works its way through the system, and asthe government finally introduces a long-delayed hike in public transport tariffs.

The deceleration in inflation over the past two years has combined with risingnominal wages to ensure a significant increase in real wages. Wages havebenefited from the ongoing economic expansion, increased productivity andgreater private- and public-sector liquidity. Real wages rose by almost 20% in thefinal months of 2002, when the average monthly wage climbed above HRN400for the first time—more than the established monthly subsistence level of justabove HRN340. The most recent data show an even stronger rate of nominal andreal annual wage growth in January 2003, despite a sharp month-on-month fallin wages. This decline followed a historical pattern, as December wages areusually inflated through the payment of seasonal bonuses and year-end socialpayments. Further strong wage growth is likely in 2003, if only because of thevote in parliament to raise the minimum wage from HRN165 to HRN237.However, the full effect of this increase will be deferred, as budgetary constraintshave postponed some of the increase until July (see Economic policy).

Earnings and arrears, Jan 2003(% change, year on year unless otherwise indicated)

Nominal wages 24.7Real wages 25.2

Private-sector wage arrears (HRN m) 2,281a

Private-sector wage arrears -15.9a

Public-sector wage arrears (HRN m) 42.0a

Public-sector wage arrears -20.3a

a December 2002.


Strong wage growth continues

26 Ukraine


Wages in Ukraine nevertheless still remain low by regional standards. InUS dollar terms, the average Ukrainian wage barely exceeds US$2 a day, lessthan half the level in Russia, and under 15% of the average level in Poland. Evenin comparison with the wage levels that prevailed in Ukraine prior to thecurrency’s devaluation in the mid-1990s, the average US dollar wage today isstill down by more than 10%. It is likely that between one-quarter and one-thirdof the population continues to live below the poverty line. Poverty remainsparticularly acute outside of the main urban centres, with wages in the ruralregions in western Ukraine equal to less than 40% of those in Kiev. For much ofthe population, therefore, the recent strong increase in wages has not broughtmuch respite. According to one recent poll, almost half of respondents claimthat their families’ economic situation had worsened over the last three years,whereas less than 20% claimed that their situation had improved.

Average monthly wages, Jan 2003(US$)

Ukraine 75.0Russia 156.5

Romania 194.9Poland 578.8

Source: Economist Intelligence Unit.

Wage arrears—which have long exacerbated poverty in Ukraine—are now farless of a problem than they were in the late 1990s. At that time, the governmentresponded to the need for budget tightening in part through long delays inpaying wages. Widespread illiquidity produced a parallel problem at theenterprise level. By end-2002 total wage arrears had fallen to half the level (innominal terms) that had prevailed two years earlier, with public-sector wagearrears down by over 80%. Nevertheless, little of this progress came in 2002.Despite continued economic growth, currency stability and the gradualmonetisation of the economy, the private sector saw almost no reduction inarrears in 2002. Public-sector arrears grew by almost one-third compared withthe first quarter of the year.

Wage arrears have decreasedslower than expected

Wages still remain low byregional comparison

Ukraine 27


The actual number of unemployed is estimated as far higher than the 1.1m (or4% of the workforce) officially counted as unemployed as of the beginning ofFebruary. A large number of unemployed do not bother registering, given thelargely symbolic unemployment benefits available (at most HRN102 per month,or under US$20), and actual unemployment rates are estimated to be three orfour times higher than those reported by official data. Even a relativelyconservative estimate by the International Labour Organisation (ILO), based ondata for the first nine months of 2002, suggests that around 10% of theworkforce is unemployed. The official data nevertheless provides some insightinto unemployment trends—including the slow pace with which manyenterprises are shedding labour through restructuring, and the existence ofsignificant regional differences in unemployment. The most joblessness isfound in the poorest parts of the country in western Ukraine, and the least isfound in industrialised eastern Ukraine, which also features the highest wages.

The gap between official and unofficial unemployment estimates is likely tonarrow over time, as the grey economy shrinks and the availability of benefitsimproves. The number of individuals registering has already begun to increase,mostly owing to improving legislation rather than rising benefits. Innovationsintroduced in 2002, such as requirements for enterprises to report the wage andunemployment histories of employees, and an improved system for accountingfor pension payments by enterprises, are already likely to have increased theincentive for unemployed workers to register.

Financial indicators

The change in the leadership of the National Bank of Ukraine (NBU, the centralbank) in late 2002 has not yet resulted in the accelerated currency decline manyhad expected (see Economic policy). Over the first quarter of 2003 the value ofthe local currency, the hryvnya, remained broadly unchanged against theUS dollar, and was down in nominal terms by less than 1% since the start of2002. The hryvnya’s greater weakening against the euro (by almost 20% overthe course of 2002) is a function of the US dollar’s slide against the euro.

The Ukrainian currency’s strength against the US dollar has been helped byforeign-currency inflows related to the record-high current-account surplus (seeForeign trade and payments). Over the past year the supply of US dollars onthe interbank currency exchange regularly exceeded demand, which permittedthe NBU to purchase large quantities of foreign-exchange in order to boost itsinternational reserves. The ready supply of foreign-exchange on currencymarkets is also a function of the NBU’s controls on foreign-currency trading.Although the NBU appears for now to have abandoned plans to abolish the50% surrender requirement for exporters, other forms of currency liberalisationare under way (see Economic policy). This is likely to bring somewhat greaternominal depreciation against the US dollar over the remainder of the year,particularly as the new NBU leadership is more receptive to complaints byexporters about the loss in external competitiveness brought on by thecurrency’s strength.

The actual unemployment rateis likely to be at least 10%

Exchange rate remains stableagainst the US dollar

28 Ukraine


The record disinflation achieved in Ukraine in 2002, as well as the US dollar’sweakening against the euro, have already given exporters something of areprieve. Even against the US dollar, the hryvnya has depreciated moderately inreal terms since the start of 2002, owing to somewhat higher inflation in theUS. Compared in real terms with a broader basket of currencies—the realeffective exchange rate—the hryvnya is down even further. The average realeffective exchange rate of the hryvnya is calculated to have depreciated bymore than 10% over the course of 2002, and remains roughly one-third weakerthan it was prior to the currency crisis in 1998.

One of the indirect consequences of the central bank’s currency controls hasbeen a transformation in the way in which commercial banks do business. Nolonger able to profit from foreign-currency speculations, banks are now farmore focused on strengthening customer relations. Combined with a risingdemand for financial intermediation, this has brought a significant increase inboth deposits and lending in recent years. Private deposits have grownexceedingly strongly, rising by over 70% in both nominal and real terms overthe course of 2002. In an indication of rising confidence in the hryvnya, local-currency deposits by private individuals rose more quickly over the course of2002 (76% in nominal terms) than foreign-currency deposits (61%). Althoughthis rapid pace of growth decelerated towards the end of 2002, stronger growthresumed in the first part of 2003, buoyed by continued low inflation andincreasing use of electronic payments. Corporate deposits increased at a lessrapid pace of around 29% over the course of 2002, with local-currency depositsonce again growing at a faster pace than foreign-currency deposits.

Commercial-bank lending and deposits(HRN m unless otherwise indicated)

Jan 2002 Jan 2003Local-currency credits to the real sector 15,393 23,700 % change, year on year 51.0 54.0Foreign-currency credits to the real sector 12,219 17,406 % change, year on year 38.3 42.5Total credits to the real sector 27,612 41,106 % change, year on year 45.1 48.9

Banking sector continues tosee strong growth in deposits

Deflation in 2002 brings areturn to real depreciation

Ukraine 29


Commercial-bank lending and deposits(HRN m unless otherwise indicated)

Jan 2002 Jan 2003Local-currency deposits 16,646 25,057 % change, year on year 48.3 50.5Foreign-currency deposits 8,309 12,432 % change, year on year 17.6 49.6Total deposits 24,955 37,489 % change, year on year 36.4 50.2


Growth in lending to the enterprise sector has lagged behind the increase indeposits, but is nevertheless also impressive. Total commercial bank credits tothe real sector increased by 48% in nominal terms in 2002 to reach HRN41.2bn,roughly the same rate of growth recorded the previous year. Although totallending to the corporate sector grew by just 2% over the first two months of2003, this pace is expected to accelerate in line with the priorities articulated bythe central bank’s new leadership (see Economic policy). The NBU is interestedin boosting longer-term lending, which until recently accounted for only 5% ofthe overall total. In 2002 the growth in long-term lending reached almost 90%and far outstripped the increase in overall lending. It now accounts for aroundone-quarter of total credits.

Despite these improvements most enterprises still have only limited access tocredit. This is partly a consequence of persistently high interest rates. Borrowingrates have fallen by almost 12 percentage points in nominal terms since late2001. However, the annual lending rate still stood at 17.6% as of early March2003, and appears particularly high in a context of negligible inflation. In thisrespect, the NBU’s aggressive rate-cutting policies over the last year have failedto generate the desired response from banks, which continue to cover highcredit risk and transaction costs by maintaining a wide spread between creditand deposit rates. Further progress in deepening macroeconomic stability,strengthening the banking sector and improving legislation are needed forcommercial bank lending rates to come down further.

Interest rates fall but remainhigh for most borrowers

30 Ukraine


Notwithstanding the improvements noted over the past two years, the financialintermediation role of Ukraine’s financial sector still remains limited. All partsof the sector—including banks, non-banking financial institutions and thesecurities market—are still largely underdeveloped and inadequate. Despiterising by 27% in nominal terms in 2002, the total capitalisation of the bankingsector (the most advanced and stable component of the country’s financialsystem) is still less than US$2bn, or roughly equal to the size of one large bankin central Europe. In an attempt to boost capitalisation, the central bank raisedits minimum capital requirements in mid-January to €5m (US$5.3m) and plansto double this towards the end of the year.

Ukraine’s securities market is also poorly developed, featuring low volumesand sporadic trading. Although a number of market indicators point to someimprovements in 2002, this is largely a function of an exceptionally low baseperiod. The PFTS index rose by around one-third in 2002, having fallen byroughly the same amount the preceding year. In 2002 total marketcapitalisation also increased by almost one-third, but remains low atHRN23.3bn (US$4.7bn), equal to a capitalisation/GDP ratio of only 12% (wellbelow the 20-30% seen in central Europe). A notable improvement has comewith the switch from trading based predominantly on shares and promissorynotes towards more trading in corporate bonds. The volume of secondarytrading in bonds grew almost sevenfold in 2002.

The total volume of securities trading fell by 12% year on year in 2002, despitestrong growth in the wake of the parliamentary election in March. However,these data do not provide an accurate picture of supply and demand in themarket for Ukrainian securities, as the vast majority of trades still happenoutside of organised trading floors. The Securities and Stock Market StateCommission (SSMSC), which regulates the industry, has repeatedly attemptedto change this over the past five years, without much success. The SSMSC’slatest effort to secure legislation requiring all securities to be traded throughexchanges and official trading floors has languished in the cabinet sinceNovember 2002.

Sectoral trends

The industrial sector posted 10.8% growth year on year over the first twomonths of 2003. Although this suggested a considerable pick-up comparedwith the sector’s performance during the latter part of 2002, the comparisonis complicated by the unusually weak base period in early 2002 (when thelarge chemicals and steel sectors were in decline). Disaggregated dataavailable for 2002 confirm that the industrial sector’s recovery is generallybroadly based. After either stagnating or declining over the first half of theyear, both the extractive sector and utilities (the production and distributionof electricity, gas and water) posted solid growth over the remainder of theyear. The manufacturing sector expanded strongly, and remains by far themost important factor in driving overall growth in the sector. Manufacturingis the largest component of industry, accounting for almost three-quarters oftotal output.

Despite improvements,intermediation is limited

The stockmarket is still weak

The generally broad-basedindustrial recovery continues

Ukraine 31


Industrial output(real % change, year on year)

2001 2002Jan-Apr Jan-Jul Jan-Oct Jan-Dec Jan-Apr Jan-Jul Jan-Oct Jan-Dec

Total 18.7 18.0 16.2 14.2 3.5 6.1 6.0 7.0Extractive industry 4.3 4.8 4.1 3.3 0.0 0.5 1.5 2.3Electricity, gas & water 0.8 3.3 2.4 2.6 -0.8 -0.1 0.6 1.1

Manufacturing 24.7 22.3 19.8 17.2 4.7 8.0 7.7 8.9 Wood & wood products 25.7 27.1 26.2 28.0 31.2 25.5 26.7 23.4 Coke & refining products 56.9 51.3 57.2 54.3 19.6 42.2 27.9 25.5 Food 23.5 22.2 20.2 18.2 13.5 10.2 6.8 8.4 Machine-building 24.4 25.7 21.7 18.8 8.7 5.4 9.5 11.3 Pulp & paper 27.0 24.9 20.8 18.2 6.4 4.6 7.5 8.4 Non-metallic fertilisers 17.7 18.5 15.0 11.4 2.2 1.2 4.3 5.3 Light industry 25.7 21.1 16.0 13.8 1.1 0.0 1.2 0.4 Chemical & petrochemicals 16.6 15.1 11.9 10.6 -0.9 3.9 5.4 6.5 Metallurgy 18.5 14.2 8.3 4.9 -6.6 -0.1 1.9 3.9


Several trends within manufacturing are worth noting. The expansion insectors that enjoyed significant foreign direct investment (FDI) in recent years—particularly oil-refining and food-processing—has continued, and these sectorshave taken on an increasingly important role. However, their expansionmoderated considerably as 2002 progressed—in part owing to a strengtheningbase period. As a result, the stronger manufacturing growth recorded towardsthe end of 2002 was predominantly a function of an improved performance insteel and chemicals—which had struggled during the first part of 2002.Similarly, machine-building picked up steam over the course of the year to helpto compensate for slowing growth elsewhere in the sector. Steel, chemicals andmachine-building continue to be vital generators of export revenue.

The metallurgy sector

A mixed picture

Ukraine’s massive metallurgy sector almost single-handedly drove the expansionunder way by early 2000. Helped by spare capacity, preferential policies, strongworld prices and rising external demand, the sector expanded rapidly throughout2000 and the first part of 2001. However, by the second half of 2001 the sector wasstruggling, owing to falling prices, proliferating trade barriers and rising input prices.Over the first four months of 2002 metals output slumped by almost 7% year on year.The situation has improved considerably since then, helped by rising prices and thesuccessful re-orientation of Ukrainian steel exports to markets in the Middle East andAsia. Output during the second half of 2002 rose by over 10% in year-on-year terms,with some of the strongest growth coming in the higher value-added parts of thesector: production of steel pipes and rolled metal stock products rose by 12% and 18%year on year, respectively.The metallurgy sector’s expansion has continued during the first part of 2003.However, the 22% year-on-year jump in output recorded in January is in large part aresult of the low base period involved. Steel output has fallen gradually in month-on-month terms since November 2002. Given the threat of price shocks and furtherprotectionism abroad, a return to the high growth rates seen in 2000 appears slim.

32 Ukraine


Output in the agricultural sector rose by just over 4% year on year during thefirst two months of 2003, considerably slower than the growth rates postedduring the year-earlier period. The sector’s output increased by less than 2% in2002, the weakest annual growth recorded since the government jump-startedsectoral reforms at the start of 2000. The weak growth in 2002 reflected a 1.5%decline in crop production. Although still strong, the grain harvest in 2002failed to match the bumper crop recorded in 2001, and sugarbeet productionfell sharply in year-on-year terms (January 2003, page 35).

Agricultural sector(cumulative % change, year on year)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec2002Output 9.2 9.8 9.8 10.6 10.1 8.9 5.9 4.2 3.1 2.8 2.6 1.9Gross value added 9.7 10.4 9.2 10.7 10.2 11.1 6.9 5.5 4.5 4.1 3.9 n/a

2003Output 4.7 4.3 – – – – – – – – – –Gross value added 5.2 – – – – – – – – – – –

Source: Ministry for the Economy and European Integration; State Committee of Statistics.

The slump in crop production in 2002—which more than outweighed the 7.2%increase in livestock production—is likely to be repeated in 2003. According tothe government, unusually long and snow-free frosts during the winter monthsdestroyed half of the winter grain crop, as a result of which the 2003 grainharvest could fall by around 20% to 30m-32m tonnes. Despite significantimprovements in comparison with the crisis-ridden 1990s, Ukraine’sagricultural sector continues to suffer from slow reforms and insufficientliquidity, which limits the availability of key inputs, including equipment, fueland fertilisers.

Main macroeconomic indicatorsJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

GDP (at constant prices, % change)2001 9.1 6.2 7.8 10.8 10.9 9.2 17.4 12.4 0.1 8.0 8.4 9.02002 3.2 4.0 4.1 5.0 2.6 6.7 5.0 3.3 3.1 3.8 4.6 4.52003 7.7 6.7 – – – – – – – – – –

Industrial output (at constant prices; % change, cumulative since Jan 1st)2001 21.5 17.2 17.8 18.7 19.1 18.8 18.0 17.1 16.7 16.2 15.4 14.22002 1.7 3.5 3.1 3.5 3.1 5.8 6.1 5.9 6.0 6.0 6.3 7.02003 11.6 10.8 – – – – – – – – – –Unemployment ('000)2000 1,185 1,214 1,229 1,234 1,199 1,173 1,160 1,160 1,147 1,135 1,143 1,1552001 1,150 1,157 1,149 1,132 1,088 1,047 1,015 1,001 985 971 982 1,0082002 1,029 1,067 1,079 1,087 1,051 1,023 1,005 1,003 985 980 999 1,034Unemployment rate (%)2000 4.3 4.5 4.5 4.5 4.4 4.3 4.2 4.2 4.2 4.2 4.2 4.22001 4.2 4.2 4.2 4.1 4.0 3.8 3.7 3.6 3.6 3.5 3.6 3.72002 3.8 3.9 3.9 4.0 3.8 3.7 3.7 3.7 3.6 3.6 3.6 3.8

Consumer prices (% change, month on month)2001 1.5 0.6 0.6 1.5 0.4 0.6 -1.7 -0.2 0.4 0.2 0.5 1.62002 1.0 -1.4 -0.7 1.4 -0.3 -1.8 -1.5 -0.2 0.2 0.7 0.7 1.42003 1.5 1.1 – – – – – – – – – –

Agriculture grows moderatelybut winter crops suffer

Ukraine 33


Main macroeconomic indicatorsJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Consumer prices (% change, year on year)2001 22.1 18.9 17.3 17.0 15.1 11.6 9.9 9.6 7.3 6.0 6.1 6.12002 5.6 3.5 2.2 2.1 1.4 -1.1 -0.9 -0.9 -1.1 -0.6 -0.4 -0.62003 -0.1 2.5 – – – – – – – – – –Producer prices (% change, month on month)2001 0.8 0.6 -0.5 0.2 0.0 0.2 0.1 -0.1 0.1 -0.7 0.7 -0.52002 -0.4 0.7 -0.8 1.2 1.5 2.2 1.0 -0.4 0.3 0.2 0.2 0.02003 0.5 0.7 – – – – – – – – – –

Producer prices (% change, year on year)2001 17.8 16.4 12.8 10.8 10.1 9.4 7.9 7.1 5.9 3.8 3.5 0.92002 -0.3 -0.2 -0.5 0.5 2.0 4.0 5.0 4.6 4.9 5.8 5.3 5.82003 6.8 6.8 – – – – – – – – – –Average gross monthly wage (% change, year on year)2001 40.0 38.3 33.4 40.7 42.1 38.9 37.2 33.1 31.0 32.1 29.8 27.72002 26.6 24.7 26.3 23.1 18.5 18.8 21.6 18.4 19.9 18.4 18.3 17.02003 24.7 – – – – – – – – – – –

Average gross monthly wage (real % change, year on year)2001 11.8 13.4 10.9 17.2 20.3 21.4 24.9 21.4 19.0 24.7 22.3 20.52002 19.9 20.5 23.6 20.7 17.2 20.4 23.2 19.9 24.7 19.4 19.1 18.12003 25.2 – – – – – – – – – – –Average gross monthly wage (US$)2001 46.6 48.6 51.8 53.3 56.0 58.8 60.9 61.6 61.1 63.2 63.3 71.52002 60.4 61.8 66.7 66.8 67.4 70.8 74.7 73.2 73.4 74.6 74.2 83.12003 75.0 – – – – – – – – – – –

Sources: IMF, International Financial Statistics; Ministry for the Economy and European Integration; Economist Intelligence Unit.

Foreign trade and paymentsMerchandise trade(US$ m unless otherwise indicated)

2002 2003Jan-Mar Jan-Jun Jan-Sep Jan-Dec Jan

Exports fob 3,873 8,129 12,757 17,957 1,489 % change, year on year 1.9 1.5 6.4 10.4 15.1

Imports cif 3,546 7,648 12,044 16,977 1,344 % change, year on year -0.4 3.1 6.0 7.6 17.2

Note. Based on monthly data.

Sources: Ministry for the Economy and European Integration; news reports.

Customs data for 2002 show a merchandise trade surplus of US$980m, upfrom US$198m in 2001. The increase in the trade surplus is entirely attributableto the strong year-on-year growth in exports recorded during the second half of2002. This reflected not only record grain exports, and improved sales of steeland chemicals after a poor start to the year, but also considerable base-yeareffects: merchandise exports to Russia had plummeted during the second halfof 2001, following Russia’s imposition of value-added tax (VAT) on Ukrainianimports at mid-year. After rising by less than 2% year on year during the firsthalf of 2002, export revenue increased by almost 20% over the second half ofthe year to total US$18bn for the year as a whole. Import expenditure alsopicked up strongly year on year over the course of 2002—rising by 11% in the

Merchandise trade surplusrises sharply in 2002

34 Ukraine


second half of the year following 3% growth during the first half—to reachUS$17bn for the year as a whole.

Ukraine’s dependence on imported energy resources from Commonwealth ofIndependent States (CIS) suppliers continue to drive Ukraine’s energy importbill, owing to limited domestic production and the energy-intensive industrialsector that Ukraine inherited from the Soviet period. The composition ofUkraine’s exports displays a similar lack of diversification, with metals stillaccounting for around 40% of total exports, or more than the next four majorexport categories combined (hydrocarbons, machine-building, chemicals andtextiles). The increase in revenue from metal sales abroad played a major role indriving exports in 2002. Although steel export earnings had declined sharply inearly 2002, owing to a combination of protectionist measures, sluggish worldprices and a global economic downturn, they recovered strongly over theremainder of the year. This reflected both rising prices and a successfulre-orientation towards less closed markets. In particular, the expansion in salesto new steel markets in Asia and the Middle East helped to compensate forweaker demand in the US, European and Russian markets.

Direction of trade, 2002Jan-Jun Jan-Dec

US$ m % change, year on year US$ m % change, year on yearExports 8,130 1.5 17,957 5.1Russia 1,436 -34.3 3,189 -13.3Turkey 649 84.9 1,235 22.4Italy 426 3.2 829 -0.4Germany 346 0.3 755 6.2China 356 23.2 700 29.2Great Britain 243 35.4 537 45.5US 240 -6.3 519 -8.8Imports 7,649 3.2 16,977 0.5Russia 2,765 -1.8 6,317 8.7Turkmenistan 988 23.0 1,886 14.0Germany 724 18.8 1,658 20.1US 267 23.0 472 3.1Poland 233 22.3 537 19.1Italy 213 10.5 462 12.1Kazakhstan 197 -42.6 383 -42.5

Sources: State Committee of Statistics; National Bank of Ukraine.

Another boost to exports in 2002 came in the form of a fivefold increase inexports of grain. The record grain harvest in 2001 permitted record high grainexports of over 9.1m tonnes in the 2001-2002 marketing year, which broughtgrain’s share of total annual exports up from under 1% to almost 5%. Thanks toa near-repeat of this record harvest in 2002 (see The domestic economy), grainexports during the first half of the 2002-03 marketing year already reachedaround 8m tonnes. However, the government will still be hard-pressed to meetits target of 10-12m tonnes in grain exports for the 2002-03 marketing year as awhole. The surge in sales to Europe at the end of 2002 is in large part due tofront-loading by Ukrainian exporters anticipating the introduction of EU quotarestrictions at the start of January. The EU has now capped all non-EU imports

Metals exports recoverstrongly by end-2002

Grain exports soar but the EUhas not introduced quotas

Ukraine 35


at 3m tonnes in the 2003 calendar year—roughly equal to what Ukraine hadoriginally hoped to export to Europe on its own. A series of recent scandalsinvolving the discovery of fungi and pesticides in grain shipments to Brazil,France and Canada, is also a cause for concern. Although resolved relativelyquickly, these incidents have dented the country’s credibility in the eyes ofprospective buyers. Ukraine still hopes to sell over 2m tonnes of grain in thepromising markets of South America during the current marketing year.

Composition of trade, 2002Jan-Jun Jan-Dec

US$ m % change, year on year US$ m % change, year on yearExports 8,130 1.5 17,957 10.4 Metals 2,441 -2.8 7,126 6.0 Minerals 1,048 30.7 2,245 28.3 Electronics 799 -10.1 1,759 2.6 Chemicals 641 -20.7 1,397 -5.4 Vegetables 396 100.0a 1,121 61.8 Textiles 298 3.4 655 6.7 Transport equipment 248 -8.2 689 25.5Imports 7,649 3.2 16,977 7.6 Minerals 3,211 0.5 7,047 4.8 Electronics 1,133 -1.1 2,502 5.2 Chemicals 666 20.9 1,375 22.0 Metals 355 -10.6 811 -1.2 Transport equipment 406 34.1 1,022 37.0 Plastics & rubbers 315 -7.7 736 5.6

a Economist Intelligence Unit estimate based on official data.

Source: State Committee of Statistics.

Ukraine hopes that accession to the World Trade Organisation (WTO) willaccelerate the re-orientation of trade towards more stable markets in Westernindustrialised countries and help to protect it from anti-dumping allegationsabroad. After several years of incoherent attempts to apply for WTOmembership, Ukraine has tried to reinvigorate the process over the past year.However, the scale of outstanding issues has prompted the government torevise its self-imposed accession deadline from late 2003 to 2004, which is stilloverly optimistic. By March 2003 Ukraine had signed bilateral protocols onaccess to markets for goods and services with half of the 22 countries in itsworking group, and achieved an important breakthrough in mid-March when itsigned a bilateral protocol with the EU. However, much of the work still liesahead, and will prove difficult given the significant risk of further politicalgridlock. Ukraine still needs to harmonise large amounts of domestic legislationto fit with WTO rules and needs to complete bilateral negotiations with theremainder of its working group. This includes negotiations with the US, whichhas so far proved to be the most difficult negotiating partner.

Recent data from the National Bank of Ukraine (NBU, the central bank) confirmthat Ukraine posted a record high current-account surplus of US$3.2bn in 2002,equal to an estimated 6.4% of GDP. In addition to the growth in merchandiseexports, the record current-account surplus reflects an even faster rate of growthin services exports, thanks to a rise in the negotiated tariff price for transporting

WTO accession remains a keytrade policy goal

The current-account surplus in2002 is at record high

36 Ukraine


Russia’s hydrocarbon exports to Europe. It also reflects the success with whichimport costs—of both goods and services—have been contained, and continuedstrong transfers inflows. These have been helped by settlement payments toUkrainians who worked as slave labourers during the second world war, andhigh inflows of remittances from Ukrainians currently working abroad.

Balance of payments(US$ m)

2001 20021 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Exports fob 4,040 4,385 4,192 4,474 4,023 4,437 4,838 5,371

Imports fob -3,872 -4,105 -4,229 -4,687 -3,780 -4,350 -4,683 -5,146Trade balance 168 280 -37 -213 243 87 155 225Services exports 945 960 1,020 1,070 1,031 1,074 1,222 1,355Services imports -894 -937 -797 -952 -757 -830 -975 -973Services balance 51 23 223 118 274 244 247 382Income credit 48 41 40 38 36 35 39 53Income debit -217 -176 -204 -237 -170 -181 -204 -214

Income balance -169 -135 -164 -199 -134 -146 -165 -161Current transfers credit 253 390 401 472 451 451 528 537Current transfers debit -14 -13 -11 -22 -7 -10 -11 -17

Current transfers balance 239 377 390 450 444 441 517 520Current-account balance 289 545 412 156 827 626 754 966Capital account 2 -1 0 2 3 2 3 7Financial account -10 -633 -447 -84 -343 -613 -661 -686

Direct investment 197 326 96 150 123 116 157 298 Portfolio investment -161 -103 -303 -299 -293 -311 -592 -520 Other investment -9 -511 573 476 -169 -285 444 -230 Reserves assets -37 -345 -813 -411 -4 -136 -669 -236 Capital- & financial-account balance -8 -634 -447 -82 -340 -611 -658 -679Errors & omissions -281 89 35 -74 -487 -15 -96 -287Overall balance 0 0 0 0 0 0 0 0

Source: National Bank of Ukraine.

By contrast, the financial account posted a sizeable deficit of US$2.3bn in 2002,compared with under US$1.2bn in 2001. The large deficit reflects significantforeign-currency purchases on the part of the NBU, which brought itsinternational reserves to a record high of US$4.7bn by March 2003. It alsoreflects large net debt repayments—related in part to rising amortisation costson the 2007 Eurobond—and significant net outflows of portfolio investments.This appears to confirm the NBU’s claim that overpriced sales of securities tofriendly offshore buyers represent one of the principle routes for capital flight(see Economic policy). Ukraine’s financial-account deficit is also a function ofits difficulties in attracting foreign direct investment (FDI) inflows. According topreliminary data from the NBU, inflows of FDI equalled US$693m in 2002,down from US$792m in 2001. FDI inflows into Ukraine still remain exceedinglylow by regional standards. Ukraine had attracted a cumulative total of onlyUS$5.4bn in FDI by the start of 2003, equal to only around US$110 per head,one of the lowest FDI levels per capita in eastern Europe and the CIS.

The capital-account deficitdoubles to US$3.2bn in 2002

Ukraine 37


FDI into Ukraine continues to flow primarily into the food- and agriculture-processing industry, which along with wholesale domestic trade accounts foraround one-third of total FDI inflows to date. The most recent official dataconfirm the US as the largest single investor in Ukraine since independence,with the UK and the Netherlands the next largest Western investors. Russia’sshare in total FDI inflows is more difficult to discern. Although it ranks onlyfifth in terms of cumulative investment into Ukraine, this almost certainlyunder-represents Russian investment, much of which originates from offshorecentres. Russian investment is likely to be partly responsible for growing FDIfrom Cyprus and the British Virgin Islands. Cyprus currently ranks only behindthe US in terms of cumulative FDI, and the British Virgin Islands ranks sixthand is likely soon to overtake Russia. Inflows from these offshore centresprobably also include returning Ukrainian capital. Recent estimates suggest thatover one-quarter of all joint ventures registered in Ukraine are established usingRussian and Ukrainian capital routed through offshore centres.

Foreign direct investment stock, 2002(end-year)

US$ m % of totalBy country of originUS 898 16.8Cyprus 602 11.3UK 511 9.6Netherlands 399 7.5Russia 323 6.0By sectorChemicals & petrochemicals 217 4.1Food & agricultural processing 852 16.0Wholesale domestic trade 855 16.0Finance 433 8.1Machine-building 469 8.8Transport 382 7.2Metallurgy 280 5.2Coke & refining 195 3.7Other 1,656 31.0

Total stock of FDI 5,339 100.0


FDI from offshore points toRussian and Ukrainian capital

38 Ukraine


The government continues to plan to return to the Eurobond market in 2002,after having placed a total of US$400m in Eurobonds during the last twomonths of 2003. It hopes to place another US$600m in bonds in 2003.Although access to external capital is highly restricted for most of the privatesector in Ukraine, one of the two leading mobile telecommunicationsproviders, Kyivstar, successfully issued a US$100m Eurobond in November2002 and a second US$60m placement in March 2003. Despite the greaterborrowing expected in 2003-04, Ukraine’s relatively strong real GDP growthand nominal currency stability against the US dollar are expected to holddown any increase in the ratio of total foreign debt stock to GDP. The ratio iscurrently equal to less than 30%, down by over 15 percentage points incomparison with 1999, and is likely to fall to below 25% by the end of 2004.

Main external indicators(US$ m unless otherwise indicated)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecExports fob2000 831 1,043 1,147 1,049 1,268 970 1,389 1,328 1,285 1,377 1,329 1,5642001 1,157 1,211 1,431 1,378 1,330 1,502 1,362 1,329 1,291 1,507 1,449 1,3162002 1,215 1,294 1,364 1,477 1,369 1,410 1,475 1,468 1,685 1,736 1,650 1,814

Imports cif2000 1,131 1,258 1,309 1,085 1,034 902 1,140 1,018 1,039 1,236 1,121 1,5962001 1,079 1,148 1,333 1,224 1,303 1,329 1,228 1,431 1,284 1,411 1,516 1,4882002 1,488 1,025 1,147 1,374 1,428 1,271 1,403 1,505 1,434 1,457 1,592 1,468Trade balance2000 -300 -215 -162 -36 234 68 249 310 246 141 208 -322001 78 63 98 154 27 173 134 -102 7 96 -67 -1722002 -273 269 217 103 -59 139 72 -37 251 279 58 346Foreign reserves2001 1,456 1,566 1,396 1,489 1,577 1,731 1,892 2,047 2,578 2,786 2,873 2,9552002 2,832 2,926 2,962 2,985 3,045 3,245 3,665 3,925 3,899 3,940 4,165 4,2412003 4,374 4,528 – – – – – – – – – –

Gold2001 120 123 120 123 128 130 126 131 139 134 133 1342002 137 146 148 153 160 160 152 155 160 158 160 1752003 183 178 – – – – – – – – – –International reserves2001 1,576 1,689 1,516 1,612 1,705 1,861 2,017 2,177 2,717 2,920 3,006 3,0892002 2,969 3,072 3,110 3,138 3,205 3,405 3,817 4,081 4,058 4,098 4,325 4,4172003 4,557 4,706 – – – – – – – – – –

Sources: IMF, International Financial Statistics; Ministry for the Economy and European Integration.

Access to commercial capitalcontinues to expand

Documents

Ukraine - International University of Japan · Net exports 1.1 Principal exports 2002 % of total Principal imports 2002 % of total Metals 39.7 Minerals 41.5 Minerals 12.5 Electronics