In 2000, for the first time since Ukraine has become independent, the national GDP grew by 6%. Even greater recovery is expected in 2001 accompanied with two-digit investment growth rates and inflation rates falling below 10%. Economists with the Prospect

FACTS, FIGURES, AND WARNINGS

In 2000, for the first time since Ukraine has become independent, the national GDP grew by 6%. Even greater recovery is expected in 2001 accompanied with two-digit investment growth rates and inflation rates falling below 10%. Economists with the Prospective Research International Center Ruslan Piontkivsky and Tatyana Sitnik share opinion on reasons behind economic growth in Ukraine and attempt to estimate its stability level.

Key determinant of Ukraine’s economic recovery is that the Government and private sector are now more capable to operate under marketing conditions. The State policy turned more predictable. Enterprises learned how to make profit through timely response to changes in demand and increased competition.

Hrivnya’s (Ukraine’s national currency) devaluation after the 1998′ financial crisis was a shot in the arm. Devaluation encouraged growth of export and import substitution. Bumper increase of external demand, as facilitated by global economic recovery, raised Ukraine’s export of goods in 2000. And even though global economic development slowed down in 2001, Ukraine’s economics keeps boosting. Recovered domestic demand is the main substitute for weaker conjuncture outside.

State policy

As before, inconsistency is the attribute of economic policy. Steady business recovery was the result of the following steps taken by the Government:

• Tight fiscal policy.

• Privatization.

• Agricultural reforms.

• Selective taxation (single tax) for small businesses.

• Reduced tax burden.

Business activity

Having adjusted to the market, Ukrainian enterprises increased productivity. The trend was mostly fostered by increased competition; though, chief background of the process was privatization. Having obtained control over enterprises, private owners required higher profitability figures from companies’ directors. Hence, in 1998-1999, heads of enterprises were forced to cut expenses, in particular, for wages. Unemployment rate calculated upon the International Labor Organization methodology moved from 8.9% in 1997 up to 11.9% in 1999. In 2000-2001, managers aimed to make use of growing demand and outride competitors. Enterprises increased investment and put manufacturing of new products on stream. Consequently adding stability, companies start paying more heed to long-term planning.

Companies are more active injecting into the national economics. In 2000, gross investments augmented by 12%, whereas the year 2001 is forecast to see even higher 16% boom. Demand for investment is extremely high, since enterprises faced the necessity to substitute outdated equipment and conquer new markets. So far, most investments are backed by companies’ revenues. Yet, further on, financial stability should encourage commercial banks to take more active part in investment process though long-term loans.

Consumer behavior changes

Recovered demand fuels economic growth. Consumer behavior tends to improve: population gives positive response to financial stability. In 2000, lower-income citizens’ welfare did go up after wage and pension arrears were settled. Cash from increased income was primarily bound for consumption.

Restricting growth factors

Private business in Ukraine keeps getting stronger. However, further economic growth will be restricted by shortage of high-quality manpower and lack of funds.

Educational reform lags behind market economy. Education system today responds inadequately to changing demand on labor market. Enterprises face shortage of manpower with particular skills. Besides, with no financial support from outside, enterprises are deprived of substantial stock to replace outdated equipment. The hardship may be overcome via banking system development and inflow of direct foreign investment.

Absence of required funds in power sector, as well as transportation and services’ sectors, put the entire economic development to risk. Investment into these sectors may only arrive under conditions of accurate market regulation and successful privatization. Infrastructure segments today may turn deterrent of the country’s economic development.

Financial stability

Financial situation in Ukraine showed notable improvement over the last three years. Inflation rate in 2001 has been kept under 10%. Exchange rate has been stable for nearly two years. Currency reserves of the National Bank hit the record high at USD 3 bln. The key two factors behind recovery of macroeconomic stability were:

- Real devaluation in 1998-1999, which added to trade balance improvement. Domestic producers made use of competitive price advantage to substitute import. Meanwhile, because of cheaper labor and resources, export-oriented sectors managed to facilitate activities on international markets. As a result, GDP changed from a 3% deficit in 1998 to proficit of 2.6% in 1999, and moved even higher in 2000 – to positive 4.7%.

- Tight fiscal policy. Lack of private financing, ironclad terms of international financial institutions (IMF and World Bank), as well as bad experience forced the Government to reduce extra spending. Budget deficit shrank dropped from 2.4-2.7% of GDP in 1998-1999 to 1.1% of GDP in 2000. Starting 2000, when privatization revenues outran shortage of the Budget, the Government began reducing of the National debt.

Combining tight fiscal policy with benefits of foreign currency inflow (thanks to positive balance of current account), the Government was able to relax monetary policy. Present-day macroeconomic situation can be described with two positive processes:

- Expansion of financial intermediation. Since the first signs of economic growth appeared, banks have been increasing loans. Since the third quarter 1999 till the third quarter 2001, bank loans in real value added 88%. Moreover, the process has been attributed with fundamental improvement of credit portfolio quality, as the portion of "bad" debts diminished from 35% to 17%.

- Increased confidence in the national currency as a result of more reliable fiscal policy, changes in exchange rate behavior, and stronger control over inflation. Monetary policy has eased following the upturn in money demand, which was fueled by production growth and lower portion of nonmonetary economic operations.

Nonetheless, the encouraging trends should not be overestimated. Later on, macroeconomic stability would depend on how the following problems are solved:

- high real interest rates;

- immature non-banking financial intermediation;

- weak direct foreign investment if not related to privatization;

- slow confidence revival toward the government bond market: many market operators believe changes in economic policy are reversal;

- large-scale currency substitution (dollarization): in this case, inconstancy of exchange rate and money demand goes up, which increases the financial crisis possibility.

External risks

Rapid slow-down of economic growth in highly developed countries puts severe threat to economics of Ukraine. It is hard, though, to estimate slow-down scale now, because no forecast is yet made as to when it stops.

Economic statistics (data of the Prospective Research International Center)

1 вЂ“ Since the State Statistics Committee from now on classified data according to economic activities (CEA – Classification by Economic Activities), data presentation in Economic Statistics has been changed. Retrospective data are published after official showdown.

2 – rcc – real cumulative change.

3 вЂ“ Capital injections, which account for the largest portion of gross investment (58.7% in 2000), embrace expenditures for machinery and equipment, construction and erection works, as well as equipment registered in construction estimates.

4 вЂ“ Figure in brackets is a portion in total volume in January-September 2001.

5 вЂ“ Hereinafter, brackets show portion in 2000′ total volume.

6 вЂ“ Data of the balance of payments of the National Bank of Ukraine differ from the State Statistics Committee data by the amount of extra charges, which are executed by the National Bank. In particular, trade balance import is calculated in CIF prices, whereas import in the payments’ balance – in FOB prices. Besides, bulk in extra charges’ amount falls for unofficial trade.

7 вЂ“ Net DFI – direct foreign investment in Ukraine subtracted direct investments of Ukrainian residents abroad.

8 вЂ“ Cash revenue – monetary revenues, subtracted the sum of obligatory payments made and voluntary injections.

9 вЂ“ While calculating the figure, the year is defined as 12 months, which fell under the calculation date. The approach allows comparison of average salary in the last 12 months with average salary in the previous 12 months.

10 вЂ“ When calculating the indicator’s change since the beginning of the year, the figure as of the beginning of the year is compared to the value in the end of the period.

11 вЂ“ Indicators of the Consolidated Budget are calculated upon the methodology of the Ministry of Finance of Ukraine.