Dangerous Curves Ahead

Economic News

22 Jul 2010
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Five weeks after September's parliamentary elections, the five parties of the new government still have not formed a coalition. Although it is expected that former prime minister Yulia Tymoshenko will once again resume her former post, the emergence of an 'orange' government is not yet set in stone. The Central Election Commission noted last week that the official convocation of the sixth Verkhovna Rada would be delayed until mid-November.



While politicians horse-trade to form a coalition, Ukraine's economic health is going virtually unchecked. For investors, ongoing political instability comes at an inopportune time. With soaring inflation, sinking global competitiveness and endemic corruption, Ukraine needs a future government to implement prudent fiscal policies and promote transparency to sustain impressive levels of foreign direct investment (FDI).



Even so, Ukraine's enormous potential in agriculture, banking, manufacturing and other key sectors have helped economic growth. In the first half of 2007, real GDP grew a robust 7.9% year-on-year, buoyed by rising demand for metals, construction, and financial services. Foreign investors have not shied away from Ukraine's manifold opportunities. Despite ongoing political turmoil throughout this year that forced snap elections, FDI skyrocketed to $5bn last year. The first half of 2007 witnessed FDI inflows of $3.3bn - a significant 27% increase from the previous period.



These bullish trends, however, may prove to be silver linings of a brewing storm. In the first nine months of this year, the current account deficit ballooned to $2.5bn - nearly ten-fold from the corresponding period last year. Although the current account deficit represents 2.6% of Gross Domestic Product (GDP), it is worth noting that the government operated a surplus of 10.6% of GDP just three years ago.



Ukraine's current account headaches are expected to continue under a populist-leaning government led by Yulia Tymoshenko. Viktor Pynzenyk, one of her economic gurus, reported that, "the new [BYuT] government would refuse some doubtful investment programmes to save funds for social programmes." Given the nature of Ukrainian politics, "doubtful" investments often fall under the umbrella of inside favouritism.



In addition, the trade deficit widened to $5.96bn in the first eight months of the year. This is troubling considering that these factors are primarily externally driven. In January, the price of Russian oil and natural gas imports increased 37%. Further price increases are all but inevitable, jeopardising Ukraine's impressive economic growth. Next year, the price of steel (a major export) is also expected to drop according to analysts. This is worrisome, considering that over 40% of total exports are metals.



Most alarmingly, the inflation rate has outpaced the most optimistic government forecasts. While the ministry of economy predicted an inflation rate of 7.6% for the 2007 budget, the International Monetary Fund now warns of an 11.5% surge of the consumer price index. This means that Ukraine would mark this year its fourth consecutive year of double-digit inflation.



This month, Ukraine's global image as a reformist emerging economy was dented. On October 31, the World Economic Forum knocked Ukraine down four places in its Global Competitiveness Report to 73rd place, roundly beaten by Uzbekistan and Sri Lanka. Entry into the World Trade Organization (WTO) once again has been postponed. Volodymyr Baluta, Ukraine's mission to the WTO, announced that Ukraine's entry would take place in autumn 2008.



In October, two separate reports were released that painted a gloomy profile of graft in Ukraine. The Atlantic Council of the US reported that "corruption has become so severe that it has the potential to threaten Ukraine's political and economic stability as well as the country's European Union membership aspirations." Meanwhile, the Strasbourg-based Group of States Against Corruption (GRECO) noted that the lack of judiciary independence, among other factors, is "systematic and wide-scale." Both reports called upon the new government of Ukraine to adapt an action plan against corruption as well as a government task force to curb graft in public institutions and business.



Sustaining the wave of foreign investment in the coming years will dependent on reducing corruption. A new anti-corruption task force would be embraced by business leaders as a concrete step. Any anti-corruption campaign must be encouraged and sustained from the highest pinnacles of leadership. Considering that the three main Ukrainian parties - Party of Regions, Bloc of Yulia Tymoshenko and Our Ukraine - all hold powerful sway in government, the track record from both 'orange' and 'blue' sides on halting graft to date has been unimpressive.



No matter the makeup of the new government, a programme of radical measures must be adopted in order to maintain foreign investment and attract new capital. Beyond this, the new government must aim at raising productivity, heightening global competitiveness, repairing a byzantine tax system, and creating a transparent and efficient energy sector to forcefully meet Ukraine's unbridled potential.

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