Unsustainable Growth

Economic News

22 Jul 2010
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What caused the decline in Ukraine's economic growth last year remains a controversial and politically charged subject. While many analysts point their fingers at ill-conceived economic policies, others insist on poor growth fundamentals and an unsustainable reliance on steel exports.

Although the final figures have yet to be confirmed by the State Statistics Committee, it is abundantly clear that GDP growth slid from the stellar 12.5% reported in 2004 to just 2.5% in 2005. Thus, last year may well be remembered as the least impressive year since the Ukrainian economy began to recover, back in 2000.

In analysing the deceleration of growth in the value of goods and services produced last year, most analysts single out two key factors: the deteriorating market for Ukraine's traditional exports, and a sharp fall in domestic investment.

The most visible source of slowing economic activity was the drop in worldwide prices for steel products - the bedrock of all Ukrainian exports, representing almost 30% of the country's industrial output.

Soaring steel prices, propped up in the past by seemingly insatiable Chinese demand, have been the main driver of economic growth in Ukraine over the last couple of years.

The correlation between the external demand for steel and Ukrainian GDP was clearly manifested in 2004, when the economy surged forward by 12.5%, largely on the back of a 12% increase in the value of metallurgical output.

Yet many analysts argue that actual growth in 2004 was statistically overstated due to the low base effect and - more controversially - by statistical fiddling. The representatives of the new Orange regime have alleged on several occasions that the previous government of Viktor Yanukovich inflated the export numbers in order to achieve better growth figures ahead of the presidential election.

The government of Yanukovich was also accused of adopting an overly generous state budget that was almost entirely dedicated to increasing social spending on pension increases and wage hikes in the public sector.

The total increase in welfare spending in 2005 rose from 19% to 28% of the entire state budget, while the level of public investment into the economy was cut by 42%. According to the State Statistics Committee, the year-on-year increase in real available income rose by 19.8% in the first 10 months of 2005, facilitating a 22% increase in retail trade.

On the positive side, the socially-oriented budget inherited by the Orange government may have helped to retain some heat in the local economy, with consumption in 2005 up by 9.9% over 2004. Politically speaking, this has also helped to keep a lid on social unrest, as most Ukrainians have not experienced a sharp deterioration in their living standards.

On the negative side however, the sudden increase in household consumption prompted a significant increase in imports, levelling off the trade surplus Ukraine enjoyed in the past. This fell from 10.5% in 2004 to 2.9% in 2005. Increasing consumption also created inflationary pressures, with the prices of some goods, such as meat, showing a dramatic increase.

The sudden rise in imports, according to analysts, served as a reminder that the Ukrainian economy does not have the necessary capacity to respond to burgeoning domestic demand and needs to be restructured.

The economists at the International Centre for Policy Studies in Kiev argue that the economic upswing in Ukraine that began in 2000 was unsustainable, because of weak investment, dependence on external factors and lack of reform.

All of these factors seem to have come to haunt the country in 2005, after the Pandora's box was opened by the Orange revolution.

Despite the reformist slogans and agenda, however, the Orange regime, according to critics, has failed to launch a process of deep market reforms and economic diversification.

To make matters worse, the first Orange government of Yulya Tymoshenko slowed down the process of investment in upgrading the economy by launching a damaging process of reprivatisation.

With many company owners fearing their property rights were at risk, investment into upgrading the Ukrainian economy declined dramatically, as real gross fixed investment shrank by 1% in 2005 compared to 10% growth in 2004.

Several industrial companies interviewed by OBG in regional Ukraine confirmed that they have put their investment plans on hold until the reprivatisation process is over and the political environment is more defined.

The moment of truth for everyone will come after the March parliamentary elections, when the next government will be announced. Optimists say Ukraine will then have a golden period of three years of no elections to put the economy back on the track of sustainable growth. Sceptics, however say that with unstable coalitions and populist economic policy still in vogue, it is going to be a bumpy ride.

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