- Patrick Lenain, and Peter Cornelius
- Published Date:
- February 1997
Accelerating the Transition to Market
Proceedings of an
IMF/World Dank Seminar
Peter K. Cornelius and Patrick Lenain
INTERNATIONAL MONETARY FUND
© 1997 International Monetary Fund
Cover and interior design by IMF Graphics Section
(The design element appears on Ukraine’s new currency, the hryvnia.)
Library of Congress Cataloguing-in-Publication Data
Ukraine : accelerating the transition to market: proceedings of an IMF/World Bank seminar / editors, Peter K. Cornelius and Patrick Lenain.
Papers presented at an IMF-World Bank seminar held in Washington, D.C. on
July 9, 1996.
Includes bibliographical references.
1. Ukraine—Economic policy—1991 Congresses. 2. Post-communism—Economic aspects—Ukraine—Congresses. 3. Ukraine—Economic conditions—1991 Forecasting—Congresses. 4. Ukraine—Social policy—Congresses.
I. Cornelius, Peter, 1960-. II. Lenain, Patrick. III. International Monetary Fund. IV. World Bank.
Address orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington D.C. 20431, U.S.A. Telephone: (202) 623-7430
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Ukraine has undergone a major restructuring of its economy over the past two years. Inflation, which reached more than 10,000 percent in 1993, has fallen sharply and a new currency—the hryvnia—has been successfully introduced. For the first time in years, Ukraine now enjoys a large measure of exchange rate stability. The budget deficit—once one of the highest among transition economies—has been reduced to one of the lowest in the region. At the same time, important structural reforms are under way and many of the administrative obstacles that previously restricted foreign trade have been abolished. These efforts have earned Ukraine a degree of respect and credibility in the international community.
Yet much remains to be done. Despite the ambitious macroeconomic stabilization program implemented over the last two years, the economy continues to contract. The reforms have stopped inflation—but they have not yet allowed Ukraine to realize its massive potential in the agricultural and industrial sectors. Without a revival of output, it will be difficult to pursue the reform program in a sustainable manner and convince the population that the present efforts are worthwhile. This is the challenge now facing the Ukrainian leadership and the international organizations that are providing it with advice and financial support.
In response to this challenge, the IMF and the World Bank held a joint seminar—bringing together government officials, academics, and staff of international organizations—in July 1996 to discuss a medium-term strategy for Ukraine. This seminar provided an opportunity for Fund and Bank staff to present the policy prescriptions that would form the basis for an economic program that could be supported, starting in 1997, by an extended arrangement with the IMF and several World Bank adjustment loans. Drawing on this experience, and on further discussions with the Ukrainian government, the policy recommendations were reviewed and amended over the following few months.
The discussions during the seminar proved to be lively and the seminar itself a welcome initiative. As John Williamson (Institute for International Economics) put it, “I very much welcome the decision of the Fund and the Bank to organize this seminar, which provides an opportunity to explain publicly the logic of a program in an important member country that has been going through particularly difficult circumstances.” The Ukrainian government representatives also welcomed this first opportunity to “debate economic issues with the IMF and the World Bank, without having to negotiate a program at the same time.” The reactions, critiques, and suggestions of the outside participants are summarized in the book.
The seminar was organized in four consecutive workshops. Each workshop consisted of a number of presentations by the IMF and the World Bank, followed by remarks by discussants and general discussion. These workshops, which constitute the backbone of this book, covered (1) the medium-term macroeconomic framework, (2) wages, poverty, and social safety net reform, (3) private sector development, and (4) trade policies and sectoral reforms. A fifth section was added to the book to include three papers covering good governance and the devastating effects of corruption.
The papers contained in this volume represent the personal views of the authors—as written in June 1996—and reflect the situation at the time of the seminar. Inevitably, some of the data underlying the analyses have changed since then, and the policies that Ukraine will implement in the context of its medium-term strategy will surely differ in some respects from those presented here. Nonetheless, we believe that the central messages of these papers are as timely and relevant as ever, and that this book will contribute to an improved understanding of the economic problems facing Ukraine and the way forward toward a successful market economy.
Basil Kavalsky and John Odling-smee
This volume contains the proceedings of an IMF-World Bank seminar that was held in Washington, D.C., on July 9, 1996 to discuss Ukraine’s medium-term economic strategy. The seminar and this volume have been made possible by the support of John Odling-Smee, Director of the IMF’s European II Department, and Basil Kavalsky, Director of the World Bank’s EC3 Country Department, who approved the initiative, influenced the topics chosen, and steered the entire effort in the right direction. Invaluable support was also provided by Adalbert Knobl, Assistant Director in the IMF, and Wafik Grais, Division Chief in the World Bank.
The Editors would like to particularly thank the authors and discussants for their contributions and for cooperating actively in preparing the published version of this volume. The success of the seminar is due largely to the contributions made by these authors and discussants. Our thanks go particularly to those who traveled to Washington from Ukraine and other European countries to participate in the seminar. We also wish to thank Marina Primorac of the External Relations Department for all of her editorial work and for coordinating the production and publication of this volume. We are also grateful to Anna Unigovskaya for her statistical assistance, and to Pamela Padmore and Mauricio Bourdin for their conscientious preparation of the texts.
Antimonopoly Committee of UkraineECM AU
European Center for Macroeconomic Analysis of UkraineEU
European Union/Technical Assistance to the Commonwealth of Independent States.ILO
International Labour OrganisationMOS
Ministry of StatisticsNBU
National Bank of UkrainePSD
private sector developmentSIEAG
Soros International Economic Advisory GroupULFS
Ukrainian Labor Flexibility SurveysURES
Ukraine Rapid Enterprise SurveyVAT
Atish R. Ghosh
David W.H. Orsmond
Jonathan Dunn and Patrick Lenain
Jeanine Braithwaite and Tom Hoopengardner
Peter Fallon, Tom Hoopengardner, and Ella Libanova
Sanjeev Gupta, Elliott Harris, and Akxandros Mourmouras
Peter K. Cornelius
Galina Mikhlin-Oliver and Sandra Bloemenkamp
Uark R. Lundell
Laszlo Lovei and Konstantin Skorik
The following symbols have been used in this book:
… to indicate that data are not available;
—to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;
–between years or months (e.g., 1995–96 or January–June) to indicate the years or months covered, including the beginning and ending years or months; and
/ between years (e.g., 1996/7) to indicate a fiscal (financial) year.
“Billion” means a thousand million.
Minor discrepancies between constituent figures and totals are due to rounding.
The term “country,” as used in this volume, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.
Since the government of Ukraine launched its economic reform program in the fall of 1994, encouraging progress has been made in stabilizing the economy and setting the stage for a recovery of growth. Thanks to financial restraint, inflation has been brought under control, the exchange rate has stabilized, and the contraction of output has slowed markedly. Structural reforms have been initiated in several key areas to promote private sector development and unleash the economy’s growth potential; price controls have been lifted; a privatization program has been implemented; the restructuring of the agricultural and energy sectors has begun; and the trade regime has been liberalized.
These achievements are indeed impressive. Now, almost two years after Ukraine’s reform efforts began in earnest, the economy has reached the critical point where sustained economic growth is within sight—provided the government can strengthen the momentum of economic reforms. Financial adjustment needs to be sustained and accompanied by a widening and deepening of systemic reforms. The private sector should be freed from obstacles impeding its development, the government’s administrative capacity should be strengthened, and the social safety net needs to be reformed to guarantee adequate support for the most needy.
But this is no easy task, for declining living standards for a wide range of the population have put severe strain on the limited reserves of goodwill and credibility that existed at the beginning of the transition. That is one important reason there is little room for graduation in Ukraine’s transition to a market economy, and why the pace of reform needs to be accelerated.
The challenges are well understood by the Ukrainian authorities, who have recently begun to design a medium-term reform program. We in the Fund, and our colleagues in the Bank, are happy to work with them in designing the program. Preliminary discussions with Fund staff on a medium-term reform program, which could be supported by resources under the Fund’s Extended Facility, have commenced recently. As part of our efforts to assist the authorities, we are cohosting this seminar today. We believe that it will provide an important forum not only for a continued dialogue between the Ukrainian authorities and the Fund and the World Bank, but also for a stimulating exchange of views among a broader audience, including other international institutions and the academic community.
The papers presented at this seminar by Fund and World Bank staff members reflect the policy areas of primary importance for a successful reform strategy and Ukraine’s transition. As always, a coherent framework to ensure macroeconomic stability is an essential component of the overall growth package. While much progress has been achieved in reducing the country’s fiscal deficit, additional reforms are required to cope with the ongoing revenue decline, the need to finance new expenditures to restructure the economy, including the banking system, and the need to clear budgetary arrears. At the same time, there is a need to lower the tax burden for enterprises and on employment, to foster economic growth. Revenue and expenditure policies must be accompanied by structural measures, including tax administration reforms, the introduction of a modern treasury management system, and reforms of the budgetary process. Tax rates in Ukraine can be lowered, and the efficiency of the tax system greatly increased—but that will require the removal of tax exemptions and the strict enforcement of tax payments. A responsible fiscal policy stance will also facilitate monetary management. Rebuilding confidence and helping to remonetize the economy must be the primary aim of the central bank. The choice of the exchange rate regime will of course play a critical role in the conduct of monetary policy. While exchange rate stability has contributed to lower inflation, unexpected capital flows may put an additional burden on monetary management. To cope with those flows better, the authorities will have to develop both the instruments of monetary control and the financial system.
Macroeconomic stabilization is a necessary but not a sufficient condition for economic growth. The most pressing order of business facing Ukraine over the medium term is structural reform, beginning with the development of a viable framework of market-based laws and practices. Good governance, which is crucial for speeding up the transition process, requires that the state remove administrative obstacles and withdraw from supplying goods and services that can be provided more efficiently by the private sector. Privatization is essential not only to facilitate restructuring and enhance competition, thereby increasing productivity, but also as a fundamental step in promoting good governance. Equally important, the banking system must be put on a sound basis. Without a sound banking system, firms essentially have to finance investment out of retained earnings and the low level of financial intermediation hinders growth.
Trade policy is another crucial area of systemic reform. Ukraine’s recent export performance has been impressive, and many firms have been able to redirect foreign trade toward the West. Nevertheless, remaining impediments to trade—especially to exports—need to be removed. On the import side, pressures to increase protection should be resisted, and efforts to fully integrate the Ukrainian economy into the global economy need to be reinforced. An open trading system will also help restructure the agricultural and energy sectors, one of the major challenges facing Ukraine over the medium term.
Finally, the labor market needs to become more flexible to cope with the possible effects of accelerated privatization and enterprise restructuring. More flexibility is also needed to deal with possible external shocks in the presence of a stable exchange rate. First and foremost, this entails a more flexible wage structure. At the same time, the system of social benefits needs major reform. While economic growth is a prerequisite for alleviating poverty, it is also necessary to improve the targeting of assistance to the poor. This will require reforms in a wide range of areas, including the system of unemployment benefits, the pension system, and the divestiture of social assets of enterprises.
There is no doubt about the magnitude of the challenges facing the Ukrainian authorities and people. To master them will require a coordinated effort of many—first and by far foremost, of course, the Ukrainian authorities themselves. But the Fund, the World Bank, and the international community can also help. And the rewards of success are commensurate with the challenge, for the future well-being of the Ukrainian people is being determined now, by the actions of those represented here, and by those they represent.
I would like to welcome all participants to this seminar and express our hopes for an open and frank discussion.
I am delighted to be meeting with you today. I join Stanley Fischer in welcoming you—especially our guests from Ukraine—to what I expect will be a very interesting day. For us at the Bank, the timing of today’s seminar could not be better. We just published the World Development Report on Transition a few days ago; it is highly relevant to today’s discussions.
I plan to structure my very brief remarks around three themes: the agenda for reform and recovery of the Ukrainian economy; the political economy (and institutional roots) of reform and recovery; and Bank support.
Ukraine was a late starter on the transition from plan to market, adopting a wide-ranging program only toward the end of 1994. Even so, the early fruits of reform are beginning to emerge. Macroeconomic imbalances and inflation have declined—although the situation is still quite fragile. Structural changes in the composition of output are beginning, but these too are fragile.
As the lessons from other transition economies clearly demonstrate, Ukraine has no choice but to proceed expeditiously with reform if it is to achieve sustained growth and a recovery of living standards. Of course, the immediate task is to consolidate the stabilization effort to lock in the foundations of economic recovery. But Ukraine’s deeper challenge lies in what the World Development Report termed the “nuts and bolts” of transition—liberalization, private sector development, and social sector reform. Let me touch on each of these in turn.
First, liberalization. Ukraine has already made much progress here. The challenge is to extend and deepen that progress, and to ensure that the ongoing reforms are effectively implemented and translated into results on the ground. Domestic prices have largely been decontrolled, with reduced budget support to agriculture and commercial enterprises. Most import and export quotas and licenses have been eliminated, and import duties are low (the trade-weighted average in 1995 was 6 percent). Tax reform has been initiated, including a modern profit tax and a value-added tax. Energy prices are close to world levels. However, payments discipline has not matched the price reforms. In January 1996, for example, the collection rate for electricity and gas was at an all-time low of about 50 percent. The result is that the economy’s energy intensity has not declined. Primary energy consumption decreased by 35 percent between 1990 and 1995, whereas GDP fell by 52 percent.
Second, the framework for private sector investment and growth. Here, Ukraine has made some progress—albeit less rapid progress than on liberalization. The priorities are property rights, deregulation, and financial sector reform. Privatization is proceeding apace. Almost half of the 1995/96 mass privatization target has been met. Two-thirds of the small-scale privatization has been completed. Land reform is making slow progress. Legal reforms, mostly ad hoc, have aimed to fill legislative gaps created by the economic reforms. Adoption of the new constitution, which guarantees equal protection to private and public property rights, is a key step toward a more consistent legal framework. With the planned adoption of a new civil code, coupled with the commencement of the planned systemic reforms, Ukraine would be well on the way to putting in place the legal system it needs to underpin its economic reform program. There is a need to streamline regulations and procedures affecting business registration, commercial activities, and compliance standards. Not only are the regulations problematic, but also the way some government structures are applying them is unnecessarily burdensome for the private sector. Witness the rapid growth of the informal sector—to evade the regulations. Essential financial sector reforms include ending subsidized credit to enterprises; enforcing new minimum capital requirements and tighter prudential rules on all banks; and encouraging banks to undertake external audits based on internationally accepted accounting standards.
Third, the social safety net. In contrast to liberalization and private sector development, there has been very little progress on social sector reforms, where the need has been intensified by the economic contraction. Poverty is rising, the quality of health and education services is declining, and basic indicators, such as infant mortality and life expectancy, are deteriorating. Fundamental reforms are needed on social protection and health and education. A critical feature is the need for targeting. The government has so far dealt with its financial constraints by allowing inflation to erode pension and other benefits across the board and to compress the benefit structure. This may have been the best way to handle the situation given the constraints. However, it will now need to take difficult decisions as the scope for further compression through this approach has been exhausted.
What is holding up private sector and social sector reform? A large part of the reason is basic political economy. The implementation of the critical private sector reforms will not be easy, given opposition in parliament and the continuous pressure from lobbies representing managers and workers of public enterprises, coal miners, farming interests, and others. Nor is there a critical mass of private sector interests lobbying for quick reforms in the legal framework and other areas. Meanwhile, there are many powerful state and collective farm and state enterprise managers, who stand to lose from reforms, lobbying against them. Social protection reform involves difficult and sensitive issues such as reducing benefits for some in order to better target them to the truly needy. But the most vulnerable sections of the population may not be the most vocal or powerful. Solving these problems will require education of civil society about the benefits and costs of reform—and of not reforming—so that informed public policy choices can be made.
Part of the problem lies in institutional weaknesses and the need to revise ministerial mission statements in line with the changing role of the government. Branch ministries in industry and agriculture have resisted reforms and privatization. Similarly, the Ministry of Health is more concerned with pharmaceutical production than with the provision of health care services. The good news is that the new constitution should open the door to the restructuring and reform of the executive branch that will be a necessary condition for moving ministerial concerns toward activities such as the formulation of sector policy, monitoring of sector performance, and the provision of public services.
The government and the World Bank have been engaged in discussions about the key elements of the reform agenda and the support we could bring to their design and implementation. The framework for our support builds on three pillars: the level of Bank support would match the progress made in adopting and implementing the critical reforms. The three main components of our financial support would be systemic reforms, the energy sector, and microlevel adjustment. Social protection, as well as environmental issues, would be mainstreamed into each operation. Nonlending services would support and complement lending activities. These would include training for officials, reaching out to civil society, notably parliamentarians and nongovernmental organizations, as well as dissemination of information and analytic findings. I see these efforts as especially important in view of the political economy of reform that I discussed. But I would also include activities such as the recent investors’ conference that aimed at helping Ukraine mobilize foreign direct investment, and the Consultative Group meeting planned for October.
In closing, let me wish you every success. I look forward to hearing the outcome of your discussions and deliberations today. And especially to receiving feedback from you on what we at the Bank can do to help facilitate Ukraine’s transition—to a better tomorrow. Thank you.
Today’s conference—drawing together officials of international organizations, eminent academics, and members of the government—is an important recognition by the international community of the reform efforts made thus far by Ukraine, and of the challenges that lie ahead. As such, it is a most welcome initiative and one that, I understand, is among the first such undertaken for any Fund member.
Our progress on macroeconomic stabilization is well known to the participants here: inflation has been reduced to about 1–2 percent a month, the exchange rate has been remarkably stable in recent months, and, were it not for the decline in the agricultural output due to weather-related conditions, real GDP would be bottoming out this year. After a somewhat hesitant start, our privatization program is in full swing. Yet the challenges are also manifold. Many of them will be taken up by the various speakers today, so let me confine myself to some remarks about the most pressing issues facing the Ukrainian government today.
Of these, surely none is more important, and more acute, than that of improving governance and enhancing the administrative capacity of the government. One legacy of the past half century is a lack of sufficiently experienced government officials, and an administrative structure based upon line ministries that are wholly unsuited to the modern market economy that the Ukrainian people demand and deserve. Prime Minister Lazarenko has recently announced his determination to analyze existing government functions and to reduce the size of the civil service. This will entail consolidation and elimination of many of the current ministries. But much more than mere recognition is required: what is needed, above all, is expertise. The credibility of the government is undermined when there are significant errors in macroeconomic forecasts. For this reason, the government wishes to strengthen the forecasting ability of both the Ministry of Economy and the Ministry of Finance, and to give them greater responsibility in implementing policy. Of enormous importance—particularly given the structure of fiscal federalism in Ukraine—will be the rapid introduction of a fully functioning treasury system. Beyond these key ministries, the government’s capacity for compiling national statistics and for fostering the development—and supervision—of securities and equity markets need to be strengthened.
All of this will require foreign assistance. Financial assistance is undoubtedly important, and will have to form an integral part of the reform efforts currently under way. But no contribution from the international community can be of greater service, or of more enduring benefit, than enhancing the human capital and administrative ability of our own officials. Today’s conference is surely a significant step in that direction.