1 A Macroeconomic Framework for Sustained Economic Growth

Patrick Lenain, and Peter Cornelius
Published Date:
February 1997
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Atish R. Ghosh

As the Ukrainian economy goes beyond its stabilization phase and toward a comprehensive program of structural reform, articulating a full macroeconomic scenario for the medium term becomes increasingly important. Such a scenario is not an unconditional forecast of the most likely evolution of the economy over the coming years. Indeed, the medium-term scenario will be very much predicated upon a set of often difficult, if not painful, micro- and macroeconomic adjustment policies. Nor, given existing data constraints, is it possible to generate a true conditional forecast (together with associated standard errors). Rather, the medium-term scenario is intended to provide a simple macroeconomic “reality check” upon projections for economic targets such as output growth and inflation. For example, generating rapid economic growth would be relatively simple if the country were willing to undertake sufficient investment. But achieving such an investment rate might entail unacceptable declines in consumption, or an unsustainably large buildup of external debt. Thus the challenge in developing a medium-term scenario lies in choosing reasonable macroeconomic targets that can be attained under plausible assumptions about the private sector’s behavior and the government’s willingness to undertake the necessary policy measures.

After five years of consecutive output declines, the primary macroeconomic objective is to restore economic growth without jeopardizing the stabilization gains made thus far. Output is expected to decline by 7–8 percent in 1996, owing mainly to the adverse weather conditions earlier this year, which are likely to result in a particularly poor harvest (value-added in agriculture might decline by as much as 15 percent). In thinking about the future, it is useful to divide up the time horizon into three phases: a “pre-takeoff” phase (perhaps 1996/97); the takeoff phase (1998/99); and the “steady state” (stretching into the first few years of the next century).

Given typical gestation periods for new investment, growth in 1997 is likely to occur primarily from a rebound in agricultural output—assuming more normal weather conditions—rather than from a sharp pickup in industrial activity or in the service sector. Accordingly, growth in 1997 might be about 2–3 percent. The fruits of macroeconomic stabilization and policy reforms are likely to be realized beginning in 1998/99, when growth might accelerate to 4–6 percent. In the years thereafter, real output growth might be expected to be in the range of 5–7 percent.

It is, of course, possible to envision more ambitious or optimistic scenarios (and, indeed, more pessimistic ones!) but, at this stage, it is worth asking whether these broad targets are attainable, or whether they require unreasonable adjustment efforts and/or implausible levels of external financing. To determine this, we must first understand the current macroeconomic situation.

Current Situation

Over the past few years, the Ministry of Statistics has made a concerted effort toward improving the quality and coverage of the national accounts statistics. While there have been marked improvements in the sectoral estimates of GDP, the expenditure breakdown remains weak and adjustments to the data are necessary if they are to be at all plausible. In general, the official statistics imply a very high saving rate and—since the estimates for the current account deficit are at least reasonable—a correspondingly high investment rate.1

According to the official data, domestic saving in 1994/95 was about 30 percent of GDP. Since the government was dis-saving, private saving was higher, at around 33–37 percent. The Ukrainian survey of households (based on banking system data) suggests saving rates—out of monetary income—of about 18 percent in 1995. Assets in which the private sector may be saving include deposits in local or foreign currency, cash, and foreign currency cash. The increase in broad money (inclusive of foreign currency deposits) during 1995 was some 7–8 percent of GDP. There are few estimates of the amount of foreign currency cash in circulation, although it appears to be substantial. Altogether, therefore, an upper estimate of private saving rates would be on the order of 20 percent of GDP, or well short of the 33–37 percent implied by the Ministry of Statistics figures. From the budget execution data, about 4 percentage points of the adjustment to domestic saving come from higher government consumption, and the remainder from higher private consumption.

Using partner country direction of trade statistics, together with information on the overall balance of payments, it is possible to check the consistency of the external trade statistics. Doing so suggests minor modifications: in 1995, net exports would have been closer to 3.5 percent of GDP rather than the officially recorded 4.0 percent of GDP (the correction in 1994 was the other way, with the estimated trade deficit larger than the official figures).

Adjusting the investment statistics is more challenging. The 14.2 percent of GDP inventories accumulation is immediately suspect because it is notoriously difficult to adjust for holding gains in high inflation environments. Moreover, the official statistics show an increase in inventory accumulation in 1995 compared with 1994 although the output decline in 1994 was substantially larger (23 percent compared with 12 percent in 1995). Inasmuch as the buildup in inventories represents the involuntary accumulation of unsold output, it is likely to have been larger during the period of steeper output decline. It is difficult to tell by how much inventory accumulation might have been overestimated, but it could be as much as 10 percentage points of GDP. Likewise, fixed asset accumulation was probably overestimated (mainly because of accounting errors by enterprises when fixed assets were indexed in 1995 to account for inflation that had occurred since 1992)—perhaps by as much as 4–5 percentage points of GDP.

In summary, adjustments to the official data suggest that in 1995, private consumption was about 60–62 percent of GDP, domestic saving was about 17 percent of GDP, private saving about 19 percent of GDP, net exports about –3.5 percent of GDP, inventory accumulation about 4–5 percent of GDP, and investment perhaps 15–16 percent of GDP.

Growth Strategy

There are four key elements underlying the growth strategy necessary to attain the output objectives outlined above.

1. Raising investment. Productive investment in Ukraine is probably quite low, and raising investment will certainly be a prerequisite to sustained growth. Part of this will necessarily be public investment—upgrading of infrastructure, particularly in transportation and telecommunications—but much will need to be done by the private sector as well.

2. Protecting consumption. Given the extraordinary declines in real output—which may have exceeded 50 percent since 1991—and the concomitant fall in real private consumption, it is unrealistic to believe that private consumption can fall much further without losing popular support for the reform program. Indeed, as discussed below, not only should private consumption not decline further, it should increase even in anticipation of the rise in output.

3. Fiscal adjustment. There has already been significant fiscal adjustment in terms of reducing the budget deficit—from 9 percent in 1994 to about 4.5 percent in 1995, and 3 percent in 1996. While the deficit might shrink somewhat over the medium term, there is clearly little scope for substantial further reduction and, at this stage of Ukraine’s economic development, there would be little economic rationale for doing so. Nonetheless, as discussed in chapter 2 of this book, there will need to be some changes in fiscal policy. First, the revenue ratio is expected to decline, partly as less of the economy is captured by the existing tax regime, and partly in response to changes in tax rates—some of which are currently very high—necessary to foster economic growth. On the expenditure side, there will need to be a reduction in consumption expenditure and, as noted above, an increase in capital expenditure. This implies a modest increase in public saving, even with a (relatively) constant deficit.

4. External viability. The growth strategy requires increasing investment while protecting consumption. This will require continued current account deficits, which should only narrow in the post-takeoff phase. As of end-1995, Ukraine’s external liabilities stood at about US$8 billion, or about 23 percent of GDP. This ratio should decline and, unless warranted by exceptional circumstances, the debt-service ratio should not be allowed to exceed 15 percent of exports. The increased domestic demand (from higher consumption and investment) will also imply an appreciation of the real exchange rate. Although the real exchange rate (measured as annual average producer prices against the U.S. dollar exchange rate) has appreciated by about 80 percent between 1992 and 1995, some further appreciation is to be expected (see below).

Medium-Term Framework

Table 1 articulates a medium-term framework consistent with the growth strategy outlined above and the broad policy goal of achieving sustained economic growth.

Table 1.Macroeconomic Projections
Average wage per month. in U.S. dollars4976103126155155
(Percentage change over previous period)
Real GDP–12–83466
(Percentage change within period)
Consumer prices1824324121010
Producer prices1722721121010
Real exchange rate (producer
prices, against U.S. dollar)60231987
(In percent of GDP)
Private consumption61.363.665.464.863.663.0
Public consumption22.
Gross fixed asset accumulation16.016.818.419.519.920.3
Private gross fixed asset accumulation13.415.716.416.516.917.3
Public gross fixed asset accumulation2.
Net exports–3.4–2.6–1.9–1.2–0.9–0.6
Exports of goods and nonfactor services45.742.936.333.130.429 5
Imports of goods and nonfactor services49.145.538.234.431.330.1
Domestic saving16.616.216.417.718.719.3
National saving15.815.915.416.817.918.5
Current account–4.2–3.0–2.8–2.1–1.7–1.4
Memorandum items
Consolidated budget balance–4.6–3.0–2.0–2.0–2.0–2.0
Revenue38936335.235.135.135 1
Total external liabilities22.62119.318.717.215.4
Debt-service ratio (percent of exports)
Source: IMF staff projections based on discussions with the Ukrainian authorities.
Source: IMF staff projections based on discussions with the Ukrainian authorities.

Standard models of growth and external borrowing suggest that an economy should use the current account to smooth consumption. In this context, “consumption smoothing” would imply a jump in consumption in anticipation of higher output growth. Accordingly, in the medium-term scenario, private consumption rises from 61 percent of GDP in 1995 to 64 percent in 1996 and 65 percent in 1997. Thereafter, consumption grows more slowly than output growth, so that the ratio of private consumption to GDP falls gradually over time. The behavior of private saving provides another way of looking at this consumption-smoothing behavior: private saving falls initially—from 19 percent of GDP to 16 percent of GDP—and then recovers slowly toward 20 percent in the long run.

Investment is assumed to increase rapidly, from 16 percent in 1995 to 18.4 percent in 1997 and almost 20 percent in 1999; thereafter it is assumed to settle at 21–22 percent of GDP. Of this, public investment is assumed to increase by almost 2 percentage points by 1998, and to remain at about 3 percent of GDP over the medium term.

In addition to higher investment, growth is expected to come through greater efficiency of the economy. In part, this will require some rationalization of taxes, which implies that the scope for further revenue increases is limited. Indeed, with a larger fraction of the economy in the private sector, and allowing for some necessary reductions in tax rates, the revenue ratio is expected to decline from 40 percent in 1995 to about 35 percent by 1998. With higher capital expenditure, and a budget deficit no larger than about 2 percent of GDP, there will need to be a reduction in current expenditures (mainly on price subsidies) and public consumption—which is assumed to decrease from 22 percent of GDP in 1995 to 17.5 percent by 1998.

Finally, it is worth asking whether the path of the current account deficit implied by the higher private consumption and greater investment expenditure is sustainable. In dollar terms, the current account is assumed to be in deficit by about US$1.5 billion over the period 1996–99. After 1999, the deficit is assumed to shrink, attaining balance by about the year 2005. The ratio of external liabilities to GDP declines continuously (from 23 percent to 17 percent in 1998, and to less than 10 percent by 2005), although much of this decline may be attributed to the assumed real exchange rate appreciation. Accordingly, the debt-service ratio may provide a better measure of external sustainability: this ratio increases from 6.6 percent in 1996 to a peak of 12 percent in 1999 (after which it declines to about 10 percent by 2004).

Much of the real exchange rate appreciation occurs over the period 1996–99, reflecting the impact of higher aggregate demand on the real exchange rate and the assumption that the domestic currency is currently undervalued in real terms. This issue is explored further below. A given real appreciation (which, at least over the medium term, is determined by real factors) may take place through a nominal appreciation or through inflation. After very high inflation rates in 1993 (when inflation reached 10,000 percent) and 1994, inflation slowed markedly in 1995 and 1996. Current projections are for a wholesale price index inflation rate of about 30 percent in 1996, falling to about 20 percent in 1997 and to 10–12 percent thereafter. These are achievable inflation targets, but not so ambitious that they are likely to be missed by wide margins—which would only serve to increase price uncertainty and erode confidence. With such inflation rates, moreover, the expected real appreciation will take place without significant movement of the nominal exchange rate.

Caveats and Issues

The scenario outlined above suggests that achieving growth of 2–3 percent in 1997, followed by accelerating growth to 5–7 percent in the medium to long run, is not impossible. Three issues, however, warrant further examination. First, is the real appreciation assumed in the scenario sustainable? Second, is the assumed increase in investment sufficient to generate the envisioned growth? And third, what will be the role of the informal sector of the economy?

Real Exchange Rate

A crucial assumption underlying the projections is the real exchange rate appreciation (it is important, for instance, in translating dollar balance of payments figures into percentages of GDP and in projecting export and import growth rates). The scenario assumes a real appreciation of about 25 percent in 1996, 20 percent in 1997, 15 percent in 1998–99, and a roughly stable real exchange rate thereafter. In general, it is difficult to judge the equilibrium level of the real exchange. Two indicators, however, suggest that Ukraine’s currency is currently undervalued in real terms. First, dollar wages are only US$76 a month, and are slated to increase to about US$155 a month by 1999. This is well below the current level of dollar wages in many of Ukraine’s trade competitors. Second, a study undertaken by the European Centre for Macroeconomic Analysis of Ukraine (ECMAU)2 of a large basket of goods suggests that, taking account of quality differences, output of most sectors in Ukraine is under-valued by 30–90 percent (as of end-1995) compared to international prices. Even without substantial productivity increases, therefore, the real appreciation over the period 1996–99 should not severely impair competitiveness (Figure 1).

Figure 1.Purchasing Power Parity Rates, by sector

Source: Authors’ calculations based on ECMAU data.

Note: Ratio above unity implies sectoral undervaluation of the karbovanets.


A second assumption concerns the level of aggregate investment. In general, a high level of investment is likely to lead to faster economic growth, but the exact relationship will depend upon many factors, most importantly the micro- and macroeconomic policy stance. The need for lowering some tax rates has already been mentioned; some of the microeconomic policies are discussed in subsequent chapters of this book. Nonetheless, it is possible to check whether the investment rates assumed are likely to prove to be a constraining factor on achieving the targeted growth rates.

To examine this issue, Figure 2 shows the distribution of investment rates (in percent of GDP) for all observations with at least 5 percent GDP growth, where the universe of observations is annual data for all Fund member countries over the period 1975–90. There are about one thousand observations in all, and of these 150 observations had at least 5 percent GDP growth. Investment rates associated with at least 5 percent output growth varied widely across observations, from less than 12 percent (the lowest being 9 percent) to more than 40 percent. The most frequent investment rate is actually 20–22 percent, or almost exactly the investment rate assumed for 1999/2000 when the economy is projected to grow at 5–7 percent a year.

Figure 2.Distribution of Countries with More than 5 Percent Per Capita Growth

Investment ratio (percent of GDP)

Source: Author’s calculations based on World Economic Outlook database.

Three factors, in fact, give ground for some additional optimism. First, given the steep declines in GDP to date, Ukraine would be growing from a very low base. Second, the data in the study pertain to the period 1975–90; that is, they include both the aftermath of the first oil shock, the second oil shock, and the debt crisis—all of which contributed to low growth. And third, empirical studies of economic growth emphasize the importance of human capital. In this regard, of course, Ukraine is much better positioned than developing countries and, indeed, most middle income countries as well. Thus, while the investment rates assumed in the scenario certainly do not guarantee the projected GDP growth, nor should they be insufficient to achieve that growth.

Informal Economy

The historical data on real GDP growth refer to the recorded sector; there is, of course, an informal sector as well. Quite what the current size of this sector might be is a topic of some debate. The high end of such estimates range up to 100 percent of the recorded sector (that is, total GDP would be twice reported GDP).3 These estimates are based primarily on the smaller decline of electricity consumption compared with the decline under (official) real GDP. With large relative price adjustments of some substitutes (natural gas and petroleum), and some output inelasticity of demand (for example, household and enterprise consumption for heat and lighting), these estimates must be treated with caution. Indeed, even with the undervaluation of the Ukrainian currency and the steep decline in GDP, 100 percent of official GDP would still be about US$60 billion or—to put it in perspective—about 20–25 percent of Switzerland’s GDP. Just a visual comparison of Switzerland and Ukraine casts doubt on such magnitudes of real activity remaining unrecorded. The service sector in Ukraine is still largely undeveloped and value added in that sector typically rather small. Most of Ukraine’s value added is in the industrial sector—heavy industry in particular—and this is likely to be captured in the official statistics. It remains true, however, that the unrecorded sector of the economy is likely to grow much faster than the official sector. If the unrecorded sector is significantly smaller than half the total GDP—say, 20 percent—then these higher growth rates will not (initially) contribute very much to overall GDP growth. Thus, the projected growth rates given above should be interpreted as referring to total GDP, on the understanding that a growing proportion of that GDP growth will be coming from what is currently the informal sector (but which, eventually, will be captured in the official statistics as well).


After suffering from a series of macroeconomic shocks, the Ukrainian economy has embarked upon a program of stabilization and structural reform. A macroeconomic framework should provide an analytical basis for identifying micro- and macroeconomic policies required to achieve a targeted growth rate. Unfortunately, the existing statistical database is too weak to be used in any formal analysis. Nonetheless, with plausible adjustments to the data, it is possible to sketch a medium-term growth-oriented scenario.

The scenario delineated here focuses on (1) promoting an increase in private investment, buttressed by public investment in infrastructure; (2) sustaining private consumption after the declines experienced in recent years; (3) undertaking fiscal adjustment to promote growth through lower taxation while avoiding inflationary budget deficits; and (4) maintaining a viable path of external indebtedness. Such a scenario should enable Ukraine to embark upon a path of sustained economic growth.

1According to Ministry of Statistics data, in 1995, and expressed in percentage of GDP, net exports were–4.0 percent; private consumption was 51.5 percent; government consumption was 18.3 percent; gross fixed assets accumulation was 20.2 percent, and inventory accumulation was 14.2 percent. Together, these figures imply domestic saving of 30.2 percent and, with some public dis-saving, private saving of about 33–35 percent (and almost 37 percent in 1994).
2European Centre for Macroeconomic Analysis of Ukraine, 1995, Ukrainian Economic Trends (Kiev: ECMAU, August). Updated data were kindly provided by Professor Duchéne of the Centre.
3Chapter 15 of this book provides an excellent discussion on the potential size of the informal sector in Ukraine.

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