Recent Economic Developments

This paper reviews economic developments in Ukraine during 1991–95. In October 1994, Ukraine finally embarked upon a comprehensive program of economic reform and stabilization. Although the efforts made in late 1994 were far reaching, the short-term results were not encouraging: inflation remained stubbornly high, the exchange rate weak, activity declined, and the rate of accumulation of external arrears dangerously rapid. By the first half of 1995, the performance .of the economy was more encouraging. Inflation slowed to monthly rates of about 5 percent. Exports to western markets also expanded strongly.


This paper reviews economic developments in Ukraine during 1991–95. In October 1994, Ukraine finally embarked upon a comprehensive program of economic reform and stabilization. Although the efforts made in late 1994 were far reaching, the short-term results were not encouraging: inflation remained stubbornly high, the exchange rate weak, activity declined, and the rate of accumulation of external arrears dangerously rapid. By the first half of 1995, the performance .of the economy was more encouraging. Inflation slowed to monthly rates of about 5 percent. Exports to western markets also expanded strongly.

I. Introduction

1. The political background

In June 1995, more than three years after regaining independence, Ukraine turned the page on its Soviet-era political system. Following months of negotiations, and a protracted political struggle. President Kuchma and Parliament reached an accord on the division of powers between the executive and legislative branches. This accord, which gave the executive branch greater powers to govern by decree, and to implement decisive reforms, defined the political landscape of the year 1995.

Like other republics. Ukraine inherited from the former Soviet Union a constitution which made it virtually impossible to conduct decisive political and economic reforms. Under the Soviet constitution, Parliament could veto any government decision and could refuse the appointment of any Cabinet member. As a result, Ukraine’s reform-minded government had to wage a constant struggle with Parliament to forge ahead with reforms.

In December 1994, President Kuchma introduced a draft law on the separation of powers which sharply limited Parliament’s authority and created a powerful presidency. The initial draft gave the President the power to dissolve parliament, after consultations with the supreme and constitutional courts, if parliament twice failed to approve a government program or failed to approve a budget within three months of the Government submitting it. These provisions caused strong opposition in Parliament, and months of political wrangling. Eventually, President Kuchma agreed to withdraw them and Parliament agreed to sign a pact.

Under the agreement signed on June 8, 1995, the President won the right to choose the Prime Minister and ministers without the approval of legislators. He also won the right to issue decrees on economic reform when legislation was lacking. Finally, the President won authority to veto legislation, but lawmakers may overturn a veto with a two-thirds majority vote. Parliament retained the right to veto presidential decrees, with a simple majority of votes, if they are deemed unconstitutional. It also kept the right to reject government programs, and to hold votes of confidence in the Cabinet. Such votes can lead to automatic dismissal of the Cabinet.

As the accord contravened many articles of the constitution, it was agreed that the text would serve as a temporary constitution--until a permanent new constitution could be agreed upon--by June 1996. Immediately following this accord, President Kuchma appointed Mr. Yevhen Marchuk as Prime Minister and instructed him to form a new government. Mr. Marchuk, who had been acting prime minister since the resignation of Mr. Masol in April 1995, said that he would form a government consisting of reformers and professionals. The new government was finally formed in July, with Mr. Roman Shpek elevated from the post of Minister of Economy to Deputy Prime Minister for the Economy.

While the new political accord was intended to allow a more decisive implementation of economic reforms, it did not result in any immediate improvement. Despite the new framework, the political struggle between the Government and Parliament continued. In September 1995, President Kuchma used his new authority to introduce, by decree, a number of tax increases required to achieve the deficit target; however, these decrees were vetoed by Parliament a few weeks later, in an apparent contradiction of the June accord. Parliament subsequently adopted a bill which blocked privatization of all enterprises in the gas production and distribution sector, without opposition from the President. Thus, while the new political accord provides a useful framework in principle, its effectiveness in practice remains, at the end of 1995. still in doubt.

Another major event marked the political landscape: in April 1995, Presidents Yeltsin and Kuchma signed an agreement that ended the dispute on the future of the Black Sea Fleet. Under this agreement. Ukraine receives half of the vessels in the fleet, but agrees to sell a large part of them back to Russia. The agreement also stipulates that Sevastopol shall be the main base of the Russian navy and that the Ukrainian navy will be based in another location, still to be identified. This agreement, together with the March accord on the rescheduling of gas debts, cleared the way toward a substantial improvement in the bilateral relations between Russia and Ukraine.

2. Summary of economic developments

In October 1994, Ukraine finally embarked upon a comprehensive program of economic reform and stabilization. The tasks faced by the Government in the formulation of this program were immense: not only had Ukraine to address the legacy of decades of pervasive controls and economic decay, but it also had to repair the damage caused by three years of mismanagement following independence. Confronted by this situation, the Government launched a radical program of macroeconomic stabilization and structural reform.

The initial steps taken by the Government in the closing months of 1994--with the support of a first purchase under the Fund’s STF--were aimed primarily at liberalization of prices, the exchange market, and the trade regime. Most price controls were removed at once, except on some foodstuffs and communal services. Interest rates were raised, and banking system credit strictly curtailed in an effort to forestall a slide into hyperinflation. The budget was also tightened by containing expenditure on subsidies. The dual exchange system was abolished, and the karbovanets was allowed to float at the auction exchange market. Finally, most export quotas were eliminated.

While the efforts made in late 1994 were far-reaching, the short-term results were not encouraging: inflation remained stubbornly high, the exchange rate weak, activity declined, and the rate of accumulation of external arrears dangerously rapid. These continued imbalances, in spite of the efforts exerted, underscores the gravity of Ukraine’s initial economic conditions.

The Government therefore introduced a second package of measures in spring 1995. This second program aimed at reducing inflation drastically to the level of 1-2 percent by the end of the year. To achieve this objective, the program focused on cutting the consolidated state budget deficit from about 9 percent of GDP in 1994 to 3 percent in 1995, and on containing the expansion of money and credit. The program also provided for an acceleration of structural reforms, in particular trade liberalization and mass privatization. Ukraine’s creditors--Russia and Turkmenistan--agreed to reschedule Ukraine’s debts and arrears, Western countries pledged financial support, and support was provided by the IMF and the World Bank.

By the first half of 1995, the performance of the economy was more encouraging. Inflation slowed to monthly rates of about 5 percent. Exports to western markets expanded strongly. The karbovanets stabilized on the exchange market. As confidence in the national currency improved, and the Government’s credibility increased, capital flows returned to Ukraine, and the National Bank was able to acquire greater international reserves than expected. There were also signs that output had stabilized.

But the resolve required to sustain these early gains appears to have been lacking, and some of the Government’s policies and actions during the summer months served to undermine the stabilization achieved. First, commercial banks were encouraged by the Government to extend new credits to the enterprise sector in amounts incompatible with the low targeted rate of inflation. Second, the budget renewed its subsidies to ailing industries, particularly to the coal sector. Third, the Government decided that the budget would continue to assume responsibility for the gas debts accumulated by the enterprise sector. These slippages in policy implementation--together with official statements shedding doubt on the commitment to economic reforms--led to a renewed weakness of the karbovanets on the exchange market in August, and to a pick up in consumer price inflation in subsequent months. At the end of 1995, Ukraine’s ability to adhere to its ambitious program of economic stabilization and reforms thus remains uncertain.

3. Major economic and political events in 1995


  • Agreement reached with Turkmenistan on gas deliveries for 1995, on settlement of the 1994 debt, and rescheduling of the 1993 debt.

  • Agreement reached with Russia on gas deliveries for 1995, on settlement of the 1994 debt, and rescheduling of the 1993 interstate debt.


  • President signs decree on financial-industrial groups.

  • Price increases for communal services intended to reach 20 percent cost-recovery.

  • Opening in Kiev of the National Privatization Center.

  • NBU prohibits the use of cash in international settlements for Ukrainian exports. Prohibition of the use of foreign currencies for domestic transactions is suspended.

  • Agreement reached with Russian Gazprom on rescheduling of debt for gas deliveries.

  • NBU permits direct trading of the Russian ruble between commercial banks.

  • First auction at the agricultural commodity exchange.


  • Cabinet of Ministers approves memorandum of policies under the Stand-By Arrangement.

  • Price of gas charged to industrial users raised to world price.

  • First auction of government bonds; Government submits 1995 budget, with a deficit of 7.3 percent of GDP.

  • Rescheduling of debt payments to Russia and to Russian Gazprom.

  • Consultative Group meeting in Paris.

  • Parliament establishes VAT rate of 20 percent.


  • No confidence vote in the government; President appoints interim Prime Minister, and proposes new government.

  • Parliament adopts 1995 budget, with 3.3 percent of GDP deficit (IMF definition).

  • 4,000 enterprises cut off from gas delivery due to nonpayment of bills.

  • IMF Executive Board approves Stand-By Arrangement, and second drawing under the Systemic Transformation Facility.

  • Preliminary agreement reached between G-7 and Ukraine on closing Chernobyl by the year 2000.

  • Cabinet of Ministers adopts subsidy scheme for communal services to ensure that combined monthly payments do not exceed 15 percent of income.


  • Decree issued setting up treasury.

  • List of 5,334 enterprises subject to privatization approved by government.

  • World Bank Executive Board approves second tranche of import rehabilitation loan.

  • Parliament fails to put the Law on Power into effect.

  • NBU stops granting licenses for sale of goods in exchange for foreign currency.

  • President Kuchma issues a Decree on Plebiscite declaring a national referendum in June to resolve deadlock over the Law of Power.

  • Signing of Interim Agreement with EU; granting of most-favored-nation status to Ukraine by EU.


  • President Kuchma announces that the new currency, the hryvna, will be introduced in the fall.

  • Presidential decree abolishing previously granted tax privileges.

  • NBU undertakes clearing operation of interenterprise arrears.

  • Parliament votes in favor of Constitutional Agreement with the President, putting the Law on Power into effect.

  • IMF Executive Board approves the first review under the Stand-By Arrangement.

  • Parliament introduces a real estate tax.

  • President Kuchma declares the need for correction of reforms and easing of monetary policy to stimulate industrial production.


  • Increases in communal services and energy prices charged to households.

  • Decree issued on levying VAT on imported goods.

  • Residents permitted to privatize land for commercial use.


  • NBU bans the use of foreign currency for domestic cash transactions.

  • Presidential decree on equity sharing of kolkhozes.

  • Presidential decree on use of housing certificates for enterprise privatization.

  • Exchange rate slides from Krb 147.300 per dollar to Krb 167,000 per dollar amidst concerns about imminent currency reform. NBU intervenes heavily.


  • Price increases for communal services and energy prices charged to households.

  • Incomes policy re-introduced.

  • Bill on industrial-financial groups amended; anti-monopoly legislation to be applied to industrial-financial groups.

  • NBU authorizes banks to buy foreign currencies on the interbank market and sell them to the population in the cash market at rates within 10 percent of the official exchange rate.

  • Introduction of new currency postponed until 1996.

  • IMF Executive Board completes the second review under the Stand-By Arrangement.


  • Government’s economic program for 1996 is approved by Parliament.

  • Parliament adopts a resolution setting the minimum income at Krb 4.8 million per month.

  • Ukrainian Interbank Exchange branch is opened in Donetsk.

  • The Supervisors’ Council of the State Credit-Investments Company created.

  • NBU adopts a credit regulation, according to which the sum of credits may not exceed 25 percent of commercial banks’ own resources.

  • NBU allows commercial banks to draw on enterprises accounts the arrears corresponding to energy consumption and to settle the energy producers.

  • Kiev administration adopts the list of land plots for hotel buildings financed by foreign capital. The plots will be given for a long-term lease of 49 years or more.


  • Parliament adopts the 1996 budget with a deficit of 2.5 percent of GDP (IMF definition).

  • The Ukrainian Government and the Russian joint-stock company Gazprom agreed to supply Ukraine with Russian gas and the transit of gas through Ukraine in 1996. Ukraine will receive at least 50 billion cubic meters of gas at US$80 per thousand cubic meters. Russia will pay US$1.75 to transport a thousand cubic meters of gas over 100 kilometers of Ukrainian territory.

  • Parliament ratifies the Free Trade Agreement with Uzbekistan and Turkmenistan.

  • Ukraine becomes a member of the European Council.

  • The 1996 Privatization Program is approved in principle by the Cabinet of Ministers. According to the Program, the privatization of small enterprises is expected to be concluded by July 1, 1996. Privatization with the use of share certificates will last until December 31, 1996.

  • The Cabinet allocates Krb 52 trillion to repay government debt to miners. The resources will be allocated gradually in order avoid the acceleration of inflation.

  • The Cabinet issues an order prohibiting the export of coal from Ukraine for the period between December 1, 1995 and March 1, 1996.

  • Ukraine and Turkmenistan agreed on supply of 23 billion cubic meters of gas from Turkmenistan to Ukraine in 1996. The Government of Ukraine will not provide guarantees to the suppliers.

  • Parliament ratifies the agreement to borrow ECU 85 million from the EU.

  • The Cabinet creates the State Committee for Establishing Exchange Markets of Agricultural Products. The Committee will institute regulations for the sale of agricultural products on exchange markets.

II. Real Sector

1. Overview of output, expenditure, and employment

During 1994. and much of 1995, Ukraine suffered steep declines in output and in real economic activity. Official statistics suggest that, in 1994, real GDP may have fallen by as much as 23 percent (Chart 1). 1/ Real GDP is expected to fall by a further 12-13 percent in 1995. The output collapse in 1994 appears to have been widespread, with net product of the industrial sector falling by 28 percent, of agriculture by 25 percent, and of construction by 38 percent. Some service sectors fared marginally better, with net output of transportation and communications falling by 9 percent, and that of the retail and catering sectors by 12 percent. Based upon preliminary data, it would appear that these trends continued-somewhat abated--in 1995. Gross domestic product fell by 11 percent in the first half of 1995, as against the 26 percent decline recorded in the first half of 1994. 2/


UKRAINE Output Indicators

Sources: Ministry of Statistics; and IMF staff estimates.1/ Chained index: rotes of change of Net Material Product through 1990. and of Gross Domestic Product from 1991.2/ Net Material Product through 1990, and Cross Domestic Product from 1991.

Underlying these trends were a number of factors affecting both supply and demand. The domestic components of aggregate demand shrank as real incomes of the population (deflated by the consumer price index) fell by almost 33 percent in 1994 and, relative to the first half of 1994, by a further 8 percent in the first half of 1995 (compared to a decline of 44 percent in the first half 1994). Correspondingly, real expenditure on goods and services, again deflated by the consumer price index, fell by 26 percent in 1994, and by about 5 percent in the first half of 1995 (compared to the 40 percent fall in the first half of 1994). 3/ Other components of aggregate demand were also very weak during 1994: in real terms, gross investment fell by about 23 percent, and there has been little recovery in capital expenditures in 1995. Exports, however, picked up significantly in the first half of 1995, particularly to non-FSU industrialized countries (Table 42).

On the supply side, enterprises have had to contend with significant changes in the micro- and macroeconomic environment. Some of the obstacles facing enterprises are outlined below, while Appendix I offers a more analytical discussion of the factors underlying the output collapse. In addition to these factors, generally slow progress on structural reforms (discussed in Appendix II) has severely retarded growth of the emerging private sector.

Notwithstanding the poor output and income performance of the economy, registered unemployment remains very low, seldom reaching more than 0.4 percent of the labor force (Table 20). Such statistics belie the reality of the labor market, however, since a significant proportion of workers are either on unpaid and involuntary leave, or are only partially employed. Figures on under-employment appear to be more commensurate with the observed output decline, with 14 percent of the labor force on involuntary leave (at some point during the first half of 1995), and 6 percent on part-time work (as of July 1995). Consistent with the slower fall in output, the number of such workers declined in the first half of 1995 relative to 1994.

Table. Comparison of Economic Activity 1994-95

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Source: Ukrainian authorities.

2. Sectoral developments

a. Industry

Many of the methodological problems of the industrial production statistics noted in previous reports remain, and indeed have been exacerbated, by high rates of inflation and sharp gyrations of relative prices. Nonetheless, on the basis of the available data, it appears that the very steep decline in industrial production observed in the first quarter of 1994, when output fell by 38 percent, was largely avoided in 1995 with industrial production falling by a somewhat more modest 13 percent (Chart 2).

UKRAINE Industrial Production
Sources: Ministry of Statistics; and IMF staff estimates.

At a microeconomic level, Ukrainian industrial enterprises have had to contend with three main issues. First, by late 1994, the system of state orders and contracts was breaking down, as branch ministries were unable to continue supplying essential inputs. State orders and contracts were formally abolished at the beginning of 1995 (with the exception of grain procurement, and some interstate agreements for debt-service and gas imports). Second, enterprises continue to be burdened by high taxes, not so much from punitive tax rates as from the broad definition of profits on which taxes must be paid. In addition, payroll taxes are more than 50 percent, and in 1994, deductions for capital depreciation were severely limited because the value of the capital stock was not indexed to inflation (depreciation allowances were increased progressively in 1995 to reflect inflation since 1993). Third, and perhaps most importantly, in November 1994 energy prices charged to Industrial users were increased substantially when the price of gas was raised to reflect the border price, valued at a market-determined exchange rate. In March 1995, this price was further increased, to the world price of gas. Ukrainian enterprises were particularly vulnerable to this energy price increase because of energy-intensive techniques of production and the timid energy-pricing policy of the past. 1/

Macroeconomic factors also contributed to the output decline. Instability of monetary and fiscal policies resulted in considerable price uncertainty and volatility of key relative prices. Inflation in 1994 averaged 16 percent per month, but the monthly standard deviation was more than 19 percent. During the first nine months of 1995, monthly inflation averaged 10 percent, with a standard deviation of 6 percent, although some of this volatility is accounted for by administered price changes.

Beyond the uncertainty engendered by this inflation, it also resulted in exceptional volatility of real credit to the economy. As discussed in Appendix I, this volatility of real credit, particularly during 1994, contributed significantly to the observed output decline. Tightening credit conditions also reflected a curtailment of lending by commercial banks as they sought to limit the deterioration of their loan portfolios. While formal channels for credit evaporated, there was an explosion of inter-enterprise arrears which rose, in real terms, by 240 percent in 1994, and by a further 128 percent in the first half of 1995 (Chart 3). After a seasonal decline in July, interenterprise arrears continued to increase in real terms.

UKRAINE Interenterprise Debts and Arrears
Source: Ministry of Statistics.

The various branches of industry have been able to cope to different degrees with the challenges of this changing environment (Chart 2; second panel). While aggregate industrial output fell by 28 percent in 1994, for instance, the machine-building and light-industry sectors, which use energy particularly intensively, contracted by 33 percent and 47 percent, respectively. Two sectors fared significantly better than the rest of the economy: food processing, which contracted by 18 percent, and power generation, which contracted by 13 percent. In both cases, this development reflected, in large measure, increases in controlled prices.

b. Agriculture

Contributing to the decline in real GDP in 1994 was the significant fall in agricultural output, particularly in the production of crops. Grain output fell by 22 percent, to about 35 million tons, which may be contrasted to the more than 50 million tons produced at the beginning of the decade. Similar declines were observed for other crops, except for fruit production, which fell by more than 55 percent. Output of animal products also contracted, though by a significantly smaller degree (Table 7).

Relative even to these depressed levels of output, agriculture is expected to contract in 1995. Drought in the early part of the year, followed by higher - than - usual rainfall has reduced expected crop yields. As of end-October, 29.2 million tons of grain (excluding maize) have been produced, or roughly 11 percent less than output during the corresponding period of 1994. Assuming some buoyancy of animal products, however, the decline in total agricultural output is expected to be in the order of 3 percent for the year.

During the course of 1995, significant structural reforms were undertaken in the agricultural sector. In the past, the absence of decentralized agricultural markets has meant that agricultural financing needs have placed enormous strains upon the conduct of financial policies. In 1994, as in the previous two years, monetary and fiscal policies were subject to the highly seasonal financing needs of the agro-industrial sector. Underlying this problem has been the chronic lack of working capital to finance either the spring planting or autumn harvesting and the inability of farmers to use market mechanisms to obtain the necessary financing. Exacerbating the issue was the practice of pervasive price controls on agricultural output which resulted in a substantial terms-of-trade deterioration for the agricultural sector. Coupled with delayed payments to farmers under the state contract, these practices substantially eroded the real value of farmers’ receipts. 1/ Whereas in 1993 financing to agriculture took the form of NBU refinanced credits from the banking system, in 1994 the summer procurement was financed through budgetary credits channelled through the banking system, and a similar scheme was adopted for the autumn crops under the state order.

In 1995, however, the Government undertook a number of measures to withdraw state involvement from the agricultural sector. The state contract for sugar beets and sunflower seeds was discontinued, and the state contract for wheat was limited to a maximum of 10 million tons. In all likelihood, procurement under the state contract will not exceed 7 million tons. More importantly, an agricultural commodity exchange has been established, which now holds weekly auctions, for both spot and forward delivery, of key agricultural products (especially wheat, barley, sunflower seeds, and sugar). Farmers are able to sell their crops forward at the commodity exchange in order to obtain financing for the spring planting work and the autumn harvest.

While the commodity exchange has had a promising start, volumes traded remain modest (Chart 4). A number of factors have hampered growth of the exchange. Until April 1995 the state procurement agencies were selling their existing stocks of grain from the 1994 harvest at prices significantly lower than prevailing market prices. Not only did this divert buyers from the commodity exchange, it also prevented the procurement agencies from building up working capital which could have been used to finance the spring planting and the harvest. Partly as a result, the Government has continued to provide agricultural financing by making advance payments for farmers fulfilling the state contract. The size of the state contract has mushroomed from an originally planned 2.5 million tons to about 6-7 million tons. Even though, in 1995, government procurement of wheat under the state contract was undertaken at a price indexed to the price prevailing at the commodity exchange, the transactions themselves typically did not take place through the exchange.

UKRAINE Auctions at Ukrainian Commodity Exchange
Sourer Ukrainian authorities.1/ Pries of wheat at US. Mexico Gulf ports, i.o.b.2/ Pries of U.S. 03 barley in Duluth.

The Government’s decision to continue the state contract for grain also reflected concerns that adequate provision for outlying areas would not be made unless the Government itself enters the market. The situation is exacerbated by the lack of privatization of storage, distribution, and transportation facilities; indeed, such enterprises in the agricultural sector have been subject to particularly stringent regulations governing their privatization (Appendix II).

After much hesitation, and several reversals, in late-1995 the Government lifted the export quota on grain which previously limited grain exports to 3 million tons (plus an additional 1 million tons to fulfil intergovernmental trade agreements). Once farmers have delivered the grain for which they received advance payment under the state contract they may participate in the commodity exchange, and grain purchased at the exchange may be freely exported.

Together with these institutional reforms, the structure of agricultural ownership has been evolving, albeit slowly, in recent years. The share of collective and state farms in terms of area under cultivation had only fallen to 85 percent by the beginning of 1995 (from around 90 percent in 1991). Currently, members of a collective farm are assigned shares of that farm and these shares are given a specific geographic assignment when any one member wishes to leave the farm. There is, however, a six-year moratorium on the sale of such land and, in the absence of adequate title registration, considerable uncertainty about ownership.

c. The energy sector

Ukraine is a substantial net importer of energy, particularly of natural gas (from Russia and Turkmenistan), and of crude oil (part of which is refined and re-exported).

Until recently, Ukraine was self-sufficient in coal. Production has fallen sharply in recent years, from 165 tons in 1990 to less than 95 tons in 1994. While some of the coal mines are clearly viable and competitive by international standards, the coal industry maintains a system of internal cross-subsidies which has served to cripple the competitiveness of mines that would otherwise have been profitable. Through much of 1994, the Government subsidized both the production and the consumption of coal (whether by industrial users or by households). The consumption subsidies have been progressively removed and, by early 1995, were largely eliminated. The politically vocal coal miners, however, have been able to secure continued, if sporadic, budgetary support for coal production. Coal imports have been increasing in 1995, though the volumes remain modest.

The volume of crude oil imported has fallen sharply in 1994, by more than 40 percent. Correspondingly, Ukrainian oil refineries have been operating at well below capacity. The decrease in oil imports may be attributed to several factors, including arrears incurred in 1994, and taxes imposed by Russia on its oil exports.

Ukraine is a large importer of natural gas, from Russia and Turkmenistan, and produces about 18 billion cubic meters, or around 22 percent of its consumption. Gas prices charged to both industrial users and to households were heavily subsidized through most of 1994. The price charged to industrial users was raised in November 1994 in the context of a unification of the exchange market, and has been increased periodically to reflect the depreciation of the exchange rate. The border price for Russian gas is below the world price because of an offset for the gas transit undertaken through Ukraine on Russian gas exports to Western Europe. Beginning in March 1995, however, industrial users are charged the world price of gas with full indexation for any exchange rate depreciation. The price of the domestically produced gas has been increased to this world price as well. Gas usage by households remains subsidized, however, with the cost recovery ratios progressively increased through 1995. This usage takes the form of cooking and heating gas, as well as heat and hot water provided through communal services enterprises. Currently, households pay 60 percent of the world price of gas. 1/

The subsidized price of gas in 1994 (which continues in 1995 for household usage) resulted in substantial external arrears. While the stock of arrears has been regularized, weak domestic payments discipline, including by the budget on the subsidized portion of communal services, has resulted in continued accumulation of arrears in 1995. Steps are being taken to strengthen payments discipline: in the first half of 1995 some 6,000 enterprises were cut off for failing to make timely payments. Higher gas prices have led to a modest decline in consumption: during the fist six months of 1995, for instance, gas consumption fell by 15 percent, relative to the same period in 1994. Appendix III describes Ukraine’s gas sector in greater detail.

Electricity production declined by about 17 percent in 1994, and preliminary data suggests a continued decline in 1995, although again by less than the fall in GDP. Electricity usage is not subsidized by the budget, although through the first half of 1995 a system of cross-subs ides existed whereby industrial users were charged substantially more than household users. 1/ This cross-subsidy has been largely eliminated, although electricity usage by rural consumers continues to be charged at a lower rate than other users.

3. Wages, income, and expenditure

a. Wages

In real terms, the national economy average wage fell by 17 percent in 1994, with the decline particularly sharp in the last months of the year as administrative and other price increases eroded nominal wages (Chart 5). In addition, the traditional Christmas bonus (typically equal to one month’s wages) was not paid to workers in most enterprises.

Sources: notional authorities; and IMF staff estimates.1/ Average for Estonia, Latvia and Lithuania.

The Government maintained an incomes policy intended to limit the increase in the enterprise wage bill to 80 percent of expected inflation. In practice, with the highly variable inflation rates, this limit was seldom achieved precisely. Some attempt was made, however, to preserve the 80 percent of inflation relationship on a cumulative basis. This wage policy was enforced by administrative control over enterprise bank accounts; in addition, there was a tax on excess wage increases although it was not enforced.

In February 1995 the Government discontinued its incomes policy and enterprises were allowed to set wages at will. Thereafter real wages rose sharply, by 19 percent in the second quarter and a further 10 percent in the third quarter of 1995. The share of wages in costs and in GDP remains small, however, and measured in dollars, the average monthly wage does not, at end-year, exceed US$55 per month. While international competitiveness is not yet a major issue, there has been a significant budgetary impact of the sharp increase in average industrial wages. A separate law requires that wages paid to professionals (who constitute about two-thirds of all budgetary employees) be indexed, with a one-month lag, to the average industrial wage. In practice there have been periods of budgetary stringency during which this indexation did not take place. Nonetheless, budgetary wages rose by as much as 50 percent in real terms during the first half of 1995, on grounds that they had been lagging the average industrial wage. Partly in response, the Government has re-imposed the 80 percent wage indexation ceiling effective September 1995--this time enforced by an excess wage tax--while Parliament considers legislation de-linking budgetary wages from the industrial average.

b. Income and expenditure

Information on household income is subject to the important caveat that, since it is collated from the banking system, it fails to capture sources of income from the informal sector. Moreover, household income is at times augmented by the receipt of goods from enterprises at cost which can then be sold at a margin by the worker. A substantial portion of the overall remuneration package is also provided in the form of social or other services by the enterprise.

Total monetary income fell in real terms by 33 percent in 1994 (relative to 1993), and a further 8 percent in the first half of 1995 (relative to the first half of 1994); correspondingly, expenditures fell by 26 percent and 5 percent over the same periods. On a cumulative basis, retail sales fell by 6 percent by the end of 1994, following a sharp decline in the early part of the year (of almost 50 percent) and an increase toward the end of the year.

With the steep increases in communal services prices, there has been a substantial shift in the pattern of expenditure. Expenditure on food, which used to account for about 45 percent of total household expenditure in 1992, rose to 65 percent by the end of 1994 and is estimated to have fallen to 53 percent by mid-1995. Expenditure on services, which used to account for less than 4 percent of expenditure in 1992, rose to 12 percent by end-1994 and may now account for somewhat more than 25 percent of total expenditure.

Savings rates (measured as the ratio of bank savings plus increments to cash balances, to monetary income) hovered around 20 percent in the first quarter of 1994, but then fell sharply in October as inflation eroded real purchasing powers. In January 1995, when increases in nominal wages were well below the inflation rate and increases in communal services charges took place, the savings rate fell to 13 percent; subsequently it recovered and in July 1995 is estimated to be around 20 percent of monetary income. 1/

4. Inflation

Following the nearly hyper inflationary conditions prevailing at the end of 1993, inflation remained high, and extremely volatile, through much of 1994 and the first half of 1995 (Chart 6). Appendix I discusses, in greater detail, inflationary dynamics in Ukraine over the past three years.


UKRAINE Money and Prices

Source: Ministry of Statistics; and IMF staff estimates.1/ Foreign currency deposits valued at parallel exchange rates.

During the first two months of 1994, inflation was 19 percent and 13 percent, respectively. Thereafter inflation fell rapidly in the face of a significant tightening of monetary conditions. The summer saw eerily low rates of inflation, despite mounting evidence that credit was again being relaxed in connection with the needs of agricultural financing. Price controls appear to have been instrumental in subduing inflationary pressures and achieving monthly inflation rates that were as low as 2 percent. By September, however, inflation started picking up. In October, inflation reached 23 percent as prices for grain and other foodstuffs were liberalized, and administered prices for communal services were increased substantially. Partly in response to the sizable devaluation when the exchange market was unified, inflation accelerated rapidly toward the end of the year, reaching 72 percent in November and 28 percent in December.

In the first two months of 1995, inflation appears to have been driven primarily by inertia from the end of 1994, and further increases in administered prices for energy and communal services. Whereas food and manufactured goods prices rose by about 10 percent in February 1995, for instance, the services component of the consumer price index rose by almost 70 percent yielding an aggregate inflation rate of 28 percent for that month (Chart 7).


UKRAINE Consumer Prices

Sources: Ministry of Statistics

Inflation decelerated rapidly thereafter, much like the seasonal pattern observed in earlier years, with monthly inflation rates averaging around 5 percent. Yet underlying this inflation performance has been much tighter monetary conditions than in previous years and the (almost) complete absence of price controls. Limits on profit and trade margins were lifted in December 1994 and most other controls have been eliminated. In addition to bread, on which profit margins still exist, there are now only sixteen categories of (mainly capital) goods, for which advance declarations must be made to the Ministry of Economy before price changes can be made. In some instances there are also limits on price increases by monopolies.

In the fall of 1995, inflation increased sharply, reaching 14 percent in September, 9 percent in October, and 6 percent in November. The September inflation reflects some monetary loosening during the summer months, weakness of the exchange rate, seasonal increases in food prices, and increases in communal services charges. The administered price increases are estimated to have contributed about 5 percentage points to the September inflation.

III. Public Finance

1. Overview

A critical component of the authorities’ stabilization effort in 1995 was containment of the budget deficit. The substantial reduction that has been achieved--from a peak of 23 percent of GDP in 1992 to around 4½ percent in the first nine months in 1995--was accompanied by restructuring of the fiscal system to better support a market-based economy (Chart 8). These reforms have been wide ranging, covering the revenue system, government expenditure policies vis-à-vis households and producers, and tax and expenditure administration practices.


UKRAINE Fiscal Indicators 1/

Sources: Ukrainian authorities; and IMF staff estimates.1/ Expenditures include directed credits; both revenues and expenditures include the Pension Fund.

2. Fiscal adjustment in 1994 and 1995

In 1994, the cash general government deficit was 8 percent of GDP, compared to 12 percent in 1993. The accruals deficit was substantially higher--estimated to be around 15 percent of GDP--as external arrears for gas imports increased sharply due to low domestic prices for gas relative to the import price. Revenue was below initial expectations as the base of the VAT was eroded by exemptions--especially for the agricultural sector--and excise tax rates were reduced. Cash expenditure was contained through the accumulation of arrears on subsidies and other social payments, and by a 14 percent reduction in civil service staff who left for work in the private sector. Wage pressure grew throughout the year following mandated increases in wages and benefits.

The STF-supported adjustment program from October 1994 saw the start of the restructuring of the fiscal sector. Most of the initial adjustment came from a tightening of expenditure. While minimum pensions and benefits were raised at the outset of the program, subsidies for coal, agriculture, bread, gas, and for household use of utilities and energy were cut sharply. Achievements on the revenue side were less positive, as tax concessions were granted to alleviate the impact of price liberalization. Arrears for gas subsidies continued to increase, and agricultural loans and directed credits to key sectors made earlier in the year were not repaid as intended.

The 1995 Budget had two major purposes: (i) to offset the potential revenue loss stemming from major tax reforms that shifted the tax system toward that in market economies; and (ii) to restructure expenditure so as to restrict outlays to the traditional role of government, while placing priority on a targeted social safety net. In addition to the general weakening of economic activity, a revenue decline in the order of 15 percent of GDP was expected from a shift in enterprise taxation procedures toward a genuine income tax that excluded the wage bill and fringe benefits from the profit tax base, a decline in the VAT rate from 28 percent to 20 percent, and a reduction in personal income tax rates and the number of bands, which saw the highest rate reduced from 90 percent to 60 percent. Further, enterprises were allowed to increase the value of their assets by up to 52 times to reflect past inflation, with the rate of increase staggered throughout the year. To offset, in part, the revenue effect of these changes, exemptions from paying the enterprise tax were reduced (agricultural income is now the only major exemption), the base rate was increased from 22 percent to 30 percent. In addition, the authorities Introduced a royalty on domestic gas and a price differential surcharge on the import of gas from Russia--both of which were set at rates so as to raise industrial gas prices to their world levels--and land taxes were increased by 25 times. A Presidential Decree in May canceled exemptions that had been introduced by the President and the Cabinet of Ministers for the value-added, customs, and excise taxes. A subsequent Presidential Decree in June reintroduced exemptions from the VAT for imports of machine building, raw materials, some equipment for production, and imports for personal use. The introduction of an enterprise assets tax and the passing of a new VAT law that would substantially reduce exemptions were presented to Parliament but are still pending, while a stabilization tax of 3 percent on gross sales was rejected by Parliament (along with the gradual transfer to the budget of social services currently provided by enterprises that the tax had been intended to finance).

Throughout the year, enterprise profits taxes performed much better than had been expected, which offset poor performance in VAT and gas and oil royalties. The 5 percent of GDP overperformance of the profits tax receipts in the nine months to September in part reflected taxation of inflationary gains from the end of 1994, but also, seemingly, a preference for • enterprises to pay their employees benefits in terms of after-tax services rather than as pre-tax wages, where the enterprise would also have to pay the high payroll tax rate. The 3 percent of GDP underperformance in the new gas and oil revenue measures reflected ongoing domestic arrears by final users of gas, but also some delay in introducing these new measures. Finally, the VAT has underperformed by 1 percent of GDP due to the failure of Parliament to pass a new VAT law that would reduce the number of exemptions.

Expenditure at the outset of the year was significantly affected by the delay until April in passing the 1995 Budget. In its absence, spending ministry allocations were made on the basis of those set in 1994, which were inadequate for some expenditure, especially the subsidy on household use of energy and communal subsides following the increase in domestic gas prices which substantially raised the cost of providing communal services. In consequence, there was another sharp build-up in domestic and external gas arrears during the first quarter. The Central Government assumed responsibility for paying these arrears during the first three quarters of 1995, and reduced transfers that had been intended for local governments so as to partly offset the direct payment by the Central Government for these services. Local government arrears for the subsidy for household services continued throughout the year.

Other expenditure items were reduced following the reduction in the role of the Government in the coal sector, for net agricultural procurement, and for other budgetary lending. The cost of restructuring the coal sector in 1995 had initially been intended to be on the basis of intra-industry transfers. In practice, the revised July 1995 Budget (see below) added direct budgetary support, and additional support was provided through targeted auctions by commercial banks. Thus far, only two mines have been prepared for closure. In contrast to previous years--and as a direct result of the liberalization of bread prices in December 1994--around half the Government’s grain purchases in 1995 were financed by reflows from budgetary loans made to procurement agencies in 1994 for grain that was on-sold by these agencies to bakeries in 1995. However, unexpected expenditure pressure arose for some budgetary wages--as a law that required wages in the socio-cultural sphere be set at the average level for industry was implemented which implied a sharp catch-up, especially for education and health wages--and from delays in raising the required cost recovery ratio. Wages of nonprofessionals and benefits have increased by around 80 percent of the increase in the CFI during 1995. Anticipated expenditure was increased--especially for capital expenditure--in the revised 1995 Budget passed in July, with a consequent increase in the projected deficit by around 1 percent of GDP. Expenditure has also been inflated by the Government’s decision to extend until the end of 1995 guarantees on the payment of gas imports.

Pressures from the sharp increase in professional wages earlier in the year, and the decision to continue to guarantee external payments, became acute toward the end of the year. In response, the President introduced by decree a 5 percent surcharge on the VAT, reintroduced a 25 percent amortization tax that had been suspended by Presidential Decree in December 1994, taxes on the import of coal and on petroleum products to fund energy sector restructuring efforts, and an excess wage tax set at 30 percent for wages in the enterprise sector that increased by more than 80 percent of the increase in the CPI. Further, the Government scaled back several expenditure lines in the revised 1995 Budget presented to Parliament in October. Parliament vetoed the revised October Budget and all the new tax measures except the excess wage tax. In addition, Parliament doubled the subsistence level and signalled its intent to also double the minimum income, upon which most wages are based. Discussions between Parliament and the Government on this and other issues are ongoing, though the budget deficit and financing targets for the year now look increasingly unlikely to be achieved.

The 1995 Budget has seen a somewhat different pattern of financing than had been intended, as shortfalls of external assistance have been replaced with additional domestic financing. In addition, larger-than-anticipated financing from the NBU has been offset by a build-up in government deposits in the banking system (see below). The authorities established a treasury bill system, which in the first nine months raised Krb 17 trillion (0.5 percent of GDP). At present, only banks can directly purchase these securities, though they can act as brokers for enterprises.

Despite the various slippages, the overall fiscal adjustment in 1995 has been remarkable. The cash deficit for 1995 is now expected to be around 4 percent of GDP--or less than half the 8.6 percent of GDP deficit recorded in 1994. This accomplishment is all the more impressive in that the deficit reduction was achieved largely through a containment of expenditure.

3. Social safety net expenditure

As noted, there were substantial adjustments to the subsidy for household use of energy and communal services (heating, water, sewerage, and rent). In October 1994, the cost recovery ratio for these services paid by households was around 5 percent; the increase in costs due to the gas price increase led to a substantial increase in the budgetary burden and, correspondingly, to an external arrears for gas imports. Since then, the authorities have gradually increased cost recovery ratios, rising from 20 percent at the end of 1994 to 40-50 percent of their tax-inclusive cost as at September 1, 1995. To protect the most vulnerable households, on may 1 the Government introduced a targeted scheme, whereby the maximum that households pay for a standard sized apartment’s use of communal services is 15 percent of household income. The scheme was later widened to include household use of coal, gas and electricity. In practice, the scheme has cost little in 1995, due to the cumbersome administrative procedures to obtain payments and the delays in raising the cost recovery ratios.

There are numerous other forms of social assistance in Ukraine. These subsidy and welfare payments are largely untargeted, and are increased at around the rate of increase for nonprofessional wages. The largest component is the Pension Fund, with expenditure around 8.5 percent of GDP in the first nine months of 1995. The substantial inflation of the past reduced all pensions to close to the minimum pension specified by the Government (pensioners represent around one-quarter of the population). Social payments are also made through the Chernobyl Fund (2.0 percent of GDP), Social Insurance Fund which is run by the trade unions (1.0 percent of GDP), and Employment Fund (0.2 percent of GDP) are financed through a payroll contribution set at 52 percent for employers and an additional 1 percent for employees.

4. Institutional aspects

In the absence of a Treasury, the authorities rely on a rigid, daily, system of cash rationing. As one outcome of this system, there has been a substantial build up of deposits in the banking system by local and other government units, which are outside the control of the Ministry of Finance. To offset this problem, the Government has made moves to establish a Treasury, with the assistance of a long-term advisor sponsored by the Fund. Relevant decrees to establish an interim manual system have been signed, a Head has been appointed, and treasury operations will start soon. A computerized system is envisioned for the medium term, and the groundwork for this is under way.

The substantial tax reforms in 1995 coincided with a need to upgrade tax administration, and the Fund is sponsoring two long-term experts to assist in the establishment of a computerized tax administration project. An initial site in one district office within the Kiev region was selected, and the authorities are now considering extending the project to other areas.

5. The 1996 budget

On December 1, the authorities presented the 1996 Budget to Parliament. The Budget envisions a deficit of 6 percent of GDP (Ukrainian definition) and 2.3 percent of GDP (IMF definition). Given the substantial changes introduced during 1995, the Budget envisions little further change in the tax code. The tax agenda is to be limited to unifying the international and domestic excise tax rates, relatively minor changes in the personal income tax schedule, passing the new VAT law that will reduce exemptions, and introducing a new assets tax on enterprises and individuals. Most expenditure lines are also maintained at their 1995 trend, with the exception of a sharp decrease in the budgetary cost of the generalized housing subsidy as cost recovery ratios are to increase early in the new year and the cancellation of many housing privileges currently provided to around 40 categories, in favor of an increase in the cost of the 15 percent housing subsidy scheme. Agriculture is to be financed almost exclusively from reflows next year from the sale of grain purchased in 1995, and coal support will be financed by the same tax mechanisms proposed in the revised 1995 budget presented to Parliament in October. A limited amount of transfer of social activities of enterprises to the budget will be undertaken in 1996.

IV. Money and Credit

1. Policy environment

Given the almost exclusive reliance of the budget on central bank financing to cover deficits, the monetary policy of the National Bank of Ukraine (NBU) since independence has largely reflected developments in public finances. 1/ In addition, politically driven off-budget directed lending programs have contributed to weaken the NBU’s policy stance. As a result, sustained monetary and price stability have been elusive goals.

Significant progress in tightening financial policies has been made in the past year, although the authorities’ credibility remains fragile, as evidenced by the exchange-rate and inflation developments during August and September 1995. Furthermore, the slow pace of structural change in the economy threatens to undermine the relative financial stability that has been achieved. There remains a real danger that sectoral interests will again gain the upper hand. Evidence of the continuing power of these groups is provided by the strong pressure exerted this year on commercial banks to engage in what are effectively directed lending operations.

2. Developments in money and credit during 1994 and 1995

Monetary policy in Ukraine during 1994 continued in the stop-go pattern characteristic of the previous two years. In the first half of the year, credit policy was gradually relaxed in order to lessen the liquidity squeeze on enterprises and banks arising from the tight monetary policy of late 1993, and to finance the budget (Tables 33 and 34). Nonetheless, inflation continued to decline during this period, primarily because of the lingering effect of the monetary tightening in late 1993, which led to a sharp fall in demand associated with the decline in real incomes of households and enterprises.

In the late summer of 1994, the weakening budget, and in particular Parliamentary and Presidential orders on financing to agriculture, led the NBU to extend large additional credits to the Government. 1/ Credit to a broad range of other economic activities also expanded sharply during this period. As a result, real base and broad money grew by 54 percent and 53 percent, respectively, during the third quarter and by early autumn the economy was in a situation of abundant liquidity (Table 35). By this time, there were also clear indications that expectations of high inflation had developed, with the exchange rate depreciating sharply in September. In addition, time deposit growth slowed significantly from its pace earlier in the year, as reflected in the declining share of these deposits in karbovanets broad money (Table 36). These developments set the stage for the double-digit monthly inflation of the last quarter of 1994 and early 1995.

Early in the fourth quarter of 1994, the NBU began to tighten monetary policy. National Bank credit to government grew slowly, reflecting the strong performance on the cash budget deficit. The refinance rate was raised from just under 12 percent per month at end-September to 25 percent per month in October (Table 37). 2/ While these actions contained the rate of growth of base money, the money multiplier jumped sharply as banks drew down their excess reserves and lent heavily to the nongovernment sector. Nevertheless, even with this credit expansion, real broad money fell by 37 percent during the fourth quarter.

Reflecting the generally good performance of the budget through the first half of 1995, the NBU’s credit policy remained tight during the period. Demand for refinancing credit was initially reduced as commercial bank lending was subdued during the first quarter; banks showed a cautious approach to new lending due to the deteriorating quality of their loan portfolios and the continued high real cost of refinancing credit. This reduced lending activity was reflected in a build-up of commercial banks’ excess reserves at the NBU from January continuing into April of 1995.

Beginning in April, however, commercial banks began again to lend heavily to the nongovernment sector and this led to a large increase in credit to the economy during the second quarter (Table 38). Much of this lending was done under pressure from governmental organizations, and was spurred by a Presidential decree of late March that directed banks to support the restructuring efforts of specific enterprises. At that time, the NBU also began to make available resources to banks for these lending operations. This led to a substantial increase in refinancing credit late in the second quarter. Commercial banks’ domestic currency resources were further increased during this period when the NBU intervened on the auction market to prevent an appreciation of the karbovanets, thereby building its own international reserves and increasing base money.

The authorities’ success in keeping credit policy tight through much of the first half of 1995 was reflected in the rapid decline in inflation during the period and contributed to an increase in confidence in the karbovanets. This was illustrated by the more than 45 percent increase in real holdings of karbovanets from March through July. 1/ In the ensuing three months, however, confidence was undermined by a number of factors. In late July, the National Bank extended large credits to the budget to cover wage payments and to finance renewed subsidies to the coal sector. In addition, commercial bank credit to the nongovernment sector continued to grow rapidly, and real base money increased by 6 percent during the month. In August, the Government announced a monetary reform that was rumored to include confiscatory measures and government officials made a number of policy statements that fed inflationary expectations. These factors led to strong pressure on the exchange rate in August and September, and it depreciated steadily through the period despite almost continuous NBU intervention on the auction market. The weakening of the exchange rate contributed to the strong surge in inflation in September and October that further eroded real domestic currency balances.

3. Interest rates

The NBU’s statutory refinancing rate is the key reference rate in the Ukrainian economy. It is the standard rate at which the NBU lends to commercial banks, and it was positive in real terms for all but four months between January 1994 and September 1995. However, part of NBU lending to commercial banks has continued to be at rates lower than the statutory rate and many of these credits have been extended at interest rates fixed at the time that the loan was made. Hence, the average interest rate on refinance credit outstanding has often been lower than the statutory rate (Chart 10). During 1995, the NBU has generally adjusted the statutory refinancing rate in line with inflation, while also taking into account exchange rate developments.


UKRAINE Monetary Ratios

Source IMF staff estimates on the basis of information provided by the Ukrainian authorities.1/ Nominal base money deflated by the consumer price index.2/ Nominal broad money deflated by the consumer price Index. Foreign currency deposits valued at parallel exchange rates through September 1994.3/ Ratio of karbovanets brood money to base money of the NBU.

UKRAINE Interest Rates

Source: Notional Bank of Ukraine.1/ Quoted nominal annual rate without taking into account the compounding of interest payments.

Average lending rates charged by the commercial banks have moved in concert with the refinance rate over most of the past year and a half. Reflecting the ample liquidity of commercial banks during the summer, however, the lending rate continued to fall in August and September 1995 even as the refinance rate was raised. As with the refinance rate, these lending rates have also been mostly positive in real terms. Lending rates typically float, with loan contracts specifying that the rates will generally be adjusted to movements in the refinance rate.

During 1995, the average interest rates offered on bank deposits have fallen less rapidly than lending rates, leading to a reduced spread between the average lending and deposit rates of commercial banks. However, the spread has remained large and was equal to almost 50 percentage points in August 1995. Moreover, average rates offered on deposits have been zero or negative in real terms since May of 1995. Rates offered on deposits also float with movements in the refinancing rate.

The NBU has held treasury-bill auctions since March 1995, with regular weekly auctions beginning in mid-August. Treasury bills have been auctioned with maturities of 3, 6, and 9 months, and, for those bills of maturity longer than three months, there is a quarterly interest payment. 1/ Effective yields on treasury bills have tracked the National Bank’s refinance rate, and therefore prevailing market rates, fairly closely. There have been a number of exceptions to this, including when investors anticipated in mid-April cuts in the refinance rate and when investors became unsettled in July by statements that anti - inflationary policies would be relaxed.

V External Sector

1. Balance of payments

Ukraine’s balance of payments continued to be under significant strain during 1995, and the country continued to accumulate external arrears, particularly on gas import payments (Table 39). Clearly such accumulation of arrears is not sustainable. It is therefore encouraging that--aided by large cuts in energy imports--the pace at which arrears were accumulated in 1995 was much lower than that observed in 1994.

The balance of payments was helped by the availability of trade credits from countries outside the former U.S.S.R. region. Ukraine also received substantial exceptional financing in 1995 (although lover than the financing envisaged under the program), particularly from the World Bank and the European Union. In addition, unidentified short-term capital has been a significant source of balance of payments financing in 1995, as capital appears to have returned to Ukraine following the liberalization of the exchange market.

This financing was insufficient, however, to prevent a balance of payments deficit, which was covered by the rescheduling of significant obligations falling due to Russia and Turkmenistan, and by Fund purchases. Such financing also helped the National Bank of Ukraine to accumulate an estimated US$450 million in reserves. As a result, gross official reserves, at end-1995, are estimated to be somewhat more than US$1 billion, about four weeks of imports.

a. Current account

The current account deficit remained essentially unchanged in 1995, at about US$1.4 billion. Exports, particularly to non-FSU countries, are estimated to have increased by about 40 percent over the first nine months of 1995. This increase has more than offset the fall in trade with the FSU. The growth of exports to the rest of the world was particularly remarkable since it took place despite a substantial real appreciation of the domestic currency during the first half of the year. This performance underscores the benefits of the trade liberalization measures taken earlier in the year (such as the elimination of the export registration scheme). 1/

Imports remained essentially flat during the first nine months of 1995, as a contraction in energy imports by about 10 percent was offset by other imports, particularly those from non-FSU countries. The latter increased by an estimated 16 percent during the first 9 months of 1995. As a result of these developments, Ukraine’s trade deficit fell by an estimated US$460 million during the first nine months of 1995.

The services account is dominated by the substantial--and rather stable--receipts of transit fees paid by Russia on its exports of gas to Western Europe through Ukraine. As a result, the surplus of over US$1 billion in 1995 is much the same as in 1994. In 1996, however, as part of a new agreement reached with Russia, payment for gas transit will be substantially higher which will be offset by a higher price charged to Ukraine for its own consumption of gas.

b. Capital account and external arrears

Despite these generally positive trade developments, Ukraine continued to accumulate external payment arrears on gas payments to Russia and Turkmenistan, as noted, and on debt payments to various creditors. These arrears reflected weak payments discipline by the Government, households, and enterprises within Ukraine. 1/

Ukraine received about US$300 million of trade-related credits in 1995, less than in 1994, perhaps reflecting an insufficient absorption capacity, and the inability to service the debts by the final beneficiaries of the loans. Such credits were supplemented by US$400 million in credits from the World Bank and US$110 million from the EU.

c. Debt

The recurring arrears have meant a very heavy burden for the budget which has been forced to take over about US$800 million in payments to Russia and Turkmenistan on account of gas payments arrears during 1995, including some arrears rescheduled in November 1995, but due before the end of the year. Resources needed to cover the official guarantee for gas payments account for more than half of the budgetary resources needed to cover external obligations. The debt now stands at over US$8 billion, or about 25 percent of GDP--a significant sum in relation to Ukraine’s budgetary resources.

Ukraine’s total external liabilities have increased significantly in the last three years (Table 43). This has resulted primarily from the cumulative current account deficits of the last few years, which were initially financed by overdrafts in the central bank’s correspondent accounts with countries of the former Soviet Union, and subsequently by the accumulation of arrears with the main energy suppliers noted above. The composition of Ukraine’s external liabilities at the end of 1994 mirrors such behavior. Since 1993 the country has accumulated nearly US$2 billion in debts to Russia and Turkmenistan. In addition, of the US$8.1 billion in overall debt, more than half is owed to FSU countries, mainly Russia.

2. Exchange market developments, arrangements, and system

a. Exchange market

The exchange rate has been relatively strong during the first half of the year, as capital inflows strengthened the balance of payments position, perhaps reflecting early confidence in Ukraine’s economic program (Table 44). Weakening policy implementation during the summer months, however, had an immediate impact on confidence and on the exchange market. The karbovanets depreciated from Krb 144,000 per U.S. dollar in July to Krb 165,000 per U.S. dollar in September, despite sizable exchange market interventions of the National Bank (Chart 11). In August there was an incipient run against the karbovanets, following public statements by senior government officials casting doubt on the course of the stabilization program and concerns about the extent of credit growth during July. The National Bank responded by tightening its monetary stance and intervening forcefully. The run was largely contained, although the exchange rate was allowed to depreciate by 11 percent in August.

UKRAINE Exchange Rate Developments
Sources: Ukrainian authorities; and IMF staff estimates.

Following the exchange market upheaval in late summer, and partly in response to increases in the National Bank’s refinancing rate, the karbovanets stabilized at around 180,000 per U.S. dollar in November and December. Ukraine’s real exchange rate has appreciated by about 60 percent since December 1994; however, the economy’s external competitiveness remains supported by the low level of wages (US$55 per month on average) in comparison to Ukraine’s main competitors.

b. Exchange arrangements and system 1/

Since the end of 1994, Ukraine has significantly liberalized its exchange system. Until October 1994, Ukraine maintained a system of multiple exchange rates, comprising an official exchange rate set by the authorities and a market rate set at a foreign currency option. On October 24, 1994, the Government abolished the multiple exchange rate regime. The National Bank of Ukraine declared that the official rate would be set at the rate established at the auction.

In October 1994, the Government re-opened the Kiev interbank auction exchange market. Since then, the foreign exchange auctions have been held every business day. Exchange rates in the auction are freely determined on the basis of supply and demand. Fifty percent of export earnings must be surrendered to the foreign exchange auction through commercial banks licensed to operate in foreign exchange. Ukraine also has re-opened the interbank market, where foreign exchange transactions are allowed to take place with a margin of plus or minus 5 percent (including commissions, fees, and charges) around the auction exchange rate. On the cash foreign exchange market, intermediaries are required to maintain a maximum spread of 2.5 percent between buying and selling rates.

Trade settlements with countries of the former Soviet Union are made mainly in convertible currencies, particularly in U.S. dollars, and through commercial banks. Transactions may in some cases involve the Center for International Settlements of the National Bank of Ukraine (CIS). The CIS operates as a private settlement system that expedites the clearing of international payments operations. Ukraine maintains bilateral trade (and in some cases payments) agreements with Bulgaria, the People’s Republic of China, Hungary, India, the Islamic Republic of Iran, and Mongolia. Ukraine also has signed free trade agreements with Russia and Kazakstan, although many of Ukraine’s imports from, and exports to, these countries are specifically excluded from the agreements.

Barter continues to be a major form of trade of Ukrainian companies in their transactions with FSU and non-FSU countries. Official estimates put the scale of foreign trade conducted under barter arrangements in 1995 at more than 30 percent; while high, it is still much below the 50 percent observed in 1994.

Table 1.

Ukraine: Net Material Product and Gross Domestic Product, 1990-94

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Sources: Ministry of Statistics; and staff estimates.

Including depreciation.

The figure for 1991 is at book value, unadjusted for actual price increases.

Table 2.

Ukraine: Net Material Product, 1990-94

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Source: Ministry of Statistics.
Table 3.

Ukraine: Net Material Product by Sector, 1990-94

(Percentage change at comparable prices)

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Source: Ministry of Statistics.
Table 4.

Ukraine: Sectoral Shares in Gross Output, Material Cost, and Net Output, 1990-94

(Share in percent, at current prices)

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Source: Table 2.
Table 5.

Ukraine: Utilization of National Income Produced, 1990-94

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Source: Ministry of Statistics.
Table 6.

Ukraine: Industrial Production, 1990-95

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Source: Ministry of Statistics.

Percentage change over corresponding period in the previous year.

Table 7.

Ukraine: Output of Major Agricultural Products, 1986-94

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Source: Ministry of Statistics.

In million pieces.

Table 8.

Ukraine: Agricultural Production, 1990-94

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Source: Ministry of Statistics.
Table 9.

Ukraine: Production of Major Energy Products, 1990-94

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Sources: Ministry of Statistics; Ministry of Economy.
Table 10.

Ukraine: Energy Prices, 1993-95

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Sources: Ministry of Economy; and staff estimates.

Ratail prices.

Includes gas tax from March 1995.

Table 11.

Ukraine: Retail Turnover in Goods and Services, 1993-95 1/

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Source: Ministry of Statistics.

Retail trade in the state and cooperative sectors.

Table 12.

Ukraine: Money Incomes and Expenditure of the Population, 1993-95

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Sources: Ministry of Statistics; and IMF staff estimates.

Deflated by the consumer price index.