A. Background

1. The Republic of Ukraine—about 10 percent larger than France in terms of geographic area—covers 603,700 square kilometers. The population is 51.6 million, of which three quarters are ethnic Ukrainians and about one fifth are Russians. The Ukrainian Republic was proclaimed on December 25, 1917 and was established in December 1919. It became part of the former U.S.S.R. on December 30, 1922. Ukraine declared itself an independent state on August 24, 1991.

2. Ukraine’s principal natural resource is its agricultural land, which forms part of the extremely fertile “black earth” zone. It also possesses some 60 percent of the former U.S.S.R.’s bitumen and anthracite coal reserves, in addition to more modest reserves of natural gas and petroleum. It has a variety of minerals, including manganese, uranium, and substantial reserves of iron ore. Agriculture accounts for about 14 percent of GDP and industry for about 30 percent. Principal exports include food products, chemical products, minerals, metallurgical products, and machinery; total exports in 1996 amounted to some $15.5 billion. Ukraine is a major importer of energy, especially natural gas. Energy imports in 1996 were about $8.3 billion, out of total imports of about $20 billion.

3. Ukraine’s economic performance since independence has been turbulent. Inflation reached 10,000 percent in 1993, and the cumulative decline in recorded output since independence is estimated at more than 50 percent.¹ In late 1994, the government launched a stabilization program, supported by the Fund’s Systemic Transformation Facility and an Import Rehabilitation Loan from the World Bank, as well as bilateral donors and creditors. The STF supported program was followed by two Stand-By Arrangements, covering 1995 and 1996. Toward the end of 1996 and in early 1997 the government prepared to launch a new reform program. This program was designed to focus especially on structural elements in order to reduce government regulations and interventions and to promote a sustained economic growth in the near future.

B. Political Developments in 1996 and early 1997

4. Political activity in the opening months of 1996 focused on Parliamentary debate of the 1996 budget. Despite intense disagreement over the composition of expenditure, there was broad consensus on the need to limit the budget deficit in line with the government’s low inflation objective. This consensus was also evident in Parliament’s support for the National Bank’s monetary program—approved in April—following the adoption of the budget in late March.

5. The adoption of the new Constitution dominated political life in the early summer. The draft Constitution aimed to delineate clearly the powers and responsibilities of the Legislature, the Judiciary and the Executive. The Constitution also provided for the protection of human rights and firmly established the right to private property, including land. Despite initial opposition from the left-wing oriented deputies, the Constitution was approved by a three-quarter majority of Parliament on June 26. Parliamentary elections are scheduled for 1998, and the next presidential elections for 1999.

6. The political climate at the end of 1996, while broadly stable, was clouded by the continued accumulation of wage and pension arrears, both in the budget and in the enterprise sectors. Public protests became increasingly vociferous. A miners’ strike, in particular, was marked by acts of civil disobedience, such as blocking of main railway lines. While most strikes and protests were settled with promises to deal with the problem, there was no improvement in the situation, with the wage arrears remaining the main destabilizing factor.

7. In the first half of 1997, political tensions again became more pronounced and resulted in a struggle between the government and the Parliament on key elements of the adjustment program that the government had hoped to implement. Several measures, in particular in the area of taxation, where the government had proposed significant cuts in payroll taxes, were not approved. The 1997 budget was caught up in this struggle and was not adopted until late June.

8. Throughout 1996 and the first half of 1997, there were several changes in the composition of the government, including in the position of the Prime Minister and in the economic team. This contributed to further uncertainty and delays in implementation of economic and structural reforms.

9. Another dominant theme in the political discourse throughout 1996 and in 1997 was the issue of corruption. This achieved international resonance with increasingly vocal complaints by foreign investors in Ukraine about the difficulties of doing business in a corruption-riddled environment. President Kuchma responded to these concerns by ordering a cleanup of the state apparatus, and by taking personal leadership in the fight against corruption.

C. Economic Developments in 1996 and early 1997

10. In 1996, Ukraine achieved a measure of macroeconomic stability for the first time since gaining independence. Inflation, which at times had bordered on hyperinflation, fell to an average monthly rate of 2.8 percent and, except in months with major administered price changes, remained low throughout the year. This trend continued in 1997, when inflation averaged less than one percent a month during the first half of the year.

11. Output recovery proved more fragile. Following declines in real GDP of 23 percent in 1994, and 12 percent in 1995, output is estimated to have fallen by a further 10 percent in 1996—though much of the decline is attributable to the poor harvest conditions, and this estimate does not take account of the growth of the informal economy. Growing uncertainty about the prospect for reforms, had a negative impact on economic activity in the first part of 1997. Real output continued to decline with official data showing a 7.5 percent decline in real GDP in January-June 1997 compared to the same period in 1996.

12. Throughout 1996 and early 1997 the authorities pursued a relatively tight monetary policy compared to previous years. With slow remonetization of the economy, domestic credit and broad money expansion were limited in 1996 to 38 percent and 35 percent, respectively, and to 15 percent and 19 percent, respectively, in the first six months of 1997. Two factors contributed to the relatively low rate of credit expansion. First, the budget deficit in cash terms fell from 4.8 percent of GDP in 1995 to 3.2 percent of GDP in 1996 although it rose again to about 4.6 percent in the first half of 1997. Second, the nascent treasury-bill market became much more active—especially in the second half of 1996 and first half of 1997, when foreign participation increased—allowing the government to finance the largest part of the deficit through treasury-bill sales. While these treasury-bill sales allowed the National Bank to limit direct credit expansion, the lack of sufficient fiscal adjustment has been nonetheless costly. With commercial banks already wary about lending to enterprises, the high real yields of treasury bills made them an attractive instrument for holding reserves, and may have resulted in some crowding out of the private sector.

13. Moreover, most of the fiscal adjustment in 1996 was illusory, with the government incurring payments arrears on wages, pensions, and other benefits equivalent to about 3.0 percent of GDP. On an accruals basis, therefore, the budget deficit in 1996 was about the same, at 6.1 percent of GDP, as in 1995. Adjustment was hampered by the lack of a functioning treasury, with line ministries able to make purchases without Treasury approval, and frequently incurring expenditure arrears. In all, expenditure of the state budget fell by 2.3 percent of GDP on a cash basis (to 40.4 percent of GDP). The sharpest cuts in cash expenditures were on national economy expenditures, housing, investment, consumer subsidies, and health and education. On a commitments basis, however, the reduction of expenditures on health and education was significantly smaller. Revenue in 1996—despite a fall of 0.9 percentage point to 37.2 percent of GDP—remained high by the standards of the region. The largest decline was in the enterprise profit tax, where the contraction of real activity resulted in about a 2 percentage point fall in revenue.

14. The 1997 budget was not approved until late June 1997, but the consolidated budget deficit, on a cash basis, remained under control (at about 4.6 percent of GDP) although the weak revenue collection gave rise to new arrears on wages, benefits, and pensions.

15. External performance continued to be strong. In dollar terms, exports grew by 14 percent in 1996, despite a substantial appreciation of the real exchange rate. The current account deficit narrowed both in dollar terms and as a percentage of GDP, from 4.4 percent of GDP in 1995 to 2.7 percent in 1996. Exchange rate policy differed widely during the course of the year. At times—especially during the monetary reform—the nominal exchange rate was used to anchor expectations and the National Bank of Ukraine (NBU) intervened heavily in support of the rate. On other occasions, the NBU allowed the exchange rate to move in response to market pressures. An informal exchange rate band of Hrv 1.7 to Hrv 1.9 per U.S. dollar was introduced in September. Toward the end of 1996 and in the first part of 1997, when foreign participation in the treasury-bill market resulted in large capital inflows, the NBU used the opportunity to rebuild its reserves, thereby expanding the monetary base. With a relatively stable exchange rate, the hryvnia continued to appreciate in real terms but this does not appear to have harmed exports. The capital account position further improved, mostly related to higher short-term capital associated with purchases in the treasury-bills market.

16. Several important structural reforms were undertaken during the year. First, the hryvnia—Ukraine’s new permanent currency—was introduced to replace the karbovanets, with a conversion factor of Krb 100,000 per Hrv. Second, there was a marked pick-up in the pace of mass privatization and small-scale privatization. Third, all remaining controls on prices and profit margins, were removed by the end of the year. And fourth, important reforms were undertaken in the energy sectors (coal, electricity, and gas).

A. Overview

17. While inflation fell rapidly in 1996, the recovery in output was more fragile. Following declines in real GDP of 22 percent in 1994, and 12 percent in 1995, output is estimated to have fallen by a further 10 percent in 1996 and 8.5 percent in the first quarter of 1997 (Tables 1-4). Part of the output drop in 1996 may be explained by poor harvest conditions which resulted in agricultural output falling by about 10 percent, while industrial output declined by about 5 percent. Construction services, as captured in the official statistics, fell by 44 percent—suggesting a growing share of the unrecorded economy (see Box 1). This was followed by an equally sharp decline in the first quarter of 1997. Real consumption by households fell by about 6 percent during 1996 somewhat less than the fall in real GDP. The uncertainty about the tax reforms and the new tax system that was discussed in Parliament in early 1997 had an adverse effect on business climate and contributed to the postponement of economic decisions.

18. National accounts statistics remain too unreliable to provide a clear picture of the expenditure breakdown of GDP. Nonetheless, it appears that, in contrast to previous years, inventory accumulation slowed significantly—from an estimated 12 percent in 1994, to 3 percent in 1995, and 2 percent in 1996. Whether this stock of inventories will eventually be sold or merely scrapped remains an open question, and accounting problems have almost certainly resulted in overestimates of inventory accumulation in the past. Even with the lower inventory accumulation in 1996, for instance, the official statistics suggest gross domestic saving of about 21 percent of GDP.² While this is much lower than the savings estimate for 1994 (32 percent of GDP), it is still sizable for a country which has seen such steep declines of output and real income. From the asset side, moreover, implied private saving rates are considerably lower. Given the relatively poor menu of available assets, households typically save in the form of domestic currency, deposits in domestic or foreign currency, foreign currency, or government treasury bills. Yet the increase in broad money during 1996 was less than 3 percent of GDP so that even generous estimates for the accumulation of foreign currency suggest private saving rates well below official estimates. The factor income breakdown of GDP is probably more reliable and shows a modest increase in the share of labor from 44 percent in 1995 to almost 45 percent of GDP in 1996.

19. Employment trends continued much as in previous years, with little registered unemployment but considerable underemployment. Registered unemployment remained less than two percent in 1996 and in early 1997, pointing to further labor hoarding, although reluctance to register could also be a factor. The year 1996 and 1997 did see a pick-up in structural reforms, especially the small-scale and mass privatization programs, though clearly much remains to be done.

B. Output Developments

20. Total industrial output is estimated to have declined by 5.1 percent in 1996, with substantial variations across industries. This situation was not much changed in the first quarter of 1997 when, compared to the same period in 1996, industrial output declined by 6 percent (Figure 1). Particularly afflicted in 1996 (and 1997) were machine building, which fell by 26 percent, construction materials, which fell by 35 percent, and wood and paper products, which fell by 18 percent (Table 5). Several factors underlie the continued decline in industrial production (Box 2). First, budget constraints have become increasingly hard—especially in regard to gas deliveries, where distribution is no longer controlled by a national monopoly, and the government guarantee for external payments has been abolished. Second, with the decline in inflation, banks have become more aware of the parlous state of their portfolios and of the large amounts of interenterprise arrears (Figure 2) and are increasingly reluctant to provide fresh credits to enterprises. And third, despite the pick-up in privatization (see Section E, below), substantial restructuring of enterprises remains to be done before productivity gains are realized. Moreover, food processing—which accounts for 16 percent of industrial output—was adversely affected by the low agricultural output.

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UKRAINE Industrial Production, 1993-97 (May)

(January 1992 = 100)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Source: Ukrainian authorities.

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UKRAINE Interenterprise Arrears, 1993-96

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Source: Ministry of Statistics.

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21. The poor harvest has been blamed on adverse weather conditions in early 1996, with a severe winter followed by an early summer which significantly shortened the spring planting period. In addition, the lack of necessary agricultural inputs, such as mineral fertilizers, has resulted in a secular decline of agricultural productivity. Grain output in 1996 was only 24 million tons, compared with 34 million tons in 1995, and an average of 47 million tons in 1986-90 (Tables 6 and 7). Output of winter and spring barley fell by 41 percent, output of winter and spring wheat by 17 percent, and output of maize by 45 percent. Livestock breeding also declined, albeit less precipitously: meat, milk, and egg production fell by 6-8 percent, and wool production by almost 33 percent. These declines are in part related to the fall in grain output, and in part to the export tax on livestock and animal skins (see Chapter V), which acted as a disincentive to raise animals. The delcine in meat and milk production occurred mainly in the collective farms, whereas private farms saw modest increases; the share of private sector production of meat rose from 50 percent to 55 percent, and of milk from 56 percent to 59 percent. Overall, the agricultural sector continues to be dominated by collectives and state farms, that combined account for 80 percent of the share of agricultural land.

Box 2.

Accounting for Industrial Production

A number of factors—structural and macroeconomic—account for the declines in industrial production. In the early 1990s, Ukraine’s industrial sector suffered a sharp fall in demand—domestic as real incomes fell, and external, as the break-up of the Soviet Union disrupted previous commercial relations and trade patterns. Slow structural reform exacerbated these difficulties. At the same time, industrial enterprises started facing tighter credit conditions in an environment in which prices for inputs were increasing more rapidly than output prices. Externally, this corresponded to the substantial terms of trade shock suffered by Ukraine as energy prices were raised to world levels (these higher prices were passed on to enterprises only starting March 1995). More important, real credit growth became highly variable, ranging from 10 percent to minus 50 percent per month, as inflation eroded bouts of extraordinary credit expansion.

Under current Ukrainian legislation, state-owned enterprises have little say in the allocation of their assets (including the disposal of unproductive assets). Accordingly, an enterprise might be thought of as a collection of assets devoted to a particular purpose—maximal production of specific goods subject to financing constraints, and the objective of providing employment to the incumbent workforce. Expenditure on current domestic inputs, px, imported inputs, ep*z, and wages, wl, must be financed by borrowing, dC, incurring arrears, dA, or selling the stock of output previously produced, q_-1.

$i{C}_{-1}+px+e{p}^{*}z+wl=dA+dC+p{q}_{-1}$

If production is subject to a technology, q=f(x, l, z), f_x > 0, f_xx < 0, then output is given by:

$q=f(\frac{dA}{p}+\frac{dC}{p}+q_{-1}-\frac{wl}{p}-\frac{e{p}^{*}z}{p}-\frac{i{C}_{-1}}{p},l,z)$

Ceteris paribus, therefore, an increase in real domestic credit or arrears will allow the enterprise to expand output, while an increase in real wages or the price of imported inputs will cause a contraction of output.

The Table reports coefficients from a co-integrating relation between the log of real industrial output by sector, the log of real credit to the economy (α₁), the log of the real wage (α₂), and the log of the real gas price (α₃):

$\log \left(q\right)={\alpha }_0+{\alpha }_1\log (D{C}^e/p)+{\alpha }_2\log (w/p)+{\alpha }_3\log (e{p}^g/p)+v$

And the short-run dynamics:

$\mathrm{\Delta }\log \left(q\right)={\beta }_0+{\beta }_1\mathrm{\Delta }\log (D{C}^e/p)+{\beta }_2\mathrm{\Delta }\log (w/p)+{\beta }_3\mathrm{\Delta }\log (e{p}^g/p)+{\beta }_3\mathrm{\Delta }\log (e{p}^g/p)+{\beta }_4{v}_{-1}$

Sector	α1	α2	α3	β1	β2	β3	β4	R2
I	0.147	−0.059	−0.294	0.104 (1.46)	0.044 (1.20)	−0.371 (−0.25)	−0.253 (−2.49***)	0.80
II	0.154	−0.100	−0.064	0.525 (3.05***)	−0.028 (−0.33)	−0.177 (−2.18**)	−0.558 (−3.44***)	0.52
III	0.245	−0.121	−0.054	−0.035 (−0.30)	0.923 (0.12)	−0.064 (−2.04**)	−0.600 (−3.88***)	0.45
IV	0.135	−0.071	−0.067	0.440 (3.00***)	−0.073 (−0.81)	−0.064 (−1.98*)	−0.453 (−3.05***)	0.33
V	0.314	−0.146	−0.043	0.301 (2.71***)	−0.092 (−1.69*)	−0.067 (−2.72***)	−0.350 (−2.68**)	0.37
VI	0.942	−0.523	−0.110	0.376 (4.85***)	−0.241 (−4.96***)	0.022 (1.03)	−0.146 (−2.29**)	0.39
VII	0.531	−0.425	−0.070	0.227 (2.11**)	−0.318 (−5.87***)	−0.041 (−1.44)	−0.500 (−4.06***)	0.44
VIII	0.644	−0.360	−0.043	0.310 (3.29***)	−0.110 (−1.39)	−0.026 (−1.03)	−0.137 (−1.65*)	0.22
IX	0.821	−0.502	−0.177	0.471 (2.60**)	−0.486 (−4.60***)	−0.043 (−0.73)	−0.263 (−1.77*)	0.36
X	0.373	−0.088	0.018	0.745 (2.57**)	−0.180 (−1.37)	−0.076 (−1.70*)	−0.184 (−0.38)	0.24
XI	0.388	−0.202	−0.058	0.401 (5.66**)	−0.127 (-2.80***)	−0.054 (-2.63**)	−0.304 (-2.01***)	0.42

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Sector	α1	α2	α3	β1	β2	β3	β4	R2
I	0.147	−0.059	−0.294	0.104 (1.46)	0.044 (1.20)	−0.371 (−0.25)	−0.253 (−2.49***)	0.80
II	0.154	−0.100	−0.064	0.525 (3.05***)	−0.028 (−0.33)	−0.177 (−2.18**)	−0.558 (−3.44***)	0.52
III	0.245	−0.121	−0.054	−0.035 (−0.30)	0.923 (0.12)	−0.064 (−2.04**)	−0.600 (−3.88***)	0.45
IV	0.135	−0.071	−0.067	0.440 (3.00***)	−0.073 (−0.81)	−0.064 (−1.98*)	−0.453 (−3.05***)	0.33
V	0.314	−0.146	−0.043	0.301 (2.71***)	−0.092 (−1.69*)	−0.067 (−2.72***)	−0.350 (−2.68**)	0.37
VI	0.942	−0.523	−0.110	0.376 (4.85***)	−0.241 (−4.96***)	0.022 (1.03)	−0.146 (−2.29**)	0.39
VII	0.531	−0.425	−0.070	0.227 (2.11**)	−0.318 (−5.87***)	−0.041 (−1.44)	−0.500 (−4.06***)	0.44
VIII	0.644	−0.360	−0.043	0.310 (3.29***)	−0.110 (−1.39)	−0.026 (−1.03)	−0.137 (−1.65*)	0.22
IX	0.821	−0.502	−0.177	0.471 (2.60**)	−0.486 (−4.60***)	−0.043 (−0.73)	−0.263 (−1.77*)	0.36
X	0.373	−0.088	0.018	0.745 (2.57**)	−0.180 (−1.37)	−0.076 (−1.70*)	−0.184 (−0.38)	0.24
XI	0.388	−0.202	−0.058	0.401 (5.66**)	−0.127 (-2.80***)	−0.054 (-2.63**)	−0.304 (-2.01***)	0.42

I	Power	V	Chemicals	IX	Light industry
II	Oil and Gas	VI	Machinery	X	Food
III	Coal	VII	Wood/paper	XI	Total
IV	Steel	VIII	Construction materials

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I	Power	V	Chemicals	IX	Light industry
II	Oil and Gas	VI	Machinery	X	Food
III	Coal	VII	Wood/paper	XI	Total
IV	Steel	VIII	Construction materials

Where the reported R² refers to the equation describing short-run dynamics, and where heteroscedastic-consistent t-statistics are in parentheses, and statistical significance at the 10, 5, and 1 percent levels are indicated by (*), (**), (***), respectively.

The regressions suggest that real credit growth in Ukraine was associated with an increase in output, while real increases in wage or other costs were associated with a decrease in output. As emphasized in Ghosh: The Output-Inflation Nexus in Ukraine (WP/96/46), an increase in nominal credit will only translate into a corresponding increase in real credit if it is consistent with the rate of monetization of the economy.

22. Output of crude petroleum remained constant in 1996, and natural gas production rose marginally (Table 8). Oil refineries processed some 13.5 million tons of oil in 1996, about 20 percent less than in 1995; the manufacture of petroleum, diesel fuel, and heating oil fell by 5 percent to 23 percent. Coal output fell by almost 17 percent, partly in the context of a comprehensive coal restructuring program (see Section E, below). Electricity output also fell, but by somewhat less than the fall in recorded GDP (5.6 percent).

C. Competitiveness

23. Following the price liberalization and exchange market unification in late 1994, the currency has appreciated considerably in real terms. From December 1994 to May 1997, the real exchange rate (measured with the wholesale price index) rose by 95 percent against the U.S. dollar, and by 11 percent against the Russian ruble; on a trade-weighted basis, the currency has appreciated by about 52 percent in real terms (Figure 3). Dollar wages in Ukraine have risen sharply since late-1994 (by about 140 percent), but remain well below those prevailing in many of its competitors, including Russia and the Baltic countries (Figure 4). Direct measures of productivity are difficult to obtain. Available statistics suggest that labor productivity has fallen by about 20 percent in the industrial sector since late 1994, implying a substantial increase in real unit labor costs. Such figures undoubtedly exaggerate the true increase in labor costs, however, since the official employment data show implausibly low levels of unemployment (less than 2 percent of the working-age population). Moreover, the base period is arbitrary, and the nominal exchange rate was almost surely undervalued at the end of 1994, following the exchange market unification. As noted in Chapter V, export growth remains robust.

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UKRAINE Real Exchange Rate Developments, 1994-97 (May)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Sources: Ukrainian authorities; and IMF staff estimates.1/ Deflated by the wholesale price index. Decline indicates real depreciation.2/ As calculated in INS; CPI based.

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UKRAINE Real and Dollar Wages, 1993-97 (May)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

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

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24. A comparison of domestic, and international prices (with quality corrections) for a basket of 290 industrial goods suggests that, on average, the hryvnia could appreciate further before international competitiveness is fully eroded (Box 3).

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UKRAINE International Competitiveness: Ratios of Value of Output by Sector at International Prices to Value at Domestic Prices ^1/

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Source: European Center for Macroeconomic Analysis (Ukraine).1/ Ratio greater than unity implies undervaluation of hryvnia.

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D. Labor Market Developments

25. Labor market trends continued much as in 1995 (Tables 15-18). Total employment decreased just marginally. The share of the labor force in the state sector declined from 69.4 percent to 64.2 percent, with a corresponding increase in the collective sector (which includes enterprises that have been transformed into joint-stock companies but not yet privatized).

26. Officially recorded unemployment remained very low, at less than 1 percent of the labor force for most of 1996, but started to rise slightly in 1997 to just under 2 percent. In general, there has been little labor-shedding, in large part because enterprises continue to be responsible for many social services—schooling, housing, medical care—so that workers prefer to remain notionally employed even if they are not being paid on time, if at all. A household survey undertaken in October 1995 suggests an unemployment rate—out of the active population of working age—of about 5 percent, with substantial regional variations. This figure almost certainly underestimates the true unemployment rate inasmuch as persons over 55/60 were deemed to be inactive, and the full extent of underemployment was not adequately captured. Indeed, in 1995 some 18 percent of the labor force was on forced leave (at some point during the year) and a further 6 percent was working less than full time. Corresponding figures for the first nine months of 1996 are 21 percent and 7 percent, respectively.

27. Real wages (deflated by the consumer price index) fell by about 3 percent in 1996, but these are accrual wages and were frequently not paid on time. The stock of wage arrears at the end of 1996 is estimated as more than Hrv 4 billion (of which about Hrv 1 billion is owed to budgetary workers)—representing 17 percent of all wages paid during the year. Additional wage arrears accrued in the first part of 1997 despite efforts to eliminate them, although the pace of accumulation slowed.

E. Structural Reforms

Privatization

28. During the past year, the pace of privatization increased markedly (Figure 6). Whereas 1,000 medium and large scale enterprises were privatized in 1995 (with at least 70 percent of shares transfered from state ownership), a further 3,250 were privatized in 1996. Two measures taken by the government in early 1996 contributed to the pick-up in privatization. First, enterprise managers were given an additional incentive in the form of an extra 5 percent preferential share allocation if they complied with privatization procedures and deadlines. Second, a presidential decree of May 1996 streamlined the procedures required for privatizing agro-industrial enterprises and reduced the time required from 12 months to 4 months. Unlike industrial enterprises, however, the closed subscription period for agro-industrial enterprises remained 10 months until September 1996 when it was reduced to 3 months. A further barrier to the privatization of agro-industrial enterprises is the Law on the Peculiarities of Privatization of Agro-Industrial Complex which stipulates that 51 percent of the shares of such enterprises should be offered to the employees of their suppliers—typically state and collective farmers. Previous versions of the bill, which would have made this provision retroactive (including re-nationalization if necessary), were vetoed by the President.

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UKRAINE Mass Privatization of Medium and Large Enterprises, 1992-97 (June)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Sources: Ukrainian authorities.

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29. Altogether, since 1992 some 9,240 medium and large enterprises (with 5.7 million employees) have started the privatization program. Of these, 1,230 enterprises (0.9 million employees) were privatized before the mass privatization program³ was instituted in December 1994. By end-1996, a further 4,251 enterprises (about 1.8 million employees) were privatized, and about 4,000 (3 million employees) are currently undergoing privatization. About 6,000 large- and medium-scale enterprises were placed on a “negative list” at the outset of the privatization program many of which are schools, kindergartens, etc., but also includes industries in defense, energy sector, and other “sensitive” areas. The negative list was reduced to 5,125 enterprises in early 1997.

30. In early 1997, the introduction of a new law on cash compensation reduced the attractiveness of compensation certificates as a mean of mass privatization and the delayed approval of the 1997 privatization program by Parliament slowed down the pace of privatization of medium and large scale enterprises. Nevertheless, some additional 1,350 enterprises were privatized in the first half of the year.

31. The deadline for picking-up privatization vouchers, originally set for end-June 1996, was postponed to end-September 1996, and later to January 1, 1997.⁴ By end-September, some 80 percent of such vouchers had been distributed. Distribution of savings compensation certificates started in mid-1996. These certificates are intended to compensate depositors in the Savings Bank for the erosion of the real value of their deposits held as of January 1, 1992. Unlike privatization vouchers, these certificates are freely tradable, and enterprises auctioned for compensation certificates are not subject to a floor “price.”

32. Finally, the small-scale privatization program was virtually completed by mid-1997 with about 90 percent out of an estimated stock of 42,000 small enterprises having been privatized. During 1996 about 1,500-2,000 enterprises were privatized each month (raising a total revenue of about Hrv 200 million)—considerably more than in previous years.

A. Overview

43. In 1996, Ukraine achieved sustained price stability for the first time since declaring independence in 1991. Inflation, which at times had bordered on hyperinflation, fell to an average monthly rate of 2.8 percent (Figures 7 and 8). Two key factors underlie this stabilization. First, the rapid development of the treasury-bill market allowed the government to finance the budget deficit—the lowest since independence at 3.2 percent of GDP—primarily through the sale of treasury bills. In turn, this allowed the National Bank (NBU) greater flexibility in conducting its credit and monetary policies than in previous years. Importantly, increased participation by non residents in the treasury bill market meant that NBU purchases at the primary auction were less than 26 percent of the total funds realized. Second, the NBU improved its general coordination of monetary and exchange rate policies, including through the active use of its treasury-bill holdings to sterilize its exchange market interventions several times during the year.

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UKRAINE Money, Prices and Gross Reserves, 1994-97 (June)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Sources: Ministry of Statistics; and IMF staff estimates.

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UKRAINE Components of the CPI, 1994-97 (June)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Sources: Ministry of Statistics.

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44. Other factors also differentiated the authorities’ policy stance in 1996 from that in earlier years. In the first half of the year the authorities began to move forward with plans to replace the karbovanets with Ukraine’s permanent currency, the hryvnia. Due to the political importance attached to the monetary conversion—and the great uncertainty generated by previous announcements of it—the authorities made a concerted effort to ensure its success. In particular, great significance was attached to the stability of the exchange rate in the period preceding the announcement of the conversion. In effect, this gave the NBU the political mandate for tight financial policies through much of the year. In addition, the influence of sectoral (primarily agricultural and energy) interests on financial developments weakened somewhat in early 1996, with commercial bankers reporting fewer and smaller directed credit operations. Moreover, NBU refinancing—often used to provide liquidity for such operations—was modest during this period compared to earlier years.

45. The NBU’s credit policy remained tight in the first half of 1997. The strong participation of nonresidents in the treasury-bill market led to significant net purchases of foreign exchange by the NBU in order to prevent a serious appreciation of the hryvnia. Monetary expansion remained moderate as the NBU attempted to sterilize the effects of its foreign currency interventions on base money.

46. While these are positive signs, the continuing slow pace of structural reform—including of the banking sector—threatens to undermine the achieved financial stability. Nowhere is this more evident than in the slow remonetization of the economy. The increase in real money demand has been fragile (see Box 5), and velocity declined by only 1 percent during 1996—a clear sign that full confidence in macroeconomic policies and the financial system is yet to be established. In addition, there is emerging evidence that directed lending—albeit without direct NBU support—which resumed in the second half of 1996, further jeopardized the financial health of already weak banks. Nevertheless, there are some tentative signs that, starting in the second quarter of 1997, money demand is increasing.

B. Monetary and Exchange Rate Developments

47. The principle monetary development during 1996 was the introduction of Ukraine’s permanent currency, the hryvnia, in September (see Box 6). The importance attached—at all levels of government—to a successful introduction of the hryvnia resulted in a substantial easing of pressure for directed lending by commercial banks and the NBU. Moreover, demand for refinancing credit in 1996 and the beginning of 1997 was very moderate as banks exhibited caution in their general lending activity to the nongovernment sector, in part because of the fragile state of the commercial banks (see Box 7). Instead, banks preferred to hold treasury bills whose real yields—though falling—remain very attractive. The banks’ cautious behavior is also reflected in their often large holdings of unremunerated excess reserves.

48. Reflecting the generally good performance of the (cash) budget and the rapid expansion in the treasury-bill market, the NBU’s monetary and credit policies were tight through most of 1996 and the first half of 1997 (Tables 24-27). Policy was tightened at the beginning of 1996 through increases in the required reserve ratios for both domestic and foreign currency deposits in an effort to reduce quickly excess reserves at commercial banks. This action was followed by tight credit policies and periodic NBU sterilization operations to offset its frequent net purchases in the exchange market from late January through the end of the second quarter. With these actions, base money growth was contained to just 15 percent through June. Against this background—and reflecting commercial banks’ cautious lending behavior—broad money grew by 11 percent during the same period.

49. Net NBU credit to the budget during the second half of 1996 was just one-fifth of the amount provided during the first six months of the year, partly because of significantly increased activity—including participation by nonresidents—in the treasury-bill market. During most of the period the NBU continued to restrict refinancing by limiting the number of auctions and use of its Lombard facility. Despite this tight credit policy, the hryvnia came under pressure several times (see below) and the NBU did not raise interest rates or otherwise tighten monetary policy to relieve the exchange market pressure. December saw a shift in policy. Credit was eased in response to political pressures to finance firms’ contributions to the Pension Fund, and a large amount of refinance credit was extended for this purpose; commercial bank lending to the nongovernment sector rose sharply during this month. In addition, the NBU intervened heavily in the exchange market during December to absorb capital inflows associated with increased nonresident demand for treasury bills and did not fully sterilize these operations. Together, these factors led to base and broad money growth of about 14 percent during December (compared to growth rates of just 5 percent and 6.5 percent, respectively, over the previous five months).

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UKRAINE Monetary Dynamics, 1994-96

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Source: IMF staff estimates.

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50. Monetary policy was relatively tight in the first half of 1997, with some loosening in June. Broad money at the end of February was at about the same level as end-December 1996, although this was mostly due to a sharp decline in foreign currency deposits as capital inflows deposited at the banking system at the end of 1996 moved to the treasury-bill market, hryvnia broad money grew by 7.9 percent in the first quarter and 14 percent in the second quarter (most of it in June) while base money grew by 6.5 percent and 18 percent, respectively during these periods.

51. In 1996, as in the previous year, Ukraine again experienced an excess supply of foreign exchange on its exchange markets beginning in the second quarter. Initially, the flows were associated with the delayed repatriation of earnings on goods exported in late 1995—particularly agricultural products and processed foodstuffs. Compounding this, May saw the beginning of sustained capital inflows that are believed to have been associated with uncertainties surrounding the political situation in Russia prior to the presidential elections there. These inflows continued through July and the NBU, while using the opportunity to build its international reserves, limited its interventions and allowed the exchange rate to strengthen significantly; the karbovanets appreciated from its most depreciated rate ever of Krb 191,100 per U.S. dollar in early March to Krb 176,000 at the end of July.

52. In August, downward exchange market pressure emerged as news of the imminent currency conversion spread. This pressure increased significantly following the official announcement on August 23 of the conversion procedures, which specified a number of administrative restrictions (Box 6). As a result, the NBU was forced to intervene heavily in the market in the last week of August to keep the official exchange rate fixed—a policy it had chosen to follow since early August in an attempt to minimize uncertainty at the time of the currency conversion. This policy proved costly, with the NBU selling, between early August and mid-September, almost all the reserves it had accumulated through exchange market intervention earlier in the year. The NBU maintained a de facto fixed exchange rate policy through early October—holding the value of the new currency at Hrv 1.76 per U.S. dollar—with a slight additional loss of reserves.

53. Following this experience, the NBU decided to let the exchange rate move in response to market pressures—at least for some time—and the hryvnia depreciated to Hrv 1.87 per U.S. dollar by mid-November. At that point, exchange market pressure again switched direction as a result of significant new capital inflows associated with rising nonresident purchases of treasury bills. The NBU chose to use this opportunity to rebuild its international reserves, however, and thereby contributed to a slight further depreciation of the hryvnia during the remainder of the year.

54. The hryvnia continued to be under sustained upward pressure for most of the first half of 1997, again largely because of capital inflows associated with purchases of treasury-bills by nonresidents. By the end of June, nonresidents had purchased an estimated $700 million in treasury bills. The NBU used this opportunity to further build up its international reserves, while keeping the exchange rate between Hrv 1.84 and Hrv 1.88 per U.S. dollar (close to the upper limit of the informal band), for most of this period, with the exception of a short time in February, when the rate was allowed to move to Hrv 1.74 per U.S. dollar. Gross international reserves of the NBU increased by $340 million in this period to $2.3 billion.

C. Prices and Interest Rates

55. Monthly inflation rates in January and February—at 9.4 percent and 7.4 percent, respectively—were the highest experienced during 1996 and were driven primarily by increases in administered prices for energy and communal services at the beginning of the year. In both months, approximately 5 percentage points of inflation are attributable to these price increases. The remainder can be attributed to seasonal effects, particularly on food prices, and the strong expansion of central bank credit to government and commercial banks in December 1995, although the impact of the latter was dampened by a substantial increase in the required reserve ratio, and other changes in required reserve policy, in January 1996. As in previous years, prices for services—especially, but not exclusively, communal services prices—rose more sharply than goods’ prices (Figure 8).

56. Inflation decelerated rapidly in March and through the second quarter, averaging just 1.5 percent per month throughout the period—in part due to seasonal factors observed in earlier years. But also underlying the strong inflation performance were the tight credit and monetary policies of the NBU and the relative strength of the exchange rate during the first half of 1996.

57. In contrast to previous years, underlying inflation did not pick up at any time during the remainder of 1996, with average monthly inflation running at 1.9 percent during the second half of the year⁶. This reflected continued tight financial policies from early summer—followed by an actual fall in both base and broad money during August due to uncertainty associated with the pending monetary reform—through November, and the continued stability of the exchange rate.

58. Inflation picked up somewhat in January 1997 with prices increasing by 2.2 percent as a result of the credit expansion at the end of 1996. The tight monetary policy conducted by the NBU contained monthly price increases to 1.2 percent in February and to less than 1 percent during March-June.

59. Although interest rates in Ukraine remained high in real terms at the end of 1996 and in 1997, most nominal interest rates moved down throughout the period; some fell rapidly during the first half of 1996 as inflation came down sharply (Table 28). In particular, from January through early July, the NBU reduced its statutory refinance rate in several steps from 154 percent per annum to 46 percent per annum⁷ (Figure 10). The decline of the average commercial bank lending rate, which was legally tied to the NBU refinance rate until September 1996, and average deposit rates at commercial banks mirrored the fall in the statutory refinance rate during this period.⁸ The fall in the commercial bank lending rate may have been of relatively little significance, however, because of the cautious lending policies of commercial banks. Indeed, with the yield on 3-month treasury bills—a key reference rate for the economy—remaining high, there was significant crowding out with commercial banks preferring to hold treasury bills rather than to extend loans. The volume of treasury bills sold during the year increased steadily, rising from an average of Hrv 121 million per month in the first quarter of 1996 to Hrv 472 million per month in the fourth quarter and to over Hrv 850 in the first quarter of 1997 (Figure 11, lower panel). This increase reflected in part the rapid rise in the participation of nonresident investors in the market, particularly in the second half of 1996 and in the first part of 1997, as the treasury-bill yields in real and dollar terms remained very attractive (Figure 11, upper panel).⁹

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UKRAINE Interest Rates and Prices, 1994-97 (June)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Source: Ukrainian authorities.1/ End of month observations.

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UKRAINE Treasury-Bill Market, 1995-1997 (March)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Sources: Ukrainian authorities.1/ On bills purchased at last auction in respective month if held to maturity.

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60. Responding to the containment of inflation at low levels in early 1997, the NBU on several occasions lowered the refinance rate, most recently in July 1997, when it declined to just under 20 percent.

A. Overview

61. The cash deficit was reduced sharply from its peak of 23.3 percent of GDP in 1992 to 4.9 percent of GDP by 1995 (Figure 12). This improvement mainly reflects the elimination of directed credits, and deep cuts in producer subsidies. The cash deficit was further reduced in 1996 to 3.2 percent of GDP, despite a fall in revenue of ½ percentage point of GDP. The deficit was achieved mainly through lower outlays for social protection, education, and health. The lower cash outlays for social spending reflect in part a sharp rise of arrears (Table 31). The origin of these arrears lies in a budget estimation of revenues that has tended to be optimistic which, in turn, has led to budgetary expenditures that have exceeded actual revenue collections. Line ministries have not curtailed expenditure commitments in the face of revenue shortfalls, so expenditures were often made without sufficient funds. The problem of expenditure control has been exacerbated by the lack of a functioning Treasury so that line ministries’ purchases of goods and services are carried out without treasury approval (Box 8).

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UKRAINE Fiscal Indicators, 1993-97 (June)

Citation: IMF Staff Country Reports 1997, 109; 10.5089/9781451838923.002.A001

Sources: Ukrainian authorities; and IMF staff estimates.1/ Income, VAT, excise and customs taxes.

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B. Fiscal Developments in 1996

62. The 1996 cash deficit of 3.2 percent of GDP understates the underlying deficit, as arrears for wages, pensions, and social benefits built up in the year amounted to an estimated Hrv 2.3 billion (2.9 percent of GDP). Arrears accumulated in 1995 amounted to about 1.2 percent of GDP, so that the underlying deficit in 1996 was the same as in 1995 at 6.1 percent of GDP.

63. Revenue in 1996—albeit falling by about ½ percentage point to 37.2 percent of GDP—remains high by the standard of FSU countries (Tables 32 and 33). Declines in revenue from the enterprise profit tax and the VAT were partly offset by an increase in the collection of payroll taxes, the personal income tax and other taxes. The largest decline was in the collection of enterprise profit tax which fell by about 2 percentage points of GDP, because of the contraction in real activity by about 10 percent. VAT collections in the first half of the year fell almost a full percentage point of GDP—mainly reflecting greater evasion. To address this problem, the State Tax Administration (STA) began in the fourth quarter to concentrate efforts on VAT collections from the largest taxpayers. As a result, one-third of all VAT collections were made in the final quarter of the year and collections for the year as a whole fell by ½ percentage point of GDP only. Personal income tax collections rose slightly as a percentage of GDP, as did payroll tax collections in response to the hike in July in the effective payroll tax rate for the Chernobyl Fund from 7 percent to 12 percent. But with the growth in nominal wages outstripping the growth of nominal GDP, the increase in revenues from payroll and income taxes should have been much greater. The difference is accounted for by the build-up in wage arrears, which are estimated at around five percent of GDP. Other tax revenue rose by around one percentage point of GDP, reflecting the strength of oil and gas tax receipts. These receipts mainly came in the fourth quarter when a massive netting operation, which cleared over Hrv 700 million (0.9 percent of GDP) in back taxes and gas-related expenditure arrears, was undertaken. Non tax revenue fell by 0.2 percent of GDP because of a shortfall in sales through the state reserve account, and a fall in collections of industry-specific charges (earmarked for sectoral programs).

64. Data for 1996 show that state budget expenditures fell 1.8 percentage points of GDP on a cash basis (Table 34). While spending rose for the pension fund (1.1 percent of GDP) and subsidies to the national economy (0.7 percent of GDP), this was more than offset by sharp reductions in the areas of consumer subsidies (2.7 percent of GDP), health and education (1.3 percent of GDP) and municipal housing, investment, and road maintenance (0.8 percent of GDP). In addition, defense outlays fell slightly by 0.3 percent of GDP. Despite the rise in cash outlays for the Pension Fund, there occurred an increase in arrears of the pension system of some Hrv 1.1 billion (1.3 percent of GDP), which tracks almost one-for-one the increase in arrears on contributions to the Pension Fund. Also, the central budget did not transfer sufficient funds to the pension fund to cover its obligations. The increase in subsidies to the national economy reflected a substantial deficit of the state reserve fund of 1.8 percent of GDP which subsidizes industries through the purchase of goods financed by the sales of its inventories. The reduction in consumer subsidies results from a higher share of the costs of housing services being passed on to consumers (see Section C), while take-up rates for the means-tested housing subsidy scheme did not grow significantly until the fourth quarter of the year. Regarding the health and education sectors, staff estimates suggest that the vast majority of the Hrv 0.8 billion buildup in wage arrears in 1996 (1.0 percent of GDP) occurred in the health and education sectors so that the underlying spending reduction in these areas was significantly less than the corresponding cash reduction. In the fourth quarter of 1996 (following a decree passed in August), the government implemented several measures to rationalize expenditure in the health and education areas, including the means-testing of several school programs (e.g., school lunches and after-school care), and the charging for certain non essential medical services (e.g., dental visits).

65. Expenditure data on an economic classification basis are not available. Nevertheless, data produced by the Ministry of Statistics regarding public sector wages in 1996 suggest a rather haphazard policy that favored the less productive areas of government. Nominal wages of health and education workers rose only 15 percent, while those of public administration workers rose 100 percent.

C. Fiscal developments in the first half of 1997

66. Passage of the 1997 budget by the Parliament was not secured until late-June 1997. In the first quarter of the year, fiscal policy was guided legally by the 1996 budget and the 1995 Law on Budgetary Procedures. However, in practice, the fiscal situation unraveled even further than in 1996. The cash deficit reached 5.7 percent of first quarter GDP compared with 3.7 percent of GDP in the first quarter of 1996. However, the loosened fiscal position in 1997 was premised on the initiation of the repayment of budgetary arrears accumulated in 1996. In fact, arrears were not only not repaid, but there was an additional accumulation of some Hrv 600 million bringing the underlying deficit in the first quarter of 1997 to 9.0 percent of GDP (compared with an underlying deficit in the first quarter of 1996 of 8.0 percent of GDP). The deterioration reflected a rise in lack of restraint in spending (which rose by almost 10 percent) while revenue was flat in nominal terms across the first quarters of 1996 and 1997, despite higher statutory rates for some excise taxes.

67. In response to the worsening situation, the President issued a decree on February 28, 1997 that required, beginning April 1, that the Ministry of Finance submit spending limits to all ministries and spending agencies and that the recipients show how these limits will be met. Under the decree, ministries and agencies are expected to give the highest priority to payments for wages and social benefits. This process is repeated each month and managers who miss their targets are liable for criminal prosecution. Since implementation of this decree, the fiscal situation improved dramatically. In the second quarter of 1997, the cash deficit fell to 4.6 percent of GDP while the accumulation of arrears slowed to little more than Hrv 100 million (0.5 percent of quarterly GDP). With the improved performance in the second quarter, the cash deficit in the first half of 1997 was 5.1 percent of GDP and the accumulation of Hrv 740 million in arrears resulted in an underlying deficit of less than 7 percent of GDP. In contrast, the cash deficit in the second quarter of 1996 was 4.5 percent of GDP but Hrv 1,200 million arrears were accumulated which brought the underlying deficit in the second quarter of 1996 to 11.4 percent of GDP; in the first half of 1996, the cash deficit was 4.2 percent of GDP with an underlying deficit of 9.8 percent of GDP.

68. Several fiscal reforms were implemented in the first half of 1997. New VAT and enterprise profit tax laws were passed that modernize these taxes, moving them to an accruals basis and eliminating many exemptions. In addition, payroll taxes were reduced from 52 percent to 49 percent. Almost 500 extrabudgetary funds and their associated fees and charges that funded them were abolished as part of a reform of the overall law on taxation. In addition, of the remaining five funds that were off-budget in 1996, three were brought on budget in 1997 (the road, environment, and social protection funds) with only two remaining off-budget (the social insurance and industrial development funds). The Pension Fund was moved explicitly off-budget in 1997 as a means to protect it from pressures to fund budgetary pension responsibilities (mainly for the military and security forces). Access of nonresidents to the treasury-bill market was improved and the tax treatment of treasury securities equalized across the secondary and primary markets. Also, work is on-going to improve the operations of the Treasury (with the financial support of the World Bank and technical assistance of the Fund). A new budget law has been prepared and the authorities are moving toward a new GFS-based classification system. Finally, a tax amnesty law was approved at end-March which allows a restructuring of tax arrears incurred between June 1994 and March 1997 over a period of 10 years and a write-off of tax arrears incurred before June 1994 and all fines and penalties on arrears incurred before March 1997.

D. Social Safety Net

69. There is a plethora of social assistance benefits. The biggest program is the pension system. Under the pay-as-you-go pension system, the payroll tax rate of 33.56 percent was reduced slightly in 1997 to 33 percent with all but one point paid by employers. It is applied to the earnings of 22 million workers and finances 14 million pensioners (out of a total population of 50 million).¹¹ High inflation in the early part of the transition period sharply eroded the real value of individual pensions. Pensions in general vary significantly between non privileged and privileged pensioners, implying an extreme inequity of the system. At present, most non privileged pensioners receive the minimum pension of Hrv 50 a month (the only exceptions are coal miners who receive monthly pensions of Hrv 60 and some war invalids who receive monthly pensions of Hrv 68), compared with a poverty level that is conservatively estimated at Hrv 70 a month. Until this year, the system’s demographics and budgetary situation required that the minimum pension rise no faster than inflation and that the maximum pension (presently set at four times the minimum pension) be capped at below statutory levels. The compression of the pension scale is such that benefits are largely unrelated to years of service and contribution. Moreover, in 1997 nominal pensions have been frozen owing to budgetary concerns. Special privileged pension regimes afford the military, civil servants, judiciary workers, and parliamentarians much higher benefits. For example, on average, military pensions are about Hrv 200 a month, with those for the judiciary and parliamentarians even higher. The pension gap between non privileged and privileged is likely to grow in 1997 because the pensions of the privileged groups are indexed to hikes in current salaries.

70. Payroll taxes finance several special funds in addition to the Pension Fund (Tables 35 and 36). The contribution rate to the Social Insurance Fund, which is administered by trade unions, was lowered in 1997 from 4.44 percent to 4 percent, all of which is paid by the employer. This fund finances mainly health clinics attached to enterprises, sick leave, but also certain benefit payments (e.g., maternity leave and child birth allowances). A 2 percent payroll tax (split 1.5 percent paid by employers and 0.5 percent paid by employees starting in 1997) finances the Employment Fund. Total outlays of this fund have been relatively small in light of the “low” official unemployment rate; however, there is significant waste in what is spent as the single largest expenditure item primarily reflects personnel and administrative costs. Outlays are low mostly because labor market laws make it costly for enterprises to restructure their workforce. Workers who are laid off must be given three months’ notice, effectively at full pay, paid by enterprises. Thereafter, workers are eligible for unemployment insurance paid by the employment fund for up to 75 percent of their last wage for six months (up to the average wage in the province), and an additional six months can be granted at 50 percent. Finally, the 12 percent tax on payrolls to finance a special fund for Chernobyl victims was lowered in 1997 to 10 percent. There are no data available detailing the Fund’s expenditure, but indications are that resources are often poorly targeted and not always used for the intended purposes. An internal government review of its operations was recently concluded with a view toward eliminating extraneous programs and a further lowering of tax rates in 1998. Also, Chernobyl victims receive special exemptions to several taxes including VAT and personal income tax.

71. There are multiple and complex family benefits. During 1996, most benefits began to be means-tested (the only exception being funerals paid by the Pension Fund and maternity and child-birth allowances paid by the Social Insurance Fund). Also, eligibility requirements based on the working status of the mother and size of family were eliminated in 1997. No single benefit amounts to more than $15 a month. They include, in addition to those previously mentioned, child benefits for children under three years, monthly benefits for disabled children, additional benefits for families with three or more children, allowances for children under 17 living in households with income below the poverty line, grants for single mothers, and special benefits for children whose fathers served in the armed forces.

72. As late as October 1994, all households—regardless of size or household income—were required to pay just 5 percent of a normative cost of housing services (for heating, water, sewerage, and rent). Since then, the norm-based cost-recovery ratio has been raised gradually to 20 percent at end-1994, to 45 percent in September 1995, to 60 percent in January 1996, and to 80 percent in August, 1996. To ensure the necessary social support for this measure, a targeted housing program was introduced in May 1995, whereby payments by households are capped at 15 percent of their income, regardless of the required cost-recovery ratio and of the form of ownership of the home. Originally the subsidy covered only the services noted above, but was later widened to cover the costs of coal, gas, and electricity. At the beginning, the program was fraught with procedural problems. In order to streamline the administration of the system and improve targeting, in early 1996 the space eligible for a targeted subsidy (communal services charges are based on the apartment size) was lowered so as to be closer to the average per person, and pensioners no longer needed to reapply for the subsidy every six months (unlike other participants) In fact, the major beneficiaries of the program thus far have been single pensioners living alone. Prior to the hike to 80 percent in August, there were 3 million households covered under the program (out of a total of 17 million households). By end-1996, the number of households participating in the program rose to 4.5 million. The move to higher cost-recovery has had a beneficial impact on enterprises. Approximately one-quarter of houses are owned by enterprises that were required to pay the difference between the true costs of providing housing-related services and the share paid by households in accordance with the required cost-recovery ratio. As cost-recovery ratios have increased, the margin paid by enterprises has fallen, since the housing subsidy is fully paid from the budget for all households (regardless of ownership).

A. Overview

73. Ukraine’s current account deficit fell from 4.4 percent of GDP in 1995 to 2.7 percent in 1996. Exports grew sharply, led by trade with nontraditional trading partners which increased by 17 percent. Despite this, there was a deterioration in the trade balance; however, a significant part of the increase of imports reflected a higher price for imported gas, and it was more than offset by higher receipts for gas transit fees in the services account.

74. On the capital account, increasing confidence led to a sharp turnaround in estimated short-term capital flows in 1996. Combined with continued bilateral and multilateral disbursements—and a doubling of foreign direct investment (albeit from a very low base)—this resulted in a significant strengthening of the overall balance in 1996. With exceptional assistance in the form of Fund purchases, and bilateral assistance (but no reschedulings), gross reserves increased by $860 million during the course of the year. The external debt burden remained manageable.

75. In the first quarter of 1997, the current account deficit further declined (relative to the first quarter of 1996) notwithstanding a drop in both exports to and imports from traditional trading partners. Exports to nontraditional partners continued to grow rapidly, by over 20 percent relative to the first quarter of 1996. The capital account position further improved, mostly due to a surge in short-term capital associated with purchases in the treasury-bills market.

B. Trade and Current Account

C. Capital Account

D. Trade Policies

91. In late 1994 and early 1995, the Government of Ukraine undertook a substantial liberalization of the external trade regime, with the removal of export quotas (with a few important exceptions), unification of the exchange market, and abolition of state export contracts. In 1996, however, this trend toward liberalization was reversed somewhat, with (temporary) restrictions on exports, and pressures for higher import tariffs. Ukraine has observer status at the World Trade Organization (WTO); the Second Working Group on Ukraine’s ascension to the WTO met in July 1996. Ukraine does not charge VAT or excise duties on its exports, but charges VAT and excise duties (if applicable) on imports. This use of the destination principle has resulted in a trade dispute with Russia (see Box 9).