1. This supplement provides information on developments since the staff report was issued. The update does not affect the thrust of the staff appraisal.

2. Parliamentary elections were held on March 31. The pro-government coalition of parties led by the head of the presidential administration was third in party-list voting, but emerged with the largest plurality of seats in the new parliament due to strong results in the single-member constituencies. The six parties or blocs voted into parliament are currently discussing the make-up of a majority coalition, prospects for which remain uncertain. It is not clear yet whether there will be consequential changes in the government or in economic policy.

3. Preliminary data for the first part of 2002 indicate that macroeconomic performance has continued to be encouraging. Real GDP increased by about 4 percent in the first quarter compared to the same period last year, signaling some slowing of GDP growth in 2002 relative to 2001, in line with projections. Inflation has continued to decline, with the 12-month inflation rate falling to 2.2 percent in March from 6.1 percent in December 2001, and the consumer price index (CPI) actually fell in February and March by a cumulative 2 percent. This drop in the CPI was driven by reductions in prices for staple foods, including bread, milk, and eggs, following a significant boost in agriculture output in recent months. Other components of the CPI have largely remained unchanged. In addition, there are some indications that administrative pressures may have contributed to the fall in inflation, including a drop in the price of some staples, decreases in gas, water, and heating tariffs in several regions, and the absence of a customary increase in communal tariffs at the beginning of the year. In this context, and in the presence of continued inflationary pressures outlined in the staff report, the staff considers that it would be premature to lower the inflation target of 9.8 percent for the year 2002.

4. Developments in the fiscal area are mixed. Although preliminary data through end-March suggest that a small seasonal surplus was achieved (as was the case last year), information on revenue performance indicates that recent administrative measures to boost tax collections have not yet had a significant impact, with the result that central government nonearmarked revenue fell short of the official target by 0.3 percent of GDP. There are also signs that tax compliance may have deteriorated as the stock of tax arrears increased by0.7 percent of GDP in the first two months of 2002. The authorities have reported that VAT refund arrears were reduced by Hrv 113 million through end-February. Continued delays in the privatization area may render it more difficult to achieve the revised privatization target for this year.

5. The authorities appear to have maintained prudent spending policies in the first quarter. In addition, to minimize the build-up of arrears, the government introduced a reporting and financing scheme for housing and communal services privileges. However, the government raised pensions by 10-12 percent in early April, which comes on top of earlier increases in pensions (10 percent) and wages of civil servants working in health, social protection, education and sciences (15 percent), effective from January 1, 2002. As a result, the pension fund balance is projected to turn into a deficit of 0.4 percent of GDP (from a projected surplus of 0.2 percent of GDP), heightening the need for prompt corrective action to secure the consolidated deficit target of 1.8 percent of GDP.

6. The exchange rate remains at about Hrv 5.3 per U.S. dollar, and Ukraine’s gross international reserves stand at $3 billion, slightly below their level at end-December, but higher than projected. Monetary aggregates continued to rise in the first quarter, although not at the rapid pace of 2001. In light of the low inflation outturn, in early April the authorities further lowered the discount rate to 10 percent, and reduced the reserve requirements ratios, with the weighted average ratio falling from 11.5 percent to 10.8 percent. Given the rapid monetary expansion in 2001, and the further wage and pension increases, the authorities will need to be especially vigilant against any upturn in inflation.

7. In the structural area, the cash collection rate for electricity increased to 68 percent in the first quarter of 2002, from 65 percent in 2001. For gas, the cash collection rate fell to 71 percent in the first quarter from an annual rate of 87 in 2001, partly due to seasonal factors. The authorities have not yet adopted the medium-term strategy for the Savings Bank, while preparations for the third-stage audit of Naftogaz have not begun.