The main outcomes of the forecast are as follows:
· The consumer price index will amount to 12.1% in 2001 (December to December), and the wholesale price index – to 12.9%. We forecast the inflationary processes to slow down in 2002, to 9.2% (December to December) and 11.9%, respectively. In our calculations, we have used an assumption of money base growth by 19.2% in 2001 and by 17.8% in 2002. According to our assumptions, hryvnia will depreciate to UAH 5.7/USD by the end of 2001, and to UAH 6.0/USD by the end of 2002.
· We forecast the nominal GDP to reach the level of UAH 196.0 billion in 2001 and UAH 254.3 billion in 2002 (we assume its real growth of 3.4% and 3.6% this year and next year, respectively).
· Our forecast of revenues from personal income tax, corporate income tax and import duty exceeds the respective indicators planned in the approved Budget 2001. At the same time, our estimate of privatization revenues is below the amount planned in the Budget.
Analysis of Current Situation
Gross Domestic Product
We continue to observe a number of stable positive trends in our economy. Thus, the rates of Gross Domestic Product growth in November amounted to 8.0% to November 1999, which resulted in cumulative growth of 5.4% from the beginning of the year.
Table 1. Dynamics of change in real and nominal GDP
The growth rates of gross value added amounted to 12.4% in industry and to 5.1% in trade and public catering (cumulative from the beginning of the year). The growth rates of gross value added in construction remained rather low, making up a mere 1% in November. The growth rates in agriculture remained at 3.7% in November (cumulative from the beginning of the year).
The output in such industrial sectors as light industry (39.6% growth from the beginning of the year), wood-processing industry (38.7%), and food industry (25%), as well as the increase in output in ferrous metallurgy (19.1% from the beginning of the year) remained stable at a high level and above the average level throughout the industry.
The declines of output in fuel industry (6.4% decline from the beginning of the year) and in construction materials industry (3.1%) have further continued.
Table 2. Change in gross value added by sectors of the economy
Monetary Policy and Exchange Rate
The money base grown significantly during entire year 2000. Its growth was particularly significant in the last month of the year (7.2% compared to the previous month), and has made up 39.9% for the entire year. The rapid money base growth in November-December can be explained by large interventions of the National Bank at the interbank currency market and by traditional end-of-the-year increase in the amounts of payments for the export contracts. During this period, the National Bank has been seeking for the instruments for sterilization of money supply. Since the T-bills, even being restructured, did not seem attractive to commercial banks due to their long period of maturity and undermined reputation in the past, the National Bank was engaged in selling the interest T-bills. The auctions started in mid-November. However, due to the lack of transactions related to sales of government securities between the NBU and the commercial banks for a long period of time, as well as due to lack of confidence to these securities, the first of these auctions have failed. Although it was possible to attract around UAH 560 million in December, the number of tender participants was not impressive. The auctions for placement of another instrument, which the NBU used to apply actively in the past, i.e., of deposit certificates, have not been successful, either. It was for these reasons that the NBU has raised its reserve requirements for commercial banks, in order to reduce the supply of money in the economy. Although the rate of mandatory reserve requirements remained unchanged, the base of reserves was expanded. Thus, both long-term and short-term credits granted by central and local administrations, together with certain components of the items “Funds of budgets of Ukraine” and “Term funds of economic entities”, as well as a few other items were included into the category of funds subject to reserve requirements Resolution of the Board of the National Bank of Ukraine #456 of November 20, 2000 “On Amending the Resolution on Rates of Mandatory Reserves of Funds by the Banking System of Ukraine of July 9, 1999”..
During November-December, the Ministry of Finance of Ukraine has actively participated in the placement of T-bills at the primary market. As a result of such activity, the liabilities of the Ministry of Finance have increased by approximately UAH 19 million during this period. Given the earlier experience, when the Ministry of Finance was not repaying its liabilities related to internal debt servicing, it appears rather risky to continue placing the T-bills at current rates. Moreover, attempts to reduce the share of debts that occurred due to repayment of international commercial credits granted against the Government guarantees, resulted in the fact that the Government was only able to receive USD 370 thousand. This followed the reduction of cost of these debts by 50%, and the Government’s initial plan was to receive USD 10 million.
Table 3. Dynamics of monetary aggregates
Similarly to the previous month, the situation at the currency market can be described as tranquil. A significant excess of supply over demand, which was caused by the improvement of overall economic condition in Ukraine (the GDP growth, especially in industry, positive balance of trade, reduction of scope of barter transactions and so forth have promoted the increase in demand for hryvnia), as well as massive NBU interventions have allowed Ukraine to service its foreign debt under circumstances of lack of funding from international organizations (renewal of financing took place only in late December). This has also lead to the increase of gross currency reserves by USD 450 million During the period of mid-November through December 2000. (as of January 1, 2001, they have reached the level of USD 1.63 billion – an all-time mark for the past two years), as well as to keeping the hryvnia from rapid apreciation, which would not be profitable for Ukrainian exporters. Such significant and regular interventions of the NBU at the interbank currency market were helpful in building confidence in the consistency of the National Bank’s exchange rate policy among the currency market participants. However, they also suggest certain contingency of the “floating” exchange rate regime in Ukraine.
An important event was a decision of the International Monetary Fund to resume its Extended Funding Facility (EFF) loan program starting December 19, 2000 and to extend its duration to September 2002. This can serve as a positive signal for other potential investors and would allow to continue the negotiations with the member countries of the Paris Club regarding the restructuring of debts.
The consumer price index has increased by 0.4% and 1.6% in November and December, respectively, making up 25.8% as of end of the year (December to December). Such increase in CPI from the beginning of the year resulted from the money base growth of 39.9% (annual change), especially high in December 2000. Among the CPI components the prices for food products, energy, and housing and communal services have increased significantly.
The end-year increase of price index for food products, which has reached 28.4%, was the main factor behind the overall CPI increase. Although the food products index has amounted to only 0.3% in November (change to the previous month), it has gone up to 2.3% in December. This can be explained primarily by the seasonal factors – the markets were filled with the new crops (the prices for potatoes and for grain processing products have decreased), the processing of certain important products (for example, raw sugar) has started, and there was a traditional price increase for food products on the eve of Christmas and New Year’s holidays. The products that registered the highest price increase during this period were vegetables and fruits (19.2%), and milk and milk products (11.9%). At the same time, it became clear in November that this year’s crops of sugar beets would not be sufficient to fill the market with sugar: the sugar processing plants have produced approximately 1.5 million tons of sugar, while the demand amounted to 2 million tons. Since the Ukrainian legislation provides for a 260 million tons quota for privileged imports of the raw sugar, the prices at this market have continued to increase (they increased by 58.8% from the beginning of the year). Filling of the market by the new crops has had a positive influence on the dynamics of prices for such products as bread and bakery (the prices have decreased by 0.3% for two months), cereals and legumes (decrease of 8.3%), and cooking oil (approximately 1%).
Table 4. Dynamics of prices and exchange rate
The increase in prices for nonfood products was rather slow (0.8% for two months, and 8.9% from the beginning of the year). This can be explained, firstly, by the restraining effect of the stable exchange rate and by the low demand for this category of products that results from generally low income level of the households. The gradual decrease in fuel prices should also be noted. The situation at this market has stabilized at the end of September, following the world price increase for oil in August – early September. These prices have continued to decrease in November-December due to the seasonal reduction in the demand for high-octane gasolines and diesel fuel during the winter and due to the stable performance of oil processing plants.
Although the tariffs for housing and communal services (i.e., for heat energy, central heating and hot water supply) have been increased starting from November 1, 2000, the paid services index has only increased by 0.8% in November-December (and by 31.2% from the beginning of the year). However, it is still premature to say that the households are paying for the cost of communal services in full (only 79.0% of their total cost has been paid during 2000).
The rate of increase in producer prices has accelerated during the past two months. During this period, the index has increased by 3.1%, while the increase from the beginning of the year has amounted to 20.6%. The highest rates of increase have been registered in heat and power engineering industry (by 7.9%), chemical and oil industry (by 5.6%), fuel industry (by 4.2%), and machine building (by 4.3%). At the same time, the decrease in prices in grains and cereals industry should be noted (by 3.9%). The major factor that influenced the increase in producer prices during this period was the fact that the “Energoatom” company has raised its tariffs for electricity: the share of this company makes up 45.5% of the total quantity of electricity produced in Ukraine.
Attempts of the Government to carry out a stricter and more fundamental fiscal policy can be broadly defined as failures. The lack of clear responsibility of enterprises and organizations within the state sector regarding their payments for resources consumed, on the one hand, and the expectations that the ban on mutual settlements will be removed – on the other hand, have served as incentives for accumulating the mutual arrears. The need for current realization of the budget and for reduction of arrears has forced the Government to resume the practice of mutual settlements for this year’s debts that were accrued as of December 1 Resolution of the Cabinet of Ministers #1693 of November 14, 2000 “On Amending the Resolution the Cabinet of Ministers of Ukraine of June 7, 2000”.. In addition, the requirement regarding the obligation to pay for current consumption of resources in cash was removed (earlier, this used to be a necessary condition for engaging in mutual settlements), while the mutual settlements schemes were applied not only to the enterprises, but also to the individuals.
Therefore, the resumption of mutual settlements with the budget and the expansion of the circle of entities that can apply such settlements is an incentive for accumulation of arrears and for reducing the confidence in the reform policy pronounced by the Government.
Despite numerous bans from the Government, the cases of repayment of foreign credits – received earlier against government guarantees - at the expense of budgetary funds have become more frequent in the past months Resolution of the Cabinet of Ministers #1708 of November 16, 2000 “On Measures Regarding Repayment and Servicing of Foreign Credits Attracted by the Government or Against Government Guarantees”.
Consolidated budget revenues have amounted to UAH 42.6 billion (27.6% of GDP) for eleven months of the year 2000, which is 100.6% of the annual plan. The major determinants of budget revenue performance at such a level are excess over the planned inflation rates and underestimation of the planned revenues for local budgets. Thus, the local budgets revenues have been realized in 128% of the annual plan in January-November, while the State Budget revenues have been performed by 92.5% for the same period.
The increase in consolidated budget revenues by 3.5 percentage points (shown as a percentage of GDP), as compared to the respective period of 1999, is a result of incorporating additional revenue items into the Budget 2000. The increase in revenues when these items are not considered makes up only 0.1% of GDP.
Table 5. Consolidated budget revenues in January-November, 1999 and 2000
Chart 1. Structure of consolidated budget revenues in 1998-2000
Source: State Tax Administration of Ukraine
Despite the fact that there was a clearing of mutual debts of this year as of December 1, the trend towards the increase in arrears to budgets of all levels is continuing.
Chart 2. Non-cash revenues under articles 60 and 71 of the Law “On 2000 State Budget of Ukraine”
Source: State Treasury of Ukraine
Thus, the increase in arrears can serve as a proof that the arrears for main taxes to the budget are accumulated in advance, which can be a source for engagement in mutual settlements in the future.
Consolidated budget expenditures have amounted to UAH 40.3 billion (26.2% of GDP) in January-November, which is 95.3% of the annual plan. The real growth in expenditures (to the base of the pervious year) has made up 0.1% of GDP, as compared to January-November 1999.
Table 6. Consolidated budget revenues in 1999 and 2000
The share of expenditures for national economy in the structure of State Budget expenditures has increased significantly. However, such increase is of a one-time nature and does not show a permanent trend.
The decrease in revenues for the maintenance of public administration, which kept increasing during the year, was to some extent influenced by the Presidential Decree, showing the initial results as early as in November. Thus, the share of the expenditures in the total State Budget expenditures has decreased from 6% in October to 0.2% in November. Another positive development is an increase in share of socially targeted expenditures, both on the national and on the local levels Decree of the President of Ukraine #1242/2000 of November 16, 2000 “On Additional Measures Related to Strengthening of Fighting the Corruption and Other Illegal Activities in Social and Economic Sphere, and to Providing for Economical Spending of Public Funds”. At the same, time, while for the eleven months of the year the local budgets’ expenditure items “Healthcare” and “Social Protection and Social Security” have been financed by 94.8% of 84.5% of the annual plan, respectively, the remaining expenditure items have been financed at the level much in excess of 100%.
Chart 3. Structure of expenditures of the State Budget and of local budgets in August-November 2000
Source: State Treasury of Ukraine
According to the annual plan, the consolidated budget expenditures for a total amount of approximately UAH 2.1 billion still remain unfunded.
The State Budget surplus in January-November 2000 has amounted to UAH 1.7 billion, according to the methodology of the Ministry of Finance According to the IMF methodology, the State Budget surplus has amounted to UAH 98 million for the respective period.. Similarly to the previous months, the source of this surplus has been the cash gap in financing of budget expenditures, as well as the increase in Government deposits.
Table 7. Net financing of the State Budget deficit in 2000
Source: State Treasury of Ukraine
The following assumptions were used in our calculations of inflation, nominal GDP, and budget revenues for 2001-2002:
· The real GDP growth will make up 3.4% and 3.6% in 2001 and 2002, respectively;
· The money base growth will amount to 19.2% in 2001, and 17.8% by the end of 2002;
· The hryvnia will depreciate to UAH 5.7/USD by the end of 2001, and to UAH 6.0/USD by the end of December 2002.
Gross Domestic Product
Assumptions on real GDP growth in the years 2000, 2001, and 2002 are based on calculations for CASE’s quarterly economic model. For the year 2001, we assume 25.2% growth of money base, privatization revenues of 4.20 bln. UAH, less than 1% fall in the government consumption and the exchange rate at 6.0 UAH/USD at the end of 2002 We predict a moderate devaluation of the currency, since there should be a net inflow of capital, both long and short term..
Higher than previously forecasted GDP growth during the first three quarters of the year 2000 again made us to increase our forecasts for the GDP growth for 2000 and 2001. We predict the annual real GDP growth to be 5.6% this year and 3.4% in 2001. According to our assumptions, the GDP growth will continue in 2002, provided no significant changes in the course of economic policy and no external shocks. The net exports will be responsible for 2000’s economic expansion. This in turn will help to considerably increase investments, both this year, and the next. However, we predict that as the favourable conditions on foreign markets will worsen in 2001, the effect of large and positive net exports will no longer be in place. Domestic demand will be the main factor promoting growth in 2001 and 2002.
Table 8. Assumptions on dynamics of real GDP for 2000-2002
The public consumption will decrease both in 2000 and in 2001, which is related to the limited scope of budgetary resources. We assume that the fall in the government consumption will stop in 20002. Here, it should be mentioned that all assumptions and calculations are based on the existing tax system. Even if the new Tax Code is adopted, the budget revenues will not be immediately reduced, and there will not be any mayor consequences for the projected growth rates of GDP.
As we have already mentioned on repeated occasions, the positive foreign economic conditions at the export markets for Ukrainian metals have caused significant inflows of currency into the domestic market. The positive part of this fact has to a large extent manifested itself in the stabilization of hryvnia’s exchange rate. Just as we have forecasted, there was no major devaluation in 2000. On the contrary, an appreciation was observed from time to time.
We expect that the situation at the currency market will remain under control from the National Bank of Ukraine during the next two years. The major factors to determine the hryvnia exchange rate will be the balance of trade, the capital inflows (a major share of this capital will be forwarded to privatization), the condition of Ukraine’s cooperation with international financial organizations (IMF, WB, EBRD and others), and the upcoming parliamentary elections of 2002.
It became clear during 2000 that the Ukrainian economy at the present stage is greatly dependent on the external demand for Ukrainian goods (For a detailed discussion on this issue see quarterly publication of the CASE center – “Ukrainian economy: trends, estimates, forecasts”, vol. #3, 2000; this publication can be found at our web-site www.case.org.ua). A significant share of the Ukrainian exports includes exports to the United States and the EU countries, the economies of which has been growing at very high rates during 2000. Such growth has undoubtedly increased the internal consumption, and hence, the demand for Ukrainian exports. According to expectations of the international experts regarding the development of the global economy in 2001, the global economic growth will slow down to 2.7%, compared to 4.1% expected in 2000 Source: Pczynski, W., Rawdanowicz, L., Sasin, M., Zawalinska, K. (2001). Global Economy. CASE: Warsaw. January. To a large extent this is related to slowing down of the growth rates in the United States. According to a preliminary estimate, the U.S. GDP grew by 5.1% in 2000. The forecast for the growth of the U.S. economy in 2001 is 2.6%. Contrary to the rapid slow-down of the U.S. economy growth, the decline of GDP growth rates in the European Union countries will be slower. According to the preliminary estimates, the growth made up 3.3% in 2000. In 2001, the growth in the EU countries will make up 2.8%. We also should note that during 2001 we expect further strengthening of the euro rate to the U.S. dollar. We should additionally mention that according to the forecasts of international experts, the U.S. imports will increase only by 7.0% in 2001 (13.9% in 2000), and the EU countries imports will increase by 8.4% in 2001 (11.1% in 2000). However, it is expected that imports to Russia will continue to increase; the rates of increase will make up 20% in 2001 (17% in 2000). To sum up, we expect that the rate of increase of Ukrainian exports will slow down. The structure of exports will also change: thus, the share of exports to the EU countries and to Russia will increase. At the same time, the share of exports to the United States will decrease. Along with the decrease of demand at the metal markets of the U.S. and Canada, the competition between sellers will tighten. We expect that the number of antidumping cases against Ukraine will increase, which will have a negative impact on volumes of sales of Ukrainian metals at these markets. Let us remind that the share of metals in the overall Ukrainian exports make up 45% (as of end of November).
According to the estimates of Yale University, there will be a minor acceleration of the growth rates for 2002. The global GDP will increase by 3.5%. Similarly to the year 2001, the economic growth rates in the EU countries will exceed those in the United States, making up 3.4% and 3.0%, respectively. The global imports will increase by 7.0%.
Therefore, the rates of growth of Ukrainian exports will reduce along with the slow-down in the rates of growth of global demand for imports. Worsening of the balance of trade as a result of effect of the above factors could be compensated by the inflow of capital into the Ukrainian market. This would be possible only under conditions of successful privatization of state-owned facilities and of stable economic environment.
Table 9. Development of the global economy in 2000-2002
Therefore, according to the calculations done within the CASE’s foreign trade model of the Ukrainian economy, the net balance of trade for goods will make up USD 400-450 million in 2001, while the balance of services will be no higher than USD 1.1 billion. That is why the purchases of excess currency by the National Bank of Ukraine will be decreasing at slow rates. The NBU will make an attempt to extend the scope of the deposit certificates market and to gradually increase the activity at the T-bills market. Altogether, these factors will result in decrease in the rates of money base growth in 2001, down to 19.2% (December to December). The hryvnia’s exchange rate will remain relatively stable, and there will be an insignificant devaluation down to UAH 5.7/USD by the end of 2001. During 2002, we expect further decrease in the rates of money base growth, the annual increase making up 17.8%. The exchange rate of hryvnia to dollar will continue to depreciate at slow rates (5.3%), and will reach UAH 6.0/USD as of end of 2002.
Table 10. Assumptions on change of money base and exchange rate in 2001-2002
Forecast of Inflation, Nominal GDP and Budget Revenues Until the End of 2002
According to our assumptions on money base growth, exchange rate change, as well as based on the calculations done by the CASE team within its monthly inflation model, we forecast that the annual increase in consumer prices in 2001 will make up 15.0%; the respective increase in wholesale prices will make up 15.1%. In 2002, the average annual increase of CPI and WPI will make up 11.0% and 12.6%, respectively. We believe that this forecast is optimistic, and it is valid only under the condition that the National Bank of Ukraine will carry out a well-balanced monetary policy.
Table 11. Inflation forecast by components, %
During the next years, there will be a significant deceleration of the rates of increase in both consumer and producer prices. Stable hryvnia and moderate rates of money base growth will promote such deceleration. A major slow down in the rates of price increase for food products will be restraining the overall CPI increase.
In 2001, the prices for food products will increase on average by 17.6% to the previous year, while the December-to-December increase will make up 13.2%. The reduction in our forecast of inflation rates for food products is caused by the expected decrease of the effect of growing monetary indicators on the inflationary processes. We expect that the household incomes will continue to increase, and the share of consumed food products in the consumer basket will decrease. On the other hand, the decrease in purchases of dollars by the National Bank will reduce the emission volumes. In addition, the demand for hryvnia by the real sector of the economy will continue to increase. During 2002, the prices for food products will increase by 11.3%, while the December-to-December increase will make up 9.2%.
The increase in prices for nonfood products will be further determined by the exchange rate of hryvnia to the U.S. dollar and to the euro. Despite the fact that the share of imports in the structure of consumption of nonfood products has been gradually decreasing, this share still remains rather significant. We expect that the existing trend will continue in 2001-2002. Based on the assumptions made, the increase in prices for this category of products will make up 6.0% in 2001 (the increase December to December will be 6.6%). During 2002, the rates of inflation of nonfood products will continue to decrease; however, this decrease will be slower than in 2000. The average annual increase will make up 6.3% (the increase December to December will not exceed 5.5%).
Following the rapid increase in prices for paid services during 2000, when the 100% compensation for the cost of communal services was introduced and the tariffs for communications services were significantly increased, we expect the inflation rates to slow down during the first half of 2001. As earlier, the bulk of prices within this category will remain under the government control. This is why during the first half of 2001, the increase in prices for paid services will reach 9%, followed by stabilizing at its usual level of 12-13%. The average annual price increase in 2001 will not exceed 13.9% (13.6% December to December). For 2002, our forecast is 13.0% annual increase (11.5% December to December).
Given our forecast of inflation of consumer and wholesale prices and of GDP deflator, and based on our assumptions regarding the real GDP growth by 3.4% in 2001 and 3.6% in 2002, we forecast that the nominal GDP will reach the level of UAH 196.0 billion in 2001 and UAH 254.3 billion in 2002.
Table 12. Forecast of nominal GDP for 2001 and 2002
We forecast that the tax revenues in 2001 will be higher than it was stated in the Budget Law. The main reason for this will be further increase of real wages and repayment of arrears. The revenues from personal income tax will increase up to 3.9% of GDP. The increase in consumption will have an impact on revenues from indirect taxes (VAT and excise), which, according to our forecasts, will amount to 5.9% and 4.1%, respectively – indicators that almost coincide with those planned in the budget. Given the forecasted increase in imports to Ukraine, we improve our forecast on import duty up to 0.8% of GDP. The fact that Russia will resume its supplies of gas creates grounds for a forecast of significant increase in revenues from gas transit.
A major share of revenues in Budget 2001 is expected to come from the privatization of “Ukrtelecom”, “Kryvorizhstal”, “Azot”, “Sumyhimprom” and of around twenty oblenergos (oblast energy companies). However, we do not have any optimistic expectations regarding the performance of privatization revenues. Constant problems faced by the State Property Fund of Ukraine cause our doubts in the fact that the planned revenues will be received. This is why we forecast that the revenues will only amount to UAH 4.2 billion (although this estimate is also rather optimistic).
Chart 4. Consolidated budget revenues in 1999-2000 and a forecast for 2001-2002
▪ A significant slow down in the global economic growth rates, particularly in the EU countries and in the United States, will result in the drop in global imports and in a sharp decline in Ukrainian exports.
▪ In case of ineffective privatization, the inflows of foreign capital will reduce drastically or even cease.
▪ The two factors can further cause BOP problems and hence, the excess demand for hard currency which may lead to huge monetary interventions of the NBU.
▪ On the other hand, expansionary monetary policy - if continued - may, in turn, preserve high inflation rates and a strong devaluationary pressure on hryvnia may occur as early as in the second half of 2001.
▪ Despite the fact that the 2001 Budget Law includes for revenues from privatization of Ukrtelecom, one should not expect that this matter will be resolved quickly. This, in turn, could result in the occurrence of budget deficit and, at the same time, in lowering government spending, which can have negative influence on the growth of domestic demand.
Appendix 1. Forecast of inflation and nominal GDP for 2001 and 2002
Appendix 2. Forecast of consumer price inflation by commodity group for 2001 and 2002
Меморандум з питань прогнозу основних макроекономічних показників січень2001 року
Група макроекономічного моделювання /CASE 17
Appendix 3. Consolidated budget revenues in 1999-2001 and a forecast for 2000 and 2001