This memorandum presents an analysis of dynamics of GDP, monetary policy, exchange rate, and inflation in July 2000, as well as analysis of budget revenues and expenditures in June of the current year. Based on this analysis and on assumptions on further developments in macroeconomic situation, we produced a forecast of consumer and wholesale prices inflation, nominal GDP, and budget revenues till the end of 2001.
Main outcomes of the forecast are as follows:
· Inflation of consumer prices will amount to 28.7% in 2000 (December to December), while inflation of wholesale prices will amount to 18.4%. In 2001, we forecast that inflationary processes will slow down to 15.4% and 14.4%, respectively. In our calculations, we assumed that the money base will increase by 35% in 2000 and 25% in 2001. According to our assumptions, hryvnia will devaluate to UAH 5.8/USD by the end of 2000, and to UAH 6.7/USD by the end of 2001.
· We forecast the nominal GDP at UAH 165.7 billion in 2000 and at UAH 193.9 billion in 2001 (we assume the growth in real GDP by 2.7% and 1.6%, respectively).
· Revenues from profit and income taxes will somewhat exceed the indicators approved in the Budget 2000 Law, while revenues from indirect taxes (VAT and excise) will be lower than the planned amounts as a result of complete ban on mutual settlements for these two taxes. The same trend will be observed in 2001. There is a threat that actual revenues from privatization will not meet the planned targets.
Gross Domestic Product
Despite our expectations, there was an acceleration in the Gross Domestic Product growth rates in July (4.7% to July 1999), which resulted in a cumulative growth of 5% from the beginning of the year. As there was a moderate GDP growth of 3.4% in June of this year, it was expected that the gross value added will continue to decline as a result of discontinuation of the effect of low statistical base of the previous year. However, the increase in GDP growth rates which is observed along with high statistical base provides another proof that this year’s GDP growth has not only statistical roots.
Table 1. Real and nominal GDP
A stable growth of industrial output, which has increased to 16.1% in July and has resulted in growth of industrial value added by 11.9% from the beginning of the year, is the main reason for overall growth of value added throughout the economy. Although the industry contributes a major part to the overall growth, such sectors as construction, trade, transportation and communications are also among those which increase the value added – albeit, not so rapidly as industry. The gradual increase in real cash incomes of the population has a positive impact on growth of value added in trade and public catering; moreover, we can assert that actual growth in this sector is significantly higher as there is a major shadow activity undergoing there.
At the same time, despite the seasonal factors, the agricultural sector was unable to maintain the growth even at very low rates of the previous month, which resulted in cumulative decline of value added in this sector by 3.3% from the beginning of the year. Poor weather conditions during spring and early summer were one of the key factors which caused the decline of value added in this sector. At the same time, even though the recently initiated agricultural reform should have positive impact on performance of the sector in the long run, it has destructive rather than constructive nature in the short run.
Table 2. Gross value added by branches (yoy change in %)
Among the industrial sectors, the following sectors were leading in output growth in July: light industry (38% growth from the beginning of the year), wood processing industry (35.7%), and food industry (30.3%). The output growth in ferrous metallurgy, despite being above average growth throughout the industry (19.5%), has nevertheless been somewhat slower in comparison to the previous months, which threatens with slower growth rates for the entire industrial output, since this sector has a very large share in the overall output.
Among the sectors, which registered output decline, were fuel industry (10.5% decline from the beginning of the year) and construction materials industry (4.3%). The decline in fuel industry resulted from overall decline in oil processing industry by 44.1% from the beginning of the year, while the decline in construction materials industry can be explained mainly by the ban on barter payments for electricity. Many of the enterprises from this sector, as extremely energy consuming, have reduced their outputs or even completely stopped to produce any output since they were unable to pay their bills to the energy sector.
Monetary policy and exchange rate
In July, there was a major acceleration in rates of increase of money base and money supply. This factor, along with insufficient activity in sterilization transactions, creates a threat that strong inflationary processes will continue in the nearest future.
Table 3. Monetary aggregates
The acceleration in rates of increase of money base (by 5.2% in July) was caused by the increase in amounts of dollars purchased by the National Bank at the interbank currency market (approximately USD 230 million in July, and over USD 1 billion from the beginning of the year). NBU was undertaking measures aimed at sterilization of a strong emission flow. Thus, the NBU transactions related to allocation of T-bills from their own portfolio at the secondary market have had a constraining effect on the rates of increase of money base (in July, the NBU has allocated a total of UAH 430 million of T-bills among the commercial banks). However, these measures were not sufficient for sterilization of the major share of the issued amounts. In addition, lack of final consensus between the NBU and the Ministry of Finance on restructuring the schedule of payments on T-bills limits the NBU capacities in managing the rates of increase of money base.
At the same time, it would be too early to say that the market of internal borrowings has been reestablished. Low yield of T-bills, which are offerred by the Ministry of Finance at the primary market, as well as lack of full confidence in this instrument, make it less attractive for the commercial banks.
In July, the situation at the interbank currency market remained unchanged, as significant excess of supply of dollars over demand for them enables the National Bank to maintain the official exchange rate at a stable level and to refresh its currency reserves through purchasing the excess supply. The stability of official exchange rate also promotes the stability of cash hryvnia. At the same time, there was a minor strengthening of cash hryvnia (by 1%) as a result of traditional increase in supply of cash currency over demand for it during the vacations season.
Since the funding from the IMF has not been resumed, the interventions at the interbank currency market remain the only source of supporting the currency reserves. A favorable situation at the currency market allows to increase the gross currency reserves even despite major current payments on foreign debt. Thus, as of August 11, gross currency reserves have reached the level of USD 1238 billion, which exceeds their level as of the beginning of the year.
In July, a deflation was registered (traditional for this month), which was caused by seasonal decrease in prices for foodstuffs. At the same time, a lasting trend towards rapid increase of monetary aggregates and an ongoing crisis in agriculture have resulted in a decrease in prices for foodstuffs much lower than in the previous years (0.4% in July of this month, compared to 3.2% in 1999 and 2.3% in 1998). As a result, the decrease in overall consumer price index in July of this year was only 0.1%.
Table 4. Basic price indices and exchange rate
Dynamics of decrease in price index for foodstuffs was determined primarily by a major seasonal decrease in prices for agricultural products of the new crop (potatoes, vegetables, fruits and berries). On the other hand, the effect of seasonal decrease was somewhat reduced as a result of increase in prices for meat and sausage. A 23% export duty rate for sunflower seeds causes a glut of oil in the internal market, which prevents the seasonal increase in prices for this product.
The increase in imports of wheat, as well as the fact that the wheat from the new crops appeared at the market, have allowed to somewhat bring down its deficit at the domestic market, which resulted in slower rates of increase in prices for flour, bread and other related products. At the same time, in order to prevent the last-year’s increase in prices for these products, the Government has issued a number of resolutions aimed at strengthening the control over commodity flows of wheat and other grains, as well as at raising the requirements for their exports The resolutions were issued according to the Decree of the President of Ukraine of June 29, 2000 “On Urgent Measures for Stimulation of Grain Production and for Development of the Grain Market”.. Although these measures will assist in increasing the supply of wheat at the domestic market, they will also lead to the increase in level of administrative interference with the agricultural market, which will have negative impact on its future development.
Another good, the prices for which have stabilized in July, is sugar. The permission for imports of 260 ths tons of raw sugar under privileged conditions Resolution of the Cabinet of Ministers of Ukraine of July 4, 2000 #1043 “On Mechanism of Regulating the Import Supplies of Raw Cane Sugar in 2000”., as well as the increase in volumes of imports of finished sugar, have allowed to practically stop the increase in prices for sugar (1% in July, compared to 46.8% for the first half of the year). However, it should be mentioned that almost the entire quota for privileged imports of raw sugar has already been used, while the sugar from new crops will appear at the market only in September. This preserves the threat that prices for this product will further increase during the nearest months.
As in the previous months, the price index for nonfood products has not increased significantly (0.6%), which to a large extent results from the lasting stability of the exchange rate. At this background, only two commodity groups have registered significant price increase: fuel materials (4%) and construction materials (3.3%). The increase in prices for oil products registered in the Western Europe has resulted in increase in volumes of their supplies from Russia, which in turn caused the respective reduction in exports to Ukraine. In addition, simultaneous decrease in supplies of oil to Ukrainian oil processing plants has resulted in decline of output of oil products in Ukraine. The effect of these factors has led to the reduction in supply of oil products at the domestic market and, as a result, to the increase in prices for them. The increase in prices for construction materials can be explained by the increase in wholesale prices for them, which resulted from unfavorable situation in the construction materials industry that followed the ban on barter transactions and the need to pay the energy bills in cash and in the entire amount.
The increase of index of paid services (by 0.4%) can be explained by continued increase in tariffs for communications services (by 5.4%), as well as by increase in prices for tourist, excursion and recreational services during the vacations season. It should be noted that in July there was no increase in prices and tariffs for housing and communal services (moreover, there was a decrease of 0.4%). At the same time, the cost of these services has not yet been brought to the level when it would cover 100% of their prime cost in all of the regions. Thus, there is still an inflationary capacity for this category of services for the nearest months.
The increase in producers prices (by 1.4%) is related primarily to the increase in prices for products of chemical and oil industry, construction materials industry, and food industry. The continued increase in prices within the construction materials industry (12.2% from the beginning of the year) is a very disturbing indicator. This is typical for a number of energy consuming sectors. The ban on barter transactions and the need to pay 100% of the electricity bills in cash, has made it impossible to pay the cost of electricity to intermediaries in kind, which resulted in output decline and in increase in prices for products of the construction materials industry.
Despite the strict fiscal policy and the Government undertaking numerous measures aimed at improvement of the situation in the budget sphere, there is still a number of problem issues. They are mainly related to the operation of certain sectors of the economy, which require constant support from the government.
The beginning of agricultural works are traditionally characterized by additional pressure on budgetary resources. Despite the reforms which are being implemented in agriculture and the Government’s actual refusal to support the agricultural producers directly, the practice of writing off the debts for material and technical resources, which were supplied to the agricultural producers in the earlier years under privileged conditions, still continues Resolution of the Cabinet of Ministers of Ukraine of June 2, 2000 “On Repealing Some Resolutions of the Cabinet of Ministers of Ukraine”. . In addition, in order to enable the supply of sufficient fuel materials to the agricultural sector, the effect of the Laws, which establish the privileged tax, regime for diesel fuel, was continued Law of Ukraine #1813 of June 13, 200 “On Amending Some Laws of Ukraine”; Law of Ukraine #1913 of June 13, 2000 “On Amending Some Laws of Ukraine”.. Although such measures can help prevent the crisis at the fuel market, on the other hand they lead to decline in budget revenues.
Another permanent recipient of the budget support is the coal mining industry. Thus, despite the ban on mutual settlements, the Cabinet of Ministers has nevertheless granted its permission for this sector to undertake mutual settlements for consumed electricity Resolution of the Cabinet of Ministers of Ukraine of June 5, 2000 “On Measures to Stabilize the Performance of Coal Mining Industry Enterprises”..
Therefore, as the experience of the earlier years shows, the undertaken measures aimed at the so-called “stabilization of performance” of economic sectors do not have the positive effect and very often are in fact a source of additional problems for the budget.
Consolidated budget revenues have amounted to UAH 20.3 billion (28.5% of GDP) in January-June, which is 3.4 percentage points Hereinafter compared to share in GDP. higher than in January-June 1999. The increase in budget revenues was determined by two primary factors. Firstly, from the beginning of 1999 a number of additional revenue items were introduced (if these items are not considered, then we can say that there was a real reduction in revenues by 0.9 percentage points in comparison to the respective period of the previous year). Secondly, there was an increase in privatization revenues.
Table 5. Consolidated budget revenues
Error! Not a valid link.
Similarly to the previous months of 2000, in June the main determinant which caused the real reduction in tax revenues was a ban on non-cash payments to the budget. In this respect, it is necessary to note the improvement in quality of budget revenues: in June 2000, non-cash revenues amounted to 0.5% of the total consolidated budget revenues, compared to 16.3% in June 1999.
Chart 1. Share of non-cash revenues to the consolidated budget
Source: State Treasury of Ukraine
The reduction in non-tax revenues in June (as compared to May 2000) by 6.4 percentage points is related primarily to the drop in privatization revenues (by 4.8 percentage points) and in own revenues of the budgetary organizations (by 1.3 percentage points).
A ban on non-cash payments both on the national and on the local level, elimination of a number of exemption and of artificial restructuring of arrears, and overall arrears crisis in the fuel and energy sector remain the principal causes of increase in arrears. The increase in arrears by over 60% in June as compared to May 2000 has occurred as a result of value-added tax and land tax. Elimination of VAT zero-rating for energy did not bring the anticipated result of additional revenues; on the contrary, it could be treated as an additional reason for deterioration of revenues.
Along with this trend towards the increase in overall amount of arrears, one can note a decrease in arrears from enterprise profits tax (by UAH 42 million) and from deductions for transit of natural gas (by UAH 18 million) in June as compared to May.
Chart 2. Consolidated budget arrears on certain revenues
The expenditure section of the consolidated budget amounted to 27.5% of GDP in January-June, 2000, which exceeds the expenditures in January-June, 1999, by 1.6 percentage points. The expenditure performance has made up 46.4% to the annual plan.
Table 6. Consolidated budget expenditures
Although major reductions in the number of civil servants were undertaken as a part of administrative reforms, in June there was a significant increase in expenditures for maintenance of public administration (by 2.2 percentage points as compared to June 1999). At the same time, there was a reduction in funding for social and cultural events and facilities (by 1.1 percentage points).
A similar trend could be observed in the expenditures of local budgets. The funding for socially oriented items (social protection of population and financing of social and cultural facilities) has amounted to 8.5% of GDP and has reduced by 0.5 percentage points as compared to June 1999.
Chart 3. Structure of budget expenditures
It should be noted that as a result of improved quality of revenues, the expenditures became more effective. However, the delay in their financing from the annual plan may become one of the reasons for increase in credit indebtedness of public sector enterprises. This, in turn, could become an additional source for mutual settlements.
The State Budget surplus in January-June, 2000, has amounted to UAH 509 million, with net financing of UAH 628 million. The main source of this surplus remained the cash gap in financing of budget expenditures.
From the very beginning of the year, the funding was performed entirely from the internal sources, and the National Bank of Ukraine remained the main buyer of the T-bills. At the same time, a certain recovery of the secondary market was treated as a positive signal to rebuilding of the confidence to government securities. Thus, in May-June, the NBU has sold a total of UAH 227 million in T-bills to the commercial banks at the secondary market.
It also should be noted that the existence of a large amount of excessive payments, including the VAT payments (almost UAH 6 billion), could be treated as a hidden deficit.
Table 7. Net financing of the state budget deficit in 2000
In our calculations of inflation, nominal GDP, and budget revenues for 2000 and 2001, we have used the following assumptions:
· Real GDP growth will amount to 2.7% this year, and to 1.6% next year.
· The increase in money base will make up 35% by the end of 2000, and 25% by the end of 2001.
· Exchange rate of hryvnia to US dollar as of end of December, 2000 will amount to UAH 5.8/USD, and to UAH 6.7/USD as of end of December, 2001.
Assumptions on the change of real GDP in 2000 and 2001 are based on calculations for CASE’s quarterly macroeconomic model (see Table 8).
Table 8. Assumptions on real GDP dynamics
A minor excess of actual values of real GDP in July over our earlier forecasts have resulted in revisions of real GDP forecast from 2.6% to 2.7% for the current year, and, as a result of increase in the statistical base of this year, to reduced value of the forecast for the next year, from 1.7% to 1.6%. As earlier, we feel that the main factor which will promote the GDP growth in 2000 wil be major excess of exports over imports. At the same time, as a result of worsening of market opportunities at the foreign markets, we assume that the effect of this factor will become smaller next year. At the same time, we assume that there will be a major increase in investments in 2001.
The public consumption will increase both this and next year, which is related to the limited scope of budgetary resources. Here, it should be mentioned that all assumptions and calculations were based on the existing tax system. In case if the new Tax Code, which provides for significant reductions in the tax rates, is adopted, this could lead to significant drop in budget revenues and to need to further reduce the budget expenditures, which would have negative consequences for the GDP growth rates during next year.
In this issue of our memorandum, we increase our assumptions on the money base growth in 2000 by additional 5 percentage points (up to 35%) and keep the assumption on its growth in 2001 at the constant level (i.e., by 25%). We assume the devaluation of hryvnia down to UAH 5.8/USD as of end of 2000, and to UAH 6.7/USD as of end of 2001.
Table 9. Assumptions on changes in money base and exchange rate
Source: NBU and CASE calculations
The rates of increase in money base in July have gone much ahead of the earlier assumptions, which is related to a significant increase in the scope of National Bank interventions at the interbank market. Thus, in July, the money base has increased by 5.2% (whereas earlier we assumed its increase by 1.6%). We assume that such scope of the NBU interventions will be maintained in the future. On the other hand, we assume that the NBU will be involved in sterilization transactions (allocation of T-bills from their own reserves among the commercial banks through the secondary market, and, possibly, starting to allocate depositary certificates). However, the volume of these transactions will be insufficient to sterilize the major share of issued amounts. Lack of consensus between the NBU and the Ministry of Finance on restructuring the schedule of payments on previously issued T-bills and, as a result, the fact that these payments will not be resumed in the nearest future, will limit the NBU capacities to restrain the increase of money base. Due to these factors, we increase our assumptions on increase of money base up to 35% in the current year.
As earlier, we forecast that the IMF financing will be resumed in the fourth quarter of the year, which will have a constraining effect on the increase of money base and will assist in supporting the gold and currency reserves of the NBU.
Inflation, Nominal GDP, and Budget Revenues Forecast up to the end of 2001
Accelerated rates of increase of money base have resulted in increase of our inflation forecast for the current year. Thus, according to the calculations for our model, the increase of consumer price index will amount to 28.7% in 2000 (December to December), while the increase of wholesale price index will amount to 18.4%. For the year 2001, we forecast the CPI increase by 15.4% and the WPI increase by 14.4% (a more detailed forecast can be found in Appendixes 1 and 2).
Table 10. Inflation forecast by components
Acceleration in the rates of increase of monetary indicators, discreet forecasts on the harvests for the current year, and inflationary expectations have forced us to increase our forecasts on increase in prices for foodstuffs up to 32.5% a year. We forecast higher rates of inflation of this group of products in November and December (average of 3.4% per month). For the year 2001, we forecast slower rates of increase in prices for foodstuffs (18.4% per year); however, the rates will be rather high during the first and the fourth quarter.
As we have mentioned before, the year 2000 will be very special for prices for paid services. Administrative increase in prices for communal services, communications and public transportation services will remain a key factor for increase in prices for paid services. According to our forecasts, annual increase will make up 36%. We assume, that during the current year tariffs and prices for these services will be brought to the level of 100% of compensation for their value, and that is why the annual increase in index of paid services will slow down to the regular level in 2001, making up 12.6%.
Since, firstly, the national currency rate is a main factor, which determines the rates of increase in producers prices, and, secondly, the development of the situation with the currency market reflects our earlier assumptions, we do not change our previous forecast of inflation for this group of products. Thus, the wholesale price index will increase by 18.4% in 2000. In 2001, the rates of increase will slow down to 14.4% annually.
Given the received results of the forecast of inflation of consumer and wholesale prices, we forecast that the average annual change of the GDP deflator will amount to 26.9% in the current year, and to 15.4% in 2001. Based on the assumption on the real GDP growth of 2.7% in the current year and of 1.6% in the next year, we forecast that the nominal GDP will reach the level of UAH 165.7 billion in 2000, and UAH 193.9 billion in 2001.
Table 11. Nominal GDP forecast
Source: State Statistic Committee and CASE calculations
Despite the fact that the draft of the new Tax Code has passed the first reading in the Verkhovna Rada, our forecast of budget revenues is still based on the existing tax legislation. The main reason for that is a great uncertainty firstly, in changes which will occur with the new Tax Code and, secondly, in the very fact of its adoption (given the sharp criticism that the suggested changes face from the international financial organizations, and primarily, from the IMF).
Our July forecast of budget revenues does not differ much from our earlier forecasts – i.e., revenues from profit and income taxes will exceed the amounts targeted by the Budget Law, while the revenues from indirect taxes will be lower from the targeted amounts (see Appendix 3 for more details). At the same time, we expect that the revenues from excise tax will increase (as a result of recent improvement in the quality of revenues from this tax) up to 1.3% of GDP in 2000. This is still, nevertheless, 0.1 percentage points below the targeted indicator. Excise tax revenues will remain at the level of 1.3% of GDP in 2001. At the same time, we lower our forecast of VAT revenues by 0.1 percentage points, to 6% of GDP (while the indicator planned in the Budget is 6.4% of GDP). In 2001, the VAT revenues will fall down to 5.4% of GDP. A total ban on mutual settlements for this tax has become one of the key determinants of reduction in revenues. However, it is necessary to note a major improvement in their quality.
We further improve our forecast of revenues from personal income tax by additional 0.1 percentage points, or up to 3.6% of GDP (the planned indicator is 3.2% of GDP). This results from the current and anticipated increase in the cash incomes of the population. The budget will also receive 3.6% of GDP in personal income tax in 2001. The forecast of revenues from enterprise profit tax remains constant, i.e., 4.6% of GDP in 2000, which exceeds the indicator planned by the Government by 0.1 percentage points. This results from higher forecasted levels of real and nominal GDP. However, in 2001 the revenues from this tax will reduce down to 4.3% of GDP – as a result of slower rates of real GDP growth.
Chart 7. Revenues of consolidated budget in 1999-2000 and forecast for 2000 and 2001
As in previous issues of our memorandum, we forecast major under-receipts of revenues from payment for transit of natural gas, oil, and ammonium in 2000 and 2001, which is based on significant underperformance of these revenue items in the preceding years.
The performance of privatization revenues is rather concerning. A recent failure with the tender on sales of Crimean Soda Plant and anticipated failures with the sales of Khartsyzk Pipe Plant and Zaporizhya Aluminum Plant (the earlier happened primarily due to the lack of bids, while the latter happened due to strict investment requirements) threaten the reality of receiving of the planned revenues. In anticipation of this threat, the State Property Fund should hurry up with the sales of 7 oblast energy companies this year, which, in turn, threatens the effectiveness of the tenders. One should consider the fact that the Verkhovna Rada has succeeded in passing the Law on Privatization of UkrTeleCom in the second reading as a very positive fact, since its privatization might actually occur as early as in the year 2001.
Annex 1. Forecast of inflation and nominal GDP for 2000 and 2001
Annex 2. Forecast of consumer price index by groups for 2000 and 2001
Memorandum on Macroeconomic Forecast July, 2000
Macroeconomic Modeling Group CASE/HIID 16
Annex 3. Revenues to consolidated budget in 1999-2000 and forecast for 2000 and 2001