In this memorandum we present an analysis of dynamics of GDP, monetary policy, exchange rate, inflation, and budget revenues and expenditures for October 2000. Based on this analysis and assumptions on further development of macroeconomic situation, we have developed a forecast of inflation of consumer and wholesale prices, nominal GDP, and budget revenues until the end of 2001.
Main outcomes of the forecast are as follows:
· Consumer price index will make up 30.6% in 2000 (December to December), and the wholesale price index – 18,4%. In 2001 we forecast the inflationary processes to slow down, to 17.5% and 14.4% (December to December), respectively. In our calculations, we have used assumptions on increase of money base by 35% in 2000 and by 25% in 2001. According to our assumptions, hryvnia will devaluate to UAH 5.6/USD by the end of 2000, and to UAH 6.0/USD by the end of 2001.
· We forecast the nominal GDP at UAH 169,3 billion in 2000 and at UAH 207,7 billion in 2001 (we assume the real GDP growth of 4,9% та 2,7% this year and next year, respectively).
· Revenues from income and profit taxes will somewhat exceed the amounts planned in the Budget 2000, while the revenues from VAT will be lower than those planned. There is a threat of the privatization revenues falling short of the planned amount.
Analysis of Current Situation
Gross Domestic Product
Growth rates of Gross Domestic Product made up 6.1% in October, compared to October 1999. This resulted in cumulative GDP growth by 5.1% from the beginning of the year.
Table 1. Real and nominal GDP
Stable growth in industry, which resulted in cumulative growth of industrial gross value added by 11.9% in October, was also the basis for overall economic growth of value added. A stable input into the growth of value added also comes from trade and public catering (5.5% growth of value added to October 1999). The rates of value added growth in construction continue to slow down: thus, the value added growth in October remained at the level of October of the previous year (compared to 3.5% growth in August and 0.6% growth in September).
Table 2. Gross value added by branches (yoy change in %)
The growth in agriculture is continuing: it comprised 3.7% in October (cumulative from the beginning of the year).
Among the industrial sectors, light industry (with 39.6% growth from the beginning of the year), wood processing industry (38.7%), and food industry (25%) remained the leaders in terms of output growth in October. The output growth in ferrous metallurgy, which is above the average throughout the industry (at the level of 19.3%) has been stable for a long time. This has positive impact on growth rates of entire industrial output, due to a very large share of this sector in the overall output. At the same time, we suspect that the real growth indicators in this sector could be somewhat overestimated and could have certain unhealthy roots in indirect subsidizing of this sector.
Among the main sectors that registered output decline were fuel industry (6.6% decline from the beginning of the year) and construction materials (approximately 4%).
Monetary policy and exchange rate
A trend towards the increase of money base that has been observed at the beginning of this year has resumed in October. As earlier, the main reason for this increase has been the NBU inverventions at the interbank currency market. At the same time, it should be noted that the NBU has gotten rid of one of its sterilization instruments that it has used lately, that being the allocation of T-bills from its own portfolio among the commercial banks. Although the fact that the Government has restructured its debts to the NBU has allowed to formalize the relationships between the two and to develop a plan for servicing of this portion of the internal debt, the restructured T-bills are less attractive for the commercial banks due to their long-term maturity (the Government will only start repayments on the restructured T-bills in January 2002). Another reason is the high risk level of T-bills (the Ministry of Finance refusal to repay against the T-bills in the amount of approximately UAH 100 million has even further increased the risk level of these securities for investors).
The Government’s measures to revive the primary market for securities at the expense of attracting the funds of other government institutions also cause great concerns. Thus, in October, the Ministry of Finance has allocated T-bills to the Deposit Guarantees Fund and the Pension Fund. There is a number of recent precedents, when the Ministry of Finance was unable to service its liabilities on internal debt. This creates a potential threat that the Government’s solvency crisis will shift to the other sectors.
Table 3. Monetary aggregates
Following the September destabilization of the situation at the currency market, the events became steady in October, similarly to the situation in August. A major excess of dollar supply over demand has allowed the NBU to renew its large-scale interventions at the interbank currency market with the “purchase” position. The net purchases have made up USD 115 million in October. At the same time, the NBU has continued to carry out the policy aimed at supporting the exchange rate stability, by purchasing only the excess of the supply of dollars. It also should be noted that the major volumes of the NBU interventions at the interbank market suggests that the exchange rate regime in Ukraine is not floating, but fixed.
The continuation of favorable situation at the interbank currency market allows the National Bank to fill its currency reserves and to perform payments on its current liabilities. However, the lasting continuation of such situation can only be possible if there are no unfavorable shocks, which could change the balance of currency inflows into the country. That is why the resumption of funding by the IMF within its EFF program remains one of the key tasks for the Government.
The consumer price index has amounted to 1.4% in October of the current year (23.3% from the beginning of the year).
Table 4. Basic price indices and exchange rate
Similarly to the previous month, the foodstuff price index had the greatest impact on the overall CPI. This can be primarily related to the seasonal price increase for a number of food products. On the other hand, the fact that the market is full with the products of the new crops has somewhat lessened the effect of this factor. Thus, the beginning of the active sugar processing campaign by the sugar processing plants has resulted in the reduction of wholesale sugar prices. The situation at the oil market is also rather optimistic, as the increase in the volumes of sunflower crops compared to the previous year will help in preserving a large supply of oil at the domestic market, as well as in stabilization of prices for oil.
Exchange rate stability remains the major factor that restrains the increase in nonfood products price index (0.8% in October, compared to the previous month). Moreover, the Verkhovna Rada has once again extended the privileged conditions for imports of fuels and lubricants Law of Ukraine #1962-ІІІ of September 21, 2000. “On Amending Some Laws of Ukraine on Taxation of Transactions Related to Production and Sails of Raw Oil and of Some Fuels and Lubricants”.. This has helped stabilize the situation at the internal fuel market, which traditionally remains the most problematic for Ukraine.
As there was no increase in prices and tariffs for housing and communal services, the paid services price index was registered at 0.7% in October in comparison to the previous month. At the same time, it is premature to say that the prices and tariffs for these services have been brought to the level when their cost is fully compensated for, since a number of local administrations have postponed the increase in these prices until the beginning of the heating season.
There was almost no change in the trend of price increase by producers in different sectors. Thus, the sectors that registered the highest price increase in October were fuel industry (by 2.3%, or 30% increase from the beginning of the year) and food industry (by 2.6%, or 28% increase from the beginning of the year). The slow-down in price increases for flour-and-cereals industry should also be noted. Thus, the prices increased by 1.1% in October, while the cumulative price increase from the beginning of the year has made up 63.5%. This could be related primarily to the reduction in prices for raw materials from the new crops.
The most recent developments in the budgetary sphere have further supported our negative expectations that the “manual” administration of the fiscal processes in the country has been restored. Being led by the needs of budgetary resources, the Government has started to actively apply its old “effective” instruments for reaching of the short-term goals.
Thus, at the beginning of October, the Cabinet of Ministers has ordered the State Tax Administration and other government agencies to fulfill the planned task of providing for additional UAH 1.3 billion in revenues by the end of the current year. The major amount of these revenues, i.e., UAH 825 million, should be provided by the State Tax Administration primarily through imposing the penalty sanctions, as well as through activation of its activities related to collection of arrears. It should be stressed that for ten months of the current year, State Budget revenues from fines and financial sanctions have already been over-performed by 63% of the annual plan. Thus, by strengthening the administrative interference into the economy, the government itself provokes the businesses to neglect its interests and to reduce their confidence to the declared reform policy.
Another instrument, the ban on which was treated as by far the greatest achievement of this year, is the mutual settlements. Thus, following the Verkohvna Rada’s amending article 60 of the Law “On State Budget of Ukraine for 2000”, the mutual settlements for the debts to the budget that were accrued this present year have been legalized. This was followed by a number of resolutions of the Cabinet of Ministers related to the mutual settlements for the debts of the current year Resolution of the Cabinet of Ministers # 1692 of November 13, 2000 “On Approving the Manner for Repayment of Arrears for Military Property (Good, Services) by the Ministry of Defense, the Security Service, the Ministry of Interior, Other Military Units Established in Accordance with the Laws of Ukraine, and by Law-Enforcement Agencies”;
Resolution of the Cabinet of Ministers # 1696 of November 14, 2000 “On Amendments to the Resolution of the Cabinet of Ministers of July 18, 2000 #1135”;
Resolution of the Cabinet of Ministers # 499-р of November 14, 2000 “On Amendments to the Item 1 of the Resolution of the Cabinet of Ministers of Ukraine of August 21, 2000 “On System of Payments for Electricity”;
Resolution of the Cabinet of Ministers # 455-р of November 16, 2000 “On Payments for Electricity Consumed by Institutions and Organizations of the Ministry of Defense of Ukraine”.
In addition to the facts mentioned above, the Government still continues its practice of granting tax privileges to both state-owned and non-state-owned enterprises. Thus, the Joint-Stock Company “Nord” and the Open Joint-Stock Company “Khreschatyk Sugar Plant” have been given tax exemptions for VAT and customs duty when importing goods, which violates the effective legislation and contradicts the conditions of functioning of market mechanisms Resolution of the Cabinet of Ministers # 461-р of November 20, 2000 “On Customs Registration of Cargoes Addressed to the Joint-Stock Company “Nord”;
Resolution of the Cabinet of Ministers # 403-р of November 18, 2000 “On Customs Registration of Cargoes Addressed to the Open Joint-Stock Company “Khreschatyk Sugar Plant”.
Moreover, the practices of writing-off of tax arrears for certain enterprises and of repayment of government-guaranteed credits at the expense of the budgetary funds are continuing. This is taking place despite the fact that attempts are made to introduce market mechanisms of re-selling of enterprises’ liabilities for credits received against the government guarantees.
To sum up, the Government actions are of a short-term and contradictory nature. While being aimed towards satisfying the current needs, they put future reforms and long-term economic growth under a big threat.
Consolidated budget revenues in January-October have amounted to UAH 38.4 billion (28% of GDP), which is 3.3 percentage points above the indicator of the respective period of 1999. However, taking into account the fact that this year’s budget contains additional revenue items, the conclusion would be that the revenues fell by 0.3 percentage points for the ten months of the year in real terms.
Table 5. Consolidated budget revenues
A major increase in revenues from enterprise profit tax in October compared to September (by UAH 538 million) can be explained by the liabilities for this tax due coming. At the same time, the increase in revenues was accompanied by the respective increase in arrears for this tax, which suggest a rather low level of the payments discipline.
Chart 1. Arrears to the Consolidated Budget in 2000
Source: State Treasury of Ukraine
A significant drop in the share of revenues from VAT results from the increase in export volumes and, most importantly, from a huge number of tax exemptions that are granted to entire sectors, as well as from exemption of enterprises in fuel and energy complex from this tax. In addition, the increase in arrears for this tax constitutes an example of inefficient administration system and of constant attempts to evade payment of this tax.
Chart 2. Structure of Consolidated Budget revenues in 1998-2000
Consolidated budget expenditures in January-October have amounted to UAH 36.2 billion (26.3% of GDP), which is 0.3 percentage points above the indicator for the respective period of 1999 (the expenditures of Social Insurance Fund and of budgetary organizations are included).
Table 6. Consolidated budget expenditures
The structure of expenditures both for the State Budget and for the local budgets has remained almost unchanged, with the exception of the increase in the share of expenditures for servicing public debt. However, there is a positive trend towards reduction in share of expenditures for public administration.
Chart 3. Structure of expenditures of the State Budget and of local budgets in August-October 2000
The problem of delay in the annual plan of financing of consolidated budget expenditures remains unresolved. This delay has made up over UAH 2 billion for ten months of the year.
The State Budget surplus in January-October has amounted to UAH 1.7 billion, or 1.1% of GDP. Similarly to the previous months, the reasons for such surplus are the cash gap in financing of budget expenditures and the increase in Government deposits.
Until October, the deficit has been financed exclusively from internal sources, with the NBU being the major buyer of T-bills. However, the Government has received external funding in October at the expense of World Bank credit.
Table 7. Net financing of the state budget deficit in 2000
Recently, the Government has decided to undertake a step to reduce the public debt by the pre-scheduled redemption of the internal and external T-bills, or, rather, by their exchange for the debts of business entities. This decision can influence the reduction in mutual debts between the government and the creditors. However, the result will be somehow spurious, due to the lack of cash transactions between the parties Resolution of the Cabinet of Ministers # 1720 of November 20, 2000 “On Pre-Scheduled Redemption of Internal and External T-bills”.
The fact that there are significant overpayments to the budget and liabilities on repayment of VAT can be treated as a hidden budget deficit.
The following assumptions were used to calculate inflation, nominal GDP, and budget revenues for the years 2000 and 2001:
· This year real GDP growth will make up 4.9%, and the next year’s - to 2.7%;
· The money base growth will make up 35% by the end of 2000, and 25% by the end of 2001;
· Hryvnia will devalue to UAH 5.6/USD by the end of December 2000, and to UAH 6.0/USD by the end of December 2001.
Assumptions on the change of real GDP in 2000 and 2001 are based on calculations for CASE’s quarterly econometric model. The forecasts were based on assumptions on changes of main monetary indicators (described below), on privatization revenues of UAH 4.2 billion for the year 2001, and on reduction in real government consumption by 1.5%. The main outcomes of the forecast are presented in the Table 8.
Table 8. Assumptions on real GDP dynamics
Higher real GDP growth rates in August and September than it was previously forecasted and quickly growing domestic demand coupled with the revision of the official data for the first half of 1999 have resulted in the increase in our forecasts of the GDP growth for 2000 and 2001. Thus, we forecast the annual real GDP growth of 4.9% this year, and of 2.7% in 2001. As earlier, we expect that in 2000 the main determinant of the real growth will be the excess of exports over imports, which will largely lead to the increase in investments. However, we expect that the situation at the foreign markets will worsen in 2001; thus the effect of significantly positive net exports will not be crucial. The domestic demand will be the main factor to determine the real GDP growth in 2001.
The public consumption will decrease both this and next year, which is related to the limited scope of budgetary resources. Here, it should be mentioned that all assumptions are based on the existing tax system. In case the new Tax Code is adopted, the volumes of budget revenues will drop during the first stage. This will force the government to cut the budget expenditures, which would have negative consequences for the GDP growth in 2001.
From the moment when our previous memorandum was issued, there were no significant changes at the currency market. As mentioned above (see “Monetary policy and exchange rate” section of the previous chapter), the excess of currency supply over its demand at the interbank market is continuing. Improvement of the trade balance and surplus of the capital transactions account have, to a large extent, pre-determined such situation. We do not expect either any major change at the external markets for Ukrainian exports or the reduction in currency receipts into the internal markets to happen until the end of this year. At the same time, the Ministry of Finance is scheduled to repay approximately USD 180 million as foreign debt servicing in November and December. For this, it will have to purchase currency amounting to UAH 998 million at the interbank market. In addition, the NBU will purchase approximately USD 190 million to restrain hryvnia from revaluation. Such actions taken by monetary regulation units will result in the increase of the money base by UAH 1.1 billion. Thus, according to our estimate, the money base will increase by 35% during the year, comprising approximately UAH 16.1 billion as of end of the current year. Hryvnia exchange rate will fluctuate between UAH 5.45/USD - UAH 5.60/USD during the last two months of the year. Hryvnia will reach the lower estimate, only if there are under-receipts of foreign currency targeted towards the privatization of Ukrainian enterprises. In any case, we think that the hryvnia exchange rate to the dollar will not drop lower than the bottom estimate until the end of the year.
In 2001, we expect the stable situation at the currency market to continue. The trade balance will make up USD 400-450 million, while the balance of services will not exceed USD 1.1 billion. Such pessimistic forecast of the balance of services is related to simultaneous increase in imports of services and decrease in exports of services. The major factor that will underlie such change will be Ukraine the purchaseses of gas from Turkmenistan, as well as the increase of the amount that Ukraine will need to pay to Russia for transportation of gas across its territory. According to international experts, the drop in world prices for energy resources, including raw oil prices, will occur in 2001; however, this drop will not be significant. That is why it is quite likely that Russia will decrease the supplies of energy resources across Ukraine’s territory. This, in turn, will result in the decrease in revenues under the item “Exports of services” in the foreign trade turnover in Ukraine.
Table 9. Assumptions on changes in money base and exchange rate
Source: NBU and CASE calculations
According to our estimates, the privatization of Ukrainian facilities will generate revenues amounting to approximately UAH 4.2 billion. The interest that the strategic foreign investors demonstrate towards the purchase of these enterprises and the relative readiness of the Ukrainian party to cooperate both make this estimate more realistic. The above amount of privatization revenues does not include the cost of UkrTelecom, which can be explained by two reasons. Firstly, privatization of this facility is scheduled to take place in the fourth quarter of 2001. Secondly, as the experience of other transition economies (e.g. of Poland) suggests, the privatization of this type of facilities is not successful at the first attempt. Hence, some additional time will be required. We feel that a more realistic time for privatization of UkrTelecom would be early or mid-2002.
The payments to service the foreign debt will amount to USD 1.7 billion in 2001, including USD 965 million that will need to be paid by the Ministry of Finance. At the same time, we expect that the International Monetary Fund will resume financing on the EFF program at the end of the fourth quarter of the current year. The cooperation with both the IMF and the other international financial organizations will continue during the next year, thus increasing the inflows of currency to the domestic market.
Thus, during the next year, the excess of currency supply over its demand will be observed at the interbank market. The National Bank will further carry out its stabilizational policy, by purchasing the excess of currency supply and by devaluating hryvnia at slow rates. By the end of the year, the exchange rate will be no higher than UAH 6.0/USD. Resulting from these actions would be high rates of money base growth. Although the resumption of activities at the secondary T-bills market looks quite likely, this will not be very rapid. The NBU will make attempts to significantly expand its use of sterilizational instruments, such as REPO transactions or deposit certificates. At the same time, the effect achieved from their application will be rather limited. That is why we assume the money base to grow by 25% (or by UAH 4 billion) during the next year.
Inflation, Nominal GDP, and Budget Revenues Forecast up to the end of 2001
According to our assumptions on money base growth and exchange rate changes, as well as to calculations done within our model, we forecast that the consumer prices will increase by 28.9% during 2000, compared to the previous year, while the respective increase in wholesale prices will be 20.6%. In 2001, the average annual CPI and WPI increase will amount to 21.7% and 14.5%, respectively.
Table 10. Inflation forecast by components, (%)
As usual, the foodstuff price increase will continue to be a major determinant of the CPI increase. A good harvest that has been gathered this fall creates positive expectations regarding the dynamics of prices for food products. Although we forecast that the annual rates of foodstuff price increase will be lower, the price increases in November and December will amount to 3.3% and 4.8%, respectively. For the next year, we expect the gradual reduction in annual rates of price increase. In 2001, the prices for food products will increase by 28.2% to the previous year, while the end-year price increase will amount to 23.2%. The reduction in our forecast of inflation rates for food products was caused by the expectations that the extent, to which the increasing monetary indicators influence the inflationary processes, will decrease. Thus, starting from the third quarter of the current year, both money base and money supply growth were targeted primarily to satisfy the demand within that portion of the private sector of the economy, which occurred as a result of Government’s actions to ban the barter transactions with the energy sector and with the budget, as well as a result of higher rates of real GDP growth. Thus, following the money base growth reaching the maximum allowed annual rates in July (almost 42% to the previous year), its gradual reduction is taking place. Lagging by 4-5 months, this change started to show positive influence on the reduction of price increase rates for food products. According to our estimates, the maximum annual price increase rates for food products were observed in October. Starting in November, we forecast the gradual reduction in these rates.
The stability of hryvnia exchange rate continues to restrict the price increase for nonfood products. During the fourth quarter, we forecast the nonfood prices to increase by 3.0% to the third quarter. For the next year, we forecast the average annual increase in these prices by 8.3%. Although we assume that hryvnia will devaluate by 7.1%, the moderate rates of producers price increase will play the restricting role in 2001. The WPI will increase by 14.5% during the next year, compared to 20.6% for year 2000.
Given the fact that one can already conclude that the transition to full compensation for the cost of housing and communal services has been completed, the individuals continue to pay no more than 75% of the required costs. Having analyzed the cash incomes and expenses of the households, we did not see any sufficient grounds for the increase of this indicator. Also, no major increase in prices for the government-controlled services is expected. Therefore, we forecast that the rates of price increases for paid services will go back to their normal level. In October-December, the increase will amount to 2.9%. The overall annual increase for this year will make up 28.1%. Our forecast for the year 2001 is 14.6% increase.
Given the results received from our forecast of consumer prices and wholesale prices inflation and of GDP deflator, as well as our assumptions on real GDP growth of 4.9% during the current year and of 2.7% during the next year, we forecast the nominal GDP to reach UAH 169.3% billion in year 2000, and UAH 207.7 billion in year 2001.
Table 11. Nominal GDP forecast
Source: State Statistic Committee and CASE calculations
Our forecast of budget revenues shows that tax revenues will exceed the amounts planned in the Budget Law (for detailed forecast, see Appendix 3). However, when we compare their relative rates (as % of GDP), the revenues from income and profit taxes will exceed the amounts planned in the Budget Law, while the revenues from indirect taxes will be lower than those planned. We also expect that the excise tax revenues will make up 1.3% of GDP in 2000, which nevertheless is 0.1 percentage points below the target. At the same time, we have improved our forecast for VAT revenues by 0.2 percentage points, up to 5.8% of GDP (compare to 6.4% of GDP as planned by the Budget Law). In 2001, the VAT revenues will go down to 4.8% of GDP, due to major increase in the number of exemption for this tax.
The forecast of personal income tax remains unchanged and amounts to 3.6% of GDP in 2000, which exceeds the planned 3.2% of GDP as a result of both observed and expected growth in cash incomes of the population. In 2001, the budget will receive 3.2% of GDP in personal income tax revenues. We have lowered our forecast of enterprise profit tax revenues by 0.4 percentage points, down to 4.4% of GDP in 2000. In 2001, the revenues from this tax will decrease down to 3.7% of GDP, due to slower real GDP growth rates.
As in the earlier issues of our memorandum we forecast significant under-receipts from payments for transit of natural gas, oil and ammonia in both 2000 and 2001, which is based on significant underperformance of these revenue items in the earlier years.
The performance of privatization revenues is rather disturbing. According to the State Property Fund statistics, until now only each fifth of the facilities that have been offered for sale were actually sold. The constant problems in this respect put the reality of the receipt of planned revenues under a threat. In 2001, it is planned that the major revenues would be received from privatization of “KryvorizhStal”, around twenty oblenergo (oblast energy companies), “Azot”, and “SumyHimProm”.
Chart 7. Revenues of consolidated budget in 1999-2000 and forecast for 2000 and 2001
▪ Possible worsening of the situation at international metal markets, which would lead to the reduction in demand for Ukrainian exports and to worsening of the current account;
▪ Maintaining of high inflation rates, primarily for food products, could create additional strong devaluation pressure on hryvnia as early as in the second half of the year;
▪ In case the euro rate to the dollar will strengthen in 2001, one could expect the increase in exports to the Euro-zone and the relevant reduction in imports. If the dollar remains strong compared to the euro, this would create additional risks for hryvnia rate stability;
▪ Another essential risk is political instability, which could lead to the breakdown of privatization processes, to under-receipts of currency, and to the worsening of the capital account.
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 December, 2000
Macroeconomic Modeling Group CASE/HIID 16
Annex 3. Revenues to consolidated budget in 1999-2000 and forecast for 2000 and 2001