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Contents | How to obtain this publication | Additional info
The following provides a summary of chapter 1 of the OECD Economic Assessment of Ukraine published on 4 September 2007.
Contents
After a decade of crisis, Ukraine has been enjoying a period of sustained strong growth
Real GDP growth averaged an impressive 7.4% during 2000–06, as the economy bounced back from the severe transition recession of the 1990s (Table 1). Yet there is more at work here than simply a post-crisis recovery. The achievement of macroeconomic stabilisation together with the structural policies of the late 1990s did much to harden firms’ budget constraints and to unleash at last the Schumpeterian processes of creative destruction that drive economic development. Like many CIS countries, Ukraine lagged the more advanced transition countries of Central Europe with respect to market-oriented reforms, as governments often focused more on preventing structural change than facilitating it. Hence, there is much still to be done in order to make strong growth more sustainable. One of the major emphases of this report is therefore on what more Ukraine can do to reduce the many remaining barriers to entry, exit and competition and thereby to stimulate a greater degree of dynamism and flexibility than its market economy has yet achieved. Tackling these issues is all the more urgent now because, although Ukraine continues to grow strongly and the scope for catch-up remains considerable, a number of the factors that have underpinned growth since 1999 have exhausted, or will soon exhaust, their potential.
Table 1. Basic economic indicators
Source: State Statistics Committee of Ukraine; National Bank of Ukraine; IMF; and IFS database.
Growth has been driven by domestic consumption and supported by rising terms of trade
In the initial phase of its recovery after a decade of contraction, Ukraine benefited from a sharp devaluation of the hryvnia and from the presence of substantial spare capacity. Throughout the period, Ukraine has also enjoyed comparatively low energy prices. Growth has been broad-based across sectors, with the largest contributions coming from services – the services share in total value added rose by 10 percentage points during 2000–05. On the demand side, growth since 2001 has been driven chiefly by booming private consumption, although the investment contribution has also been substantial. Rapidly growing household consumption has been supported by rapid increases in wages and social transfers, as well as spectacular growth in retail credit (Figure 1). Rising incomes have benefited the great mass of Ukrainian households, and both unemployment and poverty have fallen sharply since 1999. Demand growth was supported by a cumulative 17% increase in the terms of trade during 2002–06. This was primarily the result of strongly rising international prices for metals, which account for around 40% of exports. In 2006, metals price increases were sufficient even to offset the shock of a near-doubling of import prices for Russian natural gas.
Figure 1. Credit growth
Year-on-year
Source: National Bank of Ukraine.
Firms need to adapt to less favourable external conditions
Despite healthy productivity growth in manufacturing and steadily rising terms of trade, the non-mineral trade surplus has fallen rapidly in recent years. This is in part because Ukrainian industry has largely exhausted the post-crisis gains in labour-cost competitiveness. Productivity gains far outstripped wage growth in the first years of the recovery, thanks in large measure to widespread labour-shedding and more active restructuring, but wages have been rising rapidly in recent years and this gap has now closed. As a result, real appreciation in terms of unit labour costs has been much faster than CPI-based measures. A comparison of emerging economies with respect to dollar wage costs indicates that they have now reached a level in Ukraine that roughly mirrors the aggregate productivity of the economy (Figure 2).
Figure 2. Relative GDP per capita and the price/wage level
(2005, OECD=100)
1. Ratio of PPPs for gross domestic product to exchange rates.
Source: OECD; Russian Federal Service for State Statistics and State Statistics Committee of Ukraine.
Fiscal discipline has underpinned the recovery, but the level of fiscal pressure is too high
The maintenance of fiscal discipline since 1999 has been a major achievement; keeping debt low and deficits in check has helped restore confidence and support growth. However, the degree of fiscal pressure has risen markedly since 2003 and is now probably excessive. A sizeable and highly consumption-oriented shift in fiscal policy during 2004–05 pushed the expenditure-to-GDP ratio above 43%, mainly as a result of a near-trebling of the basic pension in real terms. In 2005, the government executed an impressive fiscal consolidation, chiefly via the elimination of tax privileges for firms rather than expenditure cuts. The net result of these shifts in policy was a large-scale transfer of resources from firms (with a higher propensity to save) to households (with a higher propensity to spend). Moreover, dramatic increases in pension benefits left the country with a pension expenditure-to-GDP ratio in excess of 14%, one of the highest in the world (Table 2). Given demographic trends, ensuring the long-term sustainability of the pension system is likely to be impossible unless current low retirement ages are adjusted upwards. The heavy burden of pension spending also limits the scope for reducing payroll taxes, which are exceptionally high and constitute a major incentive to under-report wages and salaries. The growth-impeding effect of Ukraine’s high tax burden is reinforced by the distortions created by the structure of taxation itself. Despite evident progress in simplifying the corporate and personal income taxes and reducing tax exemptions, there is still considerable room for improving both tax administration and the design of the tax system while broadening the tax base. The distortions created by the overly generous simplified tax system are particularly problematic.
Table 2. Balance sheet of the pension fund
(as a % of GDP)
Source: Ministry of Finance.
Reducing inflation should become the primary focus of monetary policy
A de facto nominal dollar peg remains the cornerstone of monetary policy. While this nominal anchor helped Ukraine achieve macroeconomic stability in the aftermath of the 1998 financial crisis, it is now contributing to increasing inflation volatility and the risks associated with growing dollarisation of households’ and firms’ assets and liabilities. The current exchange-rate regime, combined with more attractive interest rates on foreign currency loans, constitutes a particularly powerful incentive to borrow in dollars (Figure 1). Allowing the exchange rate to fluctuate more freely could make exchange-rate risks more apparent to agents and thus help to reduce dollarisation. Greater exchange-rate flexibility could also serve as the first step in a phased transition towards an inflation-targeting regime. Any transition to a new monetary policy framework will of necessity be gradual, given the under-development of financial markets (particularly the market for government securities), the relatively low level of monetisation and the consequent weakness of the interest-rate channel. Yet while the adoption of a fully fledged inflation-targeting regime must therefore take some time, the authorities could begin by making greater use of the exchange-rate channel, which appears to be relatively strong, to reduce the level and volatility of inflation. Macroeconomic conditions now appear to be broadly favourable for such a change.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. It summarises the OECD assessment. The complete edition of the OECD Economic assessment of Ukraine 2007 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the Ukraine Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Christian Gianella and William Tompson under the supervision of Andreas Wörgötter.
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