Ukraine’s Economic Convergence with Europe

1. Ukraine’s Economic Convergence with Europe Anders Åslund Senior Fellow Peterson Institute for International Economics, Washington, DC Adam Smith Institute Ukrainian Investment Summit London, March 10-12, 2008

2. ISSUES • High growth to continue • Decent macro • Current challenges

3. A Dynamic Market Economy since 2000 • Critical mass of market reforms and privatization • 7.4% GDP growth a year • Conservative macro policy • Problem: Few reforms because of messy politics

4. Steady Economic Growth Source: Dragon Capital, Feb 2008.

5. Revaluation of Ukraine • Ukraine’s GDP was artificially depressed in the transition • As other transition countries, Ukraine is going through a revaluation

6. Economic Growth in USD • In USD, Ukraine’s GDP grew by 24% a year, 2000-2007 • GDP rose from $31 in 2000 to $138 billion in 2007

7. 24% a year GDP Growth! Source: Dragon Capital, Feb 2008.

8. Solid Industrial Growth9.8% a year Source: Dragon Capital, Feb 2008.

9. GDP per Capita:$633 - 1999; $2,995 - 2007 Source: IMF World Economic Outlook database, April 2007

10. Ukraine Versus Euroland • In 1999, Ukraine’s GDP per capita was 2.8% of the Euro level in current prices • In 2007, Ukraine’s GDP per capita had tripled to 7.9 percent of the Euro level • Likely to double again in four years

11. Compare with Russia • In 1989, Ukraine’s GDP per capita was 10% higher than Russia’s • Today, it is 34% of Russia’s – sheer anomaly In 10 years, Ukraine’s GDP per capita should rise more than Russia’s

12. Ukraine’s GDP Growth in US$ Follows Russia’s Source: Dragon Capital, Feb 2008; UBS, Russia & CIS Daily News, April 4, 2007, JPMorgan

13. Compare with Russia (2) • Goldman Sachs: Russia’s GDP should rise by 131% in a decade. • Then, Ukraine’s GDP in US$ should increase more than 3 times in a decade!

14. Average $ Wage in Ukraine: Half of Russia’s. Why Produce in Russia? Source: BOFIT Russia statistics; Eurostat; Dragon Capital, March 2007; State Statistics Committee of Ukraine.

15. Growth Drivers • Re-monetization • 66% of Ukrainian youth go to university – more than in the EU. • Investment substantial: 24% of GDP • FDI very promising: 6% of GDP • Structural normalization

16. Money Supply Can Expand Substantially Source: EBRD Transition Reports 2007, 2004; Eurostat.

17. University Education More than in the EU, 1991 and 2004 Source: UNESCO statistical database, 2007.

18. Sound Capital Investment, 2006 Source: UN Economic Commission for Europe database.

19. Investments Grow by about 20% a Year Source: Dragon Capital, Feb 2008.

20. Foreign Direct Investment: Very Promising: 6% of GDP Source: Dragon Capital, Feb 2008.

21. Restructuring Has Gone Far • Reasonable de-industrialization • Agriculture: Too large • Services: Still too small 8% of GDP should move from agriculture to services

22. Sound Macro But Inflation Worries • Budget deficit 1-2% of GDP • Public debt 12% of GDP • Current account balance: deteriorating but reassuring • Sufficient international reserves • But Inflation rose to 16.6% 2007

23. Budget Deficit Under Control Source: Dragon Capital, Feb 2008.

24. Public Debt Minimal & Falling Source: Dragon Capital, Feb 2008.

25. Current Account: Deteriorating But Reassuring Source: Dragon Capital, Feb 2008.

26. International Reserves: Sufficient: 5.6 months imports Source: Dragon Capital, Feb 2008.

27. Inflation: Temporary Spike? Source: Dragon Capital, Feb 2008.

28. Causes of Rising Inflation • US dollar peg • Loose monetary policy • Large capital inflows • International food & energy price rises

29. InflationCure • Tighten budget: Done • Abandon US dollar peg (leads to appreciation) • Move to inflation targeting • Raise interest rates • Deregulate more

30. Challenges of the New Government

31. Successful West-orientation of Foreign Policy • WTO accession, signed on February 5, could boost Ukraine’s growth by 1-2 % a year • Free Trade Agreement with EU likely to be concluded before the end of 2008 • Applied for Membership Action Plan (MAP) with NATO firm • Ukraine can resolve all trade disputes with Russia in its WTO accession

32. Fight against Corruption • Targeting corruption in gas trade by eliminating of RosUkrEnergo intermediary • Personnel changes in the tax administration partly resolved corruption with VAT refunds • Personnel changes in customs is likely to repeat success of 2005

33. Economic Concerns • Little legislative activity • High tax pressure • Severe corruption persists But Ukraine suffers little from Western slowdown

34. Reform Challenge:Much Legislation Needed • A Law on Joint Stock Companies to protect minority shareholders • The land privatization moratorium has lapsed but legislation for land trade is missing. • Adopt a Ukrainian Tax Code • Unify social taxes • Unify tax collection • Abolish the Economic Code and improve the Civil Code

35. Social Reforms: Badly Needed • Education: • independent testing, • independence of universities, • acknowledge international (Bologna) standards • Health Care: • Introduce national medical insurance, • Decentralize financing, • Focus on primary health care

36. Excessive Tax Burden • Ukraine’s tax revenues 43% of GDP in 2006 – West European level • High tax burden limits growth

37. Tax BurdenMust Come Down Source: EBRD Transition Report 2007.

38. Severe Corruption,But Improving Source: Transparency International (2007).

39. Ukraine’s Saving Grace:Democracy – But Frail Source: Freedom House

40. A Few Political Comments • All three major parties are center-right parties • Big businessmen behind all parties • Uniquely broad consensus • Corruption is the main problem: unstable governments preferable

41. Conclusions: Good • Macro & growth hold • Ukraine is turning West • Reforms may speed up • European convergence whatever happens