February 14, 2005 | Cbonds
|The Jan. 23, 2005, inauguration of President Viktor Yushchenko represents a key milestone in the development of Ukraine's (B+/Stable/B sovereign credit ratings) democracy. However, the recent political crisis revealed a nation split across ethnic, religious, and political lines. As a result, the Yushchenko government inherits a divided country. |
Mr. Yushchenko faces an uphill struggle to fight corruption and break apart the old business nexus as he takes on a Parliament and governmental machinery established and well oiled under the administration of former President Leonid Kuchma. Powerful vested interests and widespread political patronage constrained political and economic reform in Ukraine for years, and dissolving them will not be easy.
Any upward shift in Ukraine's creditworthiness will be a function of the newly elected government's policies and its governing effectiveness. The first months of any new administration are usually crucial in defining the political economy environment, the time when a newly elected government signals what approach it will take to deal with political and structural reform. It is also the time when internal (economic agents inside the country) and external (outside observers, including investors) constituencies ascertain their future expectations.
Mr. Yushchenko's appointees to the new government included Prime Minister Yulia Tymoshenko, who was approved on Feb. 5, 2005, with a record-breaking 373 votes by Ukraine's 450-seat Parliament. Parliament also approved the provision that the new government cannot be dismissed for one year. However, the new president also faces both constitutional reform that will limit the current extensive presidential powers (as early as Sept. 1, 2005 and no later than in January 2006) and parliamentary elections in March 2006. The reform makes future Ukrainian governments more accountable to the parliamentary majority than to the president. As a result, the 2006 parliamentary elections will be crucial to Ukraine's future, making it even more critical that political and institutional reform be implemented quickly and efficiently by the new administration.
Difficult Political and Institutional Reform
Standard & Poor's has consistently viewed Ukraine's weak institutional setting as a major constraint on the country's ratings. The challenges of industrial restructuring, corporate governance, and a weak payment culture throughout the economy are also important constraints on the ratings. Easing these constraints is one of the major challenges facing the current leadership.
Mr. Yushchenko's advocates transparency, rule of law, protection of property rights, and democratic values. His track record is very solid. During his tenure as prime minister (December 1999-April 2001) he managed to deregulate the economy, abolishing hundreds of decrees that granted over-generous tax exemptions, subsidies, or trade privileges (many of which have since been restored). He also privatized many big enterprises and carried out major land reform. Economic reform stalled following his removal from office, but did not reverse. Ukraine has benefited over the past two years from the fast-rising price steel, its main export, and from growing demand for industrial machinery imports from Russia. As a result, the economy that contracted precipitously during the 1990s grew at record rates during 2000-2004.
The shift toward greater transparency and institutional reform after years of pervasive corruption and lawlessness will not be easy, as improving the institutional setting—in particular, the judiciary—will be a lengthy and cumbersome process. Given the polarization of Ukraine's Parliament (despite its recent strong accord on approving the prime minister), the new Yushchenko Administration will have its hands full harnessing legislative support to strengthen the legal environment, further restructure the economy, create a more democratic and civil society, and prepare Ukraine for eventual European Union membership. As mentioned above, the new president also faces constitutional reform that will limit current extensive presidential powers by making future Ukrainian governments more accountable to the parliamentary majority rather than to the president.
The recent very high economic growth in Ukraine will not be sustainable without serious political, institutional, and structural reform. An independent and efficient judiciary, together with improved institutional capacity to manage the relationship between government and the private sector and between corporations and individuals, are necessary reform that the new leadership must push ahead in order to transform Ukraine into a country with an open democratic political system and a market-based economy.
The commitment of the new leadership is strong, and the support of the electorate—as demonstrated during November 2004-December 2004—is expected to provide important backing as work begins on the Ukraine's transformation. The new government is very proreform, and both Mr. Yushchenko and Ms. Tymoshenko promise to depoliticize business and ensure that the issue of a West-East division of Ukraine is addressed.
The way the new government tackles the differences between and division among the population could be crucial its success, given that the majority of the electorate in the East did not vote for Mr. Yushchenko. His visit to Moscow the day after his inauguration indicates the sensitivity of Ukraine's relationship with Russia and the need for careful management. The revision of numerous privatization deals made over the last several years, as promised by Mr. Yushchenko during the campaign, could also be politically sensitive.
Monetary and Fiscal Policies
The timely and adequate policy responses needed too maintain monetary and fiscal stability are also important for Ukraine's creditworthiness in the near future. The current administration inherited an overheated economy with rising inflationary pressures and a growing fiscal deficit. Inflation as measured by CPI increased to over 12% at year-end 2004, up from 8% one year earlier and an average 5.2% in 2003. While supply-side factors and high oil prices contributed significantly to rising inflation in 2004, the National Bank of Ukraine (NBU) and the government also played a part. NBU's substantial intervention in the exchange-rate markets to prevent the Ukrainian hryvnia from appreciating injected excessive liquidity into the banking system. The November 2004-January 2005 political crisis increased inflationary expectations, especially since the previous government tried to hold prices down before the elections by freezing administrative prices and increasing spending. It will therefore take time to push down inflationary expectations (although inflation slowed to below 2% in January 2005 from a high of 2.4% in December 2004).
Fiscal preelection relaxation (including doubling of the low minimum pension) during the second half of 2004 led to a fast-growing fiscal deficit in 2004. The consolidated budget (i.e., including national and local governments) deficit in 2004 increased to an estimated almost 4% of GDP, up from 0.7% in 2003. The 2005 consolidated budget, adopted by the previous government, envisages some tightening and a deficit of 2.2% of GDP. This deficit does not include interbudgetary transfers to the social security system; including this would result in a general government deficit even higher than that recommended by the International Monetary Fund. The quality of the budget is poor, as it was approved at the height of political crisis, and the new government is expected to institute some significant changes to it in March 2005. The amended budget would have to address the serious preelection loosening of fiscal policy, which Ukraine can hardly afford.
Looking ahead, expeditious political and economic transformation, combined with more decisive fiscal adjustment and more substantial foreign investment inflows, would underpin a more favorable ratings outlook. Ukraine's future creditworthiness depends upon the advancement of the reform agenda, in particular the introduction of legal and procedural reform that would restore the economy's payment culture. Although many challenges lie ahead, Mr. Yushchenko has the proven track record to advance meaningful reform.