Economic forecast 2006–2007

Current situation

2005—the year of GDP growth slowed way down

Over the period of the economic upswing that began in Ukraine in 2000, 2005 has proved to be the year of slowest economic growth. According to ICPS estimates, GDP grew 2.5% in 2005. Despite continued rapid growth of consumption, investment in the country’s economy shrank. This decline in investment was driven by deep cuts in public investment. The lack of public resources for capital investment was the result of the new Administration’s socially-oriented policies.

According to ICPS estimates, the balance of trade fell to US $118mn in 2005, after a record-high US $4.9bn in 2004. In 2005, imports of goods grew almost as fast as during the previous year, whereas exports slowed down from 41.6% growth in 2004 to 6% in 2005. In August 2005, for the first time since 1999, the balance of trade in goods became negative. However, given the National Bank of Ukraine’s high gold and currency reserves, this negative balance does not pose a threat to the country’s macroeconomic stability at present. The main factor behind slow growth of exports was a drop in global prices for the steel products that are the main component of Ukrainian exports. Rapid growth of imports was primarily the result of rapid growth in disposable incomes.

Agriculture and the processing industries slowed down significantly. Slow growth in agriculture is the result of its high dependence on two crops, grain and potato, which causes indicators fluctuate wildly every year. Slow growth in processing industries was primarily the result of a decline in metalworking due to an unfavorable situation with prices on global markets and shrinking domestic oil refining after import duty for petroleum products was reduced and oil supplies to Ukrainian refineries shrank.

According to ICPS estimates, gross value-added in trade shrank 9% compared to 2004. ICPS economists say the key factor behind this decline was the collapse of shadow and fictitious brokering schemes in wholesale trade that accounted for a significant share of trade growth throughout 2003–2004.

Although the new government committed many mistakes that contributed little to the country’s economic growth, ICPS economists do not think that the steep economic slowdown is mainly the result of failed policies in 2005. Instead, ICPS experts are convinced that the foundation for sustainable economic development was not laid during the previous years. According to ICPS economists, slower economic growth was the result of three long-term factors:

Weak investment. Average growth of gross fixed investment was 7.2% over 1998–2004. During this period, investment was mainly channeled to upgrade capacities from soviet times. The volume of investment in the creation of new companies and innovative technologies was minor. More than half of all capital investment involved company funds, which, given weak financial indicators for domestic businesses, could not be a sustainable, multi-year source of investment. As a rule, public investment was distributed opaquely and priority of government policy goals were not identified in advance. A low level of capitalization among domestic banks, limited access of foreign banks to the Ukrainian market, and high risks of bad debt hampered the development of commercial lending. A high level of corruption in the public sector, difficult access to the Ukrainian market, the lack of a transparent and level playing field for doing business scared foreign business away from investing in Ukraine.

The lack of reforms. Despite the urgent need for reforms and regular calls to reforms by various political forces, large-scale systemic transformations have not gotten going in Ukraine. Urgent reforms are needed in the social security system, the infrastructure sector (residential services, communications and transport) and the judiciary. Every year, delays in starting transformations in the social security system have resulted in inefficient use of public resources, while the government’s inability to ensure appropriate social security has served as an excuse for taxpayers to avoid paying taxes in full. Ukraine’s residential services sector continues to be unprofitable, while the refusal of consumers to pay for poor quality services has only deepened the crisis in this sector. Ukraine’s backward provision of telecommunication services and its underdeveloped transport sector hinder commercial development and raise the costs of doing business. This, in turn, makes companies less competitive. The high level of corruption in the Ukrainian court system also raises the cost of doing business and hampers investment.

Economic dependence on external factors. Over the past five years, the country’s economic upswing was largely the result of growing exports of metal products. This high dependence on exports and the dependence of these exports on one type of product made the Ukrainian economy hostage to the pricing situation on global markets. Indeed, when metal prices began to slip, the economy revealed its lack of preparedness. The prolonged economic boom relieved successive Governments of the need to look for new drivers of economic growth and to implement policies that would facilitate structural changes in the economy. The low price of gas and other fuels did little to provide incentives for company owners and managers to invest in upgrading technologies and led to the high gas exposure of Ukrainian economy. Steep gas price rises will make products manufactured by such companies uncompetitive. 

Updated

January 9, 2006

Contents

	Overview
	Current situation
	Forecast for 2006–2007
	Forecast risks
	Highlights of the latest Quarterly Predictions

Contact person

Yevhenia Akhtyrko
Chief Economist
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phone: (380-44) 484-4403