Ukraine Ukraine at a Glance: 2002-03

COUNTRY REPORT

Ukraine Ukraine at a glance: 2002-03

OVERVIEW Efforts by both pro- and anti-presidential forces to gain the upper hand in the parliamentary election due by March 2002 will increasingly dominate the political scene. The president, Leonid Kuchma, and his parliamentary allies are likely to succeed in using their superior administrative and media resources to limit the gains of their opponents. The government will remain in power until the 2002 election and is unlikely to roll back its predecessor’s reform achievements, although electoral politics will preclude further significant reforms. The economy will grow at a more moderate pace in 2002-03, following buoyant growth in 2001. Year-end inflation will rise slightly to 12% in 2002, owing to further price liberalisation and election- related policy loosening, before falling again in 2003. Sustained export growth will ensure current-account surpluses in 2002-03, although these will narrow because of strengthening import demand and continued real currency appreciation. Key changes from last month Political outlook • The former prime minister Viktor Yushchenko looks increasingly likely to try to build an alliance for the 2002 election that is more centre- than reform-based. Economic policy outlook • Multilateral financing has resumed as expected, and should now permit completion of Ukraine’s Paris Club debts. The narrowing of the budget surplus in August underlines the Economist Intelligence Unit’s forecast that the government is likely to end the year with a slight budget deficit. Economic forecast • Preliminary trade data for the start of the third quarter has prompted a slight revision in our trade surplus forecast for this year. We now expect a current-account surplus of 4.6% of GDP in 2001. Continued deflation in August will permit even greater disinflation in 2001 than originally expected and we now anticipate an end-year inflation rate of 8.5%.

October 2001

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ISSN 1356-4129

Symbols for tables “n/a” means not available; “–” means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK. Ukraine 1

Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2002-03 7 Political outlook 9 Economic policy outlook 10 Economic forecast

14 The political scene

17 Economic policy

22 The domestic economy 22 Output and demand 24 Employment, wages and prices 26 Financial indicators 27 Sectoral trends

30 Foreign trade and payments

List of tables

10 International assumptions summary 11 Gross domestic product by expenditure 13 Forecast summary 19 Consolidated government budget 19 2002 consolidated budget proposal 22 Main economic policy indicators 23 Major indicators, 2001 24 Cumulative inflation, Jan-Aug 26 Banking sector indicators, May 2001 27 Industrial output, 2001 27 Manufacturing output, Jan-Aug 2001 28 Subsectoral contribution to industrial growth, Jan-Aug 2001 28 Crude steel output 29 Agricultural output, Jan-Aug 29 Main macroeconomic indicators 31 Merchandise trade, Jan-Jul 31 Composition of trade, Jan-Jun 2001

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32 Direction of merchandise trade, 2001 33 Balance of payments 34 Main external indicators

List of figures

13 Gross domestic product 13 Exchange rates 19 Consolidated budget balance 23 Real GDP 24 Consumer prices 25 Arrears 26 Exchange rate

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Summary

October 2001

Outlook for 2002-03 Extensive political manoeuvring related to the March 2002 parliamentary election will dominate the political scene until mid-2002. Although the new parliament is unlikely to include a solid anti-presidential majority, the position of the president, Leonid Kuchma, will remain less than secure in 2002-03, prompting him to undertake additional efforts to prevent his removal. This will preclude an improvement in political efficacy and hamper political reforms. Economic growth will ease in 2002-03 but remain at around 4% of GDP or above. Relatively sound fiscal and monetary policy will prevent a return to significantly higher inflation and will support the stability of the currency. Stronger import growth will reduce the size of the current-account surplus.

Economic policy The IMF has agreed to resume its stalled lending programme. The government recorded a narrow surplus on the state budget over the first eight months of 2001 despite lower than targeted privatisation revenue inflows. The government’s 2002 budget, which proposes a consolidated budget deficit target of 1.7% of GDP, is before parliament; for the first time it does not count privatisation proceeds as revenue. As shown by the delays in the sales of telecommunications and electricity utilities in 2001, the government’s privatisation targets have proved notoriously unreliable.

The domestic economy Ukraine’s real GDP increased by 10.8% year on year between January and August 2001, fuelled by a broadly based 16.9% increase in industrial production. Year-on-year agricultural output growth jumped sharply in July as a result of a bumper grain harvest. The nominal appreciation of the hryvnya has accelerated because of high levels of foreign-currency inflows. Deflation in July and August brought total consumer price inflation since the start of the year down to 3.3%. The strength of Ukraine’s economic recovery has brought a sharp rise in real wages, a drop in official unemployment and increased bank lending. Never- theless, wages and living standards remain low in absolute terms.

Foreign trade and Ukraine’s foreign trade surplus equalled US$728m over the first eight months payments of 2001, compared with a deficit of US$162m recorded during the year-earlier period. In contrast with 2000 the sharp rise in exports in 2001 has not depended on rapidly rising steel sales. Import growth has remained subdued, primarily because of a fall in energy import expenditure. The current-account surplus reached US$845m over the first half of 2001, up from US$292m over the first half of 2000. Ukraine’s strong external position has allowed reserves to return to a level seen before the 1998 crisis. Efforts to restructure Paris Club debts are nearly complete.

Editors: Stuart Hensel (editor); Fiona Mullen (consulting editor) Editorial closing date: October 3rd 2001 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

EIU Country Report October 2001 © The Economist Intelligence Unit Limited 2001 4 Ukraine

Political structure

Official name Ukraine

Legal system A new constitution was approved by the Verkhovna Rada (Supreme Council— parliament) on June 28th 1996

National legislature Verkhovna Rada, a unicameral assembly of 450 deputies

National elections March 29th 1998 (parliamentary); October 31st and November 14th 1999 (presidential); the next parliamentary election is scheduled for March 31st 2002

Head of state President, currently Leonid Kuchma, elected with 56% of the popular vote in November 1999; next presidential election due by 2004.

National government Led by the prime minister, currently Anatoly Kinakh, appointed in May 2001

Main political factions Democratic Union (24 seats), Motherland (26), United Social Democratic Party of in parliament Ukraine (36), People’s Democratic Party (16), Ukrainian People’s Movement (22), Socialist Party (16), Green Party of Ukraine (17), People’s Movement of Ukraine (14), Reform-Congress (15), Yabluko (15), Communist Party of Ukraine (113), Solidarity (21), Labour Ukraine (46), Ukraine’s Regions (20)

Cabinet of Ministers Prime minister Anatoly Kinakh (State Council) First deputy prime minister Oleh Dubyna Deputy prime minister for agrarian policy Leonid Kozachenko Deputy prime minister for humanitarian policy Volodymyr Semynozhenko Deputy prime minister for the economy Vasyl Rohovy

Key ministers Agricultural policy Ivan Kyrylenko Defence Oleksandr Kuzmuk Economy and European integration Oleksandr Shlapak Education Vasyl Kremen Finance Ihor Mityukov Foreign affairs Anatoly Zlenko Fuel & energy Stanislav Stashevsky Health Vitaly Moskalenko Interior Yuri Smirnov Justice Syuzanna Stanik Labour Ivan Sakhan Transport Valery Pustovoitenko

Chairman of parliament Ivan Plyushch

Central bank governor Volodymyr Stelmakh

State Property Fund chairman Oleksandr Bondar

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Economic structure

Annual indicators

1996 1997 1998 1999 2000 GDP at market prices (HRN bn) 81.5 93.4 102.6 127.1 173.0 GDP at market exchange rates (US$ bn) 44.6 50.2 41.9 30.8 31.8 GDP at purchasing power parityab (US$ bn) 107.2 106.0 105.3 106.6 115.0 Real GDP growth (%) –10.0 –3.0 –1.9 –0.2 5.8 Consumer price inflation (%; av) 80.3 15.9 10.6 22.7 28.2 Consolidated budget balance (% of GDP) –4.4 –6.6 –2.0 –1.2 1.1 Population (m; mid-year) 51.3 50.9 50.5 50.7 50.3a Exports of goods (US$ m) 15,547 15,418 13,699 13,189 15,722 Imports of goods (US$ m) 19,843 19,623 16,283 12,945 14,943 Current-account balance (US$ m) –1,184 –1,335 –1,296 1,658 1,481 Reserves excl gold (US$ m) 1,960 2,341 761 1,046 1,353 Exchange ratec (HRN:US$; av) 1.830 1.862 2.450 4.130 5.440

September 29th 2001 HRN5.3311:US$1

Origin of gross domestic product 1999 % of total Components of gross domestic product 1999 % of total Agriculture & forestry 11.3 Private consumption 60.1 Industry 28.1 Public consumption 19.0 Construction 4.4 Net fixed investment 19.9 Transportation 11.2 Increase in stocks –0.1 Trade & services 30.6 Net exports 1.1 Total incl others 100.0 Total 100.0

Principal exports 2000 % of total Principal imports 2000 % of total Non-precious metals 41.1 Fuel & energy, incl ores 43.0 Chemicals 12.2 Machinery & equipment 17.6 Machinery & equipment 11.8 Chemicals 11.0 Food, beverages & agricultural products 8.8 Food, beverages & agricultural products 6.1

Main destinations of exports 2000 % of total Main origins of imports 2000 % of total Russia 24.1 Russia 41.7 Turkey 6.0 Germany 8.1 Germany 5.1 Turkmenistan 6.8 Italy 4.4 US 2.6 a EIU estimates. b Extrapolated from 1997 World Bank data. c The hryvnya replaced the karbovanets on September 2nd 1996 at the rate of Krb100,000:HRN1.

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Quarterly indicators

1999 2000 2001 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Consolidated government finance (HRN m) Revenue 11,928 13,124 11,889 14,668 16,644 19,833 16,042 17,560 Expenditure 12,275 13,848 10,867 15,054 15,533 19,594 14,559 17,193 Balance –347 –724 1,022 –386 1,111 239 1,483 367 Output Real GDP % change, year on yeara –1.7 –0.2 5.5 5.0 5.2 6.0 7.7 9.1 Industrial production indexb (1990=100) 44.0 43.2 44.0 45.3 48.2 48.8 49.1 52.2 % change, year on year 7.6 6.9 6.5 7.6 9.5 13.0 11.6 15.2 Employment, wages and prices Employment, industry (‘000) 3,064 4,124 3,497 3,729 3,483 4,530 3,303 3,273 % change, year on year –16.7 14.6 –5.3 3.6 13.7 9.8 –5.6 –12.2 Unemployment rate (% of the labour force) 5.27 5.40 5.63 5.39 5.28 5.31 5.00 4.58 Average nominal monthly gross wages (HRN) 183.5 198.7 194.1 215.8 245.0 269.3 266.0 303.2 % change, year on year 17.5 22.2 24.7 25.6 33.5 35.5 37.1 40.5 Consumer prices (1995=100) 284.0 300.4 335.1 358.3 372.4 387.2 400.1 410.4 % change, year on year 26.0 18.6 25.1 27.4 31.1 28.9 19.4 14.5 Producer prices, industrial (1995=100) 248.0 257.7 275.9 290.1 299.1 310.3 319.0 319.4 % change, year on year 37.5 17.3 19.9 22.5 20.6 20.4 15.6 10.1 Financial indicators Exchange rate HRN:US$ (av) 4.31 4.72 5.46 5.42 5.44 5.44 5.43 5.41 HRN:US$ (end-period) 4.47 5.22 5.43 5.44 5.44 5.43 5.42 5.38 Interest rates (%; av) Deposit 17.8 20.8 17.3 11.9 13.1 12.6 9.8 11.0 Lending 50.5 52.5 49.4 40.5 38.1 38.2 35.6 32.3 Money market 45.7 63.2 23.5 9.7 21.0 19.2 5.9 21.4 M1 (HRN bn; end-period) 13,245 14,082 14,650 17,064 17,974 20,710 21,087 23,761 % change, year on year 45.9 36.4 44.4 39.8 35.7 47.1 43.9 39.2 M2 (HRN bn; end-period) 19,985 21,657 23,251 26,324 27,979 31,273 32,171 36,188 % change, year on year 41.9 41.3 49.4 44.4 40.0 44.4 38.4 37.5 PFTS Stockmarket index ( Oct 1st 1997=100; end-period) 29.1 39.1 58.7 61.8 57.9 55.5 58.5 49.5 Foreign trade (US$ m) Exports fob 2,922 3,331 3,021 3,287 4,002 4,271 3,799 4,210 Imports cif –2,939 –3,414 –3,698 –3,021 –3,197 –3,953 –3,561 –3,857 Trade balance –17 –84 –677 266 806 222 239 354 Balance of payments (US$ m) Merchandise trade balance fob-fob 231 –458 –388 285 724 158 157 n/a Services balance 241 415 355 158 98 16 39 n/a Income balance –250 –148 –365 –219 –174 –184 –169 n/a Net transfer payments 192 195 241 225 253 298 251 n/a Current-account balance 414 4 –157 449 901 288 278 n/a Reserves excl gold (end-period) 1,332 1,046 941 812 825 1,353 1,396 1,396 a Calculated on cumulative basis from beginning of each year. b Seasonally adjusted. Sources: Ukrainian Economic Trends; IMF, International Financial Statistics; Ukrainian Economic Monitor; Ministry of Economy; Standard & Poor’s, Emerging Stock Markets Review.

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Outlook for 2002-03

Political outlook

Domestic politics Extensive political manoeuvring both before and after the 2002 parliamentary election will dominate the political scene during the first part of the forecast period. The vigour with which the different political forces have already begun to jockey for position hints at the scale of the stakes involved. The presidential administration and its allies will successfully mobilise their media and administrative resources to ensure that no solid anti-presidential majority emerges in the next parliament. However, in so doing they will hamper legislative efficacy and bring further political polarisation—without actually providing the president, Leonid Kuchma, with the secure position he needs to recover fully from the serious allegations of wrongdoing that paralysed his administration earlier in 2001. As a result, Mr Kuchma will remain vulnerable to further damaging charges, and, over the second half of the forecast period, he will continue to face a sizeable parliamentary opposition intent on ousting him from office.

The presidential administration’s lingering vulnerability underlines the con- tinuing risk of political instability and reduces the likelihood that a more effective or transparent political system will emerge before the end of the forecast period. Mr Kuchma will remain a compromised and unpopular president who is unable to shake completely the allegations that surfaced in late 2000. According to his critics, these link him to serious abuses of presidential power, and possibly the murder of an opposition journalist. Mr Kuchma’s rhetoric, which generally lacks any concrete forward-looking strategy, suggests that he will be forced therefore to focus on shoring up his reputation and securing his own political survival, rather than on pushing towards clearly defined programmatic goals. In particular, he recognises that his political survival hinges on his ability to preserve a delicate balance between competing domestic interests and on preventing any individual groups or potential rivals from amassing sufficient power to threaten his administration. This strategy has served him well in recent months, but, since it depends on heavy-handed, unpredictable and divisive tactics, it represents a suboptimal foundation for political stability, and so will continue to prevent Ukraine from developing a more effective and stable political system.

The success of Mr Kuchma’s survival strategy will also depend to a considerable degree on the outcome of the 2002 parliamentary election. On balance, it appears probable that Mr Kuchma will succeed in preventing a concertedly hostile majority from forming in the next parliament. Even though pro- Kuchma forces will fail to secure a majority of their own, they will at least be able to count on a divided anti-Kuchma opposition and on the existence of a sizeable (but malleable) core of left-wing deputies willing to block attacks on the president. More specific electoral forecasts are difficult to make at this early stage, as the party political scene remains in a state of flux. In broad terms, voters will face a choice between the Communist Party of Ukraine (CPU), centrist pro-presidential groups closely linked to oligarchic business interests,

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and a handful of anti-presidential or anti-oligarchic groups on both the left and the right of the political spectrum. However, even this choice will be blurred by opportunistic alliances that cut across traditional divisions. The major oligarchic business interests will strengthen their position in parliament through the use of their considerable media and administrative resources, but will not coalesce as a united bloc either before or after the election. Mr Kuchma’s most vocal critics—Yulia Tymoshenko, a former deputy prime minister, and Oleksandr Moroz. the head of the Socialist Party—will also fail to win control of parliament, particularly as they will have access to far fewer resources during the election campaign and will face intense pressure from pro- presidential media outlets. Right-wing forces seem set to improve on their election results of 1998, but will also need to overcome their more limited financial and administrative resources.

The success of the political right will depend to a considerable extent on Viktor Yushchenko—the popular former prime minister who represents the greatest potential threat to Ukraine’s present political establishment. However, Mr Yushchenko has yet to dispel concerns over his ability to build a successful electoral coalition and is increasingly unlikely to confront openly the powerful oligarchic groups that dominate Ukraine’s political centre. Instead, he is likely to seek a broad base of support, which could include reaching out to groups connected to the oligarchs. This would permit him to emerge as an important force in the next parliament. However, it would diminish the probability of a solidly reformist parliamentary majority forming during the forecast period, and would increase the likelihood that Mr Kuchma and his allies will successfully prevent a strong anti-Kuchma majority from coalescing in 2002.

This outcome is crucial to Mr Kuchma if he is to retain any hope of putting the risk of impeachment behind him or of passing the constitutional amendments needed to strengthen presidential powers. However, even if the administration prevents anti-Kuchma factions from emerging as the strongest force in parliament in 2002, its hold on power is by no means assured. There is a risk that some of the oligarchs might finally withdraw their support from Mr Kuchma, thereby increasing the likelihood of a successful impeachment of the president by anti-Kuchma factions, or at least scuppering any possibility of a further increase in presidential powers. As only a considerable extension of these powers could provide Mr Kuchma with the political security that he seeks, this might force him to begin planning an early exit strategy similar to the one used by Boris Yeltsin when he transferred the Russian presidency to Vladimir Putin.

International relations Mr Kuchma’s failure over the first half of 2001 to satisfy demands for a transparent investigation into possible abuses of power by his administration damaged his relations with the West and forced him to rely increasingly on the support of Mr Putin’s administration in Russia. Since then, however, Western governments and multilateral institutions have gradually reaffirmed their interest in strengthening ties with the country. Despite frequent setbacks, these ties will continue to deepen in 2002-03. Russia’s effort to extend its influence will also increase over the forecast period, as Mr Putin reasserts Russia’s economic and political role in former Soviet republics. However, Mr Kuchma is

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unlikely to acquiesce entirely to Russian demands for greater sway, and will continue to support pro-European rhetoric, as well as efforts towards integration with the West. He is conscious of Ukraine’s divided polity and of a vocal anti-Russian lobby, and recognises the potential for using Western fears of closer links between Ukraine and Russia to secure valuable concessions and support from Western governments.

Economic policy outlook

Policy trends Neither the current government nor its successor following the 2002 parliamentary election are expected to backtrack significantly on the previous government’s reform achievements. Since its appointment in May the new cabinet, headed by the prime minister, Anatoly Kinakh, has retained the majority of the ministers and policies of its predecessor. Nevertheless, the formation of a government led by Mr Kinakh, a high-profile industrial lobbyist with uncertain parliamentary support, suggests little hope for any acceleration of institutional and structural reforms. Instead, electoral considerations and the presidential administration’s sense of self-preservation will dominate economic policy formulation until mid-2002, and no strongly reformist cabinet is expected to be appointed over the remainder of the forecast period.

This will bring only minimal progress towards increasing the transparency and speed of restructuring in the energy sector, or in dismantling exemptions and privileges for favoured industries. The pace of tax and regulatory reform will also be slow. Similarly, privatisation delays will persist as a result of the weak authority of the State Property Fund (SPF) and a non-transparent sales process. Nevertheless, the drive to meet the standards of the World Trade Organisation (WTO) and to fulfil multilateral conditions, combined with a widening acceptance of the need for reform, will slowly help to create a more stable and predictable trade and business environment, and to encourage modest growth in foreign direct investment (FDI).

Fiscal policy Combined with higher than expected economic growth, the fiscal reforms introduced in 2000 should produce a near-balanced consolidated budget in 2001. The government is expected to exceed only slightly its consolidated budget deficit target of 1.7% of GDP in 2002, as improvements in tax administration will offset, at least partially, an election-related loosening in fiscal policy and below-target economic growth. Budget implementation in 2002 will benefit from new methodology that counts privatisation proceeds— which had in the past often proved to be overoptimistic—as financing rather than revenue.

In the first half of 2001 the government recorded a surplus on the consolidated budget (including the pension fund) equal to 2% of GDP. However, the government remains overly dependent on privatisation proceeds to achieve its goal of balancing the budget, and is almost certain to fall a long way short of its HRN5.9bn (US$1.1bn) privatisation target for 2001—especially following the delay of major sales in the telecommunications and electricity sectors. Since there is little scope for reducing the number of tax exemptions in

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advance of the election, a shortfall in the privatisation revenue will increase the risk of expenditure sequestration or a build-up in expenditure arrears. There is therefore little chance of further fiscal consolidation, or of a new tax code being passed before the 2002 election. However, the government is unlikely to roll back the notable fiscal improvements made since 1999, which included a sharp increase in cash payments to the budget.

Economic forecast

International assumptions summary (% unless otherwise indicated) 2000 2001 2002 2003 Real GDP growth World 4.7 2.4 3.5 4.1 Russia 8.3 4.5 3.8 3.5 EU 3.4 1.8 2.4 2.5 Exchange rates (av) ¥:US$ 107.8 121.5 123.5 120.0 US$:¤ 0.924 0.901 0.968 1.015 US$:SDR 1.32 1.28 1.31 1.33 Financial indicators ¤ 3-month interbank rate 4.48 4.45 4.35 4.65 US$ 3-month commercial paper rate 6.32 3.79 3.75 6.00 Commodity prices Oil (Brent; US$/b) 28.5 27.0 26.2 24.6 Gold (US$/troy oz) 279.3 269.1 255.0 250.0 Food, feedstuffs & beverages (% change in US$ terms) –6.1 0.8 14.1 10.9 Industrial raw materials (% change in US$ terms) 13.4 –6.9 3.3 12.2

Regional aggregate GDP growth rates weighted using purchasing power parity exchange rates.

International assumptions World economic growth has decelerated rapidly in 2001, dragged down by a US economy that is close to recession. The Economist Intelligence Unit expects growth in the euro zone in 2001 to slow almost as sharply as in the US, and we also think that the Russian economy will also grow at a much slower pace than in 2000—although Russian import demand should nevertheless remain robust. A recovery of the world economy is expected to begin in early 2002, but rates of growth will go up only gradually in 2002-03. In the aftermath of the terrorist attacks on the US, world growth will dampen in 2002, forcing us to revise down our earlier forecast. Although the attacks will also increase the risks to our forecasts, the slowdown is unlikely to be much steeper than we currently expect.

Oil prices are expected to moderate over the forecast period, but they will remain well above average 1999 levels and will bring high import costs as a result. The price trend for most major Ukrainian exports is generally positive. The one important exception is in the steel sector—which accounts for a substantial share of Ukraine’s exports—since there will be only a gradual recovery in world steel prices. The primary risk to our international assumptions is that the US enters a prolonged recession. This would depress EU and

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Russian growth even further than is currently anticipated, and prompt a retrenchment of the private sector that could jeopardise Ukraine’s investment inflows. Although this would produce an even greater than expected slump in steel prices, it would also bring a sharper slump in oil prices, thus easing Ukraine’s import costs.

Economic growth Ukraine’s robust economic recovery brought annualised real GDP growth of around 10.8% over the first eight months of 2001. Owing to base-year effects and weaker external demand, economic growth will decelerate over the remainder of the forecast period. However, it should still equal around 9% in 2001 and 4-5% annually in 2002-03. This will reflect continued price and currency stability and rising domestic demand.

Although the slow pace of economic restructuring and the weakening external environment pose a risk to the sustainability of Ukraine’s recovery, economic expansion over the past year has not been as narrowly based as was previously feared. Even though Ukraine’s reliance on steel production remains a cause for concern, higher value-added sectors such as food-processing and machine- building will continue to be strong contributors to growth. Similarly, strong consumption and investment demand will help to mitigate a relatively weak external environment. Nevertheless, inadequate structural reforms and the political system’s inefficacy will constrain growth by limiting the FDI inflows and new domestic capital formation needed to renew Ukraine’s ageing infrastructure and industrial base.

Gross domestic product by expenditure (HRN m at constant 1993 prices; % change year on year in brackets unless otherwise indicated) 2000a 2001b 2002c 2003c Private consumption 564.0 592.2 621.8 640.5 (7.4) (5.0) (5.0) (3.0) Public consumption 70.0 70.7 71.4 72.3 (1.4) (1.0) (1.0) (1.2) Gross fixed investment 196.0 227.4 243.3 257.9 (8.9) (16.0) (7.0) (6.0) Final domestic demand 830.0 890.3 936.5 970.6 (7.2) (7.3) (5.2) (3.6) Stockbuilding 78.5 79.3 80.1 80.9 (0.2)d (0.1)d (0.1)d (0.1)d Total domestic demand 908.5 969.6 1,016.6 1,051.5 (6.8) (6.7) (4.9) (3.4) Exports of goods & services 354.3 393.3 428.7 465.1 (15.9) (11.0) (9.0) (8.5) Imports of goods & services –349.3 –373.8 –406.6 –435.9 (16.1) (7.0) (8.8) (7.2) Foreign balance 5.0 19.5 22.0 29.2 GDP 907.5 989.1 1,038.6 1,080.7 (5.8) (9.0) (5.0) (4.0)

a Actual. b EIU estimates. c EIU forecasts. d Contribution to real GDP growth.

Inflation After two months of deflation in July and August cumulative consumer price inflation since the start of the year equalled only 3.3%. Consumer price

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inflation is not expected to exceed 9% by end-2001, and should remain comparatively subdued for the rest of the forecast period as a result of currency stability, an easing of world oil prices and relative fiscal prudence.

Nevertheless, further price liberalisation and relatively loose monetary policy are likely to prevent average annual inflation from falling below double-digit rates in 2002-03. The National Bank of Ukraine (NBU, the central bank) will continue to reduce interest rates and reserve requirements in order to encourage commercial bank lending over the forecast period. It will also continue to soak up excess foreign currency in an effort to boost official reserves. These foreign-exchange purchases, although partially sterilised, will push up the growth rate of the money supply and risk creating greater inflationary pressure—especially as economic growth (and thus also the growth in demand for money) moderates.

Exchange rates The currency’s considerable nominal stability since early 2000 is expected to lessen only slightly in 2002-03. This will bring a cumulative nominal depreciation of less than 5% against the US dollar. Ukraine’s comparatively high level of inflation, however, suggests that the hryvnya’s nominal stability will translate into a moderate real effective appreciation against the currencies of its major trading partners over the forecast period. Although this will affect export competitiveness, the hryvnya will still remain well below 1998 levels in real terms.

Because of the potential for significant political instability, there remains some risk of renewed currency turmoil. However, it is far more likely that nominal currency stability will be maintained. Ukraine is expected to continue to record current-account surpluses, is not dependent on portfolio investment inflows, has eased its debt-service obligations, and will maintain relatively strict foreign- exchange controls—including restrictions on the foreign-currency trading of commercial banks and a requirement that exporters sell 50% of their hard- currency earnings. Currency stability will furthermore benefit from relatively strong GDP growth, further monetisation of the economy and general fiscal prudence. The most significant risk to the nominal stability of the hryvnya comes from those government officials and industrial exporters, who, concerned about the harmful effects of continued real appreciation, have stepped up their lobbying for more rapid currency depreciation and greater monetary easing.

External sector Ukraine’s current-account surplus equalled US$845m over the first half of 2001 and will approach US$1.8bn for the year as a whole. However, it will fall a little in 2002 and even further in 2003, when it is expected to equal around 1.4% of GDP. The trade surplus, in particular, will narrow in the final year of the forecast, owing to further real currency appreciation, high demand for services imports, and increased demand for investment and consumer goods—which will only partly be mitigated by continued import substitution and the public’s low purchasing power.

Moreover, export growth will moderate in 2002-03 because of limited investment and restructuring, and further trade restrictions for key metals exports.

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Ukraine’s reliance on steel exports, therefore, remains a considerable liability, given the sector’s vulnerability to anti-dumping charges and price fluctuations. Nevertheless, data for the first half of 2001 suggest that this point should not perhaps be overemphasised. Although steel accounted for around one-third of export revenue during this period, it contributed only negligibly to the 20% year-on-year growth in foreign sales on the first half and saw its share of total exports fall by several percentage points in year-on-year terms.

Forecast summary (% unless otherwise indicated) 2000a 2001b 2002c 2003c Real GDP growth 5.8 9.0 5.0 4.0 Industrial production growth 12.9 14.0 6.0 5.0 Gross fixed investment growth 8.9 16.0 7.0 6.0 Unemployment rate (av) 5.3 4.8 5.2 6.4 Consumer price inflation Average 28.2 12.5 11.1 11.0 Year-end 25.8 8.5 12.0 11.0 Commercial-bank lending rate 41.5 35.0 33.0 31.0 Consolidated government balance (% of GDP) 1.1 –0.5 –1.8 –2.4 Exports of goods fob (US$ bn) 15.7 18.2 20.1 21.9 Imports of goods fob (US$ bn) 14.9 16.9 18.6 20.9 Current-account balanced (US$ bn) 1.5 1.8 1.6 0.7 % of GDP 4.6 4.6 3.5 1.4 External debt (US$ bn; year-end) 12.1 12.1 13.9 13.9 Exchange rates HRN:US$ (av) 5.44 5.40 5.55 5.65 HRN:¥100 (av) 4.73 4.70 4.78 4.87 HRN:¤ (year-end) 5.10 5.14 5.66 5.76 HRN:SDR (year-end) 7.17 7.25 7.38 7.50

a Actual. b EIU estimates. c EIU forecasts.

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The political scene

The cabinet’s performance The prime minister, Anatoly Kinakh, has portrayed himself as a reformer eager so far is satisfactory to build upon the achievements of his popular predecessor, Viktor Yushchenko, whom parliament ousted earlier this year. Since his appointment in May Mr Kinakh has generally soothed the widespread concerns sparked by both his background as an industrial-sector lobbyist and his close connections to the president, Leonid Kuchma. Not only has he benefited from continued macroeconomic stability and followed much of his predecessor’s programme, but he has also on occasion proven his unwillingness to come under the complete control of the presidential administration. Most notably, Mr Kinakh succeeded in persuaded Mr Kuchma to modify an earlier decree designed to increase the presidential administration’s control over the cabinet (see July 2001, page 13). The administration has created and filled the state secretary positions in each ministry, as announced in May. However, the new appointees are now to be responsible to the cabinet, rather than to Mr Kuchma, as originally envisaged. Nevertheless, Mr Kinakh’s loyalty to the presidential administration should not be underestimated, and Mr Kuchma’s influence over cabinet policy continues largely unhindered. As a result, the Kinakh government is still generally viewed as an interim cabinet with little capacity for independent action—especially as it enjoys only weak support in parliament, where all factions are pre-occupied with preparations ahead of the legislative election due by March 2002.

The scramble to form The bitter campaign expected in advance of the March 2001 election will electoral alliances begins increasingly push Mr Kinakh’s government and its policies into the background as Ukraine’s ill-consolidated political groups rush to reconfigure the country’s political landscape. This process is already well under way. A distinct feature of the preparatory phase so far has been the attempt by political leaders to consolidate viable electoral blocs and political parties rather than to try to go it alone—a practice that in the past had hampered the development of a modern party political system in Ukraine. However, Ukraine’s political groups have yet to undertake the degree of party consolidation needed to effect a lasting and thorough rationalisation of the political scene. Instead, the consolidation seen so far suggests that opportunistic and temporary electoral alliances are emerging between the country’s top political leaders.

The opposition remains Mr Kuchma’s opponents, therefore, have yet to accomplish the party political divided realignment that many expected would follow from the political crisis that engulfed the country following the release in November 2000 of secret audio- recordings, which his opponents say link him to serious abuses of power (April 2001, pages 12-14). Despite months of sustained street protests and the emergence of a broad anti-presidential coalition earlier in 2001, Mr Kuchma’s critics have so far failed to form a cohesive alliance to contest the 2002 election. Although the broad umbrella group that spearheaded the anti- Kuchma effort, the National Salvation Forum (NSF), remains in existence and is still headed by one of Mr Kuchma’s fiercest critics, the former deputy prime minister Yulia Tymoshenko, its support base has narrowed considerably.

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As a result, the NSF now appears increasingly unlikely to join together with blocs headed by the two other political figures expected to attract anti-Kuchma and anti-oligarch votes—Mr Yushchenko and the leader of the Socialist Party, Oleksandr Moroz. In July Mr Moroz formed an electoral alliance with four centre-left parties and has not yet confirmed whether he will join forces with the NSF. It has become even less likely that the NSF will be joined by Mr Yushchenko. Despite mounting criticism of his slow progress in articulating his election plans, Mr Yushchenko remains Ukraine’s most respected political figure and is far more popular than Mr Kuchma or any other rival. However, although Mr Yushchenko’s intentions remain unclear, he has at least soundly rejected suggestions that he might campaign on an anti-Kuchma platform, and as such appears unlikely to make common cause explicitly with either Mr Moroz or Ms Tymoshenko.

Mr Yushchenko will nevertheless continue to be a significant force in the upcoming parliamentary election—despite dashing widespread hopes that he would lead a broad anti-Kuchma or anti-oligarch coalition. Mr Yushchenko’s public efforts to build a democratic umbrella grouping began in mid-July with his dramatic unveiling, on top of Ukraine’s highest mountain, of a new political movement called “Our Ukraine”. Since then Mr Yushchenko’s moves have been ambiguous. Although it has not been revealed who will participate in his bloc, it is assumed that the main national-democratic groups will back him, since they best conform with his stance, which is in favour of reform and Ukrainian independence.

The national-democrats Since Mr Yushchenko was ousted from the premiership in April, the national- accelerate consolidation democrat camp has actively sought to minimise their internal divisions in anticipation of joining a Yushchenko-led electoral coalition. In early 1999 the main party in the national-democratic camp, Rukh, split into two rival parties, one led by Hennadii Udovenko and one by Yuri Kostenko. This had undermined the popularity of Ukraine’s right-wing movement—even in its traditional stronghold in western Ukraine—by splitting Ukraine’s best-known pro-independence party. Only recently, through a series of moves dating back to the conference held by Mr Udovenko’s party in May, have the two Rukh parties gradually moved closer together: in June they announced their intention to reunify, and in September they confirmed their intention to run in the election as part of Mr Yushchenko’s “Our Ukraine” bloc. They have also agreed to set up a joint parliamentary faction and election coalition with the other major right-wing group, the Reforms and Order Party.

Mr Yushchenko rejects an However, Mr Yushchenko has not yet committed himself to a joint electoral opposition approach bloc with Rukh—despite calling on the rival Rukh factions to speed up their reunification. Mr Yushchenko’s hesitation has fuelled long-standing speculation that he might try to broaden his electoral appeal—and increase his access to media and financial resources—by expanding his base to include centrist and even oligarch-led groups. Ukraine’s various centrist political leaders, many of them closely connected either to the presidential or to the oligarchic camps, have further fuelled speculation about this sort of a move. The speaker of the Ukrainian parliament and one of the leaders of the People’s Democratic Party

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(PDP), Ivan Plyushch, for instance, has tried to involve Mr Yushchenko in a newly formed bloc of centrist parties comprising the PDP, the Party of Regions, Labour Ukraine and the Agrarian Party. This bloc unites prominent politicians and oligarchs and is close to both the industrialists’ lobby previously headed by Mr Kinakh and the presidential administration.

It appears paradoxical that Mr Yushchenko would join together with some of the parliamentary groups that had engineered his removal from office in April. Mr Yushchenko, however, has consistently refrained from criticising those who voted for his dismissal or who failed to support his cabinet adequately while it was in power. For instance, he has refrained from criticising Mr Kuchma despite the presidential administration’s pointed refusal to provide the Yushchenko cabinet with more than lukewarm support. Mr Yushchenko’s seemingly counterintuitive stance reflects a calculation that he can achieve more as part of a broad, ideologically diffuse majority coalition, than as part of a narrower pro-reform opposition. If, as is likely, Mr Yushchenko chooses this approach, he will in effect be deciding against a decisive realignment of Ukraine’s political scene or a frontal attack on the oligarchs’ political power. He will probably also end up helping the presidential administration to recover from the damage done by the scandal sparked by the disappearance and murder of the opposition journalist, George Gongadze, late last year. Assuming that Mr Yushchenko remains opposed to heading an openly anti-Kuchma coalition, therefore, Mr Kuchma will be unlikely to face a concertedly hostile majority in the next parliament (see Outlook for 2002-03).

The election law dispute As part of its own efforts to ensure this outcome, the presidential admin- remains unsettled istration will continue to oppose parliament’s attempts to reform Ukraine’s electoral system in advance of the 2002 vote. This represents a long-standing source of tension between Mr Kuchma and most parliamentarians, who would prefer a system that has fewer majoritarian seats, which they feel favours the well-financed and well-connected oligarchic faction (July 2001, page 17). According to Ukraine’s existing electoral legislation, half of parliament’s 450 deputies are elected in single-mandate constituencies, and the other half are elected by party list. On four separate occasions already Mr Kuchma has vetoed parliamentary bills aimed at increasing proportional representation ahead of the March 2002 election. Parliament has so far failed to override the will of the president, and has backed off on its demands for greater pro- portionality. However, on September 13th it sent to Mr Kuchma a new version of the electoral law that ignores his call for a shorter election campaign. The presidential administration is now expected to veto this version as well, and will continue vehemently to oppose any new electoral law that it feels might bolstering the Communist Party of Ukraine (CPU) and national-democrat groups at the expense of the president’s allies.

Another journalist is Mr Kuchma therefore continues to prioritise his efforts to reassert his murdered dominance of the political scene and undo the damage caused by the Gongadze scandal. However, continued international concern over the scandal and the recent murder of yet another opposition journalist have prevented him from putting the affair behind him. One year after the scandal broke, an

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international investigation into the death of Mr Gongadze is still on the agenda. Moreover, the death of yet another local journalist, Ihor Oleksandrov, has further called into question the Kuchma administration’s record on media rights and freedom of speech. Although it remains unclear whether or not the Oleksandrov murder was politically motivated, the inept conduct of the official investigations invited comparisons with the Gongadze case and raised serious questions about the transparency and independence of Ukraine’s law enforcement agencies.

Russo-Ukrainian relations Mr Kuchma’s attempts to rehabilitate himself in recent months have also remain ambiguous included concerted efforts to repair relations with Western governments and to counter the impression that he has accepted greater Russian influence in Ukraine in exchange for political support from the administration of the Russian president, Vladimir Putin. The Ukrainian Ministry of Foreign Affairs responded critically in early August to a Russian request that Russian be designated a second official language in Ukraine, and also showed signs of back-pedalling from the idea of harmonising the Ukrainian and Russian energy systems. These moves suggest that Mr Kinakh and some of his ministers are actively seeking to underscore Ukraine’s independence in an effort to improve Ukraine’s tainted image in the West.

These efforts have already proved relatively successful, and have brought a number of high-level visits from Western representatives in recent months. On September 11th a high-level EU delegation, including Romano Prodi and Javier Solana, met Mr Kuchma for an EU-Ukraine summit in Yalta. As in the past the conference centred on vague statements about Ukraine’s “European choice” and “strategic role in Europe”, as well as EU concerns over the slow pace of economic and political reform. In particular, the EU side stressed the need for a transparent privatisation process, an independent judiciary, further measures against corruption, the restructuring of the energy sector, and tax reforms. Officials in Kiev have also sought to reaffirm their commitment to co- operating with NATO, and hosted Lord Robertson, the alliance’s secretary- general, in July. As in virtually all meetings with top Western officials over the past year, the need for more rapid political reforms figured prominently in these discussions. In recent months Ukrainian officials, including Mr Kuchma, have reaffirmed Ukraine’s NATO-friendly position, arguing that the alliance’s eastward enlargement, including to the sensitive Baltic region, would add to Ukraine’s security.

Economic policy

The IMF agrees to resume Following an IMF staff mission to Ukraine in early September the IMF’s lending executive board voted on September 20th to approved the release of a US$376m tranche from Ukraine’s US$2.6bn extended funding facility (EFF). Owing to repeated reform slippages, this represents only the second disbursement since October 1999 and the first since the IMF decided once again to suspend lending earlier in 2001. Although no longer as critically important as in past years, as a result of Ukraine’s sizeable financing surplus,

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the IMF’s decision will nevertheless help to deepen financial stability by boosting official foreign-currency reserves and increasing investor confidence. It will also allow the government to finalise its recent agreement with Paris Club creditors on restructuring US$580m in bilateral debts (see Foreign trade and payments) and to secure over US$1bn in financing from the European Bank for Reconstruction and Development (EBRD) for the completion of two nuclear reactors designed to replace the power-generating capabilities lost with Chernobyl’s closure in 2000. During the second half of September the World Bank agreed to disburse a first US$150m tranche from Ukraine’s US$750m programmatic adjustment loan (PAL)

Monetary policy is In announcing its recent decision to resume lending, the IMF board accommodating commended not only the government’s fiscal policy improvements and sound macroeconomic achievements, but also the monetary policy of the National Bank of Ukraine (NBU, the central bank) over the first half of 2001. This policy has successfully expanded credit availability and facilitated a strong economic recovery, while preserving nominal currency and price stability (see The domestic economy). The NBU’s accommodating policy has included repeated purchases on foreign-currency markets, which it only partly sterilises by issuing certificates of deposit, and a relatively aggressive easing of its key interest rates over the course of 2001. After the latest move announced on September 10th the discount rate now stands at 15% and has fallen by a total of 12 percentage points since the start of the year. The current rate is below the previous low point reached before the turmoil on emerging markets during the second half of 1997.

As a result of this generally loose policy, the growth of key monetary indicators has outpaced the NBU’s initial 2001 targets. The monetary base was set to grow by 19% over the course of 2001; it was already up by 22% by the end of August. Nevertheless, any increase in inflationary pressure has been contained by reduced money velocity and an increase in monetisation, which in turn has been prompted by greater currency stability, as well as the government’s commitment to raising the level of cash payments to the budget.

Government reports small The IMF has also recently come out in support of the government’s strong budget surplus in 2001 fiscal performance, which included a state budget surplus over the first seven months of 2001 equal to HRN1,196m (US$220m, or 1.1% of GDP), and a 7% real increase in consolidated budget revenue over the same period. Consid- erably stronger than anticipated economic growth permitted tax revenue to exceed its target by approximately 6% between January and July. Nevertheless, these generally solid results mask the weakness of non-tax revenue—as a result of which the consolidated revenue intake fell 3% short of target over this period. Privatisation proceeds proved particularly weak, equalling only HRN1.7bn (US$315m) or around half of the amount targeted. Preliminary data indicate that the state budget surplus fell further in August, bringing the total state budget surplus over eight months to just HRN53m (0.4% of GDP), considerably down on the surplus of almost HRN1bn recorded over the year- earlier period.

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Consolidated government budgeta (HRN m, unless otherwise indicated) 2000 2001 Jan-Mar Apr-Jun Jan-Jun Jan-Mar Apr-Jan Jan-Jun Revenue 11,889 14,668 26,557 16,042 17,560 33,602 as % of GDP 36.5 37.4 37.0 37.4 36.3 36.8 Expenditure 10,867 15,054 25,921 14,559 17,193 31,752 as % of GDP 33.4 38.3 36.1 34.0 35.5 34.8 Balance 1,022 –386 636 1,483 367 1,850 as % of GDP 3.1 –1.0 0.9 3.5 0.8 2.0

a Includes pension fund; uses Ukrainian methodology that counts privatisation proceeds as revenue. Source: UEPLAC, Ukrainian Economic Trends.

2002 budget proposal The IMF’s support of the government’s fiscal policy also included an includes a slight deficit endorsement of the draft 2002 budget proposal, which the cabinet presented to parliament on September 14th. In a significant shift away from existing policy, the government has not included estimates of privatisation proceeds in its revenue calculations. This reflects pressure from multilateral creditors, who have often criticised the optimistic privatisation assumptions that have undermined budget planning in the past.

2002 consolidated budget proposala (HRN bn unless otherwise indicated) Total revenue 57.2 Total expenditure 61.4 Budget balance –4.2 as % of GDP –1.7

a Excludes pension fund and privatisation proceeds. Source: Press reports.

The government’s budget performance next year will also benefit from the passage of a budget code and continued improvements in tax administration, although these will be mitigated by the limited progress expected in reducing tax exemptions—especially following parliament’s repeated failure over the

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past year to approve a comprehensive reform of the tax code. The cabinet’s budget assumptions—eg an average annual exchange rate of HRN5.6:US$1 and 10% year-end inflation in 2002—are generally sound, but the official forecast for annual real GDP growth of 6% is probably overoptimistic, given uncertain external demand and the continued slow pace of economic restructuring.

Tax exemptions are to be The government has not dispelled fears that it will succumb to pressure from extended either parliament or the presidential administration to increase preferences for key sectors in advance of the March 2002 election. Electoral considerations are likely to increase calls for further fiscal loosening during the budget negotiations scheduled for later in 2001. Although the current budget proposal already reflects a degree of loosening, including a 15% nominal increase in public-sector salaries, a 20% increase in the minimum wage, and a HRN1.3bn increase in education spending, the government might be tempted to loosen fiscal policy even further by propping up key industrial sectors. The government, for instance, has already indicated that it will extend the tax breaks that were granted to metals producers in 1999, and the minister of industry, Vasyl Hureyev, has called for increasing preferences for important sectors such as engineering. Finally, cabinet members have proposed a reintroduction of “critical imports” lists, which would exempt specific imports from value-added tax (VAT). The composition of any such list would reflect the relative lobbying abilities of Ukraine’s industrial sectors and would prove a step away from increased trade liberalisation.

2002 privatisation target is Assuming that the prime minister, Anatoly Kinakh, is able to contain calls for more realistic than 2001 greater fiscal loosening, the government should be able to finance its 2002 budget gap through privatisation proceeds. The cabinet expects to receive around HRN5.8bn in financing from privatisation sales, a target that is only marginally lower than the one in the 2001 budget, although it is more realistic. Nevertheless, the risk that the cabinet’s target figure for privatisation will not be realised remains high, given that it relies on the success of a few large sales, including the privatisation, originally scheduled for 2001, of Ukrtelecom and a number of assets in the electricity sector. Delays to these sales have already caused significant problems for the 2001 budget, which received only HRN1.77bn in privatisation revenue over the first eight months, which is significantly below the figure of HRN3.48bn expected for this period. Although the government had expected much of this year’s privatisation revenue to come from sales in the energy sector, the president, Leonid Kuchma, suspended all energy deals following a succession of privatisation scandals involving the takeover of debt-ridden state-owned companies earlier this year (July 2001, page 20). Although the State Property Fund (SPF) subsequently reported that the sales in the energy sector would resume before the end of 2001, any additional privatisation sales in this sector are almost certain to be delayed until 2002.

Foreign investors will The head of the SPF has frequently opposed further rapid sales of energy remain wary companies, arguing that the conditions for privatisation are poor and that there is a lack of interest on the part of potential foreign buyers. Western investors in particular have been discouraged by excessively high asking prices

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for debt-ridden and investment-starved state assets, and by insufficient transparency in the sales process. Although the quality and speed of large-scale privatisation sales have increased since the start of 2000, the government will have recently heightened investor concern through its unwillingness to allow the new Western owners of distributors purchased in April to raise electricity tariffs. The cabinet had promised to raise electricity tariffs in its efforts to woo buyers earlier this year, but has since qualified its support for such a move. In September the National Energy Regulatory Commission (NERC) delayed a final decision on demands by Kievoblenergo and Rivneoblenergo, two of the distributors, that tariffs be increased. The state’s reluctance to do so has prompted criticism from multilateral and bilateral creditors and donors.

The president prioritises The Kuchma administration hopes that the prospect of eventual Ukrainian WTO membership membership of the World Trade Organisation (WTO) might help to solve Ukraine’s credibility problem among potential investors. It has repeatedly cited WTO accession as one of its top priorities for 2002, and has placed the deputy prime minister, Vasyl Rohovy, in charge of Ukraine’s WTO negotiations. The WTO has commented on Ukraine’s “notable progress” towards accession and has expressed support for the country’s recent reform efforts. However, Ukraine has not yet received any indication of a possible accession date and will be required to implement a number of further trade reforms. Although Ukraine applied to join the WTO as early as 1993, negotiations have progressed only slowly and were interrupted completely between June 1998 and July 2000. Ukraine has recently secured the necessary bilateral agreements with Mexico, Uruguay and New Zealand, and plans a wide range of further negotiations over the remainder of 2001, including with the US and the EU. In addition to boosting Ukraine’s profile as a desirable investment destination, WTO membership would provide the country with improved prospects for penetrating non- traditional export markets. However, a number of hurdles remain, as Ukraine has problems enforcing existing trade rules and adjusting its legislation to meet WTO requirements.

In particular, Ukraine has faced criticism in recent years for its failure to protect intellectual property rights, and has emerged as Europe’s largest producer of counterfeit compact discs (CDs). The cabinet has belatedly proposed legislation to limit rampant CD piracy—and forestall any move by the US to carry out its threat to penalise Ukraine with up to US$200m in punitive sanctions (July 2001, page 21). The cabinet’s proposals require manufacturers to obtain permission from copyright owners, and to apply to the government for a production permit and a special identification code that is to be stamped on each disc. The government has taken a long time to make even these modest concessions, which reflects the power of special interest groups in Ukraine who are not eager to see the copyright protection laws tightened. The US has urged Ukraine for more than two years to put a stop to the production of pirated CDs, and secured a guarantee from Mr Kuchma personally during the visit of the former US president Bill Clinton to Kiev in mid-2000. On September 20th parliament approved a first reading of the anti-piracy legislation.

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Main economic policy indicators

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Consolidated budget revenue (HRN m) 1999 2,539 2,609 3,208 3,799 3,199 3,422 3,929 3,757 4,242 4,113 3,415 5,595 2000 3,397 3,667 4,825 4,526 4,975 5,167 5,516 5,420 5,708 6,628 5,617 7,588 2001 5,128 5,287 5,627 5,678 6,080 5,802 –––––– Consolidated budget expenditure (HRN m) 1999 2,087 2,893 3,572 3,748 3,369 3,732 3,856 3,881 4,419 4,538 3,429 5,951 2000 2,672 3,494 4,700 5,169 4,360 5,525 5,114 5,178 5,241 5,677 5,252 8,665 2001 3,740 4,867 5,952 5,472 5,780 5,941 – – – – – – Consolidated budget balance (HRN m) 1999 452 –284 –364 51 –171 –310 73 –124 –177 –425 –14 –355 2000 725 172 125 –643 615 –358 403 242 467 951 365 –1,076 2001 1,388 419 –325 206 300 –139 – – – – – – Exchange rate (HRN:US$; av) 1999 3.427 3.471 3.773 3.934 3.924 3.950 4.004 4.461 4.456 4.467 4.631 5.069 2000 5.381 5.543 5.468 5.423 5.404 5.436 5.439 5.439 5.439 5.439 5.437 5.436 2001 5.433 5.430 5.421 5.418 5.414 5.401 5.371 5.347 – – – – Real effective exchange-rate index (CPI-based; 1997=100) 1999 66.6 67.9 64.1 63.3 65.2 66.0 64.4 57.4 58.6 58.2 59.1 56.9 2000 55.9 56.8 61.4 61.4 64.6 64.4 64.6 66.2 69.1 70.9 71.0 70.0 2001 69.1 70.0 70.9 72.5 73.4 75.1 73.9 – – – – – M2 (HRN m) 1999 14,790 15,008 15,560 16,339 17,166 18,230 18,476 19,319 19,985 20,375 20,543 21,657 2000 21,465 22,272 23,251 24,391 25,318 26,324 27,445 28,720 27,979 27,943 28,603 31,273 2001 30,074 30,818 32,167 33,296 34,438 36,184 36,692 – – – – – M2 (% change, year on year) 1999 24.4 24.5 21.9 28.7 31.6 38.2 35.5 42.9 41.9 43.4 41.7 41.3 2000 45.1 48.4 49.4 49.3 47.5 44.4 48.5 48.7 40.0 37.1 39.2 44.4 2001 40.1 38.4 38.3 36.5 36.0 37.5 33.7 – – – – – Commercial bank lending rate (%; av) 1999 55.3 58.4 68.0 66.9 54.6 47.4 46.5 50.7 54.3 50.8 54.7 52.0 2000 56.2 49.4 42.5 41.9 39.8 39.7 39.0 35.6 39.7 39.0 38.3 37.3 2001 37.4 35.6 33.8 33.0 31.7 32.1 31.1 – – – – – Commercial bank deposit rate (%; av) 1999 22.8 21.3 27.2 22.3 18.5 20.5 15.9 20.1 17.4 20.0 21.7 20.7 2000 21.4 16.7 13.7 12.3 11.9 11.6 11.3 10.1 17.9 17.6 10.9 9.2 2001 11.7 9.4 8.2 11.3 8.6 13.0 11.3 – – – – – Sources: IMF, International Financial Statistics; UEPLAC, Ukrainian Economic Trends; EIU.

The domestic economy

Output and demand

Eight-month GDP growth Ukraine’s economic recovery has continued at a remarkable pace, including a is close to 11% 10.8% year-on-year increase in real GDP over the first eight months of 2001. This buoyant growth reflects sustained external demand, despite the global slowdown, in important markets such as Russia. Perhaps more importantly, it also reflects high levels of domestic demand, with fixed capital investment rising by 24% in real terms over the first half of 2001, and consumer demand

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growing strongly as a result of rapidly rising real wages and cash incomes, as well as more timely wage payments and greater consumer confidence.

In contrast with the year-earlier period, the high growth recorded so far in 2001 has benefited not just from a solid recovery in manufacturing, but also from a strong upturn in other industrial sectors, as well as in agriculture and construction. This has compensated for a relatively sharp slowdown in the growth of metals output, which, given the importance of the steel sector to Ukraine’s economy, might otherwise have translated into far lower rates of real GDP growth. Year-on-year growth in metals output had slowed to a relatively modest 4% by July, compared with almost 20% growth in the first quarter of the year (see Sectoral trends).

Major indicators, 2001 (% change year on year) Jan-Jul Jan-Aug Real GDP 10.5 10.8 Retail trade turnover 9.0 9.0 Real cash incomes 8.7 8.5 Fixed capital investment 23.6a n/a

a January-June. Source: Ministry of Economy.

Nevertheless, the basis for Ukraine’s economic recovery is still relatively fragile, despite signs that it has started to broaden. The improvement in construction is likely to have been spurred in part by a temporary upsurge in building activity related to the celebration in August of the 10th anniversary of independence, and certain areas of the economy—such as the production and distribution of electricity, gas and water—are hardly growing at all. Finally, Ukraine’s ageing infrastructure (exemplified by the investment-starved electricity grid) continues to act as a constraint on growth, as does the slow pace of economic restructuring, which is reflected in rising levels of enterprise indebtedness. Receivables climbed by 11% over the first five months of 2001 to reach HRN196bn (US$36bn), and payables were up by 5% to around HRN234bn, well in excess of the total size of the economy. This suggests that soft budget

constraints continue to allow insolvent firms to remain in business—thereby endangering the health of stronger companies that see their invoices go unpaid and are denied the implicit subsidies enjoyed by weaker enterprises.

Employment, wages and prices

Prices fall in July and Because of the currency’s strength, an expanding economy and declining August barter, so far in 2001 Ukraine has seen remarkably swift disinflation compared with 2000. Consumer prices declined by 1.7% in July and 0.2% in August month on month, and grew at an average monthly rate of only 0.4% over the first eight months of the year, well down on the 2.2% monthly average recorded during the year-earlier period.

Cumulative inflation, Jan-Aug (%) 2000 2001 Producer prices 14.2 1.3 Consumer prices 18.6 3.3 Source: Press reports.

The deflation recorded at the start of the third quarter reflects the strong agricultural harvest, which permitted a sharper than usual seasonal decline in food prices. The minimal increase in services prices so far this year reflects the absence of any major moves by the government to raise administrative prices, and low monthly producer prices have also played a role in reducing inflationary pressure. The nominal appreciation of the hryvnya and a global slowdown have dampened prices for oil and other commodities.

Official unemployment The strong real GDP growth recorded so far in 2001 has translated into rising continues to decline employment, according to official data released by the Ministry of Economy. The government claims to have cleared all arrears in unemployment benefits, and reports a drop in official unemployment to 3.7% of the workforce in August, equal to around 1m individuals and down from 5.1% in August 2000. According to the government, the number of vacancies registered over the

January to July period is up by over 40% year on year, and youth unemployment is down by over one-fifth.

However, official data distort the true employment picture. A significant percentage of those registered as employed are actually on unpaid leave and are not receiving the wages in full or on time. Moreover, a large number of unemployed workers do not bother to register as unemployed, because monthly unemployment benefits average only HRN78 (US$15). The situation for most Ukrainian workers therefore remains dire, despite the economic upturn and greater timeliness in the payment of wages and benefits. According to survey results reported by the International Labour Organisation (ILO), over four-fifths of Ukrainians consider themselves poor and expect no change during their lifetime, and the effective unemployment rate is more than 20%. Despite the recent increases in incomes and wages, therefore, the earnings of most Ukrainians remain extremely low in absolute terms. Although average monthly wages in June were up by over 20% in real year-on-year terms, they still only equalled around US$59, well below the average of US$75 reached before the hryvnya’s steep devaluation in 1998. Relative to 1992 levels, real wages are down by over a half. Total monetary income—which provides a broader picture than wages, because wages account for less than half of total income—are also over one-third down in real terms compared with 1992.

Public-sector domestic Although wage and benefit levels are extremely low, the government has at arrears are contained least avoided a return to the large-scale pension and public-sector wage arrears seen in the late 1990s. Pension arrears, for example, reached between 2-3% of annual GDP in 1999 and were only eliminated by the Yushchenko cabinet in September 2001. Although the prime minister, Anatoly Kinakh, has ensured that pensions continue to be paid on time, he has proved less successful at keeping down public-sector wage arrears, which have grown by almost 40% in nominal terms, to over HRN140m (US$27m), since the start of the year. The persistence of wage arrears outside of the budget sphere remains an even greater problem, because they are much larger in scale. By mid-2001 wage arrears outside of the public sector were down in nominal year-on-year terms by only around one-quarter and still totalled HRN4.3bn (US$800m), equal to over 2% of annual GDP.

Financial indicators

Nominal and real exchange The hryvnya has appreciated in both real and nominal terms over the past year rates strengthen further despite significant foreign-currency purchases by the National Bank of Ukraine (NBU, the central bank). As of late September the hryvnya had strengthened by around 2% in nominal year-on-year terms, mainly because of an accelerated rate of appreciation since early June. The currency’s nominal stability reflects Ukraine’s sizeable current-account surplus, as well as greater macroeconomic stability and an increase in the monetisation of the economy, which has led to a growing need and willingness on the part of the public to hold hryvnya. According to recent data, the dollarisation level of the economy, which measures the ratio of US dollars to hryvnya, has fallen to a four-year low of around 37%.

In real effective terms against the currencies of Ukraine’s major trading partner, the hryvnya has now appreciated by over 25% since the low point reached during the third quarter of 1999. Most of this strengthening came in the first half of 2000, when Ukraine experienced relatively high levels of consumer price inflation. Compared with the level reached before the regional financial crisis in the second half of 1998, the hryvnya is still approximately 25% weaker in real effective terms.

Banking sector indicators, May 2001

% change HRN m Since Jan 2001 Year on year Total credits 12,926 26.5 62.8 Total deposits 21,122 13.6 41.0 of which: hryvnya time- & demand-deposits 13,396 17.7 53.6 foreign-currency deposits 7,726 7.2 23.4 Source: UEPLAC, Ukrainian Economic Trends.

Credits and deposits The NBU’s loosened monetary policy and Ukraine’s generally stable macro- expand in real terms economic environment, which includes currency stability, low inflation and economic recovery, have reduced the risks associated with lending to the real

sector or holding hryvnya. This has sparked a sizeable real increase in credits and deposits so far in 2001. Banking sector lending to the economy increased by around one-third in nominal terms over the first eight months of 2001, roughly equal to the rate of increase seen over the year-earlier period. In real terms, however, this represents a far sharper rate of increase compared with January-August 2000, owing to the negligible levels of inflation seen so far this year. Although the rate of increase in total deposits in the banking sector the in January-August 2001 grew more slowly in nominal terms, the real rate of increase again proved faster—primarily because of the strong rise in hryvnya- denominated deposits. Nevertheless, total lending remains low, and the average nominal lending rate (at around 31%) still far exceeds both the NBU’s key interest rates and the average deposit rate offered by the commercial banks.

Sectoral trends

Industrial output, 2001 (% real change year on year) Jan-Jul Jan-Aug Extractive industry 4.7 4.3 Electricity, gas & water 3.5 2.9 Manufacturing 22.2 20.9 Total 17.9 16.9 Source: Ministry of Economy.

Manufacturing grows by Ukraine’s industrial expansion has proved extremely robust this year and has over 20% shown little sign of slowing. Although year-on-year growth rates decelerated between July and August, month-on-month industrial production was up by 3.1% over the same period. Industry’s solid performance mainly reflects the continued surge in manufacturing output, although other major subsectors, such as extraction, are also expanding. The high rate of growth achieved by manufacturers so far this year reflects both the build-up in spare capacity following years of post-Soviet decline, and an upsurge in domestic demand, including high levels of investment and increasing consumption of domestically produced goods.

Manufacturing output, Jan-Aug 2001 (% real change year on year) Coke & refining products 52.2 Wood & wood products 31.8 Machine-building 24.9 Pulp & paper 23.1 Food 21.8 Light industry 18.9 Chemical & petrochemicals 12.4 Metallurgy 10.8 Total 20.9 Source: Ministry of Economy.

The industrial recovery is The strong performance of the manufacturing sector also reflects relatively now more broadly based solid external demand, as seen in the strong export growth recorded by a number of industrial subsectors including machine-building, fuels and textiles (see Foreign trade and payments). Ukraine’s manufacturing strength, therefore, is no longer overwhelmingly a function solely of the strength of the metallurgy sector or of buoyant demand for cheap Ukrainian steel exports, which had brought a sharp rise in the share of the metallurgy sector in overall industrial production in 2000 and proved decisive in driving growth last year. During the first eight months of 2001 metals production accounted for a large share of industrial growth, but the food and machine-building sectors were also important in this respect.

Subsectoral contribution to industrial growth, Jan-Aug 2001 (% contribution to growth unless otherwise indicated) Industrial growth (% real change year on year) 16.9 Contribution of which: food industry & agro-processing 3.47 metallurgy & metal-working 2.69 machine-building 2.85 coke production & oil refining 1.52 chemical & petrochemicals 0.92 other 5.45 Source: Ministry of Economy.

This broadening basis of industrial expansion should increase the sustainability of the recovery in the economy overall, given the metals sector’s vulnerability to trade restrictions (more than 80% of its output is exported) and its questionable long-term competitiveness. In recent years the steel sector has suffered from insufficient capital investment and relies on largely outdated technology, such that productivity and energy efficiency remain far below the levels seen in Western Europe.

Crude steel output Jan-Jul 1992 1998 1999 2000 2001 Output (m tonnes) 41.8 24.4 27.0 31.4 19.6 % share of output of top seven global producers 8.9 5.3 5.7 6.1 6.6 Source: www.worldsteel.org/index.html.

A bumper grain harvest Although the agricultural sector’s share of GDP has fallen from around 20% in drives agricultural growth 1993, it still accounts for a sizeable 12% of the economy. The bumper grain harvest collected in July and August, therefore, played an important role in pushing cumulative real GDP growth for the first eight months of 2001 up above 10%. Agricultural production over this period is reported to have grown by 28% year on year, mostly as a result of the strong rebound in grain production. As of the second week of September the government reported a grain harvest of 37.8m tonnes—a sharp increase from the record low of 24.5m tonnes collected in 2000—and had raised its forecast for the annual harvest to 40m tonnes. The 10m tonnes of food grain harvested so far in 2001 is well in excess of the volume collected in 2000 and 3m tonnes more than is

needed to meet domestic food requirements. Grain exports are therefore likely to be up sharply in 2001 from the low levels seen in 2000, particular as an improved harvest and multilateral pressure have prompted the government to loosen its controls over grain movements.

Agricultural output, Jan-Aug (% real change year on year) 1999 2000 2001 Gross output –2.0 –6.2 27.7 Source: Ministry of Economy.

Sugarbeet harvest is up, Following more modest growth in 2000 and a number of years of decline but sunflowers disappoint before that, the strength of agriculture in 2001 reflects the significant reforms that have been undertaken since late 1999—and, in particular, a presidential decree to privatise Ukraine’s collective farms. Combined with a concerted government effort to improve access to bank credits for producers, these reforms permitted an increase in both the sowing area and yields for many key crops in 2001. Sugarbeet growers, for instance, increased the area under cultivation and secured a modest increase in yields, and now are almost certain to exceed the 2000 sugarbeet harvest of 13.5m tonnes—even though poor harvest conditions have led the government to revise its sugarbeet forecast from 18m tonnes to 15m tonnes. If the government meets its revised target, Ukraine should produce around 1.75m–1.80m tonnes of white sugar, up from 1.56m tonnes in 2000, but below the 1.9m tonnes needed to meet domestic demand. Less favourable results are expected for the harvest of sunflower seeds, owing to a 25% drop in the area cultivated and poor weather conditions in July and August. The bad weather has prompted a 20% drop in yields, such that the government now expects the crop to equal around 2.3m-2.4m tonnes, down from 3.4m tonnes in 2000 and 2.8m tonnes in 1999. As of mid-September the harvest of sunflower seeds was already down by one-third from the 328,000 tonnes gathered at the same point in 2000, which is likely to lead to more subdued agricultural growth figures than were reported in August.

Main macroeconomic indicators

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Industrial output (at constant prices; % change, month on month) 1999 0.7 –1.0 0.0 0.2 2.2 2.1 –0.9 4.9 2.9 –4.1 –3.6 2.4 2000 –1.2 6.3 –3.9 1.4 2.5 1.1 3.0 3.4 –1.6 0.8 –0.2 1.2 2001 0.2 –0.8 1.0 4.7 2.3 –1.5 – – – – – – Industrial output (at constant prices; % change, year on year) 1999 0.5 –3.3 –3.8 –1.9 0.7 1.9 1.4 6.7 12.8 9.2 9.3 5.6 2000 3.6 11.2 6.8 8.0 8.3 7.2 11.5 9.9 5.0 10.5 14.4 13.1 2001 14.7 7.0 12.6 16.2 16.0 13.0 – – – – – – Unemployment (‘000) 1999 1,036 1,076 1,100 1,105 1,096 1,086 1,096 1,114 1,124 1,130 1,146 1,175 2000 1,185 1,214 1,229 1,234 1,199 1,173 1,160 1,160 1,147 1,135 1,143 1,155 2001 1,150 1,157 1,149 1,132 1,088 1,047 –––––– continued

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Unemployment rate (%) 1999 4.4 4.6 4.7 5.4 5.3 5.3 5.1 5.2 5.3 5.2 5.3 5.4 2000 5.2 5.3 5.3 5.4 5.2 5.1 5.1 5.1 5.0 4.9 5.0 5.0 2001 5.0 5.0 5.0 4.9 4.8 4.6 –––––– Consumer prices (% change, month on month) 1999 1.5 1.0 1.0 2.3 2.4 0.1 –1.0 1.0 1.4 1.1 2.9 4.1 2000 4.6 3.3 5.7 –1.9 2.1 3.7 –0.1 0.0 2.6 1.4 0.4 1.6 2001 1.5 0.6 0.6 1.5 0.4 0.6 –1.7 –0.2 – – – – Consumer prices (% change, year on year) 1999 20.2 21.2 22.2 23.4 26.3 26.4 26.3 27.3 24.4 18.4 18.3 19.2 2000 22.9 25.7 31.5 26.2 25.8 30.3 31.5 30.2 31.7 32.1 28.9 25.8 2001 22.1 18.9 17.3 17.0 15.1 11.6 9.9 9.6 – – – – Producer prices (% change, month on month) 1999 0.8 1.1 0.4 1.7 0.5 0.8 1.3 3.5 0.8 0.7 1.4 1.7 2000 3.2 1.8 2.7 2.0 0.6 0.9 1.4 0.7 1.2 1.3 1.0 2.1 2001 0.8 0.6 –0.5 0.2 0.0 0.2 0.1 – – – – – Producer prices (% change, year on year) 1999 35.4 35.7 35.3 36.9 37.6 38.5 39.4 42.6 31.4 19.5 17.1 15.7 2000 18.5 19.3 22.0 22.4 22.5 22.6 22.7 19.4 19.9 20.6 20.1 20.6 2001 17.8 16.4 12.8 10.8 10.1 9.4 7.9 – – – – – Average gross monthly wage (% change, year on year) 1999 – – – 13.1 13.6 14.4 15.1 18.1 19.5 19.7 22.4 24.3 2000 22.1 25.4 26.4 24.1 26.3 26.6 30.1 36.8 33.6 36.0 35.3 35.4 2001 40.0 38.3 33.4 40.7 42.1 38.9 – – – – – – Average gross monthly wage (real % change, year on year) 1999 – – – –8.3 –10.0 –9.5 –8.9 –7.3 –3.9 1.1 3.5 4.3 2000 –0.6 –0.2 –3.9 –1.7 0.4 –2.9 –3.5 2.4 –1.1 0.3 2.3 4.8 2001 11.8 13.4 14.9 17.2 20.3 21.4 – – – – – – Average gross monthly wage (US$) 1999 43.2 43.8 44.2 42.1 43.0 45.8 45.8 40.6 41.8 41.8 41.1 43.2 2000 33.6 34.4 38.5 37.9 39.5 42.1 43.9 45.5 45.8 46.7 47.4 54.5 2001 46.6 48.6 51.8 53.3 56.0 58.8 – – – – – – Sources: IMF, International Financial Statistics; UEPLAC, Ukrainian Economic Trends; EIU.

Foreign trade and payments

The trade surplus exceeds According to preliminary customs data, Ukraine’s strong export growth and US$700m in January-July continued import compression resulted in a merchandise trade surplus over the first seven months of 2001 of US$728m, or around 3-4% of GDP. The slow growth in imports came despite continued real appreciation and surging domestic demand, and is almost entirely explained by a 5% reduction in expenditure on energy imports, which account for around 40% of total imports. Declining energy import costs reflect easing prices, as well as greater conservation efforts on the part of users, who are increasingly responsible for paying in cash for their energy needs. Expenditure on non-energy imports, by contrast, grew by 20%. As a result of strong economic growth, high levels of investment and improved liquidity, imports of machinery and equipment and of steel grew particularly strongly.

Merchandise trade, Jan-Jul (US$ m) 2000 2001 Exports 7,697.3 9,372.0 Imports –7,859.0 –8,644.2 Balance –161.7 727.8 Sources: Interfax; Ukraine Business Panorama.

Steel export growth is no In contrast with 2000 Ukraine’s export performance so far this year has not longer decisive resulted from a strong surge in revenue from metals exports. This suggests that Ukraine’s external position might be less vulnerable to a downturn in steel exports than previously assumed. Metals exports, which account for over 40% of total exports, were up only 11% in US dollar terms during the first six months of 2001, compared with growth of more than 30% in the whole of 2000. Moreover, steel exports (which make up three-quarters of metals exports) were up by less than 2% in year-on-year US dollar terms. By contrast, non-metals export revenue was up by 31% year on year, owing in part to strong growth in sales of higher value-added exports such as machinery and food-processing.

Composition of trade, Jan-Jun 2001

Value % change (US$ m) % of total year on year Exports 8,010 100.0 21.7 of which: non-precious metals 3,400 42.5 11.0 machinery & equipment 889 11.1 69.3 chemical & related products 808 10.1 9.7 mineral products 801 10.0 20.2 food, beverages & agricultural products 758 9.5 50.9 textiles & textile articles 288 3.6 19.0 vehicles (road, air, water) 263 3.3 38.1 pulp & paper 144 1.8 56.9 wood & woodwork 123 1.5 21.5 other 535 6.7 15.4 Imports 7,416 100.0 7.4 of which: mineral products 3,196 43.1 –6.2 machinery &, equipment 1,148 15.5 22.4 chemical & related products 551 7.4 37.9 food, beverages & agricultural products 483 6.5 –9.5 non-precious metals 397 5.4 36.4 plastics & rubber 341 4.6 18.9 textiles & textile articles 320 4.3 20.4 vehicles (road, air, water) 303 4.1 24.0 pulp & paper 240 3.2 40.3 other 437 5.9 –5.6 Source: State Committee of Statistics.

The decline of Ukraine’s steel export revenue reflects both the drop in world steel prices prompted by overproduction and the slowdown in the global economy since mid-2000. Although steel prices are expected to begin to recover before the end of 2001, they will still stay well down on their mid-2000

peak. Sluggish growth in Ukraine’s steel exports also reflects a drop-off in export volumes to important markets. The surge in Ukraine’s steel exports to the US in 2000, for instance, has largely collapsed, after provoking loud condemnation from US domestic steel producers. After Ukraine rejected the US call in January for a quota on Ukraine steel exports of 1.05m tonnes (down from the 1.5m tonnes exported in 2000), the US administration levied steep anti-dumping duties of 40-90% on Ukrainian steel. Over the first seven months of 2001 steel exports to the US in volume terms were down by 80% at around 205,000 tonnes, compared with 982,000 over the year-earlier period. The US now accounts for less than 2% of Ukraine’s total rolled steel exports, down from around 7% last year. In August a Ukrainian delegation travelled to the US, but failed to agree on a quota, which, had it been settled, would have led to suspension of US anti-dumping investigations.

Trade surplus with Russia Strong growth in sales to Russia has underpinned the export sector’s solid grows rapidly for now performance. This continues a trend that started in 2000 following several years of sharply declining bilateral trade links, and reflects the strength of import demand in Russia for key Ukrainian exports such as steel and chemicals. However, the Russian export market is now in jeopardy following Russia’s decision to levy 20% value-added tax (VAT) on Ukrainian exports, which had previously enjoyed tax-exempt status. Ukrainian government officials estimate that this could cause as much as a 20% drop in export sales to Russia, with Ukrainian light industry and steel exporters likely to be hit particularly hard. Preliminary data for July, which show export revenue declining year on year, appear to confirm this fear. Even if the growth in exports to Russia tapers off as a result of this measure, however, Ukraine’s growing bilateral trade surplus should remain intact—mainly because of greater energy conservation among Ukrainian enterprises and increased reliance on Turkmen rather than Russian gas imports.

Direction of merchandise trade, 2001 (US$ m unless otherwise indicated) % change Jan-Jun year on year Exports 8,009.8 21.7 of which Russia 2,181.3 46.7 Italy 413.3 50.0a Turkey 351.0 –14.9 Germany 345.1 –1.1 China 289.1 –12.2 US 256.4 –34.7 Imports 7,416.4 7.4 of which Russia 2,818.0 –12.1 Turkmenistan 803.1 220.0a Germany 609.2 24.1 Belarus 229.9 –19.7 US 217.1 23.5

a EIU estimate. Sources: State Committee of Statistics; EIU.

The current-account Ukraine posted a record fifth straight quarterly current-account surplus surplus widens further between March and June, and recorded a total surplus of US$845m for the first half of 2001. This represents a substantial year-on-year improvement that is in large part accounted for by continued import compression and strong export sales. The growth of the trade surplus has helped to mitigate the decline in Ukraine’s traditionally high services surplus—a trend that has been increasingly evident over the last year. Owing to sharply higher services imports, spurred in part by the economic recovery, Ukraine’s services surplus, which proved instrumental in containing external imbalances throughout the 1990s, has now all but disappeared.

Balance of payments (US$ m) 2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Exports fob 3,627 3,675 4,103 4,317 4,000 4,414 Imports fob –4,015 –3,390 –3,379 –4,159 –3,843 –4,135 Trade balance –388 285 724 158 157 279 Services exports 944 923 949 984 945 960 Services imports –589 –765 –851 –968 –906 –949 Services balance 355 158 98 16 39 11 Income credit 30 35 37 41 48 41 Income debit –395 –254 –211 –225 –217 –154 Income balance –365 –219 –174 –184 –169 –113 Current transfers credit 250 280 287 319 265 403 Current transfers debit –9 –55 –34 –21 –14 –13 Current transfers balance 241 225 253 298 251 390 Current-account balance –157 449 901 288 278 567 Capital account –2 –2 –2 –2 2 –1 Financial account 153 –489 –747 –240 52 –647 of which: direct investment 126 207 131 130 188 310 portfolio investment –482 471 –96 –94 –161 –101 other investment 477 –1308 –748 261 62 –511 reserves assets 32 141 –34 –537 –37 –345 Capital- & financial-account balance 151 –491 –749 –242 54 –648 Errors & omissions 6 42 –152 –46 –332 81 Overall balance 0 0 0 0 0 0 Source: National Bank of Ukraine.

International reserves The National Bank of Ukraine (NBU, the central bank) reported liquid reach three-year high international reserves of US$2.2bn in September, the highest level reached since before the regional financial crisis in 1998. The NBU has purchased US$1.4bn on foreign-currency markets since January and has boosted reserves from under US$1.5bn at the start of 2001 (equal to just over one month’s worth of goods and services imports). Increasing these chronically low levels of reserves remains a key priority for the NBU, which is targeting end-year levels of US$2.4bn in 2001 and approximately US$3.3bn in 2002. Strong growth in exports have been instrumental to the NBU’s efforts, especially as exporters are

still required to exchange half of their foreign-currency revenue for hryvnya. The NBU’s reserves hit a low of around US$700m during the 1998 regional financial crisis.

Paris Club restructuring The IMF’s decision in September to resume lending to Ukraine (see Economic enters the final stage policy) clears the way for a final agreement on restructuring a large portion of its Paris Club debt. The government had reached a preliminary agreement in mid-July with its Paris Club creditors to restructure around US$580m in bilateral debts over a 12-year period (including a three-year grace period). These debts date from 1998 or earlier, and comprise principal payments and arrears originally due between December 2000 and September 2002. Paris Club creditors had made final agreement on this deal conditional upon the resumption of Ukraine’s IMF lending programme.

Still no deal on Turkmen However, the government has also continued with efforts to restructure and Gazprom debts energy-related debts to Turkmenistan and Russia’s Gazprom. Although the government had hoped to restructure approximately US$280m in debts to Turkmenistan along similar lines to the Paris Club deal, the Turkmen government has reportedly held out for a much shorter repayment period of three or four years. Ukraine is also still negotiating with Russia over restructuring US$1.3bn in gas-related debt. According to latest reports, the two sides have agreed that the debt will be restructured into Eurobonds to be issued by Naftogaz Ukraine, a joint-stock company in which the state holds a controlling stake. The Ukrainian government has never included this debt in calculations of its external debt stock, and has recently resisted Russian efforts to label the debt as sovereign. Instead, the government insists that the debt is the sole responsibility of Naftogaz Ukraine. Although Russia had wanted the debt structured into ten-year Eurobonds backed by a government guarantee, it is likely that it will be treated as corporate and restructured along similar lines to the recent Paris Club deal, including a 12-year repayment period and relatively favourable interest terms.

Main external indicators (US$ m unless otherwise indicated) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exports fob 1999 730 748 960 870 989 1,029 952 966 1,004 1,044 1,038 1,249 2000 831 1,043 1,147 1,049 1,268 971 1,389 1,328 1,285 1,369 1,329 1,565 2001 1,157 1,211 1,431 1,379 1,330 1,502 1,362 – – – – – Imports cif 1999 987 935 940 945 730 958 773 872 1,294 804 1,149 1,461 2000 1,131 1,258 1,309 1,085 1,034 902 1,140 1,018 1,039 1,236 1,209 1,596 2001 1,079 1,149 1,332 1,224 1,303 1,330 1,228 – – – – – Trade balance 1999 –257 –187 20 –75 259 71 179 94 –290 240 –111 –212 2000 –300 –215 –162 –36 234 68 249 310 247 134 120 –32 2001 78 62 99 154 28 172 134 – – – – – continued

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Foreign reserves 1999 599 482 673 640 753 941 1,021 1,098 1,332 1,165 1,044 1,046 2000 963 924 941 793 855 812 955 942 825 940 999 1,353 2001 1,456 1,566 1,396 1,489 1,577 1,731 1,909 ––––– Gold 1999 33 34 33 35 33 33 35 35 45 44 45 47 2000 48 49 119 119 120 127 123 121 124 119 120 124 2001 120 123 120 123 128 130 126 – – – – – International reserves 1999 632 516 705 675 786 975 1,056 1,133 1,377 1,209 1,089 1,094 2000 1,011 973 1,060 912 974 939 1,078 1,062 949 1,059 1,119 1,476 2001 1,576 1,689 1,516 1,612 1,705 1,861 2,035 – – – – – Sources: IMF, International Financial Statistics; UEPLAC, Ukrainian Economic Trends; EIU.