Ukraine Partnership: Country Program Snapshot April 2015 RECENT ECONOMIC and and Reached Almost Zero in August
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World Bank Group – Ukraine Partnership: Country Program Snapshot April 2015 RECENT ECONOMIC AND and reached almost zero in August. However, SECTORAL DEVELOPMENTS during the remainder of the year, the impact of the devaluation was dampened by conflict-related Growth and External Performance disruptions in export-oriented industries in the east and a seasonal increase in imports of gas and coal Ukraine faced a deepening economic recession (after local coal production was damaged in the in 2014. Confronted with large accumulated fiscal conflict areas). As a result, the current account and external imbalances, the authorities embarked deficit remained high at 4.1 percent of GDP in on a major macroeconomic adjustment in the first 2014. The financial account also came under few months of the year. A sharp currency pressure, due to repayments of arrears on gas devaluation—after the fixed exchange rate was payments to Gazprom, increased demand in the abandoned in March—combined with fiscal cash foreign exchange market after deposit consolidation triggered a significant decline in outflows from the banking system, and delays in consumption and investment. The contractionary official financing. As a result, the hryvnia (the local impact of the adjustment was compounded by the currency) continued to weaken and lost over 25 escalating military conflict in the second half of the percent of its value between September 2014 and year, which led to severe economic disruption in the end of the year. Foreign reserves declined to the industrialized east and undermined investor and US$7.5 billion (1.4 months of import cover) at the consumer confidence. After declining by 3.9 end of 2014 and dropped further to US$5.6 billion percent in the first three quarters of 2014, real GDP at end-February 2015. Having lost a notable fell by 14.8 percent year-on-year in the fourth portion of reserves, the National Bank of Ukraine quarter, bringing the full year decline to around 6.8 (NBU) stopped currency interventions in early percent. All sectors were affected: industry (-10.1 2015, which led to another wave of pressure on the percent year-on-year), wholesale trade (-15.0 local currency. percent), and construction (-21.7 percent). This decline was moderated by a growth in agriculture The unstable political situation and prolonged of 2.8 percent year-on-year. Meanwhile, the sharp crisis in Eastern Ukraine continue to create devaluation and an increase in gas and utility tariffs unfavorable conditions for Ukraine’s economy, led to inflationary pressures, with the consumer which is facing unprecedented challenges and risks. price index (CPI) reaching 24.9 percent year-on- The best way to deal with them is to continue year in December 2014. macroeconomic adjustments and structural reforms. Priorities will need to be given to restoring Despite fiscal consolidation efforts, public debt macroeconomic stability, strengthening the is rising rapidly. Revenues declined in 2014 due banking sector, reforming the energy sector, to economic contraction and problems in collecting seriously tackling corruption and improving taxes in the east, while security-related spending has accountability, enhancing the investment climate, grown. To contain the budget deficit, the and better targeting social assistance toward the Government adopted fiscal measures in March and poor and the vulnerable. July 2014 to boost revenues while curtailing expenditures. This helped contain the general Financial and Private Sector Development government deficit to 4.6 percent of GDP (vs 4.8 percent in 2013). However, significant below-the- The financial sector in Ukraine has been hard line financing was needed to finance a rising hit by a combination of political, security, and Naftogaz deficit (5.5 percent of GDP) and to also exchange-rate pressures since the beginning of boost confidence in the banking system by 2014. The banking system, which represents more recapitalizing the Deposit Guarantee Fund (DGF) than 95 percent of financial assets, has structural and the state-owned banks (1.9 percent of GDP). weaknesses—high rates of related-party lending, This, together with the impact of the devaluation, the short open currency position of many banks, resulted in a sharp increase in the ratio of public the high ratio of nonperforming loans (NPLs) to and guaranteed debt to GDP to 70.6 percent (vs. total bank assets—that increase its exposure to 40.6 percent in 2013). shocks and are the result of regulatory forbearance and poor governance in the system. These Balance of payment problems remained acute in structural problems have been exacerbated by the 2014, compounded by capital flight, low foreign unfolding crisis in the country. Banks have direct investment (FDI), and delays in official witnessed an aggregate deposit outflow of nearly 20 financing. Following the devaluation in March percent since the beginning of 2014, and they have 2014, the current account deficit started to adjust been further weakened by the continuing depreciation of the Hryvnia, which has lost more Under the second objective, the Bank supports than 50 percent of its value since that time. the implementation of policy reforms in the Depreciation is putting an immediate strain on areas of credit information; a regulatory and banks’ capital adequacy ratio through losses supervisory framework for insurance companies, generated from the open short foreign exchange capital markets, and credit unions; and financial position, and in the longer run, through the consumer protection and financial literacy. The deteriorating quality of the loan portfolio. Fourteen Bank also promotes access to longer-term banks have been declared insolvent since the affordable finance for exporting enterprises and beginning of 2014, and the risk is very high that a small and medium-sized enterprises (SMEs). large number of additional banks will follow, shifting the burden to the DGF, which may be Under the third objective, Ukraine has taken required to make very large depositor payouts and some steps to improve the enabling resolve multiple banks quickly. environment for private business growth and investment, but much remains to be done. In this context, the World Bank Group is Progress in the Doing Business (DB) indicators was responding quickly to reduce the impact of the marked in the previous year, particularly in dealing crisis and restore growth. Together with the with construction permits, reducing steps to authorities, the Bank has identified the following starting a business, and streamlining procedures for critical goals: (i) stabilize the banking sector and transferring property (improving Ukraine’s DB make it more resilient to possible future shocks; (ii) ranking from 140 in 2013 to 112 in 2014), but these facilitate deeper financial intermediation and flow improvements represent only a small part of a of credit to the real sector on a sustainable basis; larger picture. As shown by considerable feedback and (iii) promote deeper reforms in the business from domestic and foreign enterprises, the overall environment in order to reinvigorate private business environment in Ukraine is critically sector–led growth and investment. weakened by macroeconomic instability, burdensome and obsolete regulations and On the first objective, the Bank, in close standards, weak rule of law and protection of collaboration with the International Monetary property rights, a lack of competition in many Fund (IMF), is working with the NBU on a sectors, and the shortage of affordable and long- crisis preparedness and management term finance. framework, including external diagnostic assessments of the top 35 banks that are expected As new leadership has signed an Association to be completed by end-September 2015 (surveys Agreement with the European Union (EU) and of the top 15 banks were completed at end-July expressed a commitment to attracting 2014). The NBU will then require the banks to investment and improving the business prepare and implement recapitalization and environment, attention is focused not only on DB restructuring action plans, as necessary. indicators but also on a broader program of reforms. The World Bank Group supports In the context of the World Bank and IMF Ukraine’s efforts to maximize the benefits of access programs, the authorities have adopted criteria to EU markets by improving food safety and for the use of state funds to support under- phytosanitary standards, with significant progress capitalized, systemically important banks seen already in the meat and dairy industries. The where necessary. In addition, the World Bank Bank is also working with the authorities to address continues to provide support to strengthen the the costs of getting utilities; to improve corporate bank resolution framework, with amendments disclosure, director liability, and shareholder enacted in July 2014 that include additional criteria empowerment; and to continue to reduce the time for the timely identification of problem and and number of payments involved in paying taxes. insolvent banks. Moreover, a mechanism has been In addition, the World Bank has assisted the established for back-up funding to the DGF from Government in streamlining business permits and the Government, and additional instruments have licensing and in introducing risk-based inspection been provided to enable the lower-cost resolution systems, and has promoted tougher anti-monopoly of banks. Finally, the top 35 banks have been policies to improve competition. While further compelled by the NBU to report their ultimate progress is needed in all these areas, the Bank beneficiary owners, a first step toward improving recognizes the cross-cutting constraints posed by transparency and reducing related-party lending. weak governance, an inadequate competition regime, weak rule of law and respect for property rights, and a highly inefficient court system system. The efficiency of client intake has further captured by vested interests. improved. Application processing time per application was reduced from 4.5 to 1.4 hours in The Bank, in coordination with other development 2011 and to 1.2 hours today.