Does Ukraine need a macroeconomic stimulus now?
By Dmytro Sologub (Raiffeisen Bank Aval, Kyiv, Ukraine)
First of all, I would say that for me as a person deeply involved into the analysis (and sometimes policymaking) of Ukraine's economy and financial sector for more than 10 years now, it was very interesting to get an outside view on the situation, provided by Yuriy Gorodnichenko. And I have to admit that indeed at the moment there is no much discussion on the stimulation of the economy going on. The policymakers and analysts are mostly focusing on short-term stabilization measures, like revising budget revenues and expenditures, improving Naftogas finances, stress testing the banking system, etc. At the same time, I would like to present several arguments why I see the massive fiscal and monetary stimulus problematic under current circumstances.
First, I would say that judging on fiscal deficit figures, we do see some fiscal stimulus in Ukraine (for example, defence spending increased substantially) - general government deficit is expected to rise from 4.8% of GDP in 2013 to 10.1% in 2014 and then fell to 5.8% in 2015. Of course, the increase in deficit-to-GDP ratio has a lot to do with severe GDP decline, but anyway the fiscal parameters, to which IMF agreed in case of Ukraine, look way too relaxed compared to the fiscal consolidation Greece and Portugal were forced to few years ago.
Second, nominal devaluation is normally used in Ukraine as the main policy tool as fiscal and monetary stimulus is more problematic and have negative side effects (like corruption - for example, the lending projects of state-owned banks are normally peppered with vested interests). And the experience of 2009 indicates that the nominal depreciation might help to revive the economy rather quickly. Moreover, compared to Greece, for which the only way out was rather long-term and painful process of the structural adjustment, Ukraine is apparently in much better position as there is a number of low-hanging fruits in terms of structural improvements. In particular, I believe that the reforms like deregulation, improving tax administration and legal reform might bring the results rather quickly. Hence, there is a potential to boost productivity growth in the economy in the short run.
Third, I believe with a large-scale fiscal stimulus it would be difficult to contain devaluation and inflation, which will have negative impact on the economy. One should keep in mind that Ukraine's trade balance deficit has a structural nature—the domestic production is hampered by poor business climate and red tape, so the increase in incomes immediately spurs the demand for import. Also, fiscal stimulus might spur inflation and wage growth, thus eating up the positive effect of nomina depreciation. Here l would refer to the example of Belarus, which faced balance of payments crisis in 2011 when the currency lost 70% of value. The government tried to counter it with the fiscal stimulus, which indeed helped economic growth (GDP grew 5.5% in 2011), but sent inflation (end-of-period) up to 120%. As a result, the external adjustment was pretty muted, plus no structural reforms were executed. And now, less than three years later, the economy is facing the same problem (the currency depreciated another 25% since then) and is basically surviving on Russia lifeline.
Fourth, with the exchange rate adjusted by 50% already, further sizeable depreciation will be quite detrimental to the economy. In particular, as the economy is very much dollarized (for example, many inputs for production are imported), the large-scale depreciation substantially affects real economy (especially in the short-run), thus mitigating the positive impact of fiscal stimulus.
Hence, I believe that the large fiscal and monetary stimulus is not a proper solution at the moment and the focus should be made on structural adjustment (anti-corruption, energy efficiency, developing financial markets, legal system, public administration reform etc) and overhaul of macroeconomic policies (tax system, revising subsidies and transfers, change in monetary framework). That's what IMF and authorities aim for, but I have to admit that the track record has been pretty disappointing so far.