Economic Growth Depends on Reforms and Financing

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The FINANCIAL — Ukraine’s economy grew by 3.5 percent in the first half of 2018, supported by an early agriculture harvest and strong consumption growth from higher wages, pensions, and remittances, according to the World Bank’s latest Ukraine Economic Update. However, investor confidence is being held back by delays in key reforms, Ukraine’s large financing needs, and uncertainty surrounding the 2019 elections.

An agreement with the IMF, swift implementation of recently approved reforms, and progress on the unfinished reform agenda would send a positive signal to investors. If this happens, economic growth is projected to be 3.3 percent in 2018 and 3.5 percent in 2019, before rising to 4 percent in 2020 once election related uncertainties subside.

By contrast, if reforms do not progress and IMF reviews are not completed, overall growth could fall below 2 percent in 2019 as investor confidence deteriorates, macroeconomic vulnerabilities intensify, and financing difficulties force a compression in domestic demand.

Ukraine also needs financing for large public debt repayments in 2019 and 2020. In this context, approving and implementing a credible and affordable 2019 budget that meets the fiscal deficit target of 2.5 percent of GDP is critical. This will require affordable implementation of recent reforms in pensions, health, education, public administration, and housing utility subsidies.

It will also be important to avoid measures that reduce revenues, such as the proposed replacement of the corporate income tax with a capital exit tax which would result in the loss of an important revenue source in a challenging fiscal environment.

Higher oil prices fueled import growth by 15.3 percent from January to August 2018, while exports have suffered from both logistical difficulties in the Azov sea since July and from softening export commodity prices. With the current account projected to widen to 2.9 percent of GDP in 2018, it will be important to secure continued financing from development partners, attract foreign direct investment (FDI), and boost non-traditional exports.

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Tapping Ukraine’s trade potential …

According to the World Bank’s Special Focus Note on international trade, Ukraine has tremendous potential to boost exports of higher-value added products, but this potential has not yet been realized.

Ukraine’s exports remain concentrated in metals and cereals, while the share of exports integrated with Global Value Chains (GVC) remains low at 5.7 percent in Ukraine, compared to 27 percent for Poland, 38 percent for Romania, 38 percent for Turkey, and 59 percent for Vietnam.

Boosting higher-value added and GVC exports is a major opportunity for Ukraine to leverage its special access to the EU market. Ukraine has demonstrated potential on this front through the exports of automotive ignition wiring sets which grew from $21 million in 2000 to $1.217 billion in 2017, one of the fastest growing export product categories in recent years.

Reforms to attract Foreign Direct Investment (FDI) are an important driver of exports and integration into GVCs. Specifically, this will require reforms to strengthen anticorruption measures and the rule of law, make progress on privatization, safeguard macroeconomic stability, and clean up the high share of non-performing loans.

Ukraine also needs to create an efficient and competitive logistics system to boost exports and accelerate its integration into the global economy. Specifically, this will require improving regulatory clarity and the management of public assets, increasing utilization of river transport, reforming the railway system, and addressing inefficiencies in the storage system.

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