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Ukraine’s Economic Recovery: Good, But Slow

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The Ukrainian economic crisis of 2014-15 was caused by a number of factors, each one coinciding and reinforcing the other. Today, the country’s economy is recovering, but it remains highly dependent on the speed and the ultimate success of several key reforms, of which judiciary reform is the most important.

The previous political regime left the country with many unresolved internal structural economic problems: the huge fiscal deficit (half of which was the deficit of Naftogas); a non-performing banking system ridden with nepotistic lending and a host of other problems; the overvalued currency and depleted international reserves; and an unfriendly business and investment environment.

These structural deficiencies were put under additional stress by the aggressive actions of the Russian Federation, which annexed the Crimea and occupied Donbass, causing the loss of production assets and economic links with those territories. Trade restrictions truncating access to the Russian market were an additional hit to Ukraine’s exports and production, while in addition, the external price of key Ukrainian exports (such as grain and metals) plummeted further, hitting exports and the real GDP.

Positive changes – such as a duty-free access to the EU market for most of Ukrainian products since April 2014 – have not been sufficient enough in number to outweigh the negatives.

Stable Growth

These multiple challenges have required a multifaceted response, and the Ukrainian Government has already done quite a lot to reform the economy and ensure the return to a stable growth path.

For instance, in the monetary sphere, the banking system was cleaned up and strengthened, the exchange rate floated, while inflation targeting became a key element of monetary policy. The fiscal deficit shrunk significantly, while the efficiency of public expenditures improved. Recently, Ukraine’s parliament voted the cornerstone law for its healthcare reform, introducing the ‘money-follows-the-patient’ principle into the sector.

In 2016, after two years of deep crisis, Ukraine’s economy resumed growth. Real GDP increased by 2.3 per cent in 2016, and a similar figure is expected for 2017. According to the most recent forecast by the National Bank of Ukraine, from October 2017, the real GDP will grow by 2.2 per cent in 2017 and accelerate to 3.2 per cent in 2018.

The recovery in real GDP growth has been driven mainly by investments. Gross fixed capital accumulation increased over 20 per cent in 2016, and by approximately 23 per cent in the first half of 2017. On the production side, higher investments have been mirrored by the expansion of construction activities. The construction of infrastructure and industrial buildings grew the most significantly, creating the right fundamentals for future economic growth. Together, these two types of construction account for about three quarters of the 17 per cent growth in the sector in 2016. In parallel, the growth of investments stimulated the import of machines and equipment. The import of these products increased by 26 per cent in dollar terms in 2016.

The mapping of new factories opened in Ukraine since 2015 shows the expansion of new production capacity. As of mid-November 2017, 96 new factories had been opened in Ukraine and 52 more are under construction, as well as 27 elevators and grain terminals, plus over 60 electricity generating stations, mostly using solar and wind power. The new factories serve many sectors, including the food and chemical industries, the production of construction materials and electrical machinery. The production of automotive components for exports has in particular become one of the most actively developing sectors driven by foreign investments.

However, most investment is not financed by FDI, but by enterprises using their own funds. In 2016, these accounted for 70 per cent of all investments in fixed assets, while the share of foreign investors was only 3 per cent.

Despite this growth, the recovery of industrial production has remained sluggish. The index of industrial production increased by 2.8 per cent in 2016 after four consecutive years of decline, which began in 2012. However, in 2017, industrial recovery was interrupted by the political decision to stop trading with the occupied territory of Donbass. The negative shock was concentrated mostly in the extractive industries, but also adversely affected the coal supply. From January to September 2017, industrial production in real terms was 99.7 per cent of the production in the same period of the previous year.

Moving Up

Slow and unstable industrial production correspond to what are still negative trends in the real export of goods and services, dragging down the real GDP growth. In 2016, real exports dropped by 1.6 per cent, while real imports increased by 8.4 per cent, resulting in a negative contribution to GDP.

Ukraine has been gradually moving up the World Bank’s Doing Business ranking, a sign that the business environment is improving. In the Doing Business 2018 Report, Ukraine ranks 76th of 190 countries moving four levels up thanks to a sharply reduced taxation burden and the deregulation of construction permits system (which could be considered as a proxy for overall governmental deregulation).

However, several key pieces of the economic reform puzzle have not been put in place, at least partly explaining the slow pace of the country’s economic recovery.

First and foremost is reform of the judicial system, aimed at ensuring the rule of law and the protection of property rights in the country. A three-year reform effort was launched in mid-2016 with changes in the constitution improving both independence and the potential accountability of judges. However, implementation has been very bumpy, and success remains uncertain. The ultimate success of the fight against corruption, one of the key factors undermining the economic development of the country, has been conditional upon the success of judicial reform. Major efforts have been made to establish an anti-corruption institutional framework and to reduce the opportunities for corruption via transparency and electronic services, but the effectiveness of these efforts have remained limited given the lack of a proper judiciary. 

The views expressed in this opinion editorial are the author’s own and do not necessarily reflect Emerging Europe’s editorial policy.

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About the author

Veronika Movchan

Veronika Movchan

Veronika Movchan is Academic Director at the Institute for Economic Research and Policy Consulting - IER (Kyiv, Ukraine) and a member of the Editorial Board of VoxUkraine.

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