Ukrainian Economy and Finance in 2015

February 25, 2015

Professor Alexander Savchenko

Back in 2014, I considered three distinct scenarios for Ukraine’s economic development in 2015.  The first was an “optimistic” scenario, which entailed the formation of a professional government and a revamping of the leadership of the National Bank by adding qualified specialists who would commence with economic reforms.  Today, however, we are seeing that reforms are not being carried out and, therefore, this scenario of economic development has fallen by the wayside. 

The second, so-called “catastrophic” scenario envisaged the formation of a government which will place its bets on administrative actions, the strengthening of tax pressure and the imitation of reforms.  And mainly, it would place its bets on the preservation of large-scale, corruption components in the development of the economy.  In this case, the International Monetary Fund, the EU and the US would refuse to grant new credit lines.  In such a scenario of economic development, a default may already be declared as early as in April. 

Based on an analysis of defaults in other European countries, one may conclude that a default in Ukraine will lead to a decrease of the Gross Domestic Product on a level of 7-8%, which in aggregate with the existing trend of GDP decrease will constitute 11-12%.  A default will also lead to a significant devaluation of the national currency by 50-100% or more and an inflation level of 50-60%.  Moreover, a default will lead to a freeze of foreign investment, including investments from international financial organizations, for a minimum of 1 year.  This would significantly decrease the inflow of foreign currency into the country, which is vital not only for settling external debts, but also for purchasing critical imports and, principally, natural gas. 

In 2015, Ukraine will need to pay approximately 10.5 billion US dollars to satisfy its external debts and no less than that amount for the purchase of gas, depending on the market conditions.  Thus, a default will bring about catastrophic consequences for the Ukrainian economy.  The probability of this scenario occurring is around 40%. 

The third, and more probable, scenario of developments can be observed right now in the country.  An unprofessional (“crony”) government has been formed in which only a few honest, but not necessarily professional, individuals are active.  Specifically, I refer here to the individuals appointed (and serving) in the current government as ministers of the economy and finance, who are honest individuals but who have difficulties in understanding the peculiarities of the Ukrainian economy in general and its budgetary system in particular.  These people will stimulate the sending of more and more advisors from the EU, the IMF and the US, who will slowly but surely aid in steering Ukraine in the right direction.  In such a scenario of economic development, Ukraine will be able to move into the orbit of economic growth within 3-4 years. 

So, what is the forecast for key macroeconomic and financial indicators for Ukraine in 2015?  This year, you will see a decrease in GDP of less than 4%.  Such decrease will be around 2.5%, as the significant devaluation of the hryvnia, duty free access to 25% of the global market, the decrease in gas and oil prices and significant financial aid from the West make it difficult not to demonstrate a growth of GDP.  However, the Ukrainian government and the National Bank are hindering the development of business by their actions and, consequently, the growth of GDP. 

We can also expect an inflation level of 12-15% in 2015.  The low level of inflation is characterized by a decrease in the buying power of the population which, in the face of critical devaluation of the hryvnia and the absence of a significant growth of income, will be able to purchase less goods and services. 

In regard to the state of affairs in the financial sphere, the IMF is demanding a decrease of state spending from Ukraine.  This is a vital first step for the beginning of economic reforms.  State spending should firstly be decreased to a level similar to the level in other Eastern European countries where the average indicator of state expenditures comprises a bit more than 40% of GDP, whereas this indicator is more than 60% in Ukraine.  For realistic economic development, Ukraine should cut state expenditures by 20% of GDP, which is hundreds of millions of hryvnias.  Such a decrease can be undertaken within 2 years; however, the 2015 state budget has been drafted in such a way that state expenditures have increased.  In addition, the tax burden on businesses and the population have increased by 3.4%. 

In order to balance the budget, Ukraine will need to find approximately 300 billion hryvnias to cover for a default.  The plan is to attract 200 billion hryvnias from external and internal loans and to issue bonds (banknotes) in the amount of 100 billion hryvnias.  Such issuance is unsecured, and will lead to an increase of devaluation and inflation.  In case of an issuance in the amount of 100 billion hryvnias, the hryvnia exchange rate at the end of the year will be at the level of 25 hryvnias to 1 US dollar.  If Ukraine is unable to secure loans in the planned amount, the issuance may be 200 billion hryvnias and, consequently, the hryvnia exchange rate may increase to 30 hryvnias to 1 US dollar. 

The optimal way to decrease state expenditures is to decrease the expenses for local and state authorities.  Under EU standards, Ukraine should decrease the amount of local and state authorities and state bureaucrats by 3 times.  Accordingly, the amount of elementary schools and health care centers should be decreased. 

Another significant way to cut state expenditures is in the education and medical spheres.  In the medical sphere this means a steep cut in the number of beds and the amount of days a patient may stay in the hospital, as these indicators significantly exceed analogous indicators in the EU.  Unfortunately, there is a deeper problem in the sphere of education.  The amount of state universities should be cut by 3 times.  Statistics show that in Ukraine 80% of high school graduates go on to study for their bachelor’s degrees and higher degrees.  At the same time, the EU has a much less amount of high school graduates that move on to higher educational degrees.  For example, only 27% of high school graduates in Germany move on to earn their bachelor’s degree. 

Currently, the question remains open as to whether the government is prepared to take such radical measures and pass the necessary decisions.


Frishberg & Partners 2012