Ukraine - Public investment review

Report No. 1 6399-UA Ukraine Public Investment Review May 30, 1997 Country Department IV Country Operations Division II Europe and Central Asia Region Document of the World Bank  CURRENCY EQUIVALENTS 1 Hryvna = 100,000 Karbovanets (September 1996) 1 US$ = 1.84 Hryvna (March 1997) ACRONYMS CG = Central Government GDP = Gross Domestic Product GOU = Government of Ukraine IDF = World Bank's Institutional Development Fund IRR = Internal Rate of Return KBV = Karbovanets (Ukrainian currency until September 2, 1996) LG = Local Government MOE = Ministry of Economy MOF = Ministry of Finance MOT = Ministry of Transport NIS = Newly Independent States NPV = Net Present Value OECD = Organization of Economic Cooperation and Development PER = Public Expenditure Review PIP = Public Investment Program SCHCS = State Committee for Housing and Communal Services Vice President Mr. Johannes Linn Director Mr. Basil Kavalsky Division Chief/Manager Mr. Hafez Ghanem (Acting) Staff Member : Ms. Kathy Lindert  UKRAINE - PUBLIC INVESTMENT REVIEW TABLE OF CONTENTS EXECUTIVE SUM M ARY ............................................................... i 1. OVERVIEW .I 2. PROFILE OF PUBLIC INVESTMENT'IN UKRAINE .3 The Concept Of Public Investment .3 Trends In The Level Of Public Investment .3 The Composition of Public Investment .5 3. REORIENTING PUBLIC INVESTMENT IN UKRAINE: PUBLIC VERSUS PRIVATE ROLES 7 Reorienting Public Investment In Ukraine: A Strategy For The Transition 8 Removing Obstacles to Private-Sector Investment in Ukraine 20 4. STRENGTHENING PUBLIC INVESTMENT MANAGEMENT IN UKRAINE .23 Linking Investment and Recurrent Spending Decisions .23 From Open-Ended Requests to Global Spending Ceilings .26 Sector Developrment Strategies and Public Investment .29 Improving Project Analysis .30 Streamlining the Overhang of Unfinished Projects .32 Institutional Implications 36 ANNEX 1 - Private-Sector Participation in Infrastructure Investment . ......................................... 39 ANNEX 2 - Public Investment and the Budget Process in Ukraine . .............................................. 43 ANNEX 3 - Dual Budgeting and Public Investment Programs .. .................................................. 47 BOXES 1 - Summary of Recommendations .............................................................. iv 3.1 - The Legacy of Unfinished Projects in Ukraine .............................................................7 3.2 - A Framework for Public and Private Roles in Investment .....................................................9 3.3 - Priority Public Investments in Ukraine's Agriculture and Agro-Industry Sector .................. 12 3.4 - Priority Public Investments in Ukraine's Energy Sector .................................................... 16 3.5 - Possible Priorities for Public Investment in the Transport Sector in Ukraine ....................... 17 3.6 - Obstacles to Private-Sector Investment in Ukraine .......................... ................................. 22 4.1 - Strengthening Public Expenditure Management in Ukraine ................................................ 26 4.2 - Expenditure Ceilings ............................................................... 28 4.3 - Development Strategy for the Energy Sector in Ukraine . .................................................. 29 4.4 - Criteria for Screening Projects .............................................................. 31 A2.1 - The Public Investment Program in Viet Nam ......................................... 48  FIGURES & TABLES F1 - Trends in Public Investment as Share of GDP, 199.4-97 .......... ..............................................i F2 - Ukraine: Composition of Public Investment, 1995 . ... ................................................ ii F2. 1 - Trends in Public Investment as Share of GDP, 1994-97 ...............................................4 T2.1 - Public Investment: A Cross-Country Comparison . ......................................... 5 F2.2 - Ukraine: Composition of Public Investment, 1995 . ........ ................................................ 6 F3.1 - Reorienting Public Investment: Public/Private Roles by Economic Activity........ ............ 10 FAI. 1 - Public Investment in the Budget Preparation Process ....... ........................................... 45 This report is based on the findings of World Bank Public Investment Review mission that visited Ukraine in November 1996. Mission members included: Kathy Lindert (Task Manager), Pulapre Balakrishnan (Profile of Public Investment), Hendrick Koppen (Public Investment Allocation and Management), ILarisa Leshchenko (Public Sector Reform Program), Katarina Petrina (Public Investment Management in Ukraine), Vyacheslav Honchar (Public Investment Management in Ukraine), and Daniel Tommasi (Public Expenditure Management). The findings of an earlier draft were discussed with Ukrainian officials during a mission to Kyiv in May 1997 Valuable contributions were also received from Mark Davis (Profile of Public Investment), Bernard Drum (Private Investment), Laszlo Lovei and Konstantin Skorik (Energy Investments), Mark Lundell (Agriculture Investments), Irina Novitsky (Private Investment), Kavita Sethi (Transport Investments), and Yoshine Uchimura (Municipal Services). Rino Schiavo-Campo and Mike Stevens served as Peer Reviewers, and Hafez Ghanem provided overall guidance. The report was prepared under the general direction of Wafik Grais (Division Chief) and Basil Kavalsky (Director). Louis Biely provided computer and technical support. The mission team wishes to thank the Ukrainian authorities for their excellent support and cooperation during the missions and for the very valuable Workshop on Public Investment that was held in Kyiv on November 14, 1996.  UKRAINE - PUBLIC INVESTMENT REVIEW EXECUTIVE SUMMARY i. Improvements in public expenditure policies are a central part of Ukraine's overall reform program. To support its transition to a more market-based system, the Ukrainian Government needs to address both the level and content of public spending, and the way public expenditures are managed. ii. The need for such reforms is particularly evident for public investment. Concern about public investment in Ukraine has been raised due to a number of factors, namely, the sharp decline in public investment in recent years, the persistence of a large overhang of unfinished projects, and by the fact that a substantial share of the budget's capital outlays appear to be allocated towards areas that should be left to private initiative. iii. Public investment in Ukraine is low and has fallen drastically. The level of public investment in Ukraine has sharply declined in recent years, falling from 4.6 percent of GDP in 1994 to 1.3 percent in 1996 (see Figure 1 below).' The draft budget for 1997 projects that this figure will fall even further, to 0.27 percent this year. Overall expenditure cuts have squeezed outlays on public investment disproportionately more than recurrent spending, which, for political and bureaucratic reasons, is less easy to cut. In fact, public investment has been squeezed from over eight percent of total government expenditures in 1994 to just 3.5 percent in 1996. Figure 1 - Trends in Public Investment as Share of GDP, 1994-97 5.0% JU-h- 0 _ CILG _ 2 0% - - _ 1.3% *CGl I 20 10% 00% 1994 impl 1995 impI 1996 impi iv. Although public investment typically shrinks in transition economies, the fall in public investment in Ukraine has been particularly dramatic. The current level of public investment in Ukraine is substantially lower than in other countries, including 'These figures include budget-financed capital outlays by state-owned enterprises, but not investments made by these fimas using their own funds (non-budgetary investments) because of the autonomy these economic units exercise in their decision-making. These figures include investments made under the Chemobyl Fund.  ii Executive Summary other transition economies. Perhaps more important, much needed structural changes in the public investment portfolio have not occurred (as discussed in more detail below). v. These cuts have been accompanied by a growing legacy of unfinished projects. With the sharp decline in resources allocated to public investment, a growing number of on-going projects have not been completed due to a lack of funds. Rather than focusing financing on a small set of highest priority projects, the limited investment funds have been rationed over a large number of projects. This legacy of unfinished projects has resulted in serious delays in project implementation, considerable loss of investment efficiency, and deferred realization of the benefit stream for all projects. vi. Private investment has also fallen. Ukraine's transition to date has not witnessed a rise in private-sector investment to compensate for the decline in public investment. Although data on private activity in Ukraine are notoriously weak, there appears to be a clear downward trend in the level of private-sector investment activity. vii. Moreover, the current mix of public investments still largely reflects the priorities of the command system, and the former role of the state. One-third of public investment in the 1995 budget (close to half of central-government investment spending) was allocated to commercial projects in the agriculture, industry, and housing sectors, which are typically left to private initiative in market economies (see Figure 2 below). At the same time, critical public investment needs in other areas (including education, health, and social and environmental protection) are not being met. bn KBV Figure 2 -- Ukraine: Composftion of Public Investment, 1995 40000- 35000 - - 30000-- 25000 - - 20000 - - 3 LG 15000 l E * CG 10000 0 (0