Statement by Andrei Bugrov at the meeting of May 20, 1999

i::tcmJtional Dc\clclp:it:::·:~~ .-\ssu.;t.~tl:t,-'i 87394 . t; ~ , F; 1.:1.emJ.uOG..u ,, ~ ~ r ,. . C> r· ., ~ "!'"T' '"'I ~r..c:!l '- ·~'-~J:- '·-'·"·" 1. ) .. ..., t\lultilateral Investment Guarantee Agency FOR OfFICIAL l Sf O.~L\' EDS99-158 May 19, 1999 Statement by Andrei Bugrov Date ofMeeting: May 20, 1999 Ukraine - Country Assistance Strategy Progress Report The CAS Progress report on Ukraine is a very interesting document which points to many important lessons. Recent developments in Ukraine have been very complex. Many positive results on the macroeconomic and structural front seem to be somewhat marred by the political debate. Pre-election situation makes all short-term forecasting rather difficult. However, it should be noted that Ukraine's political life has proved to be not only very animated in terms of discussion but also very smooth and orderly in terms of transition between governing teams. Thus it is quite reasonable to expect that the overall course of economic transformation will not be reversed as envisaged in the "Collapse scenario". In short, I see this scenario as highly unlikely. The Staff correctly emphasize sound portfolio performance achieved under very difficult circumstances (Box 1). I cannot help linking this phenomenon to the peculiar feature of the Ukraine's law which requires parliamentary approval of all external loans which I believe the Staffis referring in para 33 and para 42 (The Loan Effectiveness Issue). While this procedure is often blamed for unnecessary delays in implementation, it is likely to lead to improvements in ownership. Therefore I would suggest that this important -- and admittedly controversial -- issue of trade-off between swift loan effectiveness and strong portfolio performance be further scrutinized in order to learn the necessary lessons and to find an agreeable solution. Turning to specific sectors, I find myself in full agreement with the Staffs observation on the importance of deregulation as anti-corruption mechanism. I remember that in the last year's progress report there was discussion about the Government's intention to create a special controlling agency designed to limit widening licensure requirements. It would be interesting to know what happened with these plans. In the energy sector, I welcome the important progress made in re-vitalizing the Coal SECAL. I ----------------------- ------- . . ·, ~- ,. (~ I would ask the Staff to elaborate a bit more on the issue of natural gas auctions which are said to have been successfully launched recently in line with Bank's recommendations. Do the Staff expect that this measure will really increase the payments discipline in the sector? Another energy-related issue we should analyze in more detail is a somewhat negative result of applying VAT to barter and non-cash transactions as explained in para 19. It is said that this move discouraged payments altogether and subsequently delayed removal of the loan suspension. Ifi understand this point correctly, it means that Ukraine has moved to the accrual-based VAT which automatically covers all non-cash transactions. Such a move is often recommended to transition economies; however, it involves some serious temporary difficulties. Specifically, it is known that the book value of non-cash transactions is usually much-- often as much as twice-- higher than that of cash sales of the same commodity. Thus those who traditionally paid in non-cash form suddenly find themselves facing double tax liabilities. This lesson must be viewed as a strong case for more detailed and really comprehensive analysis of taxation issues in transition economies and consequences of various reforms for sectoral development. Social issues are of course among the most critical ones in Ukraine. Incidence of poverty is on the rise, quality of social services is deteriorating. We are told that a very sizeable share of public resources is being allocated to these services. Thus, it is likely that in addition to an overall output decline, grossly insufficient targeting of these resources is a critical issue. In this context the urgency of expenditure reviews cannot be overestimated. It is necessary to identify some critical health and education areas were our financial assistance could result in visible improvements. At the same time it should be remembered that in an urbanized and modernized country like Ukraine no solution of the social issues can be found unless the overall macro situation is stabilized and growth restored. Therefore, I am not entirely sure that it is really quite the time to get fully involved in the discussions about a comprehensive pension reform. Possible profiles of such reform can be meaningfully discussed only when appropriate macro environment is in place; otherwise it is unrealistic to expect any serious ownership of reform regardless of its specific design. Turning to the overall lending strategy, I would like to express some surprise about the very first of the triggers for the Medium Case scenario, namely, the reform of the Apparat of the Cabinet of Ministries. Without taking sides in the discussion about whether this reform is needed, and if so, what specifically should be done, I just want to say that -- as far as I understand the Bank's policy -- it is plainly not any business of ours to get involved into internal operations of the Government machinery. It is clearly up to the Government, and definitely not to the lenders, to decide about these matters. Of course, we can point to some deficiencies and suggest some changes, but I do · not think it is appropriate to make it an explicit trigger. What Ukraine is probably needing is a sort of general civil service reform, but this is an entirely different matter. Another issue I have serious concern about, is a clearly unrealistic and overburdened conditionality of current monthly disbursement program. I quote: "the adjustment oftariffs for public utilities for full cost recovery levels; a large reduction in the number of budgetary employees; the first reading of a new Banking Law; initiation ofbankruptcy proceedings for 170  And all this is collective farms unable to settle their debts; and significant further privatization". es are needed; on top of specific tranche release conditions! It is obvious that all these measur a mere monthly however, it is also obvious that they should not be construed as a condition for e for having met disbursement. In this context, I strongly commend the Government of Ukrain ment. almost all of these conditions under an extremely unfavorable external environ nt experience In sum, I believe that Ukraine has accumulated, albeit somewhat slowly, sufficie severely hit by and expertise in dealing with complicated issues of transition in a large country many problems external shocks. We wish the Government of Ukraine all success in resolving associated with this transition.