Statement by Eugene Miagkov at the Board meeting of May 21, 1998

International Bank for Reconstruction and Development 87306 International Development Association International Finance Corporation Multilateral Investment Guarantee Agency FOR OFFICIAL USE ONLY CONFIDENTIAL EDS98-226 May 21, 1998 Board Meeting of May 21, 1998 Statement by Eugene Miagkov Ukraine CAS Update We strongly welcome the frank and candid language of the CAS update paper. The staff produced a vivid and unbiased report where both positive and negative aspects of the present stage of economic transformation in Ukraine are reflected concisely and clearly. We support the staff findings. We agree that Ukraine now faces a critical period in its reform. The temporary political calm between parliamentary and presidential elections should not be wasted. Moreover, the financial situation of the Government does not allow for any delay in taking resolute action. Eurobond borrowing turns out to be prohibitively expensive for Ukraine, and recent experience elsewhere proves that non-resident financing of short-term domestic debt produces no lasting advantages. Net public debt disbursements in 1998 are estimated to be negative. In the absence of serious and early response markets may try to test the monetary policy of the authorities -- and the fact that foreign reserves are only slightly greater than one month of imports does not leave much room for maneuver. In this respect we should not forget the irrational logic of financial markets which may anticipate and exaggerate economic difficulties. By showing that the Bank is ready to stand by Ukraine and thereby help alleviate financial turbulence, the Bank will safeguard the existing achievements of economic policy and help the country to overcome current problems. In short, new fortification of fiscal policy is simply unavoidable, and it is hard to imagine that this could be done without substantial overhaul of public expenditures. Nevertheless, there are obvious social downsides to such austerity program that must not be underestimated. This is why we think that the Bank should show realism and flexibility in pursuing macroeconomic and structural goals. On the other hand, one should not underestimate significant progress Ukraine managed to achieve over the last few years. First of all, I think that it is well possible that Ukraine is actually experiencing economic growth rather than decline. I would suggest, in this respect, that we treat all GDP calculation in transition economies with utmost caution. Unfortunately, too many people forget -- or fail to learn in the first place – that such measurements are subject to numerous qualifications and limitations. More often than .  2 not the use of GDP figures leads to misrepresentation of reality. For example, I see that Ukrainian exports rose by 11 percent in 1996, 2 percent in 1997, and are expected to grow by more than 5 percent in 1998 -- all in the environment of real Hrivnya appreciation. Given that export statistics certainly undervalue actual exports, this trend does not support the perceived overwhelmingly bleak picture of the real economy. Second, I noted that the staff acknowledge many of Ukraine's accomplishments on the structural front. I welcome, for example, the successful privatization program. Trade liberalization seems to be at a very advanced stage in Ukraine, although it is likely that some informal administrative barriers, including those at the local level, still exist. Third, I think that we all have to applaud the recent efforts of the authorities aimed at purposeful deregulation. I was delighted to learn about the recent Parliamentary decision to slash the number of activities subject to licensing, and about the vesting of this policy in a special controlling agency. As far as I know, such an approach is a novelty in the transition economies, and ought to be carefully analyzed and duly supported. I believe that excessive bureaucratic meddling in business affairs, most often carried out under the guise of licensing is one of the most important stumbling blocks on the path of market development. Thus, I strongly welcome our participation in deregulation efforts. Any lessons learned here will undoubtedly be highly relevant to other transition countries. However, the sectoral development demonstrates much less success. Critical energy sector presents a rather mixed picture, with policy reversals and stalled reform. The coal industry is clearly one of the most difficult issues to deal with, due to its heavy concentration and irrational overdevelopment in the previous decades. Strong commitment on the part of all participants, including local authorities and industrial partners, is essential for successful Bank assistance in this sector which is notoriously easily politicized. It would be appreciated if the staff share with us their opinions on the prospects of coal sector reform in Ukraine, as well as on the prospects for our involvement. As for the gas sector, we are looking forward to the forthcoming Gas Strategy Paper. On the other hand, it is evident that some developments in the energy sector are deemed to be quite satisfactory. This view is supported by the presentation of the large-scale heating project, which we strongly support. In this respect it would be interesting to learn something about the recent trends in enforcing payments discipline in the energy sector, and about the cost-recovery ratio in the structure of household energy tariffs. I believe that to single out agriculture as an object of our primary focus in Ukraine is the right thing to do. It is reassuring to learn that the second tranche of AgSECAL is expected to be released soon. However it would be appropriate if the staff describe the recent developments in this sector in more detail. Turning to the social area, I would agree with two major staff findings: first, that there is a clear need to speed up the necessary reforms which are long overdue, and second, that the major issue here .  3 is the rather wasteful system of widespread redistribution which features weak targeting and can only produce immense disincentives and unrealistic expectations. Finally, I wholeheartedly support the Bank's readiness to make sizeable resources available to Ukraine provided, of course, that the strong prior conditionality is observed. I am sure that the authorities are fully capable of designing and implementing a credible fiscal and structural program. .