Shigeo’s Article in Zerkalo Nedeli and Interview with Economicheskiye Izvestia

The world economy is in crisis with the industrialized world already falling into recession. What started as a crisis in financial markets has begun to affect the real economy as deleveraging hurts companies’ investment and production, as consumer confidence plunges and spending is curtailed, and as asset and commodity prices turn south, erasing the substantial gains seen in the boom of 2003-2007.

Ukraine is among the first emerging markets to be affected, but it will not be the only one. To overcome this crisis, Ukraine will need consistent and decisive policy action, supported by a strong political consensus: to rebalance the economy, rehabilitate the financial sector, protect the vulnerable and maintain key infrastructure investments to lay the foundations for recovery. It will also need the support of the private sector and of the international community.

Ukraine is moving into the first recession in a decade, suffering from simultaneous terms of trade and external financing shocks far greater than many had anticipated. But Ukraine is also paying the price for several years of unsustainable, consumption fuelled growth and a macroeconomic policy mix that has acted pro-cyclically rather than prudently, thereby increasing the size of the necessary adjustment.

vThe authorities have reacted quickly to these challenges and put together a package of measures as well as seeking support from the International Monetary Fund. The USD 16.5 billion Stand By Arrangement agreed by the IMF Executive Board on November 5, 2008 provides an anchor for macroeconomic stability, encouraging private investors to roll over credits provided to corporates and banks, thereby preventing a credit crunch from deepening the downturn.v vAnd yet some are asking whether all this is enough. Skeptics point to the large external financing needs, only partially covered by the IMF credit. Also, the volatile political situation with looming parliamentary and presidential elections and recurrent paralysis in the country’s parliament, together with the risks of corruption and poor governance in Ukraine, may reduce the effectiveness of the anti-crisis measures. In the face of these risks, some may be tempted to take their money out now before it’s too late.

Such skepticism is understandable but dangerous. Pessimism in the current environment can turn into a self-fulfilling prophecy. All would lose if confidence waned. Failure in Ukraine would presage problems in many other emerging markets. The private sector must come together collectively to prevent such an outcome. The swift passage of the anti-crisis law in parliament has confirmed that political leaders in Ukraine are able to unite in the face of necessity. They must sustain this unity and continue to communicate clearly and act decisively over the coming weeks and months. Ukrainians understand that adjustment is needed. Economic populism and mercantilism is a poor strategy in times of global crisis. It leads to isolation and destroys international trust and credibility. Countries following such strategies have paid through larger output losses and slower recovery as international credit has dried up. Ukrainian policy makers must not repeat these mistakes.

The international community can provide additional help. The World Bank Group is putting together a package of assistance to help Ukraine weather the storm and secure and a sustained recovery. This package contains three elements. The first is the provision of immediate support to the budget of Ukraine through the Development Policy Loan III. This loan, to be presented to the Bank’s Board of Executive Directors in the near future, supports key structural reforms that are designed to signal Ukraine’s commitment to improve its investment climate to international investors, improve the efficiency with which the country uses its own budgetary resources and ensure that the poor and vulnerable are protected.

Second, the World Bank Group together with the IMF, the European Bank for Reconstruction and Development and other bilateral development partners is putting together a package of assistance to rehabilitate Ukraine’s banking system. This involves technical assistance to identify additional capital needs among systemically important banks, to strengthen the bank resolution framework so that insolvent and systemically unimportant banks can be rapidly intervened and their depositors protected, to manage the assets of banks taken over by the state, as well as financial assistance to the state budget for the costs of bank recapitalization and resolution.

Third, Ukraine needs to ensure that it protects the poor and most vulnerable during the downturn and lays the foundations for a sustained and rapid recovery. Ukraine’s poverty rate has halved since 2003 from over 47.2% to some 24.5% in 2006, using a threshold of $5 a day at Purchasing Power Parities. This success – one of the highest reductions in Eastern Europe and Central Asia – is now at risk as real incomes will fall, the value of social transfers is eroded, and unemployment increases.

Ukraine has both the fiscal resources and the mechanisms to protect the most vulnerable. Ukraine spends 2.5% of GDP on social assistance transfers, the same as the OECD average. Its social benefit program for the extreme poor has a targeting efficiency of over 70% (meaning more than 70% of benefits are actually received by the poor) – among the highest rates in the world. However, the program is underfunded and therefore does not reach all the people in need, whereas many other benefits are poorly targeted. Improved targeting and coverage could be ensured by freezing occupational privileges and other non-targeted benefits (such as housing and utility benefits) and topping-up well-targeted programs, such as the extreme poor benefit program. The World Bank estimates that some 0.7% of GDP could thus be saved and reallocated to help the poor. We are working closely with the authorities to achieve this.

Following years of underinvestment compared to other emerging markets, Ukraine’s roads are in bad shape, its railways are slow and only partially electrified, its utilities incur high technical losses and are unreliable, and its schools and hospitals are falling into disrepair. In times of reduced fiscal envelopes, the World Bank is ready to scale up its investment in public infrastructure to support a rapid return to sustained economic growth. We have more than USD 1 billion in outstanding commitments for public investments in the social and energy sectors. Two major transport projects, one for the modernization of the Kyiv-Kharkiv road and one for railtrack modernization along the main North-South corridor from Russia to Crimea are close to approval, providing several hundred million US dollars in funding. Additional projects are under preparation.

Private entrepreneurship has been the motor of Ukraine’s strong economic performance in recent years. It will be the motor of Ukraine’s recovery from the current crisis. The International Finance Corporation will continue to support its clients and the development of the private sector in Ukraine. IFC has set up global facilities to unblock trade finance and provide equity to banks in emerging markets. Ukraine can benefit, too. The Multilateral Investment Guarantee Agency, the political risk insurance arm of the World Bank Group has guaranteed private investments in the financial sector totaling USD 590 million over the past 15 months, thereby encouraging long-term finance for the benefit of Ukrainian businesses.

Ukraine is a key link between East and West. Its economic potential with a qualified and comparatively cheap labor force, strong transport links to Europe, Russia and the Middle East, significant natural resources and a large and still unsaturated domestic market remains huge. Savvy investors will find ample opportunities. Ukraine’s citizens remain supportive of democracy and markets, its major political forces share the same strategic vision of integration with Europe. The World Bank Group together with its international development partners stands ready to make this vision a reality. In times of crisis, we look to the long-term and are scaling up our presence. Ukraine deserves no less.

The author is World Bank Vice-President for Europe and Central Asia.