According to the World Bank’s latest Ukraine Economic Update, Ukraine’s economy grew by 2.3 % in 2016 (after around 16% cumulative real GDP contraction in the previous two years) and grew by 2.4% in the first half of 2017. The recovery was supported by a bumper harvest and a pickup from low levels in manufacturing, construction, and key services.
Boosting economic growth to 4 percent or more in the next two years is critical to reduce poverty and improve living standards for the Ukrainian population. This will require progress on an ambitious package of reforms, including in land markets, financial sector, anticorruption, and privatization, to stimulate investment and productivity. Ukraine needs also a systematic fiscal consolidation effort, or it will have to rely on ad hoc revenue measures and expenditure cuts, which would undermine debt sustainability, growth prospects, and the quality of social services.
Also key sectors exhibiting relative strength, such as manufacturing, trade services, and transport continued to grow at a modest pace—3.7%, 3.5%, and 4.4%, respectively—in the first half of 2017. The mining and utility sectors contracted by 6.6% and 5.5%, respectively, due to the trade blockade against uncontrolled areas of the Donbas region, which affected coal, steel, and electricity production. On the other hand, construction and fixed investment continued to exhibit strong growth in the first half of 2017—at 26% and 22%, respectively—pointing toward strengthening investor confidence in some areas. Merchandise exports grew by 23% in the first half of 2017, mostly due to improving commodity prices, after declining by 13% in 2016.
The moratorium on agricultural land sales, along with weaknesses in the transparency of land rights and transactions, are major impediments to attracting investment and unlocking productivity in Ukraine’s agriculture sector. Without the ability to purchase land, farmers have a lower incentive to undertake productivity enhancing investments, and also cannot use land as collateral to secure financing from banks.
A land reform is critical to improve living standards for the Ukrainian people, by driving higher economic growth and incomes for the population, and improving the returns on land for millions of small landholders. The Government has declared land reform a priority, beginning work on improving transparency, exploring mechanisms to facilitate access to finance for farmers, and discussing design principles of a draft land turnover law with stakeholders. It is critical that the work on strengthening transparency and access to finance is completed and that a draft land turnover law is expeditiously submitted to Parliament for approval so that the moratorium can be lifted on January 1, 2018.
Even if Ukraine has experienced acute political, security, and economic challenges during the past three years, since the “Maidan” uprising in February 2014, the new Government which took office in April 2016 has committed to continuing previous reform efforts, and a government program and action plan covering a wide-ranging reform agenda were issued in May.
Key reforms undertaken since 2014 include: carrying out significant fiscal consolidation, moving to a flexible exchange rate, reforming energy tariffs and social assistance, making public procurement more transparent, simplifying business regulations, stabilizing and restructuring the banking sector, adopting a health reform package, and establishing anti-corruption agencies and asset disclosures for public officials, all the while contending with powerful vested interests that continue to oppose reforms. Going forward, Ukraine will need to advance reforms on multiple fronts to achieve sustainable recovery and shared prosperity.
The fiscal deficit is projected to widen to 3.5 percent of GDP in 2017 due to higher public sector wages and spending on social programs. Reducing the fiscal deficit to 2.5 percent of GDP in 2018 and beyond will require adopting responsible pension reform and implementing education and health reform in a manner that improves the quality of services while optimizing the school and hospital network.
Poverty remains significantly higher than pre-crisis levels and faster economic growth is critical to reduce poverty going forward. Disposal incomes contracted sharply in real terms in 2015 due to the deep recession and unsustainable social benefits. Fiscal expenditures and revenues grew strongly in the first half of 2017, with the supplementary budget adding to expenditure pressures for the rest of the year. In 2016, the fiscal deficit widened to 2.2% of GDP due to lower social security contributions, despite expenditure restraint and growth of other revenues. In the first half of 2017, both expenditures and revenues exhibited strong growth. Expenditures were up by 13.5% in real terms due to the increase in the minimum wage, as well as higher spending on social programs. Revenues also grew strongly by 22.8 in real terms in the first half of 2017, driven by higher revenues across the board, including personal, corporate, and value added tax, as well as social security contributions and non-tax revenues. As a result, the fiscal balance in the first half of 2017 amounted to a surplus of 0.9 percent of full year GDP. However, the supplementary budget adopted -in July 2017 adds to expenditure pressures for the rest of the year, including higher spending on military, social programs, and capital investment. As a result, the fiscal deficit in 2017 is expected to exceed the target of 3% of GDP. At the same time, the public debt level continued to grow, reaching 85% of GDP as of July 2017, due to the high cost of bank recapitalization. In September 2017, Ukraine successfully issued $3 billion in Eurobonds, of which $1.3 billion is new financing, with the remaining amounting helping to refinance bonds due in 2019.
The growth outlook is affected by two key factors: Ukraine faces continued headwinds from the conflict in the Donbas region, as evidenced by the coal and trade blockade with the uncontrolled areas and an ambitious package of reforms the authorities have been working on to address structural bottlenecks and advance growth prospects. The next few months are a critical window of opportunity within which to lock in these important reforms. Establishing a transparent market for land transactions would enable Ukraine to tap its vast potential for agricultural exports. Strengthening the governance of state-owned banks and putting in place measures to streamline resolution of non-performing loans (NPLs) would enable a gradual resumption of lending to the private sector. Deeper anticorruption reforms, further improvements to the business environment, and progress on privatization would strengthen investor confidence and attract foreign investment. Locking in these reforms in the next few months could raise growth to 4 percent or more in the next two years.
PRIVATIZATION
The launch of privatization has been on the agenda of the Ukrainian government for many years already and has become number one priority for further economic recovery of Ukraine nowadays.
In March 2015 the International Monetary Fund (IMF) has approved a four-year lending program for the Ukrainian economy, the Extended Fund Facility (EFF) worth circa €6.3 million. Ukraine has already received four tranches while the next tranche was expected in September 2017. However, Ukraine failed to fulfill several mandatory conditions for the program revision, including the adoption of laws on the anti-corruption court, on pension reforms and privatization. Hence, the next tranche may be possible in the second quarter of 2018 if the program will be reviewed in February-March.
There are about 3,500 state-owned enterprises that should be privatized. The largest companies to be privatized in terms of assets are: Oschadbank, Ukreximbank, The State Food and Grain Corporation of Ukraine, PrivatBank, Centrenergo, Turboatom, the Agrarian Fund. The economic, legal and financial obstacles that exist in the state-owned companies make it very hard to sale many of them. Now the Ministry of Finance of Ukraine is designing a privatization strategy and a draft law will be hopefully approved by 2018. On the 8th December 2017 the State Property Fund of Ukraine (SPF) has approved a list of almost 100 enterprises eligible for privatization in 2018, among which combined heat and power plants, enterprises in the chemical and energy sectors and others.
THE STATE OF IMPLEMENTATION OF THE ASSOCIATION AGREEMENT BETWEEN THE EUROPEAN UNION AND UKRAINE: CURRENT SITUATION AND FUTURE CHALLENGES
(by Iana Seleznova)
Summary
The aim of the present paper is to describe the state of the Ukrainian Reform Plan's implementation which was adopted with the purpose to enforce the objectives, defined by the Association Agreement between the European Union and Ukraine. The paper also identifies the main critical issues which the Ukrainian institutions will have to deal with in order to comply with the European and International requirements.***
1. THE ASSOCIATION AGREEMENT BETWEEN THE EUROPEAN UNION AND UKRAINEThe Association Agreement between the European Union and Ukraine finally came into force on the 1st September 2017, after having been provisionally applied since the 1st January 2016. This is probably the most dramatic European Union deal with a non-European Union country. Its earlier rejection by Ukraine’s former president V. F. Yanukovich sparked the Euromaidan protests. The Association Agreement, which includes a Deep and Comprehensive Free Trade Area between the European Union and Ukraine (DCFTA), has laid the foundations for the ambitious Ukrainian Reform Plan.
1. UKRAINE’S REFORM PROGRAMME
Ukraine has been a focus of European and global political attention since 2013. In particular, the International Monetary Fund, the European Union and the United States of America have provided Ukraine with a substantial balance-of-payments and budgetary support, along with technical assistance. Since 2014, the European Union and Ukraine have defined a highly ambitious reform programme. According to that, the Ukrainian authorities have started the process of adoption of deeper and unprecedented reforms in many areas, including banking system, decentralization, energy, free trade, healthcare, human rights, the judiciary, police system, prevention and repression of corruption, public administration, public broadcasting, public finance and public procurement.
2. THE STATE OF IMPLEMENTATION OF UKRAINE’S REFORM PROGRAMME
2.1 Banking system
In the early 2017, Ukraine has cleaned up a big part of the banking sector and has strengthened the institutional framework of the National Bank of Ukraine (NBU). According to international experts, the decision to appoint a new team of professionals to senior positions within the NBU in 2014 was decisive. Specifically, the NBU’s readiness to close dozens of prominent Ukrainian banks has been an example of rules trumping influence. Thanks to that, all the particularly problematic banks have been closed, changing the rules of the game and putting the country closer to achieve European and international standards.
2.2 Decentralization
The decentralization reforms that began in 2014 have brought relevant change to the country. Local administrations have now more responsibility for the services provided: in particular, with the amendments to the Budget and Tax codes, they have been transferred relevant additional budgetary powers to local governments. Thanks to that, a total of sixty percent of personal income tax, one hundred percent of state duty and one hundred percent of the fees for administrative services are paid into peripheral budgets. Local administrations can also now borrow larger sums from the central government to sustain their spending programs. Another significant point of the decentralization process is the success of the program of voluntary consolidation of hromadas, started in 2015, which has determined the creation of more amalgamated communities and has permitted a more efficient governance of these local entities. Ukraine’s decentralization program is supported by the European Union through a one hundred million project called U-Lead, that has been launched on September 2016.
2.3 Digital society and public broadcasting
The country has prepared several laws to transpose European Union rules applicable to telecommunication services, aiming to ensure the effective allocation and use of radio frequencies and a level playing field in the telecom market. On the 23rd March 2017, Ukraine amended the law on Electronic Commerce. On the 24th May 2017 the Parliament also adopted the new edition of the Technical Regulation for Radio Equipment and Telecommunications Terminal Equipment: the new measures and provisions will come into force in April 2018.
2.4 Economic development and free trade
Following the recession of years 2014 and 2015, Ukraine’s economy started its recovery in 2016. The positive trend has been confirmed in 2017: the gross domestic product grew by 2,5 percent in the first quarter of 2017 and by 2,3 percent in the second quarter of the year. Generally, Ukraine’s business environment has strongly improved, according also to the latest World Bank’s rankings.
With specific regard to agricultural and rural development, Ukraine has put in place several reforms, such as introducing auctions for rental of state land, opening e-services and transferring land rights registration from state registrars to private notaries.
In 2017 Ukraine also adopted the Concept of the State Policy in the Sphere of Consumer Protection, a package of resolutions to improve the corporate governance of strategic state owned enterprises (SOEs) and a strategy for the development of medium and small entrepreneurship.
The country is continuing the implementation of new rules on the protection of rights of shareholders, creditors and other stakeholders, company law, accounting and auditing and corporate governance, aiming to comply with European and international standards on these matters.
With regard to trade matters, in the first eight months of 2017 total trade between the European Union and Ukraine grew by 27,1 percent, compared to the same period in 2016. Thanks to that, the EU has consolidated its position as Ukraine's first trading partner: in particular, after Russia banned Ukrainian agricultural products in 2016 and cancelled its trade deal with Ukraine, the opening of the European Union’s markets helped Ukrainian producers to re-orient their exports. Therefore, Ukraine is now continuing to transfer European Union norms into its legislation, aiming to eliminate differences in safety requirements as the access to the EU’s single market is a powerful incentive.
2.5 Energy
In July 2017, the European Union and Ukraine approved the Annual Work Plan 2017 to implement their Memorandum of Understanding on a Strategic Energy Partnership. Consequently, on the 18th of August 2017, Ukraine approved the new Energy Strategy of Ukraine 2035.
Ukraine’s Energy Reform is not only about a source of income for Ukraine’s Budget, but matters for European regional security. The gas transit has given Ukraine leverage on Russia and shored up the cooperation and interdependence between the European Union and Ukraine on common energy security issues. In November 2017, the Ukrainian government appointed independent directors to the board of Naftogaz Ukrayiny, with the purpose to meet key requirements from the European Bank for Reconstruction and Development (EBRD). This measure was well welcomed by international observers, as a key for good governance and reform in energy sector and state-owned enterprises (SEO).
With regards to energy efficiency, on the 6th June 2017 Ukrainian Parliament adopted the law on Energy Efficiency Fund. Few days later, on the 22nd June 2017, the laws on energy performance in buildings and on commercial heat metering and billing were also adopted.
2.6 Healthcare
Ukraine’s Parliament adopted crucial legislation aimed at fixing the country’s healthcare system. The purpose is to define a new healthcare setup, based on western models, and to replace the remnants of a Soviet system that left Ukraine with one of the highest mortality rates in Europe.
In particular, on the 19th October 2017, the Ukrainian Parliament adopted the draft law on state financial guarantees for the provision of medical services and medicines. The newly approved measures and provisions aim to assign a new role to personal insurances, to create a new institution called National Health Service of Ukraine (NHSU) and hospital districts to regulate the existing network of hospitals, to give financial and managerial autonomy to hospitals, to introduce flexible salary of doctors and to shift from financing a medical institution to financing the services provided to the patient.
2.7 Human rights
In June 2015, the Government of Ukraine notified the United Nations Secretary-General of its derogation from certain human right guaranteed under the International Covenant on Civil and Political Rights and the European Convention on Human Rights, in light of the security situation in the eastern regions of the country. The derogation was reviewed in June 2016. On the 19th April 2017 an interagency state commission was established in order to review the necessity, territorial application and scope of these derogations. The President of Ukraine also requested to the National Security and Defence Council (NSDC) to develop a draft law on the aspects of the state policy on the restoration of Ukraine’s sovereignty over the temporarily occupied territory of the Donetsk and Luhansk regions. The annual Human Rights Dialogue between the European Union and Ukraine was held on the 13th June 2017 in Kyiv: during the meeting, the European Union particularly called for further progress to be made in the investigations into the crimes committed during the EuroMaidan protests and the violent events in Odessa on the 2nd May 2014. On the agenda of the meeting was also the non discrimination policy and the rights of the child: in particular, the European Union encouraged Ukraine to ratify the Istanbul Convention of the Council of Europe on combating and preventing violence against women and domestic violence.
2.8 The Judiciary
In the Association Agreement between the European Union and Ukraine, the rule of law is qualified as a key element of strengthening the cooperation between the parties. In June 2016, Ukraine adopted constitutional amendments concerning the justice sector. The amendments provide for the creation of a new Supreme Court, the simplification of the court system and the strengthening of the independence of the Judiciary. Generally, the access to justice improved, thanks to an increase in legal aid recipients and new legal aid bureaux. In 2017, the Ukrainian Parliament adopted a new law establishing a Constitutional Court and, on the 29th September 2017, the High Council of Justice in Ukraine proposed 111 candidates for appointment by the President as judges at the new Supreme Court. Recently, the President of Ukraine signed the law on introducing the amendments to the Code of Commercial Procedure of Ukraine, the Code of Civil Procedure of Ukraine, the Code of Administrative Procedure and other legislative acts, which aims at bringing the country’s legal procedure in compliance with European and international standards. Thanks to this continuation of justice reforms, the perceived level of judicial independence has increased, according to the latest surveys by the World Economic Forum (WEF).
2.9 Police system and security sector
The Ukrainian police reform process began in March 2014. So far, the highest point of the process was the institution of the new National Police of Ukraine (NPU), which replaced the old militia on the 7th November 2015. According to several international observers, the creation of the new patrol police is generally recognized as one of the main successes in the reform of Ukrainian law enforcement, especially considering the violent events occurred during the EuroMaidan. However, the reform process is continuing, aiming to develop a comprehensive concept of public order policing, to reinforce the principles of intelligence-led policing and to strengthen the capacity of NPO for criminal investigation. In this sector, the Organization for Security and Co-operation in Europe (OSCE) Project Co-ordinator in Ukraine is supporting the process of certification, selection and testing of the police officers, notably for neighborhood and patrol services, even offering re-training programs to the certified militia workers. The OSCE Project Co-ordinator in Ukraine also assists the Ministry of Defence, the Parliament and the Security Service to learn and introduce the international best practices in the sphere of the security sector.
3.10 Prevention and repression of corruption
Ukraine has instituted some new anti-corruption authorities, aiming to respond to public demand for a fairer and more transparent public system.
The National Agency for Prevention of Corruption (NAPC) is a special status central executive agency that ensures the formation and implementation of the state anti-corruption policy. The NAPC is a collegial body consisting of five members and has the main task to verify the accuracy of state officials’ asset and income declarations.
The National Anti-Corruption Bureaux (NABU) is a law enforcement anti-corruption agency, which has the task to investigate corruption and prepare cases for prosecution. The NABU can also investigate bribery and corruption of foreign officials. The detectives of the agency have received training sponsored by the United States of America Federal Bureaux of Investigation (FBI) and by the European Union.
The Specialized Anti-Corruption Prosecutor’s Office (SAPO) is an independent structural unit of the Prosecutor’s General Office of Ukraine. The SAPO guides the investigations conducted by the NABU.
3.11 Public Administration
Ukraine is continuing to implement the 2016-2020 Strategy on Public Administration Reform (PAR). In particular, Ukraine has launched the concept of reform staff positions, focusing on the merit-based and transparent recruitment of officials. The country is also implementing a comprehensive policy cycle management, policy-making and salary reform, an e-Governance system, a human resource management information system and a new law on general administrative procedure.
Recently, the reform implementation in public administration has been confirmed as the key for a good governance and as essential for the resilience' strengthening, in the Declaration signed off on the 24th November 2017, during the Eastern Partnership Summit.
3.12 Public Finance Management
In February 2017, Ukraine adopted a new Public Finance Management (PFM) strategy. Then, in May 2017, a connected Action Plan was adopted. Thanks to that, the country aims to create fiscal space, by eliminating inefficient public spending and by strengthening revenue mobilization, and to make more strategical the budgeting process, with the improvement of programme-based budgeting and the introduction of medium-term budgeting. Ukraine also has started the reform of internal control of public finances, by transferring the Central Harmonisation Unit for Public Internal Financial Control from the State Audit Service to the Ministry of Finance. On this matter, the country is jointly supported by the European Union and the World Bank, through the Strengthening Public Resource Management Project: in particular, the European Union provided a 3,03 million Euro grant, which main beneficiaries are the Ministry of Finance and the National Agency of Civil Service. As recognized by the same World Bank, the country has made considerable progress in reducing large structural imbalances and restoring macroeconomic stability.
3.13 Public Procurement
A key area of the reform plan is Public Procurement (PP), a huge arena for corruption in the 1990s and 2000s. Making it fair and transparent is an important goal of the Association Agreement. It has been also qualified as a requirement for an International Monetary Fund (IMF) disbursement and EU visa waiver. However, on these field, Ukraine went further: its online procurement system, called “ProZorro”, has already become a global brand. Thanks to that, also in 2017, Public Procurement continues to be one of the flagship of the government. According to the PP reform strategy 2022, Ukraine started to work on a significant approximation package to be adopted in 2018. As recognized by the European Union in its last progress report, the business community, civil society and the professionalization efforts through on-line PP training for public officials achieve high take-up and bring successes. Thanks to all these efforts, Ukraine was admitted to join the World Trade Organization’s government procurement agreement. Even the European Bank of Reconstruction and Development (EBRD) accepted Ukrainian e-procurement model as a showcase of the digitalization of state tenders.
4. FUTURE CHALLENGES
The reform plan’s results have been achieved despite the security problems caused by the current conflict in Eastern Ukraine. The EU reaffirmed its commitment to support Ukraine in continuing to accelerate reforms and their sustainable implementation, confirming also its firm and continuing support to Ukraine's independence, sovereignty, territorial integrity and union, by condemning and not recognizing the illegal annexation of Crimea and Sevastopol by Russia. In this matter, the EU endorsed its support for the implementation of the Minsk agreements and a peaceful and sustainable resolution of the conflict in eastern Ukraine, and expressed a strong concern for the deterioration of human rights in the Doneck and Luhansk regions and the violation of persons belonging to ethnical and religious minorities and those who don’t recognize Russia’s illegal annexation. The European Union constantly stresses the importance of continuing the reforming efforts and intensifying the implementation of reforms in key areas such as better healthcare, rule of law and taxation, the fight against corruption, the judicial reform and more efficient public administration. Some of these reforms have just started, but many of them depend on human capital: the need to recruit new people, honest and professional, remains the biggest challenge. In fact, insufficient staffing at public institutions continues to represent an important obstacle. Reforms are costly and time-consuming but, despite such problems, the signs are numerous that changes are taking place and that they are irreversible.
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by SSC and Iana Seleznova