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Illarionov: How Ukraine can avoid default and start economic growth

Russian economist Andrey Illarionov is convinced that it is almost inevitably there will be default in Ukraine in January-February 2015. But there is still a chance to avoid it, some concrete steps that the expert has described in his new article should be taken.

Andrei Illarionov: It is necessary to close the budget hole, through which about three billion dollars "leak" per month.
Andrei Illarionov: It is necessary to close the budget hole, through which about three billion dollars "leak" per month.
Photo: szona.org

On January 12, 2015, the National Bank of Ukraine (NBU) declared that as of January 1, 2015 the volume of international reserves of the state amounted to 7.533 billion US dollars. Six months ago, in July 2014, reserves stood at more than 16 billion dollars.

In early January 2015, when the NBU data have not yet been made public, Russian economist, a senior fellow at the Washington-based Cato Institute, Andrey Illarionov, in an interview with "Gordon" said that "default of Ukraine is practically inevitable. It will come in the end of January, up to February 2015 year. "The expert calculated: at the beginning of a new year Ukraine's international reserves amount would be about $ 7.5 billion, which, combined with the budget deficit and increase in the share of public spending in gross domestic product (GDP) from 53% to 67% means "suicide for Ukrainian state."

In his new article Illarionov offers concrete steps to reduce government spending in Ukraine, which will help to avoid a default and start economic growth.

To avoid default, you must cover all budgetary and quasi-fiscal holes

- Yesterday's message of the National Bank of Ukraine on the amount of international reserves at the end of December 2014 as a whole confirms the preliminary information about the main sources of loss of foreign exchange reserves in recent months and, therefore, identifies the main directions of the most urgent actions of Ukrainian authorities (if they still dare to do them) to prevent the coming of default. To avoid it, you need to close all fiscal and quasi-fiscal holes, through which in October-December 2014 from the foreign exchange reserves "leaked" almost $ 9 billion., Or an average of approximately $ 3 billion monthly.

"Naftogaz"

In December 2014 to pay for imported gas 1.65 billion dollars was spent. That is two-thirds of the total decrease in reserves. Budget deficit of "Naftogaz", according to various estimates, is ranging from 4% to 7% of GDP. Without closing this hole we cannot hope to stabilize public finances. Of course, it was necessary to start to do this at the latest, last spring, when the country was in a much more favorable terms, - at least, when the reform of "Naftogaz" was recommended to the Ukrainian authorities for the immediate implementation by Kakha Bendukidze and by the author of these lines. In the current environment, alas, it is left almost the only method that can give results immediately - the complete elimination of budget subsidies and raising tariffs on gas consumption to a level that ensures the balancing of income and expenses of "Naftogaz" and, therefore, the elimination of its deficit. Such an increase in tariffs will lead to a sensitive reduction in gas consumption, which per dollar of GDP in Ukraine today is higher than in Europe, about 4.5 times. Decline in demand for imported gas and the payment of the remaining imports (if, of course, it will remain) by consumers will close one of the biggest holes in the Ukrainian public finances.

NBU

In December, the NBU has spent on foreign exchange intervention $ 831 million. The massive interventions in the foreign exchange market, as well as administrative restrictions on the purchase of foreign currencies, multiple exchange rates and the rapid spread of the black market of currency suggest that the current rate of hryvnia is artificially inflated. In this situation, the only way out - the immediate, complete and unconditional liberalization of the foreign exchange market, the removal of all restrictions on foreign exchange transactions, the refusal of the NBU of foreign exchange interventions and other types of currency subsidies. The inevitable result of these actions will be the decrease of hryvnia. It will lead to a substantial lessening of demand for currency and override the second direction of leakage of foreign exchange reserves.

The budget deficit

There is no doubt that the main source of loss of foreign exchange reserves is the general government deficit, financed, in particular, by quasi-loans of NBU, which are sooner or later get to the foreign exchange market, and thereby engage an intensive "drain" of national foreign exchange reserves. According to the latest estimates of the Institute of International Finance, the budget deficit in 2014 reached 12% of GDP. According to preliminary calculations, the budget proposed by the Cabinet and approved by the Verkhovna Rada on December 29, 2014, provides for a deficit of at least 15% of GDP. However, estimates of the country's needs for external financing are ranging from 30-32 billion dollars (Government) to $ 50 billion (George Soros). This means that the real budget deficit of all the expanded government in 2015 is actually expected in the range of 25 to 43% of GDP. As already was noted, such a budget deficit when trying to increase government spending to planned in the budget law level in two-thirds of GDP is undoubted suicide for Ukrainian state.

The budget for the Ukraine in 2015

In view of the above, the absolute imperative of fiscal policy in Ukraine in 2015 is to reach a zero budget deficit, unconditional full balancing of revenues and expenditures of the state budget.

Along with this, there are at least two major priorities of fiscal policy. The first of these – is the need to start the economic growth in Ukraine, which requires at least a little to reduce the present excessively heavy tax burden. The second – is the need to ensure the required level of defense spending, which will guarantee the external security of the country. Simultaneous adherence to these priorities allows to outline the framework of fiscal policy of expanded government of Ukraine in 2015

The proposed outline of the budget-2015 allows you to achieve the following objectives:

- Completely eliminate the budget deficit, thereby stop wasting foreign exchange reserves and to create the necessary macroeconomic conditions for recovery of moderate financial support of Ukraine by external creditors;

- To reduce the tax burden by 4.6 percentage points of GDP, thereby sending minimum necessary signals to the business, operating in Ukraine for the resumption of the investment process and economic growth;

- To increase defense spending to a minimum level - 5% of GDP; this will provide basic security conditions in the country under foreign aggression;

- To reduce all other (non-defense) expenditures up to 32% of GDP, which will also create favorable conditions for the resumption of economic growth. The value of non-defense expenditures in 32% of GDP and of all public expenditure in 37% of GDP are still unacceptably high for the country with such a level of economic development as Ukraine has. These figures are much higher than the corresponding indicators in most countries, with the same and similar GDP per capita.

The preparation of the state budget in accordance with the proposed priorities, principles and criteria and its rapid approval by Parliament in the coming weeks would avoid waste of foreign exchange reserves and default of Ukrainian government; would provide the minimum required level of defense of the country, the restoration of a moderate external lending, as well as to create basic conditions for the resumption of economic growth in the country.

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