New Cabinet, Old Problems: The Economy Inherited by Shmyhal’s Government
7 March, 2020
Ministers of the old and new Cabinet sit together at the government's bench in Parliament during the vote to recall Oleksiy Honcharuk's government (right-most on the first row) and the installation of a new government led by Denys Shmygal (second from the left on the first row.) Kyiv, Ukraine, March 4, 2020. Oleksandr Kuzmin / UNIAN

Any big government reshuffle can seriously harm the economy of the country. Ukraine has recently changed its Prime Minister, as well as most ministers. Notably, the Ministry of Finance got a new minister too, and one that's critical to the International Monetary Fund.

Moreover, Ukraine's two key ministries still have no heads: that is, the Ministry of Economy and the Ministry of Energy.

The presidential party, Servant of the People, stated the probable financial crisis, as well as the risk of a coronavirus spread as the reasons for this reshuffle.

What economic problems will the new government have to deal with?

Budget Shortfall

For the first two months of 2020, the state budget was not executed in terms of revenue. In January, non-execution was about 25%, and about 5% in February. The revenues that the state expected to receive in order to finance education, medicine, infrastructure, etc., were not received in full. Funds lacking have to be borrowed to finance public spending.

In planning the 2020 budget, the government’s calculations were overstated. In particular, the dollar exchange rate: the budget for 2020 was calculated at the rate of 27.5 hryvnias per one U.S. dollar, while in January-February the real exchange rate was 24-25 hryvnias.

The customs revenue depends on the dollar exchange rate. When goods are imported into Ukraine, they are subject to customs duties and value-added tax (VAT), and some (e.g. alcohol and gasoline) are also subject to excise duties. These taxes depend on the customs value, which is calculated as the hryvnia equivalent of the commodity price in dollars. Therefore, the lower the dollar, the lower the cost of imports and the lower the taxes paid on the import of goods.

The budget shortfall was harshly criticized by President Volodymyr Zelenskyy during his speech in the parliament.

“We have constantly heard about the economic leap, but there is an impression that the economy was accelerating but stumbled and may fall flat on its face. In the two months of this year, the non-execution of the state budget amounts to 16 billion hryvnias ($640 million). 13 billion ($520 million) of them is a failure of customs revenue,” Zelenskyy stated.

To solve the budget shortfall problem, the macroeconomic forecast on which the government is calculating the budget has to be revised.

This process began in January, and by the beginning of March, the updated macroeconomic forecast by the Ministry of Economy has already been submitted to the Ministry of Finance. The Ministry of Finance has begun to calculate how much the updated forecast will change the budget indicators and whether there is a need to amend the state budget for 2020.

However, it is still unknown whether this process will come to a conclusion — vote by the parliament on amendments to the budget — after the government reshuffle. The new government may want to recalculate the macro forecast, which will take several months. At the same time, new Prime Minister Denys Shmyhal has already said he wants to revise the 2020 budget. However, not to close the budget gap, but to increase social payments.

Coronavirus and the Global Economic Crisis

Until the 2020 budget is revised, the state can only cover the gap by borrowing money from the market. It was quite easy in 2019 and early 2020, as government bonds were in high demand, particularly among foreigners. However, in February the situation is different: the panic has began in world markets due to the coronavirus outbreak. Investors have started to sell risky assets - stocks of companies and bonds of developing countries. This has already affected Ukraine: demand for the Ukrainian national debt has decreased, and it is increasingly difficult for the Ministry of Finance to borrow money at low interest rates and for long periods.

This means that the state can take a step back from its successful track record of paying off debt: since 2019, the value of government loans in hryvnia has been reduced by more than 2 times - from 20% per annum to 9-10% per annum.

However, the crisis in the world markets may force borrowing at higher interest rates, and the state, instead of spending money on medicine, salaries and other needs, will have to spend more money on debt repayments to creditors.

In the longer term, the coronavirus can cause an economic crisis in Ukraine, Acting Minister of Economic Development, Trade and Agriculture Tymofiy Mylovanov believes, by affecting trade with China.

China is Ukraine's largest trading partner, and a slowdown in its economy could lead to a fall in imports (and thus a fall in budget revenues) and a fall in exports (and thus a fall in foreign exchange earnings into the economy and the devaluation of the hryvnia).

Mylovanov believes that the new government should be ready for prompt actions during the coronavirus outbreak - urgently reduce taxes, allow pensioners to skip utility and communal payments, provide subsidies to vulnerable sectors of the economy, as well as cooperate with business.

The Fall of the Manufacturing Industry

Another problem that the Honcharuk government left for the Shmyhal government is the sharp slowdown in Ukraine’s manufacturing industry, which increased to 5.1% in January 2020 (compared to January of the previous year).

Why is the industry declining? Metallurgy is one of the leading industries of Ukraine. Ukrainian metallurgists mainly work for export, and their profits are directly dependent on demand for metals and world prices for these products.

In 2019, steel prices plummeted amid the U.S.-China trade war. The price situation was exacerbated by the fall in the exchange rate: metallurgists' export earnings began to decline.

Moreover, as global metal prices started falling, some metallurgists began refurbishing their plants, causing production to decline as well.

Another reason for the industry's fall is the warm winter. According to January results, the largest fall of the industry was recorded in the energy sector — 11.8% compared to the previous year.

This is due to the fact that because of the warm winter, Ukrainians use less gas and electricity for heating, thermal power plants began using less coal, and at the same time, the state accumulated a lot of coal in its warehouses. Because of this, mines cannot sell coal because there is no demand for it. Thus miners accumulated unpaid wages.

The industries that are not dependent on energy and metallurgy did not suffer a significant decline, with some even growing (in particular, the chemical industry grew by 24.4% and computer equipment manufacturing by 17.4%).

But in light of the economic crisis surrounding the spread of the coronavirus, Ukrainian industry may fall even lower, as metal prices continue to fall in 2020 - due to falling metal demands and a slowdown in the Chinese economy.