Ukraine: Prime Minister Yatseniuk wins confidence vote, military clashes continue in the east
August 1, 2014
Ukraine’s already frail political stability was threatened again this month. The Ukrainian army has made progress in regaining some of the conflicted regions in the east, although violent clashes with rebel armed groups continue in the region of Donbass. The downing of the Malaysia Airlines MH17 jetliner by a land-to-air missile in the Donetsk region increased military tensions and accusations on both sides of the conflict. Moreover, the stability of the country’s coalition government was jeopardized when Prime Minister Arseniy Yatseniuk presented his resignation to the parliament on 24 July because the government was unable to pass crucial bills concerning the economic reform program. However, Yatseniuk won a confidence vote on 31 July and will continue as PM.
Yatseniuk’s resignation came a week after the International Monetary Fund (IMF) released the First Review under the Stand-By Arrangement (SBA) on 18 July. The IMF had acknowledged progress in the implementation of the reforms that are necessary to be granted the second tranche of financial support, which is worth USD 1.4 billion, although some of the reforms had been implemented “with a delay”. Although on 24 July he was unable to gain the parliament’s support to introduce further cuts to public spending, to make budget reforms, and to push the energy sector reform bills further, Yatseniuk regained the parliament’s confidence and, on 31 July, the bills were passed.
According to the government, an additional USD 1.0 billion of expenditure for military equipment was needed to continue the campaign in the east. In order to contain the budget deficit, further cuts to public spending and new taxes were introduced by executive. The government introduced a new tax on oil and gas producers and on the metallurgy industry. Additionally, a temporary “war tax” of 1.5 percentage points will be levied on salaries, although it is expected only to last until the end of the year. The impact of the war on the economy has lowered GDP growth projections and is also making it difficult for the government to collect taxes in the conflicted regions, which is why it is pursuing further fiscal efforts.
The IMF announced that it had revised down its GDP growth projections for 2014. Whereas the SBA program was designed with a projected GDP contraction of 5.0% in 2014, the new forecast was lowered to a 6.5% decline. Consequently, the IMF also reconsidered its projections for the fiscal deficit in both 2014 and 2015. This year, the Fund expects the fiscal deficit (including the Central Bank’s foreign exchange losses) to reach 10.1% in 2014 (previously estimated: 8.5%) and to moderate to 5.8% in 2015 (previously estimated: 6.1%). Alexander Valchyshen, Head of Research at Investment Capital Ukraine (ICU) analyzed the main reasons behind the drag that the military conflict is having in the economy:
“The statistical data available for 2Q reveals that retail trade and passenger transport are the most severely hit sectors of the economy. The key reasons behind their collapse (…) are: first, currency devaluation impacted the purchasing power of the households in general and particularly in relation to purchasing imported goods; and second, passenger transportation took a severe hit, too, which is attributable to a large extent to the annexation of Crimea (which used to accommodate mostly Ukrainians from the mainland); and then, third, de-facto war in Donbass.”
On 30 July, the State Statistics Service of Ukraine released a preliminary estimate of Q2 GDP. According to the estimate, the economy contracted 4.7% over the same quarter last year (Q1: -1.1% year-on-year) and fell a seasonally-adjusted 2.3% on a quarterly basis. The contractionary spiral in which the economy is now trapped will continue to pose difficulties to the implementation of the economic reform program that is in the government’s agenda. Moreover, as long as the military conflict continues in the east of the country, it is unlikely that Ukraine’s outlook will improve in the near term.
Accordingly, FocusEconomics Consensus Forecast panelists cut their growth expectations for the sixth consecutive month. The panel expects the contraction to last until the beginning of 2015. Panelists see the economy contracting 5.1% this year, which is down 0.2 percentage points over the previous month’s estimate. However, economic reforms and the global economic recovery are expected to spark a rebound and push the Ukrainian economy to a 1.5% expansion in 2015.