Page 76 - bne Magazine August 2022

76 Opinion
bne August 2022
During the active phase of the war (1991-1993), the Croatian National Bank also tried to patch the fiscal deficit with monetary financing, which triggered rampant inflation. However, the deterioration in the economic situation and the looming hyperinflation prompted the government
to take decisive action by conducting a rapid fiscal consolidation and rolling back the central bank’s financing of the budget deficit.
The joint actions of the government and the Croatian National Bank contributed to the achievement of macroeconomic stability, a rapid slowdown in inflation, stabilisation of inflationary expectations, and transition to sustainable economic growth.
What options are on the table?
What should Ukraine do if the government’s needs for meeting budget expenditures grow as the central bank insists on cutting back on the monetary financing of the budget deficit? Option one is the simplest solution, but it will cause a crisis
in the long run. This option is to do nothing. This means continuing to rely more and more on the issuing of money by the NBU to finance the budget deficit.
The justification seems to be obvious: the nation is at war. But then we have to visualise the consequences of this scenario. After public confidence evaporates, the authorities may eventually lose control of the economy, social inequality will deepen, and the country’s defence capability will suffer a major blow, as will its monetary sovereignty.
Option two requires difficult decisions to be made, but it
is effective. The economy has a limited resource. Given political will, it is realistic to redistribute this resource to meet priority needs (after all, this is supposed to be the goal of macroeconomic management).
On the one hand, there is a need to cut expenses by sequestering the budget and curtailing non-core spending, a task the government has already begun to accomplish.
The alternative is that if monetary financing is allowed to continue, the inflation-depreciation spiral will not make it possible to prioritise budget expenditures, and government expenditures will depreciate in real terms, making it impossible to achieve the set goals.
On the other hand, there is the need to increase revenues. Doing it by putting a greater tax burden on businesses and workers is not the best choice. Businesses need to recover.
Taxes should be an incentive to limit the indiscriminate spending of resources necessary for continued defence. This can be done by raising taxes on consumption, imports, assets and rent.
It is vital to ramp up domestic borrowing, including by increasing the rates on hryvnia domestic government debt
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securities to the market level. This will increase the appeal of hryvnia assets and allow the government to raise market resources to cover the budget deficit and, accordingly, reduce the need for the issuing of money by the NBU.
This will also safeguard households’ incomes and savings from inflation and reduce FX demand, which will prevent the further accumulation of imbalances, ease pressures on Ukraine’s international reserves and gradually resolve the issue of multiple exchange rates.
In addition, all representatives of the authorities should
make maximum diplomatic efforts to increase the amount of international aid. We have already received unprecedented amounts of official funding. However, they remain dwarfed by the magnitude of the losses that Ukraine suffers with every day that the war drags on.
Of course, option two will in the short run take a more painful toll on the population and businesses. But at least it is straightforward and honest. It will make it possible to take pressure off the hryvnia and avoid a speed-up of inflation and a drawdown of international reserves. After all, such adverse processes will by no means contribute to the stability of public finances.
This will allow the authorities to retain control of the financial system and the economy as the war rages on, and will also facilitate a quicker return to the market-driven operation of the economy and financial markets after the war.
“Option one is the simplest solution, but it will cause a crisis in the long run. This option is to do nothing. This means continuing to rely more and more on the issuing of money by the NBU to finance the budget deficit”
How monetary financing impacts the European dream
Large-scale financing of the public sector by the NBU can significantly prolong or even hinder Ukraine’s accession to the European Union.
The possibility of accepting a new country into the EU is provided for in Article 49 of the Treaty on the European Union. Any European country applying for EU membership must also meet what is known as the Copenhagen criteria, which require the candidate country to comply with certain requirements.
The eligibility criteria in the field of economic and monetary policy, in particular, contain clear rules that, among other