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programme is only 1%, whereas the corresponding share for the US is 87%, according to CEPR.
Sovereign and private investors have also pitched in, recently giving Kyiv a 1- to 2-year debt repayment holiday and the resulting $6bn in savings for the govern- ment and state-owned enterprises over 2022-2023 will be helpful, but this will go only a small way towards closing the fiscal gap, the CEPR authors said.
Things are coming to a head as the government starts reversing one
policy after the next as it increasingly focuses on husbanding what dwindling resources it has.
The government was adamant since the Russian onslaught began that it would honour all its obligations and pay its bonds off on time in the hope that the international markets would reopen for Ukraine and it could raise some of the money it needs with Eurobonds.
But those hopes are dead now. The state-owned gas company Naftogaz
was forced into default on a $335mn redemption on July 26 after the govern- ment ordered the company not to pay in order to “preserve cash”, despite the fact that the company had the money and the management were willing to pay.
The NBU also did an about-turn and abandoned its efforts to defend the currency. It spent $3.4bn and $4bn of its foreign exchange reserves in May and June respectively to defend the exchange rate to retain the public’s confidence in the currency. Faced with the realisation it was going to burn through all its cash very quickly, the regulator abandoned that policy in July and devalued the hryv- nia by 25% on July 21 to align the official exchange rate with the cash rate in the market. The currency has since slipped further and the NBU may have to devalue again, as there is still a gap between the official rate of UAH36.6 to the dollar and the cash rate of about UAH40, although the rate seems to have stabilised in the last few weeks.
Both the international and domestic bond markets remain unavailable for
raising funds. The banking system is actually saturated with liquidity, but government bonds offer below-inflation interest rates, which makes domestic bonds impossible to sell.
With little access to international fund- ing and almost no access to bond mar- kets, that leaves the government with a handful of alternatives: raise taxes, print money or tap into domestic savings.
Policy recommendations
The situation is bad, but not impossible, says the CEPR team. There are several things the government needs to do to be able to raise the resources it needs from within its own resources.
First, the government must mobilise more resources to improve its fiscal position so that the country can fund huge military expenditures and main- tain basic public services in an economy ravaged by the war.
Raising tax revenues involves three basic elements. First, a stronger, larger economy provides more resources for taxation. High military spending already gives a powerful demand-side stimulus and CEPR recommends exploring more supply-side policies. Second, the govern- ment can broaden the tax base, by intro- ducing new (ideally, easy to administer) taxes but also eliminating exemptions. For example, with zero import duties in
April-June 2022, Ukraine imported light vehicles worth about $1bn, which cost the government budget approximately UAH25bn in lost tax revenue –
a loophole that has been closed in the meantime.
One obvious change is the government should introduce progressive income taxes, as Ukraine has a flat personal income tax with a rate set at 18% and the existing military levy (introduced in 2015) is also a flat 1.5% of income. The story is the same for corporate profit taxes.
“The aim should be to increase the collection of tax revenues and for remaining shortfalls to be financed primarily through non-monetary means: preferably through external aid, but if not, through domestic debt issuance, with much less reliance on seigniorage (printing money),” says CEPR.
The way you can do that is to restore some credibility to the government, and that means first and foremost bringing inflation down.
“There is an urgent need for a durable nominal anchor. Heavy reliance on money printing to finance government deficits has been unavoidable in the first months of the war but if the current reliance on money finance is sustained, inflation, already over 20%, could easily drift much higher,” says CEPR.
Running Ukraine's economy for the first six months of the war has been little more than crisis management, paid for with the printing presses. As a second six months beckon, now the country needs a plan. / bne IntelliNews
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