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18 August 2017
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Budget 2017: defense, wages, and roads

Ukraine welcomes the new year with the state budget adopted. That is, one of the key conditions for continued cooperation with the International Monetary Fund has been met. Prime Minister Volodymyr Groysman named the law passed in the year’s longest night the budget of development and growth, while experts deem experimental some of its innovations.

Photo from UNIAN
Photo from UNIAN

President of Ukraine Petro Poroshenko has signed the Law on State Budget 2017, adopted by the Verkhovna Rada in the early hours of December 21, setting a deficit at 3% of GDP and laying down economic growth also at 3%. The document has already been published on the parliament website and will come into effect from January 1, 2017.

By signing the document, the president confirmed that the country’s defenses remain a priority, as defense spending is set at 5.2% of GDP. "For the first time, new samples of weaponry designed over the past two and a half years will shift from the process of testing to the direct setting into service significantly increasing combat capability of the Armed Forces,” the presidential press service has quoted Poroshenko as saying.

In turn, Prime Minister Groysman has said that Cabinet is ready to perform the budget of development and growth, involving large-scale road construction, improvement of social standards, healthcare support, and further decentralization.

In particular, the state allocates the unprecedented UAH 35 billion for road repair and reconstruction.

Local budgets are now responsible for utility expenses of their education and healthcare facilities, but at the same time, combined territorial communities get almost UAH 9 billion in subventions for their maintenance.

Under pressure from foreign creditors, Ukraine finally abolishes VAT refunds special regime for agribusinesses, but at the same time, the industry will get UAH 5.5 billion of direct support from the budget’s general fund.

In the coming year, maintaining a healthy lifestyle may save a lot of money for Ukrainians, because the excise tax on alcoholic beverages will increase by 20% and tobacco products - by 40%.

Perhaps someone will have to shift from driving a car to riding a bike, as the Rada has abolished the fee for retail sales of petroleum products, however, it increased the basic rate of excise duty, thus limiting opportunities for gas stations to avoid paying a duty.

A key innovation of the new budget, of course, was the Cabinet decision to double the minimum wage to UAH 3,200 from Jan 1 2017, which will be ensured with an additional UAH 28 billion on public sector wages. Thus, the Cabinet is trying to not only raise social standards, but also to encourage businesses to deshadow salaries.

Given the budgeted sharp increase in social standards, expert opinions regarding the quality of the budget and its feasibility vary.

The National Bank called the decision to sharply increase social standards and experiment with certain risks / Photo from UNIAN
The National Bank called the decision to sharply increase social standards and experiment with certain risks / Photo from UNIAN

Social experiment

Commenting on the adoption of the state budget, the National Bank said that this decision would accelerate the completion of the third review of the Extended Fund Facility signed with Ukraine’s key creditor, the International Monetary Fund, and bring Ukraine to getting another tranche of the loan. At the same time, in its December financial stability report, the regulator called the decision on a sharp increase in social standards an experiment with certain fiscal risks. According to the NBU estimates, increasing the minimal salary increase will add 1% to the index of inflation next year, but at the same time, about 0.5% could be added up to the GDP index.

The decision to raise salaries in the next year's budget has also seen mixed reactions of the expert community. According to the director of Case Ukraine analytical group Dmytro Boyarchuk, budget revenues are more or less realistic, while the provision on the minimum wage is a problem. "Even if we ignore the unknown effect on the economy, leveling of salaries is expected in the public sector. I do not know how they will deal with it, but it is potentially an additional problem for the incentives in this sector," he said.

According to experts from Case Ukraine, the tax burden on the Ukrainians in the new fiscal year will rise by an average of 20%. Next year, an average taxpayer will pay some UAH 55,000 to the state, while in 2016 this sum amounted to UAH 45,600. In particular, the income tax and single social contribution will increase as a result of raising the minimum wage. Raising excise tax rates on alcohol, fuel, and tobacco will also play its role.

Senior economist at the Center for Economic Strategy Iryna Piontkovska believes that, in general, the budget for 2017 contains a number of positive changes, including the reduction of the transfer to the Pension Fund and VAT exemptions, as well as maintaining a deficit limit at a safe level. At the same time, she noted a number of risks for the implementation of the budget. "It is obvious that the government is counting on deshadowing of economic activity due to the withdrawal of salaries from the shadows. But previous initiatives by the authorities aimed at deshadowing gave no tangible results," said the expert.

Piontkovska also believes that the risk is also on the agenda of non-receipt of UAH 10.5 billion as a result of recovery of assets derived from corruption and the risk of non-receipt of the planned UAH 17 billion of privatization proceeds. She assesses the amount of potentially risky budget revenues, which the government has already distributed in different directions, at about UAH 23 billion, or about 1% of GDP, warning that the lack of these revenues will require additional debt financing of the budget deficit.

"In general, these risks can be considered moderate, as they can be offset either as a result of economic growth higher than it is currently expected, or as a result of acceleration of structural reforms, including a thorough review of the state expenditures for their feasibility and efficiency," the expert says.

Head of ICU Group’s research department Oleksandr Valchyshen considers appropriate the government decision to raise social standards because domestic demand heated in such a way will be the main driver of economic growth in the coming year. "The increase in government spending through the budget is a key element of support for domestic demand in the economy. The government is trying to reverse the trend of the last two years, when the share of wages in GDP income structure fell to its historic lows," he said.

According to the expert, there is simply no other way, as the export-oriented sector in the current environment cannot yet be an accelerator of economic recovery. That is why the government is taking steps to boost domestic demand, including consumer demand, which now accounts for 68% of GDP. At the same time, Valchyshen noted that fears of a significant acceleration of price growth as a result of wage increase are exaggerated and the average annual inflation in 2017 will be at about 10%.

It is highly probable that the state budget will see adjustments / Photo from UNIAN
It is highly probable that the state budget will see adjustments / Photo from UNIAN

Global experience

Ex-Minister of Finance of New Zealand Ruth Richardson, whose government was the first in the world to report on the effectiveness of the use of public funds, has paid a visit to Ukraine this December. During her visit, she noted that in our country she was struck by two things - the quality of the national cuisine and irrational tax system that encourages big businesses to split into microbusinesses. Also, the foreign guest opined that the Ukrainian tax system did not contribute to the development of the agricultural sector.

"In New Zealand, fiscal regulations would not allow any official to fund their programs, according to Richardson. The point is not about changing the figures, it’s about modifying behavior, she said. These practices should be broken down, she believes, and new rules should be applied in all areas – fiscal and monetary. It is impossible to liberalize labor market and it is important for the businesses to understand that the rules of the game will not change tomorrow, according to Richardson. This will encourage more investment, she noted.

Günter Weiland, the expert at Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH, which implements in Ukraine the project of supporting administration reforms with public funds, during a Kyiv conference presented the German experience of budgeting. The pragmatic approach of the Germans has at its core performance indicators that allow comparing the result with the planned objectives. For example, the goal to reduce the crime rate requires increasing the number of police officers on the streets and giving young people more opportunities to engage in sports.

Program-target method of planning does not bring additional funds into the budget and neither does it help overcome the debt crisis, but it helps to use public funds effectively," said the German expert, noting that whatever the performance indicators, they must be measurable and they must be analyzed in dynamics.

Taking into account the opinions of foreign experts, we can assume that the Ukrainian government is taking steps in the right direction. In mid-December, the Ministry of Finance presented the concept of medium-term budget planning. As Finance Minister Oleksandr Danyliuk said during parliament debate on the budget, economic development trends for the next three years have been laid in Budget 2017, while the document for the first time in Ukraine’s history was drawn up based on the assessment of necessary expenses, not the potential revenues.

At the same time, given the number of crucial decisions adopted on the New Year’s eve, including the nationalization of Ukraine’s largest bank, it is likely that the budget, as well as a three-year strategic plan, is yet to see adjustments, and we know that Ukraine has been used to it.

Olha Hordienko

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