Economy Goes Down, Financial Risks Go Up. Execution of Budget 2019

The World Bank and the Ministry of Economy have reviewed their forecasts of Ukraine’s economic growth, lowering the expected rate from 2.9% to 2.7% and from 3% to 2.8% to 2.7% respectively.  The IMF’s prediction is the same as the one provided by the World Bank.

One characteristic shared by all these expectations is that they are lower than the ones built into the national budget for the current year. The national financial plan is calculated with a projected 3% GDP growth. Under the Budget Code, the difference between projected figures and the actual macroeconomic situation is the primary reason to amend the budget.

“In the case of the World Bank, we have changed the macroeconomic outlook from 2.9% to 2.7% GDP. It is an insignificant change. There is a team of IMF experts in the country right now, and I am certain that this (the budget – EP) is being discussed with the Ministry of Finance. We see no reason to make significant changes to the budget,” said Satu Kahkonen, World Bank Country Director for Belarus, Moldova, and Ukraine, to VoxUkraine. At the same time, the World Bank points out that if reforms slow down, so will the economic growth rate.

Analysis of budget execution reporting attests to the fact that the slower economic growth rate is already making an impact on the budget. The country’s financial plan suffers from lost key taxes. Capital spending is underfunded, and the typical absence of the billions required to make up the deficit from large-scale privatization makes the budget more dependent on loans.

In the first quarter, the total National Budget fund was executed by 91% in revenue and expenses, which means a shortfall of the plan by UAH 16 billion and UAH 21.1 billion respectively.

VoxUkraine analyzes why the budget has not been executed correctly since the beginning of the year and whether the situation can still be settled.

Revenue

The reasons why the budget is not executed in terms of primary taxes are mostly not new, but one factor proves to be the most significant (Fig. 1). 

VAT. A shortfall of VAT obtained from import can be explained by strengthening of the national currency. Another reason is the import of certain goods and services, such as gas, being lower than projected.

According to the Ministry of Finance, this tax has also been affected by the removal of VAT surcharge for imported solar panels and windmills, in effect since 1 January 2019.

The main reason for a shortfall of domestic VAT is the return of significant amounts of VAT to those who applied for a refund during the fourth quarter of 2018 and whose application had been verified and granted.

Excises. A shortfall of excises on products manufactured in Ukraine has been due to two primary reasons. The first reason was the decreased production of tobacco products manufacturing volume in January-March 2019 by 13.3% compared to the same period last year. The second factor is one that affects the market every single year. Ahead of increasing excise rates, manufacturers build up inventory with excise taxes paid during the previous years. They have accumulated inventory this year as well.

Rent. Rent collection failed to meet the plan due to last year’s overpayment of rent for gas in the amount of UAH 845.7 million. According to the Ministry of Finance, a major part of this sum (UAH 782.4 million) was overpaid by Ukrgazvydobuvannia. In April, the situation improved, with the amount overpaid reducing to UAH 22.4 million. These overpayments happen due to attempts to accumulate budget resources during peak periods of subsidy payout. 

The plan was outdone for two taxes – the personal income tax and the corporate tax. The increased income from the corporate tax is the result of the improving financial performance of enterprises. The greater income from the personal income tax comes from the growth of the average salary.

Table 1 REVENUE

Expenses

Three types of expenses have been funded by the Ministry of Finance by 99%-100%. They are social expenses, including spending on grants-in-aid and subventions, and public debt management (Fig. 2). 

Social expenses are traditionally a priority for the government. The Ministry of Finance always disburses them first and foremost, and the year of both presidential and parliamentary elections is an extra motivator for scheduled funding of pensions, salaries, and social benefits.

The budget statistics illustrate that the government has spent less than planned on subsidies since the beginning of the year.

This year, subsidies are paid both in cash and by bank transfer. The resource has not been selected for both programs. 

“During the first quarter of 2019, UAH 22.3 billion, or 87%, has been spent on subsidies, which is UAH 3.4 billion less than allocated for this period, namely UAH 25.7 billion,” –  Ministry of Finance. The Ministry of Finance allocated exactly the amount of money requested by the Ministry of Social Policy. 

Minister of Social Policy Andrii Reva explained in his conversation with VoxUkraine: “Last spring, we strengthened control over citizens’ income and changed eligibility criteria for subsidies. It turned out that we received fewer applications than we expected.”

The Minister added that since monetization started earlier, in March instead of May, there was a need to transfer part of the funds from the cash-free program of subsidy disbursement to the cash one. This issue will be discussed additionally.

Education and healthcare have been funded on a high level – by 99-100%. This is especially true for nationwide expenses, grants-in-aid and subventions. 

The reason is that most of these expenses in healthcare and education are of a reformist nature. They finance a certain reform component on the national and local levels. These sectors are considered a priority in terms of funding.

Expenses on apparatuses of the Ministry of Education and the Ministry of Healthcare have been underfunded by 17%, or UAH 1.2 billion, and 32%, or UAH 0.7 billion respectively. The presidential foundation to support educational and research programs for young people has not come into operation, and the projected UAH 300 million have not been allocated.

Expenses on defense and security have been relatively high yet uneven. The National Police has received 92% of the planned funding, the Ministry of Defense – 88%, the Prosecutor General’s Office – 89%, and National Security and Defense Council – by 78%. The funding cuts have affected primarily apparatuses of the respective agencies.

Economic activity. This is the type of expenses with which the government tends to experiment, as opposed to well-protected social payments – something is financed more, something less, depending on the priorities, seasonality, and availability of funds.

Some of these expenses are rather significantly underfunded.

For instance, restructuring of the coal industry has been financed by 33% of the projected amount, adding up to less than UAH 1 billion. Funding of smaller programs has also been quite low: engineering infrastructure of the border has been funded by 23%, benefits and subsidies for the population to purchase solid and liquid heating fuel and liquefied gas – by 19%. Expenses on the National Space Agency have amounted only to 17% of the plan.

The government is still “gaining momentum” with funding of road repairs. In the first quarter, Ukravtodor received UAH 2.6 billion, or 8% of the projected resource for the entire year. Funding of public roads has not yet started for routes Lviv – Ternopil – Uman; Bila Tserkva – Odesa – Mykolaiiv – Kherson. The situation is the same with roads R-51 Merefa – Lozova – Pavlohrad, N-08 Zaporizhzhia – Mariupol, N-14 Kropyvnytskyi – Mykolaiiv, and some others.

As a reminder, the road fund was created in the budget in 2018. It finances the road sector – both national and local roads. The fund was created to enable Ukravtodor to plan long-term expenses on road development.

This year, the fund is projected to provide UAH 50.4 billion for road development, with UAH 13.7 billion already disbursed as of May 16, according to the Ministry of Finance. Expenses on roads depend on seasonality and readiness of local authorities for repair works. This means that in summer and in autumn, the Ministry of Finance may transfer more funding.

Transfers to local authorities and development expenses. Primary subventions – ones for healthcare, education, social and economic development of territories, a number of smaller subventions in the sectors of healthcare, social safety net and education, basic grant-in-aid – have all been fully funded.

Development expenses traditionally suffer from underfunding – in the first quarter, disbursement of funding from the State Regional Development Fund has not yet started.

According to the Ministry of Finance, the Cabinet of Ministers has approved a list of projects financed from the Fund for the total amount of UAH 3.3 billion. However, this list is yet to be published.

Underfunding of expenses on economic activity and development expenses is a typical situation that happens every year; however, in the recent years, a new reason for this has emerged.

For two years straight, the minimum wage and additional sectoral bonuses were growing. According to the World Bank, this increased the payroll budget to 11% of the GDP last year, up from 9% in 2016.

Operational budget expenses have been actively growing and remain high – over 38% of the GDP.

“Last year, it was only possible to maintain the budget deficit within the planned limits by reducing capital expenses by 27% of the plan. This approach has a negative impact on the economic development prospects,” says Senior Economist with the World Bank Anastasiia Holovach.

This year, the budget will continue undergoing pressure for public sector maintenance. “However, it is important that the growth of the minimum wage has been maintained at the level of the nominal GDP. Thus, we expect the most significant financial risks for the payroll fund to be offset. Now, it is more important what is projected in the 2020 budget, so that the medium-term financial risks can be mitigated,” she summed up.

What Will Influence the Budget

In the long run, the situation with the budget will depend on the following key factors.

Further cooperation with the IMF. May is the month when the program of Ukraine’s cooperation with the creditor was supposed to be reviewed. Ideally, Ukraine should have met the deadline for fulfilling the memorandum conditions, which was the end of March, receive the following tranche in the amount of USD 1.3 billion, and move on to the next stage of the program. However, it is already clear that Ukraine’s performance of the program conditions leaves something to be desired.

UAH exchange rate. Strengthening of the national currently entails not only reduction of taxes on import, but also reduction of expenses on debt management and other governmental expenses in foreign currencies.

Timely identification of ways to offset budget losses. There is already a major shortage in the budget connected with revenue from privatization – UAH 190.7 million has been collected as opposed to the projected UAH 17.1 billion during the year. The Ministry of Finance has offset this shortage with loans. In the future, availability and cost of loans will depend on cooperation with the IMF.

“Speaking of budget revenue, the main stopgap to offset the deficit can be a higher-than-expected transfer of NBU profit – since the audit-verified profit is higher than it was expected at the end of 2018”. The NBU transfer is expected to amount to UAH 65 billion, up from the projected UAH 47.6 billion.

Economic slowdown rate. The rate of economic growth has been declining this year, but it is hard to say where the limits of this decline are. Among other things, they depend on whether Ukraine will keep moving along the reforms in the year of power shift.