Ukraine’s plans for institutional reforms

We consider the EU-2023 review, Ukraine Facility plan, the current IMF program for Ukraine, and Ukraine’s Revenue Strategy adopted in December 2023. These documents focus mainly on fiscal policy and the financial sector, although they cover more specific areas, such as green energy, or more general issues, e.g. human capital too. Many reforms in these documents overlap making it easier for the Ukrainian government to implement them. In this article we consider general governance reforms and reforms on public finance management. We will consider sectoral reforms in a future article.

Decentralization: developing grassroot democracy

Both EU-2023 Review and Ukraine Facility briefly address the need to strengthen local governments and develop decentralization reform that has been successfully implemented in Ukraine since 2014. Specific steps for this are as follows.

First, during the full-scale invasion, civil-military administrations were established in some municipalities, replacing elected local authorities. While these are needed for defense, EU-2023 Review recommends setting clear rules for establishing these administrations so that they do not become an instrument to undermine local self-government, and local self-government is restored when it becomes possible. 

Second, when the martial law is lifted, Ukraine will need to complete the decentralization reform with amendments to the Constitution. Previously, both Poroshenko and Zelenskyi tried to introduce relevant draft laws into the parliament — without much success because their suggestions bore risks of power centralization and reversal of the reform. In the current setup the Ukrainian president already has too much power, which makes the system unstable. However, it seems that Ukrainian presidents are unwilling to cede their powers, even though this would be in the best interest of Ukraine.

Third, the distribution of powers between central government and local authorities should be clearly delineated. This exercise is not hard per se but reviewing and distributing multiple functions implemented by central and local authorities requires some time and effort.

Fourth, the EU-2023 Review recommends granting municipalities (communities) the status of legal entity in line with EU practices. Some Ukrainian experts support this idea, some oppose. Therefore, the Ukraine Facility foresees a study of pros and cons of this issue that would allow making an informed decision.

Finally, to provide local governments not only with powers but also with resources, no less than 20% of grants provided for reconstruction under the Ukraine Facility (EUR 1.1 billion) shall be allocated to local authorities. This will strengthen local-level decision-making and competition between local governments. At the same time, local governments should be properly controlled – both by citizens and by central authorities. Thus, there will be the law on public consultations and the rules for supervision of local authorities’ activities in line with the European Charter of Local Self-Government (currently public consultations are regulated by the Cabinet of Ministers Decree and suspended due to martial law). 

At the same time, the EU-2023 review does not recommend enacting the infamous law on urban planning in its current form because it entails large corruption risks. 

Table 1 below summarizes the documents that should be adopted within the framework of decentralization reforms.

Law enforcement and judicial system: overwhelming changes

Both EU-2023 Review and Ukraine Facility pay the most attention to the judicial system and more generally to law enforcement. Indeed, law enforcement is the cornerstone of any reform because without it the “rules of the game” become useless. Perhaps for this reason the judicial reform in Ukraine has seen the most opposition and sabotage – because at all times vested interests did not want to lose an opportunity to bend the rules for their benefit. Nevertheless, with the help of the civil society and Ukraine’s international partners the reform has been progressing. Interestingly, Ukraine has about twice less judges and twice more prosecutors per 1000 population than the EU (EU-2023 Review). Perhaps this is not a direct indicator of law enforcement quality but certainly should suggest the strategic direction of the reform. 

Ukraine Facility plan has a few specific indicators of the judicial reform that should be met during 2024-2027 while the EU-2023 Review provides a broader view on law enforcement: besides judges and prosecutors it considers enforcement of court decisions and legal education, operations of the Bar, protection of human rights and fighting organized crime, as well as migration and smuggling. Both Ukraine Facility and EU-2023 Review touch upon the bankruptcy legislation but we consider this issue in the business environment section below. 

Specifically, the EU-2023 Review talks about raising the quality of legal education. This implies modernization of curricula, zero tolerance to cheating and plagiarism, merit-based financing, etc. 

In the human rights domain, Ukraine should continue implementation of the Istanbul Convention (including investigation and punishment of war-related sexual violence) and work on ratification of the Rome Statute. It should implement the action plan on barrier-free environment and the law on rehabilitation of people with disabilities, update the Human Rights Strategy (2021-2023) and respective action plan, update the legislation that counteracts discrimination and hate speech and adopt the law on civil partnerships (we analyzed this draft law some time ago).

The EU-2023 Review pays a lot of attention to the rights of prisoners: prevention of torture, provision of proper living conditions and medical care. The report suggests (1) establishing a permanent body including CSOs and Human Right Commissioner to monitor the situation and (2) annual reporting of Prosecutor General and State Bureau of Investigation on investigation of cases of torture and protecting victims. 

In line with the EU-2023 Review recommendations, the government renewed the Migration Policy Strategy until 2025 (however, it does not include Ukraine’s ratification of the International Convention on the Protection of Rights of Migrants). Ukraine still needs to adopt the relevant action plan with specific indicators for assessment of Strategy implementation. 

Other needed changes in this domain include aligning Ukraine’s legislation with Victims’ Rights Directive and EU Directive 2004/80/EC on compensation to victims of crimes, improvement of personal data protection, including implementation of EU Protocol on automated data processing, and de-institutionalization of children and elderly (according to Ukraine Facility plan, Ukraine should adopt the relevant strategies by the end of 2024). Finally, the Ukrainian government should communicate how rights and freedoms will be restored after martial law ends.

The section on fighting organized crime foresees upgrading the respective law and adoption of witness protection law. Prosecution should strengthen its pre-trial investigation function while the State Security Service should be deprived of this function. Ukraine should develop relevant institutional capacity to implement SOCTA (Serious organized crime risk assessment) and establish a permanent coordinator on fighting organized crime, improve legislation on firearms possession and work on prevention of illicit firearms possession and trafficking. Criminalization of large-scale smuggling of goods also foreseen by the EU-2023 Review, was implemented in December 2023. 

The EU-2023 Review touches upon media freedom as the main mechanism to protect democracy and people’s rights. The document recommends strengthening independence of the national media regulator, developing together with journalists clear rules for reporting from combat zone and establishing a more effective mechanism to obtain public information. The government should also adopt a roadmap of return to pluralistic, transparent and independent media after martial law is lifted. Ukraine Facility prescribes changes to the Plan for the distribution of radio frequencies and implementation of EU Directives on cyber security by Q1 2025.

The major milestones for law enforcement reform (Table 2) include merit-based selection of judges and prosecutors, establishing the procedures for punishing those of them who lack integrity or violate the law, and strengthening enforcement of court decisions. EU-2023 Review and Ukraine Facility provide specific recommendations for random allocation of cases to judges and prosecutors that would lower opportunities for corruption. Proper introduction of remote court hearings would support this change by widening the pool of judges to whom a case could be assigned. Remote court hearings were introduced in Ukraine during Covid-19. Today the law should clearly define what kind of cases and what type of hearings can or cannot use the online format so that the rights of trial participants are protected.

Taken together, these changes should strengthen the integrity and effectiveness of law enforcement and thus the business climate in Ukraine. Unfortunately, a lot of time has been wasted and we will see changes only gradually. 

Civil Service Reform: change in remuneration system and re-launch of competitions

Civil service reform is the key to implementation of all other reforms because competent and trustworthy public servants are needed to develop and implement relevant legislation.

During 2024 Ukraine will need to align existing legislation with the new Law on administrative procedure. The government also plans to introduce the long-discussed changes to the laws on remuneration of civil servants. Namely, the fixed part of their salary should be no less than 70% (currently it is only 40-50%), seniority supplement should be reduced from 50% to 30%, and classification of positions should be established (under implementation since 2024). Together, this should increase professional independence of public servants and attract more “outsiders” to the system. 

The EU-2023 Review provides a few specific recommendations on improvement of the statistical system of Ukraine. These are (1) strengthening independence of the State Statistics Service, (2) adoption of the strategy for the development of statistics in 2024-2029, and (3) increasing production and transmission of quality data to Eurostat. Ukraine already has a law on statistics that establishes independence of Ukrstat and the program for the development of statistics until 2028. Hopefully these documents are implemented.

Anti-corruption and anti money laundering

The measures in this sphere can be broadly classified into (1) support of existing institutions (since there are continuous attempts to sabotage or compromise them); (2) strengthening of those institutions that function properly, and (3) “reload” of institutions that do not function properly.

The first group of measures includes implementation of the existing anti-corruption program (2023-2025) and Asset Recovery Strategy, support of e-declaration system, proper selection of the new NACP head.

The second group includes adoption of new anti-corruption strategy and program for after 2025 (to strengthen ownership, adoption of institution-level anti-corruption programs should be transferred from National Agency for Corruption Prevention (NACP) to institutions themselves); the recent law on increasing independence of Specialized Anti-corruption Prosecutor Office (SAPO) and the planned increase of its staff from 70 to 150 people; the increase of National Anti-corruption Bureau (NABU) staff from 700 to 1000, shielding it of interference and broadening its powers, including on independent wiretapping; increase of the number of Higher Anti-Corruption Court (HACC) judges and allowing single-judge hearings of certain cases to speed up the work of the court. 

Examples of the third group of measures are planned “reload” of the Bureau of Economic Security and Asset Recovery and Management Agency (ARMA).

Some recommended legislation has already been adopted, such as the law increasing powers of NACP and allowing it to check assets acquired by a person before joining the public service, and the law on lobbying. Some of this legislation, namely the law on the Bureau of Economic Security has not been adopted despite repeated nudging by G7 and Ukrainian civil society.

Table 4 lists the relevant documents and indicators for anti-corruption and anti-money laundering.

Business regulation: introducing EU norms

While poor law enforcement and high levels of corruption pose an obstacle to business development, there are other issues that need to be addressed to attract investment and facilitate business activity. These include deregulation, intellectual property rights protection, company law, and antitrust. 

Specifically, the EU-2023 Review foresees launch of the e-license system (the system that issues licenses and permits in electronic format) by the end of 2023 (only parts of this system are operational today). 

Ukraine has done a lot for intellectual property rights protection in the recent years but there is still the need to comply with the EU acquis on copyright, improve the functioning of collective management organizations, combat piracy, and finally launch the Intellectual Property Court that formally operates since 2017.

In the antitrust policy domain, besides changing the state aid rules mentioned in the anti-corruption section, Ukraine should create a comprehensive inventory of state aid schemes, improve transparency of state-owned enterprises and public-private partnerships, and adjust the antitrust law so that anyone could file a market concentration case to a court without the AMCU conclusion. 

Company law should be modernized to increase transparency of company structure and cross-border operations, support shareholder engagement, digitalization, and gender equality.

Banking sector and financial markets: strengthening supervision and activation of loans

Not surprisingly, the IMF program pays the most attention to banks and financial institutions. But other documents mention it too. Given Ukraine’s extremely high financing needs, having a healthy banking system and financial sector is crucial for Ukraine’s survival and recovery (the other side of the medal is efficient use of funds which we consider in the next section). 

Some general provisions that should be implemented continuously are prudent macroeconomic policy (e.g.,  avoidance of “money printing” to finance fiscal deficits). The government should restrain from “saving” banks and increasing state ownership of the sector (this will require an approval from the IMF). The strategy for reducing state ownership in the banking sector remains intact: state-owned banks will be privatized as soon as this becomes possible. Besides, the government will continue its efforts to recover Privatbank assets. 

Planned changes in the banking sector focus on restoring credit. The necessary steps for this are a plan for reduction of non-performing loans (interestingly, the IMF program foresees that the NBU should develop this plan by the end of June-2024, while Ukraine Facility suggests development of the relevant strategy a year later), “reload” of the subsidized loan program “5-7-9” (so that it corrects the market failure rather than crowds out market loans), and gradually introducing EU norms into banking regulation. 

Reform program for non-bank financial institutions is more extensive – perhaps because the capital market in Ukraine is much less developed than the banking sector. Here focus is on insurance which is key to attract investment to Ukraine. The need for war insurance has been discussed for quite some time but at the moment insurance initiatives are too small and fragmented. The IMF program foresees development of the draft law on war insurance by the end of June 2024. Adoption of two draft laws — on valuation and on Motor Transport Bureau — will also strengthen the insurance sector. More generally, the planned changes should align Ukraine’s capital market regulations with the European and international standards.

The reform program (both EU-2023 Review and the IMF) also foresees development of regulations for financial innovations, such as p2p lending, banks as a service or virtual assets (the recently adopted law on virtual assets has many flaws and needs to be amended).

Public Finance Management, including state-owned enterprises (SOEs): more efficient use of public funds

Since Ukraine’s resources are very scarce and it largely depends on foreign support, both Ukraine Facility and the IMF program pay a lot of attention to public finance management, with the aim to improve its efficiency. 

General provisions of these documents are not new: additional expenditures should be covered by additional revenues; the government should work on reducing foreign debt and its replacement by domestic debt (and the capacity of debt management agency should increase so that debt management is more transparent); the government should return to mid-term budget planning and start a more thorough assessment of fiscal risks (and those who use state guarantees should pay risk-based fees for them); and budget spending reviews should be finally introduced.

Both the IMF program and Ukraine Facility plan support the implementation of the National Revenue Strategy that should bring about 3-4% of GDP of additional budget revenues. On the expenditure part, they argue for strengthening of the Accounting Chamber of Ukraine, State Audit Service, and EU-2023 Review recommends restoring budget data transparency where possible. Since spending efficiency largely depends on efficient public procurement, the considered documents recommend aligning Ukraine’s procurement legislation (including laws on PPPs) with the EU acquis, enhancement of procurement monitoring (including AMCU capacity to monitor public procurement for potential collusion), and keeping exceptions from public procurement procedures to a minimum. More details on the public finance reforms are provided in table 7.

State-owned enterprises (SOEs) are a large source of inefficiency and corruption. Therefore, SOE reform has faced a lot of sabotage since its start in 2015. As Table 8 shows, Ukraine’s partners pay much attention to proper SOE management. The planned reforms include another triage of SOEs, development of proper ownership policies, implementation of the recently adopted law that improves SOE corporate governance, and appointment of professional and independent supervisory boards to the largest SOEs.

Tax and customs administration: less avoidance

Problems in tax administration and movement of goods across borders are well-known. Different governments tried to address it with limited success. The Revenue Strategy adopted at the end of 2023 provides a comprehensive roadmap for reforms of both tax and customs policies and administration. Here we consider the administration part and look at the policy part in the next article.

By and large, the major instruments to solve the problems of tax and customs administration are centralization and digitalization. More specifically, Revenue Strategy plans to depersonalize (automate) communication between tax or customs inspectors and people or enterprises and introduce risk-based approaches to identify  those who violate  the law. To this end, tax inspection will get access to the banking data of taxpayers, after it introduces a proper data management system. Customs inspection will transfer document checks from border crossing points to central offices. To implement the recently adopted law on criminalization of large-scale smuggling, the customs service will develop a law enforcement function, i.e. it will investigate cases of smuggling. At the same time, more enterprises will receive the status of Authorized Economic Operator and thus be eligible for simplified customs control.

Both tax and customs services plan to develop their staff (training, raising salaries, merit-based selection procedures, introducing KPIs), exchange information with respective agencies of other countries and implement their anti-corruption programs. By 2030 information resources of both tax and customs administrations will be consolidated at the Ministry of Finance level and managed by an independent administrator.

Conclusions

This article lists only the institutional reforms foreseen by several Ukraine’s support programs. The next article will overview the sectoral reforms and planned changes in tax and customs policy. 

The amount of work to implement these reforms is quite impressive. Moreover, some of these reforms will be unpopular with vested interests. Some will be unpopular with the general public (e.g. closing loopholes for tax avoidance). However, these reforms will make the Ukrainian state stronger and improve its ability to repel Russian aggression. They will also attract investment and help create jobs. Therefore, they need to be implemented sooner rather than later.