Echoes of war. The conflict in Eastern Ukraine is forcing the Cabinet of Ministers to review the national budget

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The government of Ukraine plans to adjust the national budget for 2014 to factor in the newest macroeconomic forecasts, which envisage a sharper economic decline. As the Ministry of Economic Development and Trade informed, review of the budget was one of the subjects of discussions between the ministry and the mission of the International Monetary Fund, which arrived in Kyiv on June 24 headed by Nikolay Gueorguiev to audit the results of Kyiv’s compliance with the conditions of the IMF stand-by program to the tune of US $17 bn. The first tranche of the loan in the amount of US $3.2 bn was issued at the beginning of May. The second tranche of US $1.4 bn is planned to be issued on July 25.

Achieved with difficulty

As for filling and fulfillment of the budget over five months, the government has nothing to please representatives of international organizations with. According to published data of the State Treasury Service, in January-May the plan for revenues of the general fund of the national budget will fulfilled 100%, however this was due to the fact that the shortage of tax proceeds was compensated by the over-fulfillment of the plan of non-tax proceeds.

Meanwhile, the Ministry of Finance received 78% of non-tax proceeds from the National Bank of Ukraine over 5 months, instead of the standard 20%. The NBU transferred the difference of UAH 16.3 bn to the budget as an advance before May as the IMF rebukes such a practice and the loan memorandum presupposes its elimination.

By the same token, the fulfillment of the tax part was to a great degree the result of advance payments. In particular, payments for the future guaranteed 60% of proceeds from corporate profit taxes. At the same time, the budget fell short of the planned proceeds from the VAT by 3.9%, 12.1% of the excise tax on domestically produced goods and 12.9% of import duties. Given the significance of the role of advance payments on the backdrop of the shortage of tax proceeds, the filling of the budget coffers in the remaining months will be extremely difficult.

Due to the problems with filling the budget coffers the government has already agreed to underfinancing the expenditure side of the budget. According to data of the State Treasury, the planned expenditures of the general fund of the national budget for five months were underfinanced by 8.5% or UAH 13.5 bn. To be sure, official transfers from the central budget to local budgets were traditionally cut. Local bodies of power did not receive 5.4% or UAH 2.8 bn of stipulated funds from the general fund of the national budget. The government saved another UAH 3.1 bn on defense expenditures and UAH 2.3 bn on guaranteeing civil order, fighting against crime and protection of the national borders. Only an unfulfilled number of expenditures allowed the government to fulfill the fiscal landmark set by the IMF.

Extraordinary recalculation

The next step after analyzing the fulfillment of the national budget from the start of the year will be the preparation of new macroeconomic forecasts, which will become the foundation of the reviewed budget for the next year. “Our priority task in the initial stage is to put efforts to forming a holistic vision of the situation and make a short-term forecast on its basis, which should first and foremost be realistic,” noted Representative of the IMF Mission Mikhail Gorbanev. Speaking of the “holistic vision of the situation”, the expert implies first and foremost the assessment of damages from the protracted military conflict in the east of Ukraine. Last year the Donetsk, Luhansk and Kharkiv oblasts accounted for 21.5% of the country’s GDP, 30% of industrial output and 28% of export and net proceeds to the national budget to the tune of 1.3% of GDP.

Realizing the importance of these regions for Ukraine’s economy, the IMF envisaged in its loan memorandum the possibility of reviewing the national budget in the event of the escalation of the conflict. “This conflict will reduce revenues to the budget and will significantly undermine investment prospects. As a result, the budget deficit may go through the ceiling set in the program, thus necessitating adjustment measures or compensatory donor financing,” it is written in the memorandum.

First and foremost, the review will have an impact on the economic growth indicator. The national budget of 2014 that was revised and cut in March is based on forecasts of a decline in GDP by 3%. The memorandum between Ukraine and the IMF, which was drafted by the end of April, envisages a downswing in the economy by 5% and does not take into account the escalation of the conflict in the east.

While according to a quarterly consensus-forecast of Capital revised in June Ukraine’s economy will decline this year by 4.6%, while economists at the European Bank for Reconstruction and Development have made a more pessimistic forecast of up to 7%. In view of the development of the situation in the Donetsk and Luhansk oblasts over the past two months, the IMF could offer the government of Ukraine to reduce the revenue side of the budget factoring in the weakened growth of the economy, says Senior Analyst at the International Center for Policy Studies Oleksandr Zholud. Be that as it may, in his opinion the IMF will not likely lower its forecast of the decline in real GDP to less than the 5% fixed in the memorandum. “Due to the high level of uncertainty around the situation in the Donbas, the IMF will most likely defer the revision of its forecast to the regular review in October and will propose to the Cabinet of Ministers that its fixes in the budget its forecasts made in April,” the expert believes.

Simultaneously with the cutting of the revenue side of the budget the government should have cut the expenditure side. However, as Capital learned the Cabinet is trying to come to an agreement with the IMF to increase the allowable deficit of the national budget for 2014 from the current 3.6% to 5.2% of the GDP.