Saving the Ukrainian economy from the coronavirus crash
As the coronavirus pandemic continues to spread, global financial markets are in sharp decline and the international economic outlook is increasingly alarming. Indeed, the current panic is very reminiscent of the collapse of the Great Recession of 2008-2009, with additional uncertainties as entire economies begin to enter preventive shutdown mode. As an emerging economy dependent on commodity exports, Ukraine is particularly vulnerable to such crises. Ukraine’s economy currently faces the prospect of a perfect storm as the price and volume of exports plummet as domestic consumption and production collapse amid an unprecedented lockdown imposed across the country in order to to fight against the spread of the virus.
The Ukrainian government must act quickly to avoid a repeat of the 15% GDP contraction the country experienced in 2009. Encouragingly, it can count on relatively solid fundamentals. The banking sector is doing much better than in 2009; the level of public debt is relatively low; and the National Bank of Ukraine has ample reserves. The first steps have been encouraging, suggesting an awareness of the need to stimulate the economy and ease the burden on business. However, the magnitude of the ongoing global crisis makes significant economic hardship for Ukraine inevitable in the near future. What can policymakers do to weather this storm?
The current crisis has several components. First, there is panic in the foreign exchange market, with the hryvnia already experiencing a significant depreciation. Second, foreign demand for Ukrainian products is collapsing. Third, there are many negative spillover effects on demand due to lower exports. Fourth, measures to prevent the spread of the coronavirus will have a major disruptive impact on domestic production and consumption. We have a relatively standard playbook to cover the first three components. The fourth requires a little more creative answers.
Addressing the issue of currency is vital. In times of panic, investors typically liquidate their risky positions in countries like Ukraine and move their funds to safe havens like US government debt. As a result, many countries experience a depreciation of their currencies against the US dollar. Today, the spread between interest rates on corporate debt in emerging economies and the interest rate on short-term US government debt is growing rapidly.
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In such an environment, it can be safely assumed that the IMF and other international institutions such as the World Bank and the European Commission will be the only affordable sources of foreign exchange. The establishment of an IMF program to secure financing and thus unlock access to other sources must therefore be an absolute priority for Ukraine.
The Ukrainian banking sector will have a key role to play in the coming months. Sharp fluctuations in the value of the hryvnia can be directly disruptive for the Ukrainian economy. The banking industry could be under a lot of stress if people panic and rush to withdraw their deposits. The NBU must therefore provide abundant liquidity to Ukrainian banks to ensure the smooth functioning of the country’s banking sector. As Ukrainian banks are now in much better shape than ever, any concerns about insolvency should be alleviated. The central bank must vigorously exercise its role as lender of last resort. In doing so, it should not relax prudential requirements.
As inflation expectations are so tied to the exchange rate in Ukraine, a sharp depreciation of the hryvnia can generate high inflation expectations and hence inflation. Without trying to fix the exchange rate, the Ukrainian central bank should use its reserves to stabilize the currency market. It should also be prepared to resort to capital controls, which proved to be quite effective in 2014-2015, in order to tame any signs of growing panic.
Ukraine has to reckon with a collapse in exports and a consequent domestic recession. As foreign demand for Ukrainian exports decreases, some depreciation of the hryvnia is inevitable to absorb this negative shock. After all, it is the benefit of using a floating exchange rate regime. It is the first line of defense.
At the same time, the government should prepare to support export-oriented industries by offering tax breaks, loans and other forms of short-term assistance to help these industries weather the crisis. Of course, this support must be very transparent and based on clear criteria.
The government should also support those who need it most, including low-income families, the unemployed and the sick. Cash injections to these vulnerable groups can not only alleviate the wider economic crisis through stimulating consumer spending, but also enable these groups to weather the difficult times ahead.
To finance this recovery strategy, the Ukrainian government must seek to release additional financing by obtaining a program from the IMF. This will pave the way for new resources such as EU macro-financial support and World Bank loans for infrastructure projects, all of which are conditional on setting up a program with the IMF.
Speed and precision are crucial. As the Ukrainian government will have limited resources for any stimulus package, the response must be swift in order to stop the crisis before it takes hold of the economy. It must also be targeted to use valuable resources most efficiently.
The coronavirus crisis is in many ways unprecedented and will bring entirely new supply shocks that will spill over into the entire Ukrainian economy. This will disrupt production in a number of ways, ranging from reduced labor supply when workers fall ill or have to care for out-of-school children, to shortages in input stocks. With the closure of restaurants, cafes, shopping malls and cinemas, entire swathes of the economy are crippled.
The experience of the 1970s, when oil prices rose dramatically, teaches us that there is no simple solution to this kind of shock. However, this crisis also reminds us that there are opportunities in such challenges. America’s oil and gas industries boomed in response to high energy prices in the 1970s, for example.
Since Ukraine is in dire need of investment in its health care system, the government can kill two birds with one stone. By spending heavily on healthcare through measures such as hiring short-term healthcare workers to treat the sick and providing free coronavirus testing for the public, the government can potentially reduce the consequences of the adverse shock from the country. supply side, while providing the necessary fiscal stimulus.
The financial relief measures adopted by the Ukrainian parliament on March 17, including tax breaks for the self-employed, the cancellation of property and property taxes and an easing of penalties on delinquency, are a step in the right direction. Plans to create a state budget stabilization fund are also welcome. However, external financial support will be essential to sustain a sufficiently large stimulus package, which is why getting a new program from the IMF is so important.
In conclusion, Ukraine is facing very difficult times, but we must not despair. The lessons of the Great Recession and other crises teach us that the worst can be avoided. The Ukrainian government should not try to reinvent the wheel, but rather should seek to use the lessons available to develop a swift and decisive response to the crisis. Above all, it is vital to act with the kind of urgency the situation demands.
Yuriy Gorodnichenko is a professor at the University of California at Berkeley.
The opinions expressed in UkraineAlert are solely those of the authors and do not necessarily reflect the opinions of the Atlantic Council, its staff or its supporters.