Roman SHPEK: Business is ready to believe, but corruption and excessive state intervention are still standing in the way

2011 will be a decisive year in this country’s political and economic development. As the economy has shown no signs of modernization in the past two years of crisis, the government passed a new tax code, introduced administrative and pension reforms, and drew up the customs and labor codes. In other words, the government is trying to make radical changes. At the same time, criminal proceedings are being initiated against some former governmental officials, which the opposition says is nothing but political persecution that jeopardizes democratic freedoms in the country. Foreign investors and the EU are closely watching these events. The latter recently reminded Ukrainian leaders, via its commissioner, that adhering to common European values is an indispensable condition for EU membership. What should we focus on in order not to lose another chance for economic transformation and ensuing European integration? The Day put this and other questions to Roman SHPEK, advisor to the president of Ukraine, senior advisor at Alfa Bank, ex-minister of economics, ex-permanent representative of Ukraine to the EU, and graduate of Kyiv’s International Institute of Management.

What do you think of last year’s economic successes? What factors will be central for economic development in 2011?

“The year 2010 saw the beginning of structural reforms and renewed economic growth. The government mustered strength at last and was mature enough to make many important decisions: it passed a law on the gas market, established a body to set public utility rates, reduced the budget deficit, resumed cooperation with the IMF and World Bank, and launched difficult, yet indispensable, reforms.

“In my view, the main achievement of 2010 was a stable and predictable macroeconomic situation and predictability on the currency market. As a result, individuals have begun to gradually resume their trust in commercial banks. This is confirmed by the growing deposits of natural persons. In the autumn deposits returned to their pre-crisis levels.”

Does this mean we have overcome the crisis?

“Unfortunately not. It will take a very long time to overcome the crisis, but we have already managed to neutralize its main negative consequences. Yet the achieved economic revival rate (4-4.5 percent of GDP) are not sufficient for a wide-scale modernization of the economy, which the president’s program envisages — the national economy has not yet reached the pre-crisis level. Therefore, the government and business should make a concerted effort to achieve an annual economic growth of 9-11 percent of GDP. Only then will Ukraine come closer to the world’s 20 most economically developed countries. In my view, the Ukrainian economy will return to its pre-crisis level in the second half of 2012.

“As for the economic downsides of 2010, I would single out a large budget deficit and financing a major part of it with government bonds — about 69 billion hryvnias. This strips the real sector of the economy of credit resources. Due to the early payment of the profit tax and tardiness in VAT refunds, many businesses experienced shortages of operational assets. We still have to solve the problem of the gray economy and ‘gray delivery’ of goods, such as oil products, etc., to Ukraine’s customs territory.

“And, although the 2010 balance of payments is on the whole positive (thanks to direct investments and remittances from Ukrainians who work abroad), the structure of imports shows that this country takes in goods that are or can be produced by national businesses. On the whole, what causes alarm is a negative trade balance and, especially, the structure of import.

“For example, the import share in the steelmaking industry essentially grew in 2010. This means Ukrainian metallurgists are choosing the easier road: they turn out very simple and low-quality products. Meanwhile, the development of national mechanical engineering is impossible without high-quality raw materials or semi-finished items which have to be purchased abroad. Unfortunately, this is not the only example. So we must pay special attention to the development of a domestic consumer market by means of Ukrainian industrial products. The implementation of high-profile infrastructural projects will promote domestic revival, like with the projected public utility sector reform.”

STRUCTURAL REFORMS SHOULD BE SPED UP

What would you, as advisor to the president of Ukraine, advise the head of state to put the main economic emphasis on in 2011?

“We must carry out structural reforms even faster. These reforms should be carried out in two directions. The first is to change the structure of the economy by launching innovative businesses and manufacturing a new range of products that will be successful on the domestic and foreign markets. The second is to increase the competitiveness of national entrepreneurs. Here it is very important to cut power consumption per product.”

Can you see any positive changes in the attempts to build an energy-efficient innovative economy from the angle of the state budget?

“The current revenues allow for social functions only: financing the socially protected articles accounts for 80 percent of all funds. An urgent solution is needed, as there are now as many workers as pensioners. If we do not carry out the pension reform, the situation may become unpredictable.

“In my view, energy efficiency and innovations should be stimulated by funding from private, rather than budgetary, sources, provided there is a favorable investment climate. Alas, the investment climate in Ukraine has not improved of late, and the 2011 Economic Freedom Index ranked Ukraine 164th, two places lower than last time. So the authorities must do their best to win the trust of investors.”

INVESTORS ARE NOW STUCK IN THE MIDDLE

Does this mean the government may not fulfill its plans to attract 100 billion hryvnias in 2011?

“Any rating is a biased judgment. Yet there is a negative trend there. As the Tax Code was being drawn up, Ukrainian businesspeople and members of the European Business Association and the US Chamber of Commerce showed that they still have a lot of complaints about not only the law itself, but also about the way it can be applied. For example, I, as a representative of the banking sector, would call into question a judicial system which often makes unlawful decisions. What public notaries are doing transgresses the law, and the level of corruption and state intervention in the economy remains too high. All this makes investors leery. Therefore, the authorities should focus all their actions at improving the investment climate.”

What does your business intuition tell you: will the government’s plans to attract investments be fulfilled or not?

“Investors are now stuck in the middle. What makes them trust in Ukraine is a realistic budget with a three percent deficit, cooperation with the IMF and Word Bank, the Tax Code, deregulation, and administrative reform. Investors are ready to trust in Ukraine, but corruption and excessive state intervention in the economy is still limiting their interest.”

What impact will the Tax Code have on Ukraine’s banking system?

“The code will promote economic development on the whole because it will speed up GDP growth. It is good for the banking sector to have a single ‘tax grammar.’ Yet, from the viewpoint of accounting experts, the document somewhat complicates accounting and introduces additional limitations for banks, including restrictions on expenses for working with non-residents (including those working under a simplified regime), which may force these entrepreneurs to revoke signed contracts. Banks are also supposed to oversee taxpaying by individuals as well as payment of incomes to these people. Besides, banks must supply tax authorities with information about the incomes that individuals have drawn from selling investment assets, including securities and precious metals.”

The code also has a clause on taxation of deposits and on supplying tax collectors with information about individual’s accounts. Do you think this may cause an outflow from the banking system?

“No, I don’t think so. Deposits of individuals are taxable in all civilized countries barring offshore zones. Ukrainians want to live as Europeans do, but let us see who provides the Europeans with all their benefits. Only two things — death and paying taxes — are mandatory in the West, all the rest being voluntary. Even birth is not mandatory because it can be planned or prevented. But everybody must pay taxes. So, to change the state and the living standards, one should begin with oneself.

“I think Ukrainians should change not only the law but also their own mentality. I mingle with many participants in the economic process, who do not always want to pay all their taxes. Whenever I ask why one does not pay, I hear that taxes are too high or no one knows where this money will go. Parliament has now passed a law on making information public. You are welcome to ask where this money has gone and control the transparency of its use, but you must pay all your taxes.

“In other words, to live the way Europeans do, you must learn to pay taxes and stop being socially lazy. For, in my view, these features are inherent in many Ukrainians today. I think the present-day Ukrainian is a person who works, has a lot of good time, and pays only some taxes. The Ukrainian is always looking for somebody: a messiah (we can see what this has resulted in) or a president who would, instead of him, solve all the problems on the road to a European way of life. We usually believe, for some reason, that if we have voted once in five years, we have made our contribution to improving social wellbeing and those elected should [do the rest]. That is wrong. No one else but we will turn our house into a paradise. So we should not be socially and politically lazy.”

MORTGAGE LENDING TO RESUME IN 2011

Speaking of building this paradise for everybody, do you think Ukrainians should expect the resumption of mortgage lending? At what rates?

“Mortgage lending is to resume in 2011. What will help people receive housing on credit is legalization of individual incomes, which the Tax Code is supposed to control, and the gradual stabilization of the economic situation in the country. Before the crisis, banks used to shut their eyes to ‘gray’ wages and assume excessively high risks. But the crisis has taught them to be cautious. Therefore, banks will set conditions for mortgages, including, first of all, that wages be legal and the original installment. The mortgage rate will be 15-18 percent if the annual inflation rate is 9 percent (depending on the bank’s assessment of the customer’s financial state).”

And what about hryvnia deposit rates?

“With an annual inflation rate of 9 percent, their value will range from 11 to 13 percent.”

Experts estimate that there are more than 40 billion hryvnias of untied funds in the banking sector. How can we make them work in the real economy?

“In my view, untied funds worth about 30 billion hryvnias are now circulating in the banking sector. Financial institutions are not exactly rushing to give them out as loans to the real economy sector because there is a lack of reliable customers on the market. Add to this the lack of transparency of Ukrainian courts. As a result, with the bitter experience of the 2008 crisis in mind, banks are opting for less risky operations. For this reason, they are buying government bonds and the National Bank’s deposit certificates. For banks to begin crediting, the real sector should try and do such things as repaying debts and concluding long-term contracts — not just for one to three months.”

THERE ARE ABOUT 150-170 BILLION HRYVNIAS IN THE “GRAY ZONE”

Mr. Shpek, only big business, which has a crediting history, can meet all these demands. What about small- and medium-scale businesses which, are Europe’s experience shows, are the economy’s backbone? Where can they get loans?

“Banks cannot dish out money to all those who need it. A bank is a financial institution that issues loans and runs certain risks. So the borrower should be solvent. The Tax Code will help small- and medium-scale businesses [fully legalize itself], as there are 150-170 billion hryvnias circulating in the ‘gray zone’ today. These funds are outside the banking system and serve a certain economy. This is why banks are showing more and more trust in these entrepreneurs. I think crediting small- and medium-scale businesses will begin in 2011. Also, an estimated 50-70 billion dollars is outside the banking system. Even if just a part of these funds comes back into official circulation, we will be able to do so much!”

How effectively are state banks run? Is the state paying an adequate price to keep them afloat?

“Nationalized banks are run ineffectively. The proof of this is their financial performance and the fact that the state spends more and more money to keep them up. In my view, the go-vernment ought to denationalize these banks as soon as possible. The state may retain ownership of some of their shares in order to sell them after these banks have resumed making profits. The main thing is not to allow further spending from the state budget.”

If the government offered these banks for sale right now, would Alfa Bank enter a bid?

“Alfa Bank may be among those bidding for the nationalized banks if the sale process is simple, clear, and free of politics.”

FULE’S STATEMENTS ARE NOT A DIPLOMATIC WARNING

You were head of Ukraine’s Permanent Representation to the EU for seven years. So I would like to ask you about the latest visit of the EU Commissioner for Enlargement and European Neighborhood Policy Stefan Fule to Ukraine. Western media called it a warning to Ukraine’s president, and the commissioner himself told the press that their might be a response from the EU in the case of undemocratic developments in this country. This statement is all the more interesting as Brussels is exploring the possibility of denying Belarusian officials EU visas because of a crackdown on the opposition in that country, and questions the democratic nature of the presidential elections. Would you, an experienced diplomat and an expert in Ukraine-EU relations, say what Mr. Fule’s visit and statements mean?

“In my opinion, his words are clear enough: the EU is prepared to intensify cooperation with Ukraine and reach a compromise on many still unresolved problems. But there will be no compromises in the question of basic European values, such as democracy, freedom of the press, development of civil society, etc. I do not think Mr. Fule came to Ukraine to defend or lecture anybody. All that he can defend is common European values.”

But the EU functionaries of this level, who have visited this country before, never gave such hints or expressed alarm about Ukrainian democracy.

“I have been dealing with Ukraine’s European integration since 1996. In all this period, the question of political and democratic freedoms has been in the center of attention. Maybe, this question arises more often in Ukrainian society today. For this reason, everybody wondered what Fule would say during the visit and how he would assess the democratic processes in this country. But this was a routine visit. I do not think that Mr. Fule’s visit and statements are a diplomatic warning because officials of his level never warn anybody — they only express a joint viewpoint of EU member states. The Ukrainian authorities are well aware of the thinking and behavior of their European partners. They know and foresee the reactions their actions may trigger.”

So you do not think that Mr. Fule’s visit will have a negative effect on Ukraine-EU relations?

“It may have if Ukrainian courts continue to hand down unlawful rulings. But if decisions are made as part of the judicial or investigative practice of the law in force, there will be no negative consequences.”