Oct. 7 (Bloomberg) -- Ukraine must act quickly to correct the economic imbalances that threaten to swell its budget and current-account deficits beyond the government’s control, the World Bank said.
Ukraine should allow a more flexible currency exchange rate and give up gas-price subsidies, which will also boost its chances of qualifying for international bailout funds, Quimiao Fan, the World Bank’s director for Belarus, Moldova and Ukraine, told reporters today in Kiev, the capital. The Washington-based lender cut its estimate for the country’s 2013 economic growth to zero from 1 percent.
Ukraine is struggling with an economic contraction, a widening current-account gap, shrinking foreign reserves and trade restrictions from Russia, its biggest export market. Delaying an economic overhaul beyond presidential elections in 2015 would only make the changes more painful and the recovery more protracted, Fan said.
“The economic situation is bad,” Fan said. “Adjustment is inevitable. The only question is whether Ukraine will reform now or will adjustment be delayed.”
Ukraine’s government bonds due 2015 fell, sending the yield up to 13.01 percent, the highest level in a week, as of 5:16 p.m. in Kiev, according to data compiled by Bloomberg. The cost to insure Ukrainian government debt against non-payment for five years using credit-default swaps surged to a three-year high of 1,089 basis points on Sept. 27. They were little changed at 1,055 basis points today.
Low residential gas and heating tariffs are maintained through subsidies, which amount to about 7 percent of economic output, according to the World Bank.
“This imposes fiscal costs that Ukraine can ill-afford and undermines fiscal sustainability,” Fan said. The government should gradually increase gas prices to cover the import cost, combining that with better tailored social assistance, he said.
Ukraine’s gross domestic product declined 1.3 percent in the second quarter after shrinking 1.1 percent in the first three months of the year. The economy will expand 0.6 percent from a year earlier in the July-September period, helped by a good harvest, according to the median estimate of 20 economists in a Bloomberg survey carried out Sept. 20-25.
Moody’s Investors Service downgraded Ukraine’s debt rating on Sept. 20 by one level to Caa1, seven steps below investment grade, citing growing political and economic risks due to deteriorating relations with Russia, low central bank reserves and a lack of progress on an international bailout from the International Monetary Fund.
Central bank reserves are languishing at a seven-year low of $21.6 billion as of end-September, down from $29.3 billion a year earlier, as policy makers dipped into the stockpile to support the hryvnia. That’s less than three months of imports, a threshold economists deem important for financial stability.
If the exchange rate policy remains unchanged, reserves will decline to a level below two months of imports by the end of 2013, according to the World Bank.
Ukraine’s budget deficit, including state-run energy company NAK Naftogaz Ukrainy, may exceed 6.5 percent of gross domestic product this year, while the current-account gap may total 8 percent, Anastasia Golovach, World Bank’s economist in Kiev, said.
“It is impossible to support twin deficits, while the central bank’s reserves are declining,” she said. “Also, such tendencies have a negative impact on investors’ mood, making it more difficult for the government to borrow on international markets.”
Increased natural gas imports from Russia and foreign repayment needs will bring Ukraine’s external funding gap to more than $5 billion this quarter, the World Bank estimates.
Should the government delay the changes until after the elections, GDP may shrink 1 percent in 2015, while inflation may jump to 18 percent, Golovach said.
“Ukraine needs to start reform this year or next year at the latest, preferable reaching a deal with the IMF,” she said. “Then its economic growth may accelerate to 1.5 percent next year and 3 percent in 2015.”