How can Ukraine improve macro forecasting and its connection with the budget process?

Macroeconomic stability in Ukraine depends on fiscal sustainability, which in turn depends on high-quality macroeconomic forecasting.  Currently the Cabinet of Ministers currently makes a macroeconomic forecast, using not only a technocratic approach but also taking into account political factors. Moreover, the process of its coordination and approval is overregulated. Due to political influence on the forecast indicators, the budget’s revenue has been consistently inflated in Ukraine. 

Developed countries have adopted more flexible mechanisms of macroeconomic forecasting and integration of such forecasts into the budget. Such an approach allows them to increase the efficiency of public finances and keep the budget deficit under control.  

We have analyzed the international experience and Ukrainian legal framework, which regulates the forecasting system, and conducted six in-depth interviews with experts in macroeconomic forecasting. As a result, we identified the following key issues:

  1. Macroeconomic forecasting is influenced by politicians based on their own interests. At different forecasting stages, indicators have to be formally agreed upon with the relevant stakeholders who have political leverage . Ministry of Economy is not fully responsible for the final outcome. Thereby, politicians have an incentive and an opportunity to add extra, usually unrealistic, budget resources. Inflated revenues allow politicians to allocate more expenditures. When reality does not match the forecast, fiscal and macroeconomic stability is disrupted.
  2. The adoption of the macroeconomic forecast is highly regulated. Coordinating the forecast with various government departments can slow down the process. The development of the forecast should be a purely technical procedure, without an external input of other executive bodies or politicians, except for the ministry or the agency that directly has the authority and model apparatus for developing the forecast. The only stage at which the forecasting process should involve other institutions is making assumptions on the minimum wage, subsistence level, and the salary level of the first tariff category (which are not forecasted but set by law). Other indicators may be determined in consultation with other departments and institutions but do not need to be agreed with them.
  3. Some stakeholders do not comply with the law and make late submission of fundamental indicators that are used in the macroeconomic forecast calculations. The indicators that Ministry of Economy must use in the forecast and which are approved at the legislative level, are adopted later than the law states. This is a violation of the laws which regulate when such amendments must be made, namely the Tax and Budget Codes. Violations of these norms are systematic.
  4. The forecast should be approved by a decree of the Cabinet of Ministers. Ideally, the macroeconomic forecast should not be approved and agreed upon with any governmental institutions. In Ukraine, the Cabinet of Ministers must approve the forecast and publish it in a separate decree. This, as well as the participation of co-executors from external institutions besides Ministry of Economy, leads to pollicization. A macroeconomic forecast process should be a purely technical procedure, based on mathematical models and relevant data and be entirely handled by a single body. Political influence, let alone regulatory approval, should not be a part of this process.

How can these issues be resolved?

  • Creating macroeconomic forecasts should be a completely technical taskthat is performed independently . Coordination of macroeconomic forecasts between departments should be canceled. Ministry of Economyshould only receive official indicators on the minimum wage, subsistence level, etc., which are set by law and correspond to the expected changes in public policy for next year. The requirement to approve the  forecastby the Cabinet of Ministers must be abolished, as it politicizes and extends the process over time. The development of a macroeconomic forecast should be a purely technical procedure. In this case, Ministry of Economymay hold informal consultations with other government bodies, but it should not be necessary to have the indicators approved. 
  • There should be a liability for violations of budget and tax legislation regarding the late adoption of amendments to the Tax Code or establishing norms for social standards later than the specified deadline. However, given the weakness of the law enforcement, exceptional circumstances and the diffusion of responsibility, a more effective solution may be public coverage of the problem and influence on decisions through the media, as independent fiscal authorities mostly do it in developed countries.
  • An independent fiscal body, the Fiscal Council should be created. It does not necessarily have to createa forecast, but it must analyze macroeconomic forecast and fiscal situation and give recommendations on how to improve them. These recommendations must be taken into account. The Council’s budget should not depend on political decisions, which will ensure the independence of its conclusions. An alternative to a Fiscal Council could be to set up an expert group to assess the macroeconomic forecast, which could be set up, following the public procurement procedures, as it takes place in Germany when a joint macroeconomic forecast is developed. In the early stages such group can be funded through international grants.
  • When the parliament votes on the budget in autumn, it is necessary to take into account the updated macroeconomic indicators. If the official coordination of indicators between different government bodiesis abolished and drafting of the macroeconomic forecast is a purely technical procedure handled by the Ministry of Economy, macroeconomic forecasting and updating budget indicators on its basis will not take much time. This is important, as budget changes between parliamentary readings happen quite often.  

The study is presented within the German Ukrainian Researchers Network (GURN) project, which is implemented with the financial support of the German Ministry of Foreign Affairs. The project is initiated by the Institute for European Policy (Berlin) together with the Ilko Kucheriv Democratic Initiatives Foundation, the New Europe Center and think twice UA. The contents of this publication are the sole responsibility of the Centre for Economic Strategy and do not necessarily reflect the views of the German Ministry of Foreign Affairs.