Review of the draft budget 2021. The first reading

27 September 2020

Read the transcript of the press conference by Maria Repko and Anastasiia Teleton and the discussion on the expenditures on human capital with Pavlo Kovtoniuk, the Deputy Minister of Health (2016-2019), Egor Stadnyy, the Deputy Minister of Education and Science (2019-2020), and Olesya Ostrovska-Luta, the General Director of National Cultural, Art, and Museum Complex “Art Arsenal.” The 2021 budget has three main features: the increase in the minimum wage by 30% to UAH 6 500, a huge state budget deficit at 6% of GDP, an unrestricted opportunity for the government to provide guarantees on debt.

Budget revenues are projected based on a 19% increase in revenues from personal income tax and a 21% increase in VAT (domestic and import). Simultaneously, the economy will grow only by 13% in nominal terms according to governmental forecasts for 2020 and 2021. The Ministry of Finance expects the economy to start to move out of the shadows, but this approach is not conservative because there is always a risk that this move will not happen; therefore, no additional income will be received.  In addition to an optimistic inflation forecast (7.3% against current 2.5%); however, those calculations are based on two factors that may not come true. If no or moderate deficit was expected, a slight increase in borrowings could fix the situation. Compared to previous years (except for the “quarantine’s” 2020), the largest deficit is already expected, and the Ministry of Finance has no room to maneuver anymore.

A total of 45% of GDP will be allocated for general government expenditures. It is 5 percentage points less than is planned for 2020 but exceeds the average of 2017-2018 of 42% GDP. The nominal growth of spending will be affected by set forecasts of macro indicators and two political “whims”: an increase in minimum wage and financing of road constructions. Healthcare and education will receive the most additional funding (+17.1% and +12.2% accordingly). Economic activities will lose 14.4% of its funding. The government plans to get extra UAH 70 billion road construction spending through borrowing under state guarantees. This could be considered substitution of budget expenditures with quasi-fiscal expenditures.

The budget deficit will be financed through domestic borrowings. Given that a large deficit is planned for 2020 and that as of the end of September it is still below the planned level, so planned net borrowings without timely receipt of the tranches from the IMF will be an unaffordable amount for the domestic market over the next 15 months.  We would like to see the following global changes in public finances:

  • A more conservative approach in planning budget revenues, as receiving less revenue than planned, will mean budget sequestration. The macro forecast must be depoliticized and revenues must be planned conservatively, otherwise, the country may get an unpleasant surprise. For such a vulnerable and fragile economy as the Ukrainian one, fiscal stability is crucial.
  • Arrangement and approval of a three-year budget declaration
  • Compliance with norms of budget code for the maximum size of the deficit, debt, and state guarantees

In the 2021 budget, we think it is appropriate:

  • Slowing down the wage raise (let’s say, increasing the minimum wage to UAH 6 000 in 2021 and UAH 6 500 in 2022, and further develop a transparent depoliticized mechanism to determine the level of social guarantees)
  • Revising the macro forecast accordingly, without taking into account the increase in minimum wage and forecast indicators for budget revenues
  • Allocating expenditures in such a way that deficit will constitute no more than 3% of GDP, based on a conservative revenue forecast
  • Restoring the norms of Budget Code that limit the size of state guarantees and not creating a new quasi-fiscal “black hole” from Ukravtotodor, as it was previously a case of Naftogaz, Pension Fund, and state-owned banks.