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Fiscal Reform Adjustments as per the Arrangements made with the International Monetary Fund

On 21 July, 2014, the Government submitted to the Verkhovna Rada of Ukraine a draft law “On Amendments to the Law of Ukraine “On the State Budget of Ukraine for 2014 “(concerning the indices adjustments)”, which provided for indices adjustments in the State budget of Ukraine for the current year. However, the Verkhovna Rada did not carry the motion and soon after Prime Minister A.Yatseniuk, announced his resignation from the rostrum of the VRU.

A precondition to amend to the State Budget is the tax revenue underperformance due to the military activities in the east of Ukraine and the increase in necessary national defence expenditure . As a result, by the end of the year, a “cash deficiency” may appear in the State Budget, which the Government will be unable to fund.

The State Budget revenue decrease is influenced by a number of factors:

1. The tense situation in the eastern regions. Military actions in the Donetsk and Luhansk regions have caused a reduction in business activity, and in most cases – its paralysis.

Industrial output of the sectors concentrated in the east of the country has decreased. In the Donetsk region, the industrial production index comes out at 87.7% of that of January-June, 2013; in the Luhansk region – at 95%. Black and brown coalmining has decreased by 5%, metallurgy output – by 8.7%, engineering industry output – by 18%, chemical industry output – by 14.1%, electricity and gas supply – by 0.4%.

2. Economic indices growth slowdown. According to the State Statistic Service of Ukraine, the reduction of the real GDP has become greater. The real GDP has come out at 97.7% in January-May compared to the same period of 2013, and in June – 94.1%.

Indexes of the basic industrial output are falling. In the first half of 2014, when compared with the same period of 2013, the industrial output index in industry has come out at 95.3% (metallurgy output – 91.3%, engineering industry output – 82.0%; electricity and gas supply – 99.6%). According to customs statistics, the turnover from January-May, 2014 compared to last year decreased by 16.1%.

With the purpose of balancing the State Budget it is submitted that:

1. The following Budget revenue indices should be decreased:

  • corporate income tax – by UAH2.8b (EUR0.173bln). Real corporate income tax revenues in the State Budget General Fund in the first half of 2014 equate to UAH24.8b (EUR1.534lnb). Estimated corporate income tax revenues in 2014 equate to UAH39.8b (EUR2.463bln), which is UAH2.8b less than the approved index.
  • VAT on goods manufactured in Ukraine – by UAH5.7b (EUR0.353bln). Activity-based gross added value in January-June, 2014, equated to 97.0%, (industry output – 95.5%, construction operations – 90.6%, wholesale and retail trade – 94.8%). Nominal GDP in the first half of 2014 amounted to UAH648.9bln (EUR40.16bln). With the account of the nominal GDP, the situation in the east and payments of NJSC Naftogaz of Ukraine, approved VAT index will reduce by this amount.
  • VAT on imported goods – by UAH4.5bln (EUR0.278bln). The decline in consumer demand and the devaluation of the UAH against a backdrop of the overall economy slowdown in Ukraine led to a higher rate of decline in imports. Imports declined in the 1st half of 2014 (excluding gas imports) to 82.4%. In addition, a significant budgetary shortfall is expected, according to the analysis of VAT on imported goods in Donetsk and Luhansk regions.

2. The following Budget revenue indices should be increased:

  • individual income tax – by UAH3.3b (EUR0.204bln). Changes in tax and budget legislation concerning the capital income taxation – passive (deposit) income taxation at the 15% tax rate and tax revenues from the taxation of income. 
  • VAT on goods produced in Ukraine – by UAH0.4b (EUR0.02bln). Changes to the tax legislation regarding the cancellation of VAT exemptions for timber, wood fuel, timber industry waste sales and delivery.
  • VAT cash refund using budget funds – by UAH1.8b (EUR0.111bln). Continuing the VAT exemptions regime for cereal and industrial crop exports till 1 January, 2015 will decrease the refunds from the Budget.
  • fees for subsoil use – by UAH9.0b (EUR0.557bln). Provide for a rate increase for the subsoil use fee for oil, gas condensate and natural gas output. 
  • revenues under the EU support programmes – by UAH4bln (EUR0.25bln). Revenues from the European Union monetary aid.
  • environmental tax – by UAH2b (EUR0.125bln). Part of the environmental tax put to a special fund for more efficient financing of the programmes.

The Government submits that the state debt ceiling should be increased by UAH149.6bln (EUR9.2bln) by means of:

  • increasing the UAH equivalent of the state debt denominated in foreign currency (through depreciation) totalling UAH79.7bln (EUR4.93bln);
  • increasing the capitalisation of NJSC Naftogaz of Ukraine by UAH70.6 млрд. (EUR4.4bln) due to the need of balancing the company’s deficit, creating a reserve for the Eurobonds 2009 obligations, satisfying the gas debt and buying new gas via reverse supply.

In light of the situation including (not least) issues in the banking sector due to the loans (deposits) high cost and bank assets income decrease, which in turn leads to the lack of bank capital, it is introducing a mechanism of interest rates partial compensation from the state budget for the loans taken by domestic enterprises in the domestic market, that will encourage banks to finance the real economy in the amount of UAH432.4m and will allow the enterprises in the priority growth area to draw on bank resources before the end of the year. The partial compensation intended for the above mentioned loans amount at 9% of annual loans up to UAH15bln.

The draft Amendments to the State Budget for 2014 provides for:

1) a reduction in the central executive bodies management expenses by 70 % compared with the expenses approved on 01 January, 2014 (sparing the room heating expenses).
2) a reduction of 90 % of two months’ expenditures for other state agencies (except for those which ensure the country’s defence capabilities) compared with the amounts approved as of 1 July, 2014 by the State Budget General fund (Pension Fund) allocation lists for August-December 2014 (sparing the room heating expenses);
3) a reduction in the judicial authorities expenses, bearing in mind that in the second half of 2014 expenditures should not exceed 2% of the cash expenditure in the first half of the year.

At the same time, the draft provides for the list of measures that should be taken by the heads of budgetary institutions in order to ensure such a reduction.

In addition, Pension Fund budget deficit reduction amounting to UAH2.342b (EUR0.145bln) is planned within the State Budget General fund. This reduction will not lead to the failure of the Pension Fund to perform its functions and will be compensated by extracting UAH2.0b from the Social Insurance Fund for Temporary Disability and the Social Insurance Fund for the Unemployed and crediting this amount to the Pension Fund of Ukraine (EUR0.145bln).

With the purpose of economical and rational use of State Funds meant for maintaining central authorities’ and other state agencies’ functions, providing an urgent stabilisation for the country’s financial situation it is submitted that the other expenses by the state authorities should be reduced. In particular, the largest spending cuts are expected in the government support programme for coalmining companies for partial coverage of the costs from the net back price of finished marketable coal for UAH1.0b (EUR0.06bln) and expenditures of the State Regional Development Fund for the same amount.

The draft amendments to the State Budget of Ukraine for 2014 also provide for increased expenditures, in particular:

  • financing for activities under the anti-terrorist operation, elimination of possible emergency situations consequences and the restoration of social facilities damaged during the military actions – UAH16.9b (EUR1.0bln);
  • ensuring the urgent expenses for military attachés’ administration abroad, given the significant devaluation of the national currency – UAH37.7m (EUR0.02bln);
  • purchasing medications for children suffering from rare diseases – UAH4.0m (EUR0.24m);
  • running Ukrainian diplomatic missions abroad and the expansion of Ukraine’s property for the needs of these institutions – UAH0.198b (EUR0.12bln).

For more detailed information, please contact:
Victor Maziarchuk, [email protected]
The Open Dialog Foundation