Amendments to the Tax Code in 2020: The “BEPS law”

The “BEPS law” containing changes to the Tax Code of Ukraine came into force in May of this year. This law implements anti-tax-avoidance and tax transparency measures recommended by the OECD’s BEPS project to combat tax base erosion and profit shifting. Important changes combat tax-avoidance schemes that exploit loopholes in double-taxation agreements with complex international constructions and unregistered permanent establishments. The law also contains general changes to improve the tax system.

The changes constitute an important step ahead towards strengthening Ukraine’s tax receipts and improving the business environment. Whilst companies will benefit from many fixes to existing problems in the tax system, the use of complex international tax avoidance schemes will be significantly discouraged. The law also represents a much-needed shift in the philosophy of tax administration from “form over substance” to “substance over form”. For this shift to translate from legislation to actual practice, however, implementation will play a key role and solid training of tax authorities’ staff will be required.

The German EU Presidency and Implications for Ukraine

Ukraine’s special relations with Germany, both as an economic partner and also as a key actor in the talks on the Donbas conflict within the Normandy Format have set its expectations high from Germany’s EU Presidency. But do they match Germany’s priorities for the next six months? In few instances they do, but not in many. An overly ambitious German agenda means less focus on Ukraine’s key challenges – fighting the war in Donbas and recovering its economy in the aftermath of the COVID-19 pandemic.

Land market: how much light do we see at the end?

In March 2020, the Ukrainian Parliament made a revolutionary step and brought to the end the 20-year long moratorium on agricultural land sales. The Law on Amendments to Legislative Acts on Turnover of Agricultural Land (552-IX) was finally adopted. Ukraine effectively completes the land reform, which transformed the Soviet-era state land into truly private property with all corresponding rights. Despite the importance of this step, we keep hearing voices from both sides of the land reform camp that the adopted law will make no good to Ukraine. To assess if such statements have any justice, we highlight the key features of the law, the benefits and losses to the key stakeholders and steps that remain to be taken to realize the full potential of the agricultural land as a driver of sustainable growth in Ukraine.

Covid-19 leads to sharp contraction of Ukraine’s economy

The Covid-19 pandemic has taken a firm grip on the world economy. Ukraine will unfortunately not escape this global trend. A scenario-based analysis by the German Economic Team shows both the direct shocks and the total economic effect of the Covid-19 pandemic on Ukraine. Direct shocks include the temporary closure of domestic sectors, shocks to goods and services exports of Ukraine and a drop of remittances income.

Ukraine’s foreign trade in 2019

Ukraine’s foreign trade continued to grow in 2019, exports and imports of goods expanded both by 6%. The trade deficit amounted to USD 11 bn. This corresponds to 7.1% of GDP, which is lower than in the previous year. Economic growth and hryvnia appreciation were the main reasons for this reduction.

Ukraine’s economy in good shape

Ukraine emerges from 2019 in a stable economic shape. GDP growth was at 3.5%, driven by strong domestic demand, despite two elections being held in 2019. Due to strong inflow of foreign capital to the domestic bond market, the Hryvnia appreciated by 16% against the US dollar. Inflation was at 4.1% and thus for the first time within the National Bank’s target range, allowing a gradual reduction of the policy rate. Both the current account and budget deficits are under control at ca. 3% and 2% of GDP, respectively.

The new Russia-Ukraine gas agreements

Gas negotiations between Russia and Ukraine were ultimately successful: a package of agreements has been reached which allow Russian gas to be transported through Ukraine for five years at a roughly 50% level compared to average volumes of the past five years. Enabling factors included the successful unbundling process of Naftogaz in a race against time, Ukraine’s focus on achieving short-term gains, Russia’s willingness to bend to the Stockholm arbitration awards payment. With sanctions from the United States on Nord Stream 2, Russia was plunged into uncertainty over the opening of this alternative route and compelled to secure a longer and larger deal with Ukraine than it initially considered. Next issues to watch for are two remaining legal disputes, Gazprom’s possible direct gas supplies to Ukraine, and the fate of the Yamal-Europe transit pipeline.

Labour migration from Ukraine: A mixed blessing

Significant changes in patterns of labour migration from Ukraine have occurred since 2014. There has been a direction change of migrant streams from East to West and an overall increase of labour migration. The total number of labour migrants from Ukraine in the beginning of 2017 was at least 2 million. Out of these, at least 500,000 were in Poland and a further increase of this migrant stock by 200,000 migrants per year in 2017 and 2018 appears credible. Remittances of labour migrants amounted to ca. USD 11 bn in 2018, around 8% of GDP.

The new government plan: It’s not the destination, it’s the journey

Ukraine’s new government has recently unveiled its 5-year Action Programme, which sets its priorities in the economic and social sphere. While some targets like obtaining USD 50 bn of FDI inflows or reaching a foreign credit of “A-“ look (over-)ambitious, other targets like the reduction of the public debt to GDP or the diversification of borrowing into local currency look quite realistic. It is also very positive that budget planning is done with a conservative approach. Regardless of the ultimate achievement of all indicators, the focus should be on the implementation of key reforms underlying this programme.

New trade barriers in the steel market: Limited impact on Ukraine

Following the introduction of an additional 25% customs duty on selected steel imports by the USA in 2018, the EU and other markets responded by imposing their own safeguard measures. Especially the measures of the USA and EU matter for Ukraine: While the EU is Ukraine’s primary destination market for steel products with a share of 38% of steel exports, the USA are the third most important market, with a share of 8%. Steel remains a key export good of Ukraine, accounting for 23% of total goods exports in 2018.

Banking sector recovery continues, but risks remain

Banks operating in Ukraine have considerably improved their performance during the last few years. While the sector as a whole recorded a record loss of UAH 160.5 bn in 2016 (after the nationalisation of PrivatBank, the biggest bank in the country), the corresponding figure for the first eight months in 2019 is a profit of UAH 44 bn, also in part due to a turn-around in PrivatBank.

Positive economic outlook

The successfully held presidential and parliamentary elections in Ukraine have clearly dominated public attention with their surprising outcomes.

Electricity market opening – still work to do

Ukraine’s electricity wholesale market has been opened for competition on 1st of July. In theory, large retail suppliers and industrial consumers can now buy electricity freely from different generators on the open market. Hopes are that this will lead to a more efficient electricity sector. However, despite two years of preparation, there are concerns that the sector is
not yet ready for the opening.

Positive effect of the DCFTA on Ukraine’s exports to the EU

Ukraine and the EU concluded a deep and comprehensive free trade agreement (DCFTA) in 2014. In a recent comparative study, which also includes Georgia and Moldova, we look at the effect of the DCFTA on
Ukrainian exports to the EU.

Reforming the support scheme for renewables in Ukraine

The expansion of renewable energy in Ukraine has recently gained momentum. This development has been fostered by a generous feed-in tariff for producers of “green” electricity which is guaranteed by the state. However, this feed-in tariff has caused high costs and therefore made a reform of the support scheme inevitable. With the introduction of an
auction system, the development of renewable energy shall – in line with the international trend – become more competitive, controllable and costeffective.

Losses in EU trade due to a shortage of transport permits for trucks

Almost 40% of the value of Ukraine’s exports to the EU in 2018 was transported by trucks. At the same time, Ukrainian road carriers experienced a shortage of transport permits for key EU countries. Transport
permits for Ukrainian trucks to operate in several EU countries ran out before the end of 2018. Most strongly affected were permits for Poland. Noticeable shortages at the end of 2018 also affected permits for
Germany, Austria and Slovakia.

Currency liberalization in Ukraine: a fundamental step forward

Since February 7, 2019, the new Law on Currency has taken effect. It shifts the authority on certain capital flow restrictions from the level of Parliament to the level of regulatory acts issued by the National Bank of
Ukraine. In contrast to the previous post-Soviet spirit of strict capital controls, the new law is based on the fundamental principle: “Everything which is not specifically forbidden is allowed”.

Ukraine’s upcoming presidential elections

The electoral campaign for the upcoming Ukrainian presidential elections on 31 March is now in full swing. Amidst difficult reforms that do not deliver on citizens’ expectations of the Euromaidan protests, and a
military conflict with Russia in Eastern Ukraine, candidates look for new ways to convince a weary and undecided electorate that immediate progress is still feasible. The contenders’ views on conflict settlement
and corruption will likely determine their odds at winning the presidency. The overall outcome, however, is highly unpredictable. Domestic elites as
well as external actors may take advantage of the mood swings of Ukrainian citizens and the weak state institutions to sway election results in their favour.

IMF programme supports stable economic outlook

The cooperation with the IMF, which was resumed at the end of last year, has already borne fruit. Inflation is slowly declining; foreign exchange reserves have reached a multi-year high and public finances contin-ue to consolidate. The macroeconomic and financial situation is therefore stable, which is not a given in the light of the upcoming elections and a rather vola-tile global environment. Given the high external pub-lic debt interest and principal payments schedules for the current and upcoming year (USD 13.3 bn), there is no alternative to the cooperation with the IMF.

Challenges to agricultural budget support policy

Over the last years, Ukraine’s agri-food sector demon-strated resilient growth and developed into a key source of foreign exchange for the economy. In 2017, it accounted for 14.5% of GDP and more than 42% of total goods exports. This positive development came against a significant reduction in the volume of agri-cultural budget support over the recent years. The structure of the support also changed, moving from tax benefits to direct support in the form of input sub-sidies. However, the way the direct support pro-grammes are designed and implemented, as well as the negative effects of input subsidies on efficiency and productivity, raise serious concerns about their sustainability and effectiveness. A more targeted and modern approach is needed in order to address the current major problems of the sector (shortage of workers and financial constraints) under severe fiscal constraints facing the country.

The new IMF agreement: all good things come in threes

Ukraine has recently reached an agreement with the IMF on the continuation of the financial cooperation. Although the final decision by the IMF Executive Board is still outstanding, this would be the third programme since 2014. A smooth implementation of the USD 14.9 bn programme over the coming 14 months would be an important anchor for the macro-financial stability of Ukraine in the double election year 2019. Particularly in the context of further financial support by the EU and World Bank, the external public debt service would be made much easier.

Reform proposals for improvement of the investment climate

After overcoming the economic crisis of 2014/15, Ukraine is back on course for growth. However, to give their citizens a real perspective, higher growth rates are needed and more investment is a key prerequisite.

Decentralisation reform in Ukraine

Since 2014, the Ukrainian government has initiated extensive reforms. While some reform projects have stalled recently, the comprehensive decentralisation reform is considered one of the most successful and
dynamic reforms in Ukraine, despite challenges and difficulties. It has already changed the reality of many people’s lives outside the capital Kyiv. In the last four years, the reorganization of the municipalities has
been driven forward and competencies and resources have been transferred from the central state to the local level. The decentralisation reform is supported by Ukraine’s Western partners, above all the EU and Germany. Despite successes, however, there is still a long way to go before the reform is completed.

Ukraine’s exports grow, driven by shipments to the EU

Ukraine’s exports continue to grow for the second year in a row, although at a somewhat slower pace than in 2017. The growth has been driven primarily by strong expansion of exports to the EU, where the DCFTA has been fully enacted since September 2017, although actual implementation started earlier.

Economic outlook: growth continues, but fiscal risks remain

Ukraine’s economic growth is slightly accelerating: after growing by 2.5% in 2017, real GDP is forecast to increase by 3.2% this year and 3.3% in 2019. The demand-side drivers are investment and consumption, with most sectors on the supply side growing as well. Inflation continues to run above the National Bank’s inflation target and is forecast at 9% at the end of 2018. This has led to hikes in the policy rate, which currently amounts to 17.5%. In all likelihood, inflation will only return to the target band set by the National Bank at the end of next year.

Anti-corruption reforms in Ukraine: progress or lack thereof?

During four years of anti-corruption reforms, a number of institutions were established to tackle the problem at different levels. New state bodies provide the infrastructure for investigation and prosecution of criminal cases, for monitoring, guidance and surveillance of implementation of anti-corruption measures, and administration of confiscated assets.

Economic effect of foreign direct investment in Ukraine

Recent research by the German Advisory Group shows that foreign direct investment (FDI) strongly benefits Ukraine. FDI companies, which are at least 10% owned by a foreign investor, make up only 4.6% of companies in Ukraine. Yet these relatively few FDI companies account for over 20% of employees, own 24% of the total capital stock of Ukraine and produce almost 35% of total gross value added, a measure of output. Hence, FDI companies are not only much larger than purely domestically owned companies; they are also significantly more productive. The economic benefits of FDI to Ukraine are therefore large, despite the hit that the value of the FDI stock has taken in recent years due to difficult economic circumstances.

Renewed Naftogaz-Gazprom tensions after Stockholm arbitration

The recent awards in the Stockholm arbitration dispute between Naftogaz and Gazprom turned Naftogaz into a net winner of about USD 2.6 bn. Yet there are renewed tensions over their enforcement and risks for European gas supplies in January 2020. Gazprom must show reasonable and responsible behaviour while Naftogaz and Ukraine must pursue their reforms and refrain from using the transit tariff negotiations as a way to maintain the status quo.

Tax on Withdrawn Capital: Economic and fiscal effects

Introduction of a Tax on Withdrawn Capital would be a fundamental change of Ukraine’s corporate tax system. The proposed tax is an internationally unusual corporate tax based on profit distributions
rather than on the financial profits of companies. Although the effect on investment in the short run is likely to be limited, the new tax has potential to improve business climate in the long run. Fiscally, introduction of the new tax will lead to a significant annual fiscal shortfall of 1.2% to 1.5% of GDP in the first years following the tax reform, which should be fully compensated in the budget. Also, the potential for improvement of the business climate can only be realised if the tax reform is combined with a
substantial reform and improvement of the tax authority.

Economic outlook Ukraine: Higher growth to be expected

Last year the Ukrainian economy expanded by 2.2%, in spite of the trade suspension with the noncontrolled area in the East, which dampened growth by ca. 0.9%. Except for inflation, which exceeded the National Bank’s target, macroeconomic indicators performed rather well. Especially the fact that fiscal consolidation is bearing its first fruits and led to a
decrease in the public debt-to-GDP ratio for the first time since several years is to be highlighted: This indicator decreased from more than 81% of GDP to 73%.

Ukraine’s reform performance and latest developments

Since 2014, Ukraine has conducted key policy reforms. This is particularly the case for the banking and energy sectors, as well as for the state budget.
Despite the significant success that has been reached, the overall reform performance is mixed. Neither the judicial system, nor customs authorities or parts of the tax administration – all being central determinants of the business climate – have so far undergone thorough reform; also privatisation is not gaining momentum.

Banking sector: The long and winding road to recovery

EU autonomous trade measures: Positive, but minor impact

Preconditions for lifting the Moratorium on Farmland Sales

An Export Credit Agency: Good idea, but more work needed

The effect of company seizures and trade suspension in Donbas

Ukrainian economy continues its recovery path

Naftogaz versus Gazprom: First news from Stockholm

DCFTA implementation in Ukraine: Assessment after one year

The doubling of the minimum wage: Impact on employment?

Gas market: the direction is clear – but the devil is in the details

The Banking Sector in Ukraine: Trends and Developments

Budget 2017: Continuation of the fiscal consolidation process