The ex-Prime Minister of Ukraine on the menacing situation in the Ukrainian economy and industry

The industrial agenda does not seem to be a priority for the Ukrainian government and ordinary people. Today, prospects of the Ukrainian IT or agriculture, service sector or small business are a more popular topic.

Nevertheless, a significant drop in industrial production last year brought the problem to the focus of even skeptics.

In October 2019, industrial production decreased by 5% y-o-y, followed by a 7.5% drop in November and 8.3% in December. 2019 saw deepening of the problem with the domestic commodity market structure, says Anatoliy Kinakh, ex-Prime Minister of Ukraine and Chairman of the Ukrainian Union of Industrialists and Entrepreneurs (UUIE), in his interview to GMK Center.

What is the danger of deindustrialization of the domestic economy? Will Ukraine restore the ministry of industrial development? What role will the National Bank play in the country’s economy? Which industries are most promising in Ukraine? Keep reading to find out.

Mr Kinakh, what do you think caused the drop in the Ukrainian industry last year?

— To begin with, an industrial policy as such actually ceased to exist in Ukraine. The government’s action plan lacks such words as ‘industry’ or ‘innovative industrial development’. No national industrial development strategy has been drafted so far. The ministry of industry has long been abolished. No prime minister for industrial development has been appointed. This is absolutely unacceptable.

Secondly, the business, in fact, lost access to financial resources. The banking system of Ukraine is failing one of its key functions, i.e. business loans, which has deepened the crisis in industry. In 2019, the interest rate of the National Bank ranged between 18% at the beginning of the year and 13.5% at the year end. At the same time, the interest rate for commercial loans was 15% and higher. In such conditions, an industrial company dealing with long-term hi-tech production has virtually no chance to borrow money to meet its simple needs, such as modernization of production facilities, working capital financing etc.

Thirdly, Ukraine lacks meaningful targeted programs. As a result, the domestic market is characterized by a very low ‘solvent’ demand for products of the basic industries. Thus, for example, only 20–25% of the Ukrainian mining & metals products are consumed in the domestic market, the rest is exported. This is a very unstable situation.

How bad was the last decline? Does it mean that deindustrialization in Ukraine has accelerated?

— Deindustrialization in Ukraine has been lasting for already years in a row. We are losing entire sectors of economy producing high value added products. Here I mean mechanical engineering first of all, which includes aerospace engineering, shipbuilding, vehicle engineering. 72% of Ukraine’s exports are raw materials, including agricultural commodities, minerals and metals, certain semi-finished products.

Such structure of economy poses huge threats. First of all because a resource-based economy cannot possibly create the needed number of modern jobs. There is no known economy of the kind in the world that offers high standards of living, high real incomes, salaries and therefore high purchasing power.

In the long run, deepening deindustrialization causes the loss of the most valuable asset that a state can have — human potential, human resources. Today, at least 8 to 9 million Ukrainians earn for a living abroad — this is not just a response to low salaries, but also a symptom of degradation of the national economy in general.

Deepening deindustrialization, turning Ukraine into a supplier of raw materials for developed economies, exporter of cheap labor force may cause a situation, as forecasted by the World Bank and other international experts, where Ukraine’s population reduces to 15–17 million people. It begs the question of who is going to live in Ukraine several generations from now if we turn out to be unable to stop these threatening trends.

How do you find the government’s response to the current challenges?

— Unfortunately, the government’s behavior has been inadequate, unprofessional and inconsistent so far. There is no one even to have a consistent dialogue with, though we eagerly offer our experience and expertise. There are no officials responsible for industry at the institutional level. The government is neglecting the industrial sector. We propose to at least establish a post of Deputy Minister for Industrial Policy in the Ministry of Economic Development. But we don’t have even that yet.

How probable do you think is creation of the ministry of industry which is now being actively discussed?

— There’s no progress on it so far, unfortunately, but the discussion is still on. We are backed by the Parliament Committee on Economic Policy. The Cabinet of Ministers has recently established an industrial coordination center headed by the Prime Minister and composed of representatives of the Ministry of Finance, Ministry of Environment and Energy, National Bank, parliamentary committees, Tax Service and Customs Service as well as UUIE and a number of large industrial associations and enterprises. However, it is far too early yet to assess its efficiency.

Which steps would you propose, apart from creating the ministry of industrial policy?

— The government needs to change their way of thinking and follow a reasonable HR policy — that’s the most important condition. The principle of economic patriotism should become one of the key tests for capability and efficiency of representatives of both legislative and executive branches of power. They should also demonstrate consistent institutional memory (the principle of continuity), professional experience and knowledge.

People in power should have a clear understanding of the economic laws that work for all countries without exception, and rational approaches to be able to defend the national interests, including economic ones. People in power should be patriots of the Ukrainian economy.

You mentioned that the banking system of Ukraine is failing its business lending function. What is the solution to the problem, in your opinion? What should be the role of the National Bank?

— I think the U.S. Federal Reserve System or the European Central Bank are examples of proper financial structures. Of course, they are supposed to prevent hikes in price in the first place. But what’s even more important is that they create favorable conditions for economic development, improvement of the business climate and employment. This is something we don’t have in Ukraine today.

At the end of 2019, the National Bank’s interest rate was 13.5%, while the yearly inflation rate reached 4.1%. There is no other country in the world with such a gap between the current inflation and the central bank’s interest rate. The interest rate should be 6–7% at the most, but not 13.5%.

Today, the cost of credit in the EU is 2–4%. And that’s a ceiling! Sometimes it’s even lower. Meanwhile, the cost of credit for Ukrainian agricultural or mechanical engineering businesses is 15% and more. Can such businesses be competitive in foreign markets in such conditions? This factor alone makes our industrialists non-competitive, and other adverse factors are numerous.

The government and the National Bank should develop a common action plan for creation of favorable conditions enabling businesses to access resources. If the government fails to fix this problem, no declarative statements of high growth rates — like 40% GDP in 5 years — will have a chance to come true.

What are the necessary preconditions for boosting foreign investments in Ukraine?

— Practice shows that foreign investors are ready to adapt to the Ukrainian context — to our taxation, among other things. But investors will never come to a country whose government is not capable of protecting private property under the rule of law, and equality before the law, creating conditions for transparent and fair competition. These are the most burning issues today.

To be competitive in the international arena, Ukraine needs $8–10 billion of direct foreign investments annually — at the very least. It is also important to create favorable conditions for the national investor. That is perhaps even more important than attracting foreign investments.

Ukraine’s domestic market is very limited, as you mentioned. Is it possible to increase domestic consumption in Ukraine and how to achieve that?

— It is possible given a ‘solvent’ demand and incentives for producers of goods and services. Where there is no ‘solvent’ demand, there can be neither foreign nor domestic investor. Who’s going to invest in production if there is no ‘solvent’ demand for the products?

Solvency of the domestic market is a strategically important factor for production development. If prices, tariffs and cost of living grow faster than real incomes in general, crisis is inevitable.

In 2019, Ukraine ranked last in Europe in terms of per capita purchasing power. We were outrun by Albania, Moldova and Belarus. This is a very important signal. An average Ukrainian family, according to different estimations, spends 60–70% of the family budget to meet their basic needs, i.e. food, utilities and transport. This indicates a very high poverty rate.

Lifting a ban on agricultural lands sale is one of the most discussed issues in Ukraine nowadays. What are your expectations of the new land market in Ukraine?

— I am deeply convinced that a civilized land market in Ukraine is a must! Land should be on the market, it should have its cost and contribute to investment in the country’s development.

I would like to emphasize that the Land Code was adopted back in 2001 due to the efforts of the government that I chaired then. But the document has never been finalized. Real introduction of the Land Code in Ukraine required adoption of some additional 35 different acts of secondary legislation, such as cadaster, fertility standards and fertility protection rules, cost factors and so on and so on.

This process has not been completed in these 20 years. The Land Law which is now under discussion is a very simplified document. What we now witness is a primitive politicized discussion about whether or not lands should be sold.

This is a very dangerous trend. To simply lift the ban on selling lands without any clear action plan means to welcome corruption and shadow schemes. There should be a clear program of transition from the ban lift to establishing and operating a land market.

Which industries do you think are most promising in Ukraine?

— If we talk about Ukraine’s potential, it has been recognized globally. But without introducing reasonable rules of the game, this potential will never be fulfilled.

I think the most promising industries are the following:

  • A large number of licensed programmers and IT specialists makes Ukraine one of the top 5 IT countries in the world, next to the United States, India, Russia and Israel. This is another proof of our great intellectual potential.
  • Agrarian sector. Ukraine’s agribusiness is very strong today. It is necessary to develop the processing industry to increase the added value of Ukrainian agricultural products. To put it simply, we should sell pasta, not wheat.
  • Mining & metals sector. This is one of our traditional industries, in particular because we have plenty of raw material.
  • Hi-tech industries, such as aerospace engineering where we have both a basis and a potential, and aircraft engineering. Ukraine is one of the 10 or 12 countries in the whole world capable of producing modern aircrafts: from design to finished product.
  • Vehicle engineering and transportation. Kryukivskyi Railway Car Building Works produces modern equipment that can compete with the famous Hyundai. Thanks to our unique geographic position, transport and freight transit services will always be our priority sectors.
  • Construction industry. Ukraine could be a successful exporter of construction services.

In conclusion, I would like to underline that today’s key priority is development of a modern industrial policy and creation of a corresponding institutional framework. This was recently discussed at a meeting of the Anti-Crisis Council of Public Organizations and the Board of UUIE where Priority Actions 2020: Industrial Package was presented. The document builds on the proposals developed by UUIE experts in cooperation with their partners from line unions and associations of industrialists, entrepreneurs, employers and scientific institutions. It contains a demand to finalize the Industrial Complex Development Strategy and draft an action plan to implement that or another similar document to reflect the government’s position on the industrial policy, including introduction of Industry 4.0 innovations and principles with the purpose to upgrade industrial production. I believe this is where the way to revival of the domestic industry begins.