Fiscal loosening during the 2004 Presidential election campaign : three steps towards instability

The 2004 Presidential election campaign has left a deep effect on the budget process 2004-2005, which came about in three steps: (1) In the course of amending the 2004 budget, privatization receipts were misused to finance higher minimum pension payments, raising net public liabilities in the future. (2) The draft budget 2005 envisages further increases in transfers to the population and in sectorspecific state aid. If all liabilities are taken into account, the resulting deficit of the central budget will reach 3% of GDP in 2005, provided there is no correction on the expenditure or revenue side. This is extremely inappropriate in a high growth environment as Ukraine’s. (3) Fulfilling all social promises made by presidential candidates during the campaign will create an additional fiscal gap of some 1.9% of GDP in 2005. Besides, there are high risks on the revenue side that might result in an additional fiscal gap up to 3% of GDP, and doubtful privatization receipts that may increase the need for external borrowing, raising serious fiscal sustainability concerns. The ensuing fiscal instability would negatively affect the so far excellent overall macroeconomic situation. Rapid increases of transfers to the population will contribute to price pressure on the final goods market. There is thus an urgent need to implement corrective measures, which, however, are subject to various, mostly political constraints. As we consider the political costs of renegotiating the 2004 budget amendments to be too high to be taken on, we rather propose: not to incorporate additional social promises into the draft budget 2005, such as those made by the presidential candidates during the 2004 campaign; to restrict state aid to coal mining and agriculture; to continue to broaden the tax base by cutting tax privileges. While all this will help to decrease the fiscal imbalances outlined above, it will not be sufficient to prevent price pressure from the budget. Solving the fiscal and macroeconomic imbalances brought about during the election campaign thus calls for a joint fiscal and monetary policy response.