Professor at the University of California Berkeley Yuri Gorodnichenko – is one of the most successful Ukrainian economists. In an interview with the EP, he talks about the inevitability of tax increases, the impact of mobilization and the Russian economy.

"Denmark and Turkey can end Russia in a year"

In an interview with the EP, he talks about the inevitability of tax increases, the impact of mobilization and the Russian economy.
For 28 years of independence, Ukraine was not a very diligent student that international financial organizations and Western countries tried to teach a market economy. However, after February 24, 2022, everything turned upside down.

Ukraine is now delighted with many economists and representatives of international financial organizations, as its economy continues to operate stably even in the context of the largest war in Europe since the end of World War II.

MONDAY, JUNE 24, 2024, 08:00 - YAROSLAV VINOKUROV

To a large extent, this result was achieved with the support of partners. However, in the context of the war on depletion, Ukraine will have to rely more and more on its own forces and resort to unpopular measures

"We need to rely more on our own resources. And here the logic is very simple: a long war can only be financed by taxes, – says Yuri Gorodnichenko, a professor at the University of California Berkeley. He considers raising taxes almost inevitable and will not save even the decision of G7 leaders to provide $ 50 billion credit from frozen Russian assets.

Gorodnichenko – is one of the best Ukrainian economists specializing in monetary and fiscal policy. In early 2023, he became an adviser to the chairman of the National Bank, Andrei Pishny. EP spoke with Gorodnichenko in the fields of the Annual Research NBU conference.

"No one really knows what the interest rate should be"

— Recently, the former head of the National Bank Valery Gontarev criticized the monetary policy of the NBU. Like, if in 2022 the regulator sharply raised the rate from 10% to 25%, then he could also lower it. And how do you assess the monetary decisions of the NBU?

— I'll start with the thesis of a one-time rate increase and then its gradual reduction. There is this principle in economic theory: if in conditions of uncertainty you have calculated that you need to lower the interest rate by 2 percentage points, then you have to do half of it.

At the beginning of the war, conditions were more critical. Now the situation is more controlled, but the uncertainty has not disappeared: we do not know what problems we will have with energy, what we will have with the exchange rate. Macroeconomic stability is important to maintain and protect without creating additional risks, so flexibility and predictability of decisions are important.

— Could the occurrence have been avoided over-profits of banks and Minfin's ultra-high expenditures on the servicing of domestic government loan (OVDP) bonds in the adoption of NBU monetary decisions?

— Now that we look back, the question arises as to why we have such a situation at all. However, I want to remind you where these IGLBs and profits came from. This happened because there was a large issue at the beginning of the war, because we had no other money. Therefore, I would not say that these phenomena – are the fault of Natbank. We just need to understand that these are the consequences of the issue we still live in.

The government owes the National Bank almost 700 billion. Who is getting rich on these debts?

— Another reason for raising the discount rate from 10% to 25% in 2022 – is high inflation and high inflation expectations. Currently, inflation in Ukraine is 3.3%, and the discount rate is – 13%. How is this in line with the NBU's intention to resume lending?

— First, no one really knows what the interest rate should be. We live in such uncertainty that we have nothing to compare with. There is no textbook or formula for our conditions. For example, if inflation is currently around 3% in the United States and the rate is – about 5%, then that does not mean that we should have the same, because they have no war.

Secondly, we need to see what the interest rates were in Ukraine before. For example, our inflationary target (target) is 5%. This means that the NBU interest rate must be at least 5%.

The next – is country risk, ie what allowance is given for the risk of investing in Ukraine. At present, this is difficult to estimate due to the lack of market borrowing, but it is probably also about 5%. There are other factors, such as credit risk. He didn't go anywhere. We both had problems collecting overdue loans and staying.

If you add it all up, the discount rate is 10% and above – it's not something space. Of course, I would like interest rates to be lower, and I'm sure we will come to that. But this requires preconditions, in particular macroeconomic stability. This is one of the factors that will allow us to lower interest rates.

— Gontareva also criticized the NBU's exchange rate policy. At the end of 2022, you too spoke for Natbank to abandon the fixed exchange rate. NBU moved to controlled flexibility mode only in October 2023. If this transition had taken place earlier, what would be the situation in the economy now?

— In 2022, when I wrote that column, I wanted to say that we need to start talking about the exchange rate and prepare to release it when the conditions are right. Here, for example, we release the course, and the ports are closed. Because of this, there will be no benefits from devaluation, because there is simply no physical ability to export.

It is difficult for people from a party like me to comment on when it was the right time for this decision, because I do not have enough information. I do not know what the government's wishes were, what the NBU knew about our international assistance. However, it is important that this has been done, because this decision strengthens the resilience of our economy. And the fact that the course fluctuates in both directions, – is a great achievement.

Less than 40 will no longer be. What happens to the dollar exchange rate?

— Although the course is currently unrecorded, it is largely determined by the National Bank.
The market does not always understand how it works and what the NBU is guided by when setting a course.
How effective is current exchange rate policy?

First, the National Bank does not set the exchange rate alone. They look at what market forces are, supply, supply.
Second, they look at the structural deficit that has arisen due to the need for imports and destroyed capacity in Ukraine (eg refineries). Important macroeconomic stability: if we have a course of 45 hryvnias, tomorrow 50, the day after tomorrow again 45, then it is for us very bad.

Thus, if they understand that the exchange rate, for example, wants to go into some kind of devaluation, they come to this result gradually. If they see that we have a lot of international aid and the hryvnia is strengthening, they are also doing it gradually.

— When can we return to more market exchange, how was it before a full-scale invasion?

— After our victory. For us, the main problem is that there is a huge uncertainty. For example, during the first two months of 2024, we had no international aid revenue at all. In May, too, there was about zero. In such conditions, it is extremely difficult to predict something.

By the way, Valeria Gontareva mentioned that we have big ones reserves. Indeed, if you look at the criteria of peacetime, we can say that the reserves are too large. But we are not in peace. We have a huge uncertainty. Our foreign trade balance is minus 3 billion a month. This is huge money that needs to be covered somehow.

The same with the budget deficit. If we have problems with allies, for example, choose someone who is not very good at Ukraine (in parliamentary or presidential elections in the EU and the US – EP), then, probably, we will stay alone with Russia. In such circumstances, it is critical to have large reserves in order to last as long as possible.

"We need to raise taxes"

— How would you describe the Ukrainian economy every year of the Great War?

First year – huge shock. Many people left the country, the loss of territory, many things were destroyed, many things did not work.
Second year – is an adaptation to this shock. We are trying to make new mechanisms, schemes, to restart the economy, and we have begun to recover.
Third year we have this process going on, but with new challenges.

That, what happens to energy, this is probably the most painful of them.

If there is no electricity, it is difficult to talk about the stability of the economy or recovery.

— Does the Ukrainian economy have the resource to continue the struggle? What period will it be enough for?

We have a resource and will have enough for a long time.
We depend on international aid: both military and economic.
At present, we have enough economic aid, but it will continue to decline.
We need to rely more on our own resources.

Here the logic is very simple: a long war can only be financed by taxes. Theoretically, money can be "printed", but it is a bad idea that will destroy the economy.

We need a stable, strong economy for the war on exhaustion. You need to raise taxes, borrow more money. Raising taxes – is a very painful decision, but if we have more resources, we will be able to repay creditors more, and therefore – continue to borrow.

Tax mobilization. Where will the authorities look for an extra trillion hryvnias to close the hole?

— Tax increases are also talked about in the government, in particular due to the lack of funds for defense needs, which is 400-500 billion hryvnias. However, is it possible to block this deficit through involvement in the domestic market? In other words, can the market still invest in IGLBs?

— There are still opportunities, but the main growth points here – are the democratization of the borrowing process. We have bought a lot of individuals, but it seems to me that this resource is far from exhausted.

How was the United States raising money during World War II?

There was whole campaign.
Hollywood stars have told how important this is.
There were automatic deductions from salaries for military bonds.
This could be embodied in Ukraine as well.
So you can collect if not the entire required amount, then at least a couple of hundred billion.

— What about banks? For example, in 2020, former Natzbank Chairman Kirill Shevchenko said that the Ukrainian banking system has a certain limit on investment in IGLBs. He then called the number 35% of the deposit base. What can this limit be like now?

— Nobody knows the right answer. It is possible that in 2020 such estimates were correct, and now there may be another figure. Here you need to look at the situation and decide whether you can take more or stop. In addition, if banks spend their resources on IGLBs, they have less money left to lend to the rest of the economy. Therefore, it should be approached carefully.

Lending to the economy is recovering, but very slowly due to the incredible risks of non-repayment of the loan, because you never know what can happen to the borrower tomorrow.

— Going back to raising taxes, does the economy have the potential to service the increased tax burden?

— Our war is often compared to World War II.

Conditions there were even more difficult, but taxes there were constantly raised to finance all these military expenditures.

For example, at the beginning of World War II in the United States, the tax on the income of physoids was paid by only 4 million people. In 1945, there were already 42 million of them. That is, the tax base has been greatly expanded. At the beginning of the war, the tax rate was 10-15%. In the middle of the war, the maximum tax rate was 90%. Yes, it was paid by several thousand people, but it just illustrates how big taxes can be.

Well forgotten – new. The government wants to return income taxes to the rich, but does not know how

Economics – is the science of how to make the most of limited resources. We have a certain internal resource and there are two sources of consumption: households and the state. We need to redistribute this resource from households to the state.
One way to do this is to force or encourage households to owe the state. In order for them to make savings instead of consumption, which they passed on to the state. This is what we have already talked about.
Second option – raise taxes: either income taxes or indirect taxes such as VAT and excise duties.

Theoretically, the easiest option is – to increase VAT and excise duties. I don't know how much can be squeezed out of economics, but there is such a rule of thumb (a method of quickly determining mathematical or technical significance without accurate technical calculations – EP): if you raise the VAT rate by 1 percentage point, revenues increase by about half a percent of GDP. That is, if our GDP is about 8 trillion hryvnias, then raising VAT by 1 percent will bring about 40 billion.

— But there is also the Laffer effect, when raising the tax rate after a certain limit leads to a reduction in budget revenues due to the shadowing of the economy.

— What is the Laffer curve built on? Because you raise the tax rate and the tax base shrinks. At some point, reducing the tax base becomes the dominant force, meaning you raise taxes, but the base shrinks so fast that fees actually decrease.

The question is where this point comes from. Researchers estimate that in peacetime for income tax, this point is 60-70% for developed countries. We are not there at all at the moment. (The PIT rate is 18%, military collection – 1.5%. 19.5% – is paid on the income of citizens EP.)

— The day before, G7 leaders agreed on a $ 50 billion loan for income from frozen Russian assets. Will this save Ukraine from raising taxes?

— Let's think.

We need funds, so everything we are given from the outside reduces the need to raise taxes. However, the question is how much we can relax after this decision.

The West will share with Ukraine revenues from Russian assets. How it will work

First, various calculations show that Ukraine's approximate need for external assistance (military and economic) is 100-150 billion dollars a year. Even if you take 100 billion, 50 billion will close only half the need and only one year. This is not enough for a long war.
Secondly, the decision was made, but when we see the money – it is unknown. Hopefully at the end of this year, but maybe much later.
Third, this transaction is a – one-time measure. G7 agreed to take interest from frozen Russian assets, to calculate present value (assumed value of future cash flow – EP) and then hand them over to Ukraine.

However, in terms of a protracted war on depletion, these one-off measures do not solve long-term problems.

We need a constant flow of aid, we need a commitment that they will give us $ 100 billion a year after year. Only then will we be able to hold on calmly and not think about raising taxes.

"After the war, Ukraine will become a land of oportunity"

— Many companies complain about the lack of employees due to mobilization. How does it affect the economy?

— It has a bad effect, but I would look not only at the demand side, but also at the supply side. Lack of employees – is a limiting factor for the economy, but we have very many unemployed – about 15%. Why do we have a shortage of workers and such a huge unemployment rate? We use resources inefficiently.

There are also many stories that businesses have begun to attract women more actively. This is also a huge resource, because women do not have such a high percentage of employment. They could be involved in production.

Mobilizing – is a very difficult issue, because it is impossible to do so that it is both fair and cost-effective. From the point of view of economic expediency, it is necessary to protect people with high human capital who earn money, but it will be unfair.

The draft law on economic booking is registered. How will it work?

It is fair that everyone is involved in mobilization, but that means we will pull out people who are critical or in metropolitans, or at some factory. There is no simple solution. Ukraine's advantage is that we remain a democracy. It is necessary to have an honest conversation at the level of society: to say what the situation is, what the pros and cons are and to decide what to do.

— You have already started talking about the so-called economic booking, which is discussed in the Verkhovna Rada and the government. What fiscal effect can it have? For example, the authors of the initiative talk about 350 billion hryvnias a year.

— I didn't make calculations, so I can't name a number or criticize someone calculations. Efficiency and fairness, this trader-off, did not go anywhere. Conditionally speaking, wealthy people will not fight for this economic booking. This may be the right approach, and perhaps – no. Hard to tell.

— Two key approaches are discussed: when employees who have a certain salary are booked, and when employees are booked, for which the employer has paid a fee. Which is more effective?

First, if you look at a clean economy, then people who generate more income are – more important to the economy.
Second, we had the question that mobilization reduces men's interest in working officially. In this context, the main thing is to have predictability. If the company wants to hire me or you, there must be a guarantee that this person will work for a year or another term, that is, there will be no threat of losing it through mobilization. There is obviously a plus in this.

— Let's talk about the future.

Public defense spending – is a colossal fiscal stimulus that supports the economy.
What will happen when the war is over and this stimulus disappears?

— This is a very interesting and important question. Let's look at historical examples.

What happened in the States after World War II?

There was the same story: colossal military spending, which was radically reduced.

After that there was a small recession, but then a very big boom began, which lasted for many years.
People began to spend more on cars and housing.
That is, the source of economic growth, its engine, has changed. It used to be a state, and then it became the private sector.

After the Korean War, there was the same story: there were huge military spending, then the war froze, there was a small recession again, but then there was a boom in private consumption.

I think we will have something like that. There will be a transition between public and private consumption, but there is one difference between us and previous examples: we will have a very aggressive and active recovery phase immediately after the war. At least I have that kind of hope.

From aid to investment one step. What he asked for and what Kyiv received at the conference in Berlin

The state will still spend a lot of money, but not on military spending, but on recovery: on bridges, roads, schools, which can help avoid this recession.

— Looking at it in the longer term, what could be Ukraine's economy after the war?

---- Given that a lot refugees will not return, the country will remain with high state debt and increased social spending, in particular to support those affected by the war.

— I believe in the bright future of the Ukrainian economy, we will be fine.

Yes, we have great challenges, in particular the public debt you mentioned. However, this debt,

firstly, is not so expensive, and
secondly – extended in time.

When the war is over, there will be debt restructuring – for both officials and others. Returning to historical examples, Iraq had a similar situation: after the war, there was a restructuring, during which about 80% of debts were written off. I think we will have a similar situation.

As for refugees, this is a really painful question. However, if we have an active phase of recovery, Ukraine will become a land of opportunity. That is, you will be able to achieve much more in Ukraine than, for example, in Germany or Poland. It will be a force that will encourage people to return.

We will have limited resources, at least in the early stages, so the capabilities of the state will be limited. Taxes may need to be raised to recover. In rich Germany, an additional 5 percent tax on "solidarity" on income was made to finance the costs of modernizing East Germany.

It is difficult for us to do this now and it will be difficult to do it after the war. What can be done – is to simplify tax administration, to fight shadowing. That is, make sure that the rules of the game are equal for all and, through a more equal approach, gather the resources needed to recover.

What does the experience of Poland and the Czech Republic testify to?

They had a boom in economic growth simply because they had the prospect of joining the European Union.
I think we will have something like that.
It may not be so rapid in eastern Ukraine due to more difficult conditions, but there will be a strong economic recovery in the west and center.

"If the oil dollars run out, the Russian economy will end in a year"

— What is happening to the Russian economy? On the one hand, there is also talk of raising taxes, and on the other hand – they are actively developing a military-industrial complex.

— This is a difficult question. Much economic information in Russia is classified, so it is difficult to draw an objective picture. However, some indicators are eloquent. For example, inflation in Russia is now higher than in Ukraine. We said that the interest rate in Ukraine is high – 13%, and in Russia it is even higher – 16%. What does this indicate? There is a lack of resources that Russia's economy is overheated, that they also lack workers.

What is happening to Russia's economy?

They are extremely dependent on oil revenues. If something happens to oil revenues, the Russians will have extremely difficult conditions, because they are disconnected from foreign markets, they have no other resource.

The Soviet Union has lost its oil resources since 1986, when oil prices collapsed. After that, the USSR ended very quickly. Russia is also extremely dependent. The sanctions packages introduced by Western countries are gradually stifling the Russian economy.

Economic growth of 3% for Russia in the context of incredible fiscal infusions into the economy – is not really a big increase, so when they run out of oil dollars, then they will definitely lose.

— For what period can Russia have enough economic resources to continue the war?

— If they have oil dollars, it is very long. If the oil dollars run out, the Russian economy will end in a year.

— It follows from your words that sanctions against the Russian energy sector are the most effective. However, they were introduced gradually and Russia learned to circumvent them. What sanctions could limit Russia's access to oil dollars?

— If I understand correctly, about 90% of Russian oil exports go through two seas: Baltic and Black. If these seas are somehow closed, it will be difficult for Russia to reorient its export flows. Can this be done? It is possible. Denmark controls exits from the Baltic Sea, and Turkey – from the Black Sea. At some point, something has to happen to have the political will to do so. And then Russia will end very quickly.

In addition, if you look at Gazprom, they lost a huge market not because of sanctions, but because two "North Streams" were blown up". In a sense, the fact that refineries are now burning in Russia is also a form of sanctions, because they limit the ability to earn petrodollars.

— That is, the best sanctions – are "sanctions" carried out by SBU and GUR?

— Everyone understands that Putin's best opposition – is the Armed Forces of Ukraine.

— In early 2023, you became an adviser to the chairman of the National Bank, Andriy Pishny. How often and on what issues does the NBU chairman consult with you?

— For me, this is an important opportunity to help Ukraine. Basically, he can call me at any time. Sometimes he does. But I'm not one advisor to the Magnificent, we're a whole group. We hold regular meetings, discuss both strategic and tactical issues.

— How often does he listen to your advice?

— It's hard for me to say how the decision-making process is going, because we can talk today and start this process, but we'll see the results much later simply because that's how the state apparatus works. I think it's better to ask him how effective our advice is and how useful it is.

YAROSLAV VINOKUROV

Ekonomichna Pravda journalist

NBU COURSE RATE LOANS ECONOMY

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