Ukraine Reforms Update: 1H2015

Currently, Ukraine is in the early stages of the reforms process. Since the election of the pro-European parliament and the formation of the professional government in late 2014, there have been several initiatives, mostly in the sphere of taxes, energy efficiency and deregulation. The empty coffers of the Ukrainian treasury forced the parliament to pass a series of changes to the tax code. As a result, the tax on all passive income to 20% and introduced some new taxes on property and excisable goods. However, the overall number of taxes was decreased to 11 from 22, which should ease the tax management for enterprises. As a result, we have seen a positive balance of the central government budget in 1H2015, and the Ministry of Finance indicated that they are ready to present a new vision for tax reform in autumn of 2015. We believe that for the tax reform to be successful, the government will need to decrease the overall tax burden on business and put a ban on any changes to the tax system for at least 5-10 years.

The pressure from the IMF and other international lenders helped to increase the pace of reforms, which was clearly visible by the amount of bills approved just before the IMF’s decision on the new loan package to Ukraine in March 2015, and again in July 2015 before the program review and the disbursement of the second tranche. The key initiatives implemented by the government are listed below:

  • The Ukrainian Parliament approved two bills on deregulation. The first bill decreased the time limit on getting administrative services, cancelled some permitting procedures and transferred certain functions related to approvals and permits to the local level. The second bill decreased the number of business activities that require a license to 29 from 57. Moving forward, the Ministry of Economy intends to implement a “regulatory guillotine”, a procedure during which all regulatory norms are reviewed by the government and representatives of the business to eliminate unnecessary and burdensome regulation.
  • The Parliament passed a bill on investors rights protection. The bill introduces the practice of derivative suits and accountability of the company’s management for their actions that result in a loss to the company, as well as a legal procedure to recognize certain transactions as invalid and the return of profits earned as a result of such transaction. Additionally, the bill creates conditions for the transition of quasi-public companies to the private form (through squeeze-out of minority investors).
  • Domestic prices for natural gas, heating and electricity were increased in an effort to bring the tariffs to the market level and reduce the deficit of the state-owned Naftogaz of Ukraine. However, the new tariffs do not fully cover the costs, so they would have to be increased further in 2016 and in 2017.
  • The natural gas market was liberalized. The Ukrainian Parliament passed the bill #2250 “On the natural gas market”. The bill is intended to break the monopoly of several business groups in the gas distribution sector and create competitive market conditions. 
  • The Anti-Corruption Bureau was created and vested with wide authorities to investigate cases of corruption and bribery. Artem Sytnyk, a 35-year-old lawyer, was appointed as the Head of the Bureau. It is expected that the Bureau will start working in autumn 2015. 
  • Judicial system reform was launched. The Ukrainian parliament passed the presidential bill on the judicial reform in the second reading and in whole. The bill increased responsibilities of judges and introduced a more competitive procedure for hiring and training judges, but leaves the right to appoint judges (based on the proposal from the High Justice Council), liquidate and reorganize courts to the President. The bill also envisions the initial evaluation of the qualification of judges and monitoring of the lifestyle of judges. However, we haven’t yet seen any tangible changes in this area as of August 2015.
  • The Ukrainian government made steps towards improving transparency. The Ukrainian parliament passed a bill that envisages public access to data on the use of public funds by the recipients, including public enterprises, local and state authorities, as well as state social insurance funds. Additionally, the parliament voted for the bill that stipulates public access to company registers and information about state procurement, as well as another bill that opens access to declarations of public officials and makes it harder to distort information or hide property. The Ukrainian government also allowed public access to the databases of property rights and geological licenses, while making efforts towards moving some of the public tenders to an electronic system (mostly the low-value tenders). Furthermore, as was stated by the Ukrainian Ministry of Economy, several large state-owned companies (including Naftogaz and Ukrainian Railways) will be audited by the Big-4, and will publish their financial reports online.
  • The Ukrainian law enforcement took a tougher stance against corruption. There has been a flurry of cases with top government officials charged with corruption, including the Ukrainian Minister of Emergency Situations, three Yanukovich-era judges, several Ukrainian Army Generals and even two high-ranking officials from the Attorney General’s Office. However, to our knowledge, none of the cases were concluded with jail time, with offenders either being let out on bail or just being fired from their position. 
  • The introduction of the National Police that would replace the soviet-era “militia” was generally deemed as a success, with Kyiv being the first city to see the new 2,000-force patrol force as an “experiment” led by Eka Zguladze, an ideologist of the police reform in Georgia. The key differences between the two are high standards set out for the new policemen, which are being recruited and trained from scratch. It is expected that by the end of 2015, the new police force will fully replace the old “militia”. 
  • Another far-reaching experiment is making a transport hub out of the Odessa region, steamrolled by Mikheil Saakashvili, the former Georgian President, who was recently assigned as the region’s governor. It includes reforming the customs, deregulating port procedures, reconstructing a military airport into a commercial one, among many other initiatives. If successful, it would serve as a role-model for other regions to be reformed as well.
  • The decentralization reform led to the rapid increase in budget funds available to local authorities (estimated at around UAH 40 bn or USD 1.8 bn of additional revenues in 2015) as a result of the new distribution system of taxes. Simultaneously, more authority was passed on to the local communities. Additionally, the Parliament of Ukraine is about to vote for the amendments to the Constitution regarding the decentralization of power after they reviewed by the Constitutional Court in July 2015.
  • The Parliament adopted the bill on increased responsibility of bank owners and management. The new law is intended to fight related party lending by banks and introduces criminal responsibility for actions that lead to the bankruptcy/liquidation of a bank. We believe that it will help stabilize the Ukrainian banking system and reduce related party lending. 
  • The National Bank of Ukraine cleaned the banking system of banks that were insolvent or fraudulent, removing more than 40 banks from the market. While this step resulted in large outflows from the Deposit Guarantee Fund as insolvent banks’ assets were sold at a fraction of their book value, it sanitized the country’s banking system. Furthermore, the NBU is planning to do a stress testing of 20 largest Ukrainian banks and push for shareholders of banks with low capital adequacy ratio to increase the share capital, as well as enforce a more strict position on insider lending.