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1)Policy 2.5 & 2% respectively. This objective

1)Policy Recommendations

Ukraine presently has spare
capacity i.e. negative output gap (Appendix
– Picture 13).Thus, the immediaterequirement is to increase aggregate
demand (AD) which will have succeeding effects on employment and inflation.
This should in principle,drive the economic growth and pull Ukraine further away
from recession. To achieve this as a short-term challenge, three demand side
polices are recommended below:

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A.    Fiscal Policy

Fiscal policy should be
anchored to gradually reduce government budget deficit to GDP, which is
currently at 3.1% of GDP. The long-term target should be below 1% of GDP, but
mid-terms targets for 2018 & 2019 should be kept at 2.5 & 2%
respectively. This objective will be preliminary achieved by increasing capital
investments in public infrastructure and decreasing current government spending.
Taxation revenue will prove to be another major contributor in controlling the
budget deficit. Instead of tax cuts or tax raises, the government should focus
on implementing & tightening the nooses of existing tax administration to
cover all loop holes in the system. Focus should be to correlate increasing
wage rates with increasing social security contributions. Any tax reforms or
tax evasion schemes promoting tax savings or special commercial tax treatment
should be avoid for few years,until 2020. The illegal activities like gambling
and amber mining, which are run by traditional mafias, should be legalized with
higher tax brackets. These enforcements will provide the required additional
liquidity push to government revenues. Lastly, revenue expenditure &
spending details between central & local government bodies should be
audited to avoid accumulation of residual revenue at local levels. Any increase
in revenues should be subsequently used to increase capital investments.

B.    MonetaryPolicy

The monetary policy of
Ukraine is focused on inflation targeting framework, which aims at setting quantitative
goals to reduce inflation. The inflation target for 2017 is 8%, but at 2017 Q3
it is hovering at 12%. For future, the medium level targets should be set for
inflation, presumably at 6% & 5% for 2018 & 2019 respectively, which seem
to bemore realisticwhen viewedfrom a global perspective. To achieve thisobjective,
holding stable prices and maintaining flexible exchange ratesare the key
priority factors. The NBU should also tighten this inflation targeting
frameworkby developing interbank markets with assistance from liquidity forecasting
& management. Meeting these inflation targets are very vital in attracting
global investments, establishing market credibility and stabilizing
dollarization. If the inflation targets are derailed by market outlook or
geopolitical shocks, then the key interest rate should be used as a tool to
bring inflation closer to therealistic forecast (withinadequate margins of
error). The importance of decreasing inflation rates and relaxing foreign
exchange regulations will be clearly seen in increasing international reserves.
These foreign currency reserves should be linked back to investing in
infrastructure, increasing liquidity in market and improving aging service
sectors such as health sector and education sector.

C.     Exchange Rate Policy

Liberalization of foreign
exchange restrictions is an essential and a fundamental element when controlling
inflation is also a primary target. This strategy bringstransparency and improves
liquidity in the foreign exchange market. In coming few years, relaxing of
foreign exchange regulations tied to a stringent fundamental driven framework
will reinforce the liquid reserve situation and decrease dollarization, which in-turn
will prove helpful inincreasing resiliency and absorbing global economic
shocks. In the long-term,gradual removal of FX restrictions should be kept as an
activeoption, but that will also depend on various economic & global
circumstances of theperiod in time. To avoid or resists tradeoffs, the
liberalization roadmap should do impact analysis of previous relaxations
beforehand and should also make corrections in subsequent easing steps. The assessments
of relaxation measures shouldalso be updated periodically, as the roadmap
progresses towards complete removal of FX restrictions. The stabilization in
exchange rates together with lowering inflation & improving GDP, will
improve investor confidence, reduce discouragement of foreign direct investment,
recover foreign reserves and eventually ensure macro-financial stability.


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