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Apr 11, 2014

Kyiv could reap rewards from decentralization

Kyiv Post

Kyiv could reap rewards from decentralization

If the central government satisfies a key demand of southeastern Ukrainian separatists by giving local authorities more powers, such as the ability to expand their tax bases, then the nation’s capital stands to benefit greatly.

As a city, Kyiv generates around 20 percent of the country’s gross domestic product, according to Dragon Capital investment bank data, meaning that a substantial amount of taxes is paid here. However, the municipal budget only gets to keep half of what it collects in personal income taxes. Meanwhile, Kyiv-registered companies pay all of their corporate income and value-added taxes straight into the state budget.

As part of Ukraine’s industrial heartland, Donetsk, Kharkiv and Luhansk oblasts assume that if they get to get keep more of what gets taxed, then their regions would prosper because they wouldn’t have to send money to Kyiv and wait for reverse allocations.

Experts say the flaw in this belief is that the Donbas industrial region is highly dependent on coal subsidies from Kyiv. Decentralization may cut off tliis aid, passing the burden on to local or regional governments. In turn, Donetsk and Luhansk would struggle because their combined share of GDP is half of what the central government allocates to them, according to 2012 figures.

On the other hand, Kyiv would like to keep more tax revenue and exert more control over the quality of life in the city. Dragon Capital analyst Anastasia Tuyukova said that Kyiv would have received $920 million more in 2013 if it didn’t have to send money to state coffers. It also wouldn’t have had a budget deficit, she added.

Tax revenue allocation was the subject of a long-lasting disagreement between former Prime Minister Mykola Azarov and ex-Kyiv city manager Oleksandr Popov. Azarov lobbied for the interests of eastern oblasts, while Popov wanted more cash flows to end up in the municipal budget.

Kyiv’s budget this year projects $173 billion in revenues with a $22.6 million surplus — an overly ambitious plan, said Tuyukova. Only 84 percent of last year’s revenue plan was met, while this year revenues are expected to grow by 24 percent amid an ongoing economic crisis.

"Kyiv’s approved budget for 2014 is absolutely unrealistic. As in the previous years, the revenue plan will underperform by 10-20 percent," said Vitaliy Vavryshchuk, an analyst at SP Advisors investment house.

The city budget currendy lacks $171 million to cover social expenses, Kyiv City State Administration deputy head Ruslan Kramarenko told the Kyiv Post.

Volodymyr Bondarenko, the current city administrator, on March 20 said that Kyiv is on the brink of default. It has to service $250 million of direct debt this year and will have to repay $250 million in eurobonds next year, and an additional $300 million in eurobonds in 2016.

Tuyukova of Dragon Capital thinks there will be no default because the internal debt is held by friendly state-owned banks, but sees risks attached to Kyiv’s ability to meet its international financial obligations. An International Monetary Fund aid package of up to $18 billion could ease concerns.

Kyiv has not asked for any of the IMF money, Kramarenko explained. The fund’s suggestions of raising energy tariffs for households will have a significant impact in Kyiv because the capital has some of the lowest rates nationwide.

Much of the $250 million of debt this year is due in November, but the city budget only sets off $115 million to service this debt. The analysts’ assumption is that much of it will be rescheduled.

Regarding the $550 million worth of eurobonds maturing in 2015-2016, SP Advisors’ Vavryshchuk said, "Kyiv is unable to fulfill (its) debt obligations independently."

Meaning, Kyiv needs central government assistance and support from state-run banks.

Borrowing on the international financial market isn’t an option for the near future, said Kramarenko, because the country’s sovereign credit rating is too low and the nation’s currency continues to devalue.

To reduce its addiction to borrowing, Kyiv has begun implementing austerity measures, even before the national government started its program to meet IMF demands, said Kramarenko. It has frozen non-essential expenditures, put development projects on hold, and prioritized expenses, for example.

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