The newspaper “Dzerkalo Tyzhnya” № 24 dated July 4, 2014, published an article by Lesia Shevchenko "State aid for businesses and industries - when to expect the change?"
On July 1, 2014, Ukrainian Parliament voted the Law "On government support for businesses." What could this mean for country’s economy and the budget?
The ill-conceived policy will lead to default
Support for domestic production has been one of the most problematic issues of both Ukraine’s state economic and fiscal policy for a long time. Politicians and experts had divided into two camps. Some deny the appropriateness of support per se (just as government intervention in the economy in general), reasonably believing that the budget and tax credits are used inefficiently. Others promote laws for favorable conditions for certain industries or businesses. To date, more than fifty of such bills are pending revision in the parliamentary committees, each of these representing the interests of individual firms, which use their proximity to policy makers to improve their financial situation.
Unsolved dilemma "to support or not to support” costs a lot to both state budget and businesses. Finance Ministry reports annually on high expenditures on economic activity (more than UAH 40 billion, excluding state guarantees) and loss of income from tax benefits (UAH 50 billion). Along with custom privileges the total amount of contingent government support is about UAH 150 billion. It is considered “contingent” because in most cases the state does not define its efficiency and transparency. One company was overpaying taxes in order for another company to receive the aid from the state budget.
In the first quarter of 2014 MoF reported the fiscal gap of UAH 300 billion, including over UAH 30 billion in advance tax payments. This pre-default condition is due to the lack of modern approaches to public support for business. The government had never publicly reported on the cost-effectiveness of various tax breaks and budgetary spending. At the same time each year the campaign for reduction of state benefits is being launched. Which benefits should be decreased and what are the bases for these? The answers remain in possession of a narrow circle of persons.
This leads to huge imbalances in economic policy. For example, the amount of budgetary expenditures for support of the coal industry had reached UAH 13 billion. At the same time the support amount for SMEs totals with UAH 13 million! State funding of the coal industry had doubled for the past four years. However, coal production increased by 20% only, according to official statistics. The government compensates for the high cost of thermal coal mainly, UAH 1200 per ton. Meanwhile, its market price is only UAH 500 per ton. The cost of the coal has been actively increasing since 2010. In terms of industrial policy this situation is at an impasse. Social expectations of the miners are sky-high; their salary is at least UAH 5-8 thousand per month. No prospects cost reduction expected.
Theoretically, there are two options: restructuring, that is actually mines closure (this means additional billion annually), or their privatization. Clear enough the private owner would not pay for the overpriced coal. Since no upgrade was performed, the coal industry remains dependent on the state budget like no other. Funding termination would mean massive social explosion - 200 thousand miners without pay or with reduced salary. This could be caused by the lack of funds in the state budget and the refusal of foreign creditors to provide such funds.
This year the state budget has to cover more than UAH 2 bln debt for the companies that took advantage of government guarantees, and did not repay the loans. The cost of debt repayment in the road construction sector is about UAH 10 billion, which are three times the expenditures on construction and maintenance of the roads (UAH 3.2 billion). At the same time more than UAH 2.3 billion is expected from international financial institutions.
To date, the main beneficiaries of government support are agriculture, coal mining, energy, chemical and food industries and aircraft. However, there are significant problems with transparency of state support instruments. One can track the recipients of budget funds, soft loans or state guarantees via request for public information. But those companies enjoying tax benefits are protected by non-disclosure of trade secrets. Budget itself has its own "surprises". For example, farmers "consume" about UAH 9 bln worth of subsidies according to the functional distribution of government expenditures, yet only 3 billion according to program-vise distribution.
Association Agreement with the EU: a chance to improve the situation
Thus, government support faces many problems. These concern validity, intended use, transparency and efficiency. Therefore, a radical new approach is needed in this area.
What will it be? Firstly, the political objective in the public interest is necessary. State could favor producers in entering new markets, especially since the EU had temporary reduced tariff barriers for Ukrainian companies for this year. It could also saturate the domestic market with high quality goods, produced in partnership with foreign investors. Secondly, this approach has to meet European standards, as Association Agreement with the EU contains commitments in this area.
Solving these issues is difficult, but they need to be addressed. Of course, there are complicated WTO and European Union rules, which impose certain restrictions on government support. However, this does not mean such support should seize existence at all. Such inconsistency and double standards had led, for example, to termination of free economic zone regime six years ago, with no modernization attempts (for some reason in Poland they still efficiently work), completely eliminating the instruments for the regions to stimulate investment and cross-border activities.
Association Agreement (its FTA part) introduced obligations regarding state support for businesses and thus provided the government and politicians the final chance to ensure order in this matter.
EU member states have a special regime regulating state support for business. It was designed to prevent negative effects on competition and trade within the common market through excessive, inefficient and opaque subsidizing of domestic producers by own governments.
The mechanism is about the prior approval of government intervention by the European Commission, expressed in the form of draft legislation. Treaty on the Functioning of the European Union serves as the legal basis for this mechanism, as well as the wide range of horizontal, industry and special rules for state aid. Horizontal rules refer to the joint (cross-sectoral) projects, industry rules touch upon a number of sectors (shipbuilding, coal, energy, etc.), and special rules define support tools, such as state guarantees, sale of assets, risk capital, etc.
In addition, the governments of the Member States must report annually to the Commission on the current programs of state support. The Commission, in turn, monitors these schemes and activities and may make suggestions to governments for their correction. Government websites should contain public information about each company, which receives annually EUR 500 thousand of state aid and more in any form.
The rules are complicated, but they make it possible to effectively support business and attract investment. The regime of free economic zone in Poland, for example, has been completely redesigned according to the EU state aid rules and would remain valid until 2020. At the same time similar regime in Ukraine was abolished in 2005 with no alternatives. During the financial crisis of 2009 up to 25% of the EU banking sector was improved through special state aid rules. The “Airbus” subsidies for the automotive industry is another example of EU government support policy effectiveness.
However, breaking the rules and ignoring the European Commission demands can cause refund of state aid. Bankrupt "Malev" airlines served as an example, as Commission considered its support by the Hungarian government illegal and demanded the return of aid to the state budget.
It is worth mentioning that implementation of EU state aid rules had been provided by the Partnership and Cooperation Agreement between Ukraine and the EU, which came into force in 1997, and confirmed by the EU-Ukraine Action Plan and EU-Ukraine Association Agenda. Still, no progress on this issue did occur. Ukrainian exporters were often subjected to risk of anti-dumping measures by the EU. Yet, in any such case, their relation with government support was not publicly admitted.
Will the government make use of it?
The Law "On government support for businesses" adopted on July 1 can be considered a declaration of intention to clean up the state aid, rather than specific instrument. The law is trying to recreate the EU plot to protect competition from government interference. This sphere, in turn, remains in yet deeper trouble, comparing with the efficiency of budget spending. Specifically, Article 15 of the Law of Ukraine "On Protection of Competition"(in action since 1993) prohibited government benefits to enterprises. Yet it had never been applied to government incentives, subsidies or preferential treatment that had harmed competition. Instead, local authorities were the ones always "suffering" for small chores of architectural accessories, gas stations and so on.
Competition protection in general had been present during the last parliamentary elections in the programs of majority of the opposition parties. “Batkivschyna" was going to "declare a war on monopolies in all areas, to create conditions for fair competition”. "Svoboda" sought to eliminate private monopolies and oligopolies. However, “UDAR” party program did not include activities in the field of competition policy. However, they were unlikely to guess protecting competition is possible in such way.
Thus, the law on government support declared state aid inadmissible for competition in general, except:
It gets even more interesting further. The competent authority - the Antimonopoly Committee of Ukraine (AMC), may recognize state aid as being valid for competition, if it was provided for the following purposes:
1) promotion of socio-economic development of Ukraine’s regions with low quality of life and high unemployment;
2) implementation of national development programs or to solve social and economic problems of national scale;
3) promotion of certain economic activities in certain economic zones, provided that it does not contradict international treaties of Ukraine ratified by the Parliament;
4) maintenance and preservation of the national cultural heritage, where the effect of such state aid on competition is unimportant.
The AMC will determine the admissibility of state aid for competition based on criteria approved by the Cabinet of Ministers.
Omitting the procedural aspects of the law, what do we eventually get?
The Antimonopoly Committee in three years (the law comes into force with such delay) would be able to both approve new state aid laws and revise acting ones. Also, it will be empowered to check the specific instances of state assistance.
The AMC will be able to make a decision on the admissibility or inadmissibility of state aid for competition, its admissibility provided the recipient compliance with the recommendations of the AMC, or termination and refund of the aid to the budget.
The acts of the government, which would create the basis for AMC to take such decisions, should include:
One can hope these acts will be developed based on the relevant European standards.
AMC will have to prepare an annual report on state aid based on the information provided by the ministries.
In other words, minimum of three years is left before modernization of the governmental support for business. Within this time the Antimonopoly Committee should prepare a regulatory framework in the form of resolutions of the Cabinet of Ministers, on the basis of which it will determine the allowable state aid for competition. This admissibility can automatically imply compatibility with the EU rules. This depends on how clearly relevant EU rules will be reflected in the acts of the Cabinet. Everything said about the role of the EU standards is evident from the Association Agreement, but not a word about it in the law.
The constructs, composed of fuzzy rules of the basic law referring to "the acts of the Cabinet of Ministers" and "procedures established by the Cabinet of Ministers of Ukraine" become more and more widespread in national legislation. Considering such decisions would solely depend on subjective evaluation by officials, a threat or corruption is obvious. The lobbyists of various support schemes for certain companies would receive formal approval from the Antimonopoly Committee, but no one will properly analyze the impact of such support on the competition.
Therefore, at first glance no novelty was introduced by mentioned law. Issues covered by the law appear in the legal field of state target programs, budgeting and tax legislation. However, no emphasis on competition was placed so far. Yet the other accents, referred to in the first part of the article and which nobody has yet obeyed, are present. So whether the law would offer the protection for competition and whether it will be a starting point for the reform of state aid remain the big questions.
