International Centre for Policy Studies in Kyiv -

During the second half of 2006, Ukraine's government turned to foreign lending institutions more often than at any other time in the history of the country by doing so four times. The total amount of loans, $1.9bn, is also the largest since 2000. But because these new loans are being signed at the same time as the country pays off its old ones, the country's external debt only grew by $500m over the year.

At this point, the increase in national debt does not constitute any threat. The ratio of debt to GDP remains low, only 15.5% at the end of 2006, with 9.5% external debt.

Right now, borrowing externally is better for the country than borrowing domestically, says International Centre for Policy Studies (ICPS) economist Oleksandr Zholud. First, it ensures that hard currency comes in to finance the current account deficit that emerged in 2006. In Central European countries, the main source of financing in a similar situation was FDI, but inflows of FDI to Ukraine are insufficient to finance the deficit.

Secondly, when a country borrows on foreign markets, it does not affect private investment domestically. This happens when the state increases borrowing on the domestic market without any increase in the money supply: domestic interest rates tend to go up in this situation, increasing the cost of capital. This leads to less borrowing in the private sector; that is, business is squeezed out of capital markets by the state. In the end, this means investment in fixed assets goes down and, with it, economic growth.

Although increasing state debt is currently not threatening, Ukraine's overall state and private external debt is growing sharply.

ICPS economists estimate that over 2006 external debt grew more than 24%, reaching 47% of GDP by the end of the year. Private external debt grew the fastest and is already three times higher than public debt.

Such rapid growth in debt could lead to problems in the future, especially if the exchange rate begins to fluctuate or the rate-setting policy is changed. Most loans in Ukraine are in US dollars, and this is the currency to which the hryvnia is tied. Should the Government try to devaluate the hryvnia as a way to stimulate exports, this would sharply increase the external debt, increasing the risk of a default and making it harder to turn to world capital markets.

Since external borrowings are only one means of financing the Budget deficit, the size of state debt depends directly on the size of this deficit. Thus, according to the ICPS expert, to control the size of external debt, the government should first pay attention to the state of its finances.

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