“ Ukraine : the Path to Stability and Growth ”

1. “Ukraine: the Path to Stability and Growth” 29 May 2014

2. Challenges • Sharpdeterioration of external and internal political situationDirect lossesfrom annexation of territories and gas war with Russia+Threats for the investments into the economy of Ukraine • Internal political conflictDistrust to governmental institutions+ Decrease of controllability of economic and political processes • Economic slowdownandrisks of macroeconomic destabilizationUkraine remains one of the poorest in Europe(planned GDP per capitafor 2014 is$3200, e.g. 4.5 times lower than in Poland) • High corruptionand incomplete deregulationUnfavorable investment climate • Unreformedenergysectorand low energy efficiency of the economy Highexternal energy dependence and fiscal pressure (subsidies in gas sector reached 7% of GDP in 2013) • Sluggish rate of modernization of the sectors responsible forhuman capital development (healthcareandeducation) undermines possibilities for Ukraine to regain stable economic growth (mortality rate of working age populationis 47.8 per 10 thousand.; Poland – 29.5, Czech Republic – 22.8)

3. Main goals • Political stability – overcome the external threats for territorial integrity, legitimation of government, fiscal decentralization • Restoring macroeconomic stability – mitigate the consequences of current economic crisis and move to the macroeconomic policy aimed at supporting sustainable economic growth • Fighting corruption – continue deregulation, improve business climate for investments • Modernization of energy sector – eliminate inefficient system of subsidies,increase the energy efficiency of the economy • Healthcare reform for sustainable economic growth – increase the efficiency of budget expenditures on healthcare and affordability of medicines for population

4. Opportunities window should be used • There is public requestforpivotal modernization of the country. Opportunities window is open for implementation of serious (and unpopular)changes in the policy and economy • Political stabilizationSecond wave of economic reforms, aimed at liberalization of the economy=Return to stability and growth • Maturity tests for the new state authorities: • Competence to lower the scale of the social and economic populism • Ability to maintain «historical memory» • Promptness to comply with all necessary procedures before making decisions that are important for the society • Decisiveness in achieving the «critical mass» of the reforms

5. 1. External and internal political challenges Achievements • Signing the political part of the Association Agreement with the EU and scheduled for signing in June the economic part should promote the implementation of democratic reforms • Election of the President has been the first step towards restoring trust to the institutes of the government Unsolved issues • Trust to the government institutes or to the parliament remains very weak • Risk of spontaneous regionalization leads to the loss of territorial integrity • After annexation of the Crimea by the Russian Federation, the threat of additional territories losses / persisting instability at the East of Ukraine remains high • Breaking economic links with CIS countries and risk of new trade barriers between Ukraine and the Custom Union • Low combat capacity of the army, outdated equipment and army’s inability to conduct war of a new type. Low professionalism of the national security forces and the police

6. 1. External and internal political challenges Recommendations • Reduction of political risks • External policy • Ensure a de-escalation of the Ukrainian-Russian relations by holding the new round of four-party talks including Ukraine, the EU, the USA and the Russian Federation • Start the negotiations with the Russian Federation to maintain the access to the markets and mutual guarantees of property rightsby restoring parliamentary dialogue and work of the expert groups • Conduct the deep reform of the national security and defense • Internal policy • Demilitarize the political life in the country • Foster constitutional reform, ensure the proper check and balances mechanism and clear delimitation of the power of central and sub-local governments • Ensure early parliamentary elections • Consider the use of advisory plebiscite as the mechanism of solving social tensions

7. 2. Restoring macroeconomic stability Achievements • Start of the fiscal consolidation in 2010-2011 – natural gas and district heating tariff increases, raising pension age and decreasing budget expenditures on state administration • Development of the joint government and NBU the anti-crisis package for macroeconomic stabilization and its adoption by the parliament • Signing in March 2014 the political part of the Association Agreement with the EU • Successful negotiations of the Yatsenyuk government on the international assistance package from IFO and first tranche of the IMF rescue package Unsolved issues • Continuing economic stagnation (In the 1Q2014 GDP, industrial production and construction declined by 1.1%, 5.0% and 6.4% respectively) • Increasing fiscal risks – government debt/GDP ratio increased to 52.7% and the service of the state debt amounts to 35.5% of the budget • Deep uncontrolled devaluation (more than 40%) and high inflation (IMF and WB forecasts for 2014 are 15.0% and 16.2% respectively) • Deposit flight and increasing risks for banking system • Additional fiscal pressure of anti-crisis package went mainly to population while large business avoided it • Lack of progress with tax evasion fighting and raising fiscal pressure on legal business

8. 2. Restoring macroeconomic stability Recommendations • Fiscal policy • Implement the medium-term fiscal consolidation plan aimed at stabilizing government debt within 55-60% of GDP range and supporting economic growth of at least 4% • Liquidate tax loopholes, abolish the advance payments of corporate income tax, liquidate indebtedness on VAT refunds • Accelerate the full application of the transfer pricing legislations to large financial and industrial groups • Optimize the non-working sectoral tax exemptions • Monetary policy • Adopt and start the implementation of the medium-term plan on inflation targeting with responsibility division between NBU and the government, which envisages the rigid inflation targeting below 5% since 2016 • Ensure the predictability of the monetary policy – switch to the manageable exchange rate floating after the stabilization of the situation • Increase the political and financial independence of NBU and its transparency • Banking sector • Implement the stress-tests and make a decision on recapitalization of the system banks by their owners or by the state; prepare the plans on strengthening the largest banks and ensure the tight control of refinancing • Improve the legislation on protection of creditor rights and simplification of bad assets write-off; increase the capitalization of the banking sector by increasing the capital adequacy requirements

9. 3. Fighting thecorruption: deregulation (1) Achievements • Since2010 more than50 laws were adopted on deregulation and provision of administrative services • Permit system. Declaration principle and principle of acquiescencewere adopted. The list of types of economic activities that must be licensed was shortened by30% • State supervision. Division of policy-making and controlling functions, risk-orientedapproach to implementation of planned inspections,moratorium forinspections of business units on simplified taxation system,requirement of a court order for a suspension of operations of a company • Opening/ closing of business.Since2012 a companycan be registered via Internet based on the model charter. Maximum duration of 6 months was set for the business closing procedures.Mandatory audit of liquidation balance sheet was eliminated Unsolved Issues • Legislation work was not finished (technical regulations, duplication of controlling authorities’ functions) • The adopted laws on permit system and state supervisionwere not fully implemented. Partial return of controlling functions to the central authorities(in ecology and agriculture) occurred • The number of unplannedinspectionsinthe 2nd quarter of 2013 increased by 4 times (!) Duplication of controlling authorities’ functions remain.Single rules for making decision about suspension of operations of a company were not implemented

10. 3. Fighting thecorruption: deregulation (2) Achievements • Taxation system. The Tax Code was adopted: number of taxes and duties decreased from 44 to 22. Average time for servicing taxesanddutiesshortened from 657 tо 390 hours per year • Publicprocurement. In 2010 Law on Public Procurement was adopted. The list of exceptions included only 5 positions. • Provision of administrative services. Basic Law on administration services was adopted, as well as provision of administrative services through administrative services provision centers (ASPCs), which is based on the principle of ‘single window’. 636 out of needed 680 ASPCs were created • Regulation of automobile services. Mandatory inspection of passenger cars was abolished that saved UAH 0.7 bln of official and UAH 3.0bln of ‘unofficial’payments annually to car owners; general powers of attorney for driving were abolished Unsolved Issues • Further decrease in the number of taxes was postponed. Further improvement of tax administration system did not occur • Although the new Government eliminated tender-exempt procurement (that were widespreadduring the last 2 years), the risk of purchases from one participant remains • The list of ‘guaranteed’ administrative services provided by ASPCs was not adopted.Tariffs for administrative services were not fixed. Development of ASPCs network covering all territory of Ukraine was not completed • Although Ukraineimproved its position in Doing Business rating from 138 to 112, it did not enter the top-100 group, besides inGlobal Competitiveness IndexUkraine lost 11 places and shifted to the 84th position out of 148 countries

11. 3. Fighting thecorruption: deregulation Recommendations • Implement the adopted laws on deregulation, using the mechanism of social control and in cooperation with international financial organizations • Implement social control over realization of the new law on public procurement (transparency and objectivity of tender procedures) • Decrease the number of permissive documents by 30% (first of all in agriculture and transportation)and expand the practice of declarative principle • Introduce complex tax inspections by all controlling authorities, decrease the number of reasons for unplanned inspections,eliminate duplication of controlling authorities’ functions • Continue reform of technical regulation system in accordance with the EU requirements; implement adaptation of the system of state control over safety and quality of food productstowards the EU best practices • Improve ranking of Ukraine in the ‘Doing Business’ rating to the 100th or higher position through simplification of the procedures needed to connect a construction cite to the communications and electricity supply, enforcement protection of investors’ property rights

12. 4. Modernization of energy sector Achievements • Accession to the Energy Community and Candidate in the of Extractive Industries Transparency Initiative • Adopted in 2011 amendments to the law on production-sharing agreement (PSA) allowed to sign PSA with Chevron, Royal Dutch Shell и ExxonMobil in 2012 • Adopted Law on power market reform aims at modernizing power sector and incentivizing competition in the industry • The privatization of fossil-fuel power generating plants and distribution and supply companies was almost completed • In April 2014 the government adopted schedule for natural gas and heating tariff increases for residential consumers Unsolved issues • Energy intensity is almost twofold higher than the average figure for the EU, even after correcting for structure of the economy • Poor business climate does not allow to attract the investments in the sector • Fund for Cost Imbalances Settlement contradicts to the competition goal of the Law • Adopted by the government in 2012 heating sector modernization plan was not implemented • Coal sector reforms were not implemented while state subsidies doubled • Tariffs for subsidized consumers remain far below cost-covering level

13. 4. Modernization of energy sector Recommendations • Oil and gas sector • Foster Naftogaz restructuring plan to guarantee its unbundling and creation of the independent, sustainable and transparent extraction, transportation and supply companies • Comply with the adopted schedule on natural gas and heating tariff increases for residential consumers till 2018 • Improve the business climate and investment attractiveness in oil and gas sector by complying to the obligations to Energy Community • Power sector • Ensure real competition in generation and supply segments of the power market • Evaluate the required schedule and necessary funding for complying with the Large Combustion Plant Directive • District heating • Foster the implementation of energy efficiency increasing in the district heating. The priority should be given to modern building-level heat metering and installation of the individual heating substations • Improve the legislative framework on possible transfer of the district heating infrastructure into leasing or concessionand on energy performance contracting and energy service companies (ESCO) • Coal sector • Liquidate «VugilliaUkrainy» by 2015 and switch to the direct contracts and coal trade on coal exchange • Foster phasing out of the state loss-making coal mines. Develop the programs for IFO assistance to address the social and environmental issues of coal mines closure • Promote implementation of the new technologies in the coal industry

14. 5. Healthcare Reformfor Sustainable Growth Achievements • Fourbasic laws were adopted: changes into The Budget Code, law on‘pilot’ regions, changes to Basics of healthcarelegislation, law on emergency care • Increasing efficiency of budget expenses: • The 3-levelmodel of financing (state, oblast, rayon) was established • Priority of primary health care (PHC) increased, legal separation of PHC from secondary health care (SHC) was made, system of economic motivation was introduced for medical workers on PHC • Performance Program Budgeting and contracts were introduced in financing of public healthcare • Raising accessibility of medicines: • Reference pricing and reimbursement were piloted on anti-hypertension medicines Unsolved Issues • Law on healthcare institutions was not adopted • Low efficiency of budget expenses : • Attempt to return back to 4-levelmodelof financing (state, oblast, rayon, community), funds are still channeled based on maintaining beds approach • Bonuses to medical workers are still limited only to PHC in ‘pilot’ regions • Provision of ‘free medical services’ to population remains declarative • Low accessibility of medicines: • Excessiveregulation in the areas of registration (re-registration) and licensing of medicines • Use of reference pricing and reimbursement was not expanded to other groups of medicines • Very low investmentinto production of new medicines

15. 5. Healthcare Reformfor Sustainable Growth Recommendations • Increaseefficiencyof budget expenses: • Adopt law on healthcare institutions aimed at implementation of healthcare institutions financing based on medical services they provide to population;equal access to budgetary financing for public and private healthcare institutions;economic autonomy of public healthcare institutions • Introduce Performance Program Budgetingfor healthcare financingby types of healthcare service • Transit in the medium-run towards financing healthcare institutions based on agreements for provision of medical services signed between healthcare institutions and local governments, which will enforce the key indicators of medical services treatment • Develop and introduce system of bonuses for medical workers in all healthcare levels and in all regions of Ukraine • Eliminate declarations of ‘completely free medicine’, develop guaranteed package of free medical services to the population • Raise accessibility of medicines for population: • Simplify and bring closer to the EU standards regulations in the areas of registration (re-registration) and licensing of medicines • Introduce reference pricing for budgetary purchases of medicines and for socially-important medicines used in ambulatory treatment • Implement shift from free of charge provision of medicines by doctors to subsidized categories of patients towards provision of these medicines through pharmacies where patient has the right to choose a more expensive medicine with a co-payment

16. Opportunities window is open for modernization of the policy and economy And this opportunity should not be wasted! Than you for attention!