“Assessment of financial convergence of Ukraine with the CIS countries and the European Union”

The article evaluates the financial convergence criteria of Ukraine with the major countries of the Commonwealth of Independent States: Russia, Kazakhstan and Belarus. It also studies the criteria of financial convergence of Ukraine with its main trading partners in Europe: the Eurozone, Poland, Hungary and the Czech Republic. Using the results of the comparative analysis the conclusion has been made that Ukraine has a bigger financial convergence with the CIS countries.


Introduction
The increased uncertainty on the international commodity and financial markets reduces the potential of economic growth for small open economies, including Ukraine. As a result, the study of the practical aspects of the formation of international economic integration structures at the regional level grows in importance.
Given the geopolitical, economic and historical factors of Ukraine, its entry into the regional economic formations is traditionally viewed in terms of two alternative directions: accession to the European Union (the EU) or integration with the countries of the Commonwealth of Independent States (the CIS). Considering the complexity and multidimensional nature of the problem we try to identify certain solutions based on the comparative analysis of criteria of financial convergence of Ukraine with some of the CIS countries and the European Union.

Justification for the selection of countries and the list of criteria for financial convergence assessment
For the study of criteria of Ukraine's financial convergence with the CIS countries and the EU it is necessary to solve two related problems. Firstly, it is important to justify the list of countries to be included into this analysis. Secondly, we have to determine the criteria of financial convergence, which will be investigated.
In our opinion, the first problem can be solved by using the following procedure: at first we determine the list of the CIS countries and countries of the European Union, which are the main trade partners of Ukraine. Then, by using the formal logical analysis this list is narrowed. According to the method of calculation of the real exchange rate [1], the main trade partners of Ukraine are the countries, the share of which in the total foreign trade turnover exceeds 1%. Serhiy Kozmenko, Taras Savchenko, Dmytro Kazarinov, 2012. Among the CIS countries the major trading partners of Ukraine are Russia, Kazakhstan, Belarus and Moldova [2]. According to the analysis of socioeconomic development of the CIS countries, we believe it appropriate to exclude Moldova from the list of countries for potential economic integration. Our conclusion is determined by the insignificant volume of this country's internal market, as well as the negative trends in its socio-economic development in the period 1990-2011. Moreover, this country is characterized by significant levels of political instability and possibilities of an armed conflict.
The paper assesses the expediency of Ukraine's economic integration with Russia, Kazakhstan and Belarus. These countries have made some practical steps towards economic and financial integration: (1) Russia, Kazakhstan, Belarus (as well as four other CIS countries) are involved in the implementation of the concept of cooperation and coordination in the currency area [3,4]; (2) on July 30, 2012 Ukraine ratified a free-trade agreement [5], becoming the third country (along with Russia and Belarus) that implemented this procedure.
Ukraine, Russia, Kazakhstan and Belarus have already been studied by researchers [6,7] in order to assess the possibilities of economic integration. The creation of the currency union of Russia and Belarus is also discussed.
In determining the list of the EU countries we use the following considerations. In the first place, we believe it important to analyze the economic expediency of Ukraine's integration into the most advanced monetary union in the world -the Eurozone. In doing so, we have investigated the prospects of the monetary integration of Ukraine into the Eurozone as an integral economic and currency group rather than with its individual member-states.
In the second place, we have identified those European countries that are considered the main trade partners of Ukraine (their share in the total foreign trade turnover of Ukraine exceeds 1%). This list in-cludes Germany, Italy, France, Spain, the Netherlands, Poland, Hungary, Czech Republic and the United Kingdom [2]. It should be noted that the first five countries are part of the Eurozone. Therefore, separate calculations regarding the prospects of the monetary integration of Ukraine with these countries is not needed.
In the third place, considering the fact that common borders contribute to the successful development of regional monetary integration we have eliminated the United Kingdom from the list of countries that remained after the second stage of selection. This paper examines the economic expediency of the monetary integration of Ukraine with Poland, Hungary and Czech Republic, and the prospect of Ukraine's joining the Eurozone. It should be noted that although these Eastern European countries are part of the European Union, they are planning the introduction of the euro only in the medium-term perspective. A delay in the introduction of the single European currency in these countries is linked to both the macroeconomic issues of the post-crisis period and the problems of the EU itself. Therefore, we consider it necessary to conduct a separate assessment of Ukraine's economic integration with these countries.
Economic convergence can be assessed in different ways. Recognizing the diversity of forms and types of economic integration, in our study we have tried to create a list of criteria in terms of formation of the currency union as the highest form of economic integration. Methodological approaches to assessing the economic convergence have been summarized in the works of Drobyshevsky [7], Islam [8] and Weimann [9]. Some methods for assessing the expediency of economic integration of the countries were examined in the works [10][11][12][13][14][15][16][17][18].
On the basis of the general content of the above mentioned works we have determined the criteria of macroeconomic and financial convergence. Macroeconomic convergence criteria include: the size and diversification of the economy, the mobility of production factors, the symmetry of macroeconomic shocks and trade convergence (volume and structure of foreign trade). The criteria of financial convergence include: fiscal integration, inflationary convergence, similarity in interest rates, development levels of the financial sector, monetary convergence and adequacy of gold and foreign exchange reserves.
The research results of macroeconomic convergence criteria are given in a separate study. This paper presents the results of the study of expediency of financial integration of Ukraine with the countries of the CIS and the European Union. For assessing the financial convergence criteria we use the databases of the following international organizations: United Nations Statistics Division [19], International Monetary Fund [20], Interstate Statistical Committee of the Commonwealth of Independent States [21] and the World Bank [22].

Assessment criteria of financial convergence of Ukraine with the biggest CIS countries
First, we analyze fiscal convergence. To assess this criterion we examine the budget deficit given as a percentage of GDP (Table 1). For the calculation of this table's values we have used the real GDP in U.S. dollars [19]. Budget deficit in U.S. dollars is determined by using the official exchange rate of national currencies to the U.S. dollar during the reporting period [21]. Further we analyze the inflationary convergence of the CIS countries (Table 2). To analyze this criterion we examine two parameters: the difference in standard deviations of logarithms of consumer price index growth rate (further referred to as CPI) and the correlation of the growth rates of this indicator. It should be noted that according to the IMF database [20], for this analysis we use the CPI growth rate to the previous year, rather than the more common indicator of price dynamics: CPI from December 2002 to December of the previous year. Based on the analysis of the data in Table 2, we can conclude that the economy of Ukraine and Belarus is characterized by significant volatility of price dynamics while the situation in Russia and Kazakhstan is more stable. The analysis of inflation dynamics correlation provides different results: the inflationary tendencies are similar for Belarus and Russia and for Ukraine and Kazakhstan. The indicators of CPI correlation for these groups of countries are statistically significant. Similar approaches were used to study the similarity of interest rates dynamics ( Table 3). The object of our analysis are refinancing rates of central banks [20], which are the key indicators of the cost of funds on the national money markets. The results of the analysis make it possible to claim that there are no significant differences in the volatility of refinancing rates between Ukraine, Russia and Kazakhstan (Table 3). On the other hand, the money market of Belarus is characterized by the high volatility of refinancing rates that is 2-3 times higher than the volatility of rates in other countries. We have also assessed the dynamics of convergence on the basis of the comparative analysis of standard deviations in different time intervals. The results of the analysis demonstrate the reduction of refinancing rates volatility during 2011 in these countries.
The analysis of the rates correlation in the period 2001-2011 shows that the only statistically significant relationship is observed between the refinancing rates of Belarus and Russia. The average strength of relationship exists between the rates in Ukraine and Kazakhstan, as well as between the rates in Ukraine and Russia.
We will analyze the currency convergence based on the study of volatility and correlation of national currencies rates to the U.S. dollar [20] (Table 4) and the study of expansion of foreign exchange transactions in the national economies (Table 5). The results of the analysis make it possible to conclude that Belarus has the highest rate volatility. Currency markets in Kazakhstan and Russia are characterized by low volatility of rates. These countries and Ukraine have a high mutual correlation of the national currency exchange rate to the U.S. dollar during the period from 2002 to 2011. Therefore, only the dynamics of the Belarusian ruble is not linked to the dynamics of the national currencies of potential currency union partners. In our opinion, this aspect can be explained by the strict government influence on the exchange rate in this country, as well as the currency crisis which took place in Belarus in 2011. Table 5 presents data to assess the expansion of foreign currency transactions in the financial system of these countries. This assessment was based on the analysis of the ratio of non-resident liabilities of banks and M3 aggregate. These figures have been obtained from the IMF database [20].
The value of the indicator in these countries fluctuates within 18-45% of the broad money. However, its dynamics varies. We can make a conclusion about the similarities in the expansion of currency operations in the majority of the surveyed countries. The only exception is Belarus, where the significance of financial resources of non-resident is growing. Another conception for assessing the convergence criteria on the basis of standard deviations includes the research of "sigma convergence". We will complete the analysis of rates and inflation rates by assessing their sigma convergence ( Figure 1). To assess the currency sigma convergence we have calculated standard deviations of logarithms of the growth rates of national currencies to the U.S. dollar for 2001-2011. Similar approach was used to assess the sigma convergence of consumer inflation and refinancing rates.  [22], we will conduct a comparative analysis of indica-tors of the financial sector development (Table 6). To provide an opportunity to compare the results, all figures are presented as a percentage of GDP. Having analyzed the relative size of the banking assets (with the exception of government loans) and bank loans to residents, we can conclude that in comparison with other countries the banking system of Ukraine plays the biggest role in the structure of the national economy. Russia and Belarus are characterized by almost the same relative size of the banking system, which is 1.5-2 times smaller than the Ukrainian one. The relative size of assets in the banking system of Kazakhstan is somewhat higher than in Russia and Belarus, but significantly lower than in Ukraine.
We have also studied the monetization of GDP, which is defined as the ratio of M2 to GDP. The monographic study of T. Savchenko [23, p. 235-239] shows that for the Ukrainian economy an equilibrium value of the monetization level is around 50-55%. In our opinion, this value can be used as a benchmark for other CIS countries, which are analyzed in this paper. For countries with developed market economies the equilibrium level of monetization is significantly higher. Thus, the monetization of the economies of Ukraine and Russia is close to the optimal value whereas the economies of Kazakhstan and Belarus are not sufficiently monetized and characterized by significant volatility of this indicator.
The analysis of the banking system should be complemented with the study of performance figures of the national stock markets, which are calculated according to the World Bank data [22] (Figure 2). The last criterion involves the analysis of the adequacy of gold and foreign exchange reserves (Figure 3). The calculations were carried out on the basis of the World Bank data [22].

Fig. 3. Relative indicators of the adequacy of gold and foreign exchange reserves of Ukraine, Russia, Kazakhstan and Belarus in the period of 2001-2011
To perform this task we have researched two relative ratios: foreign exchange reserves in percentage to external debt (left scale) and foreign exchange reserves in months of import (right scale). According to the results of their analysis, we can conclude that Russia possesses the highest gold and foreign exchange reserves. The reserves of Kazakhstan and Ukraine are sufficient, but their relative value is not much higher than the minimum set by the IMF. The reserves of Belarus are insufficient and they remained below the recommended values throughout the analysis period.

Assessment of financial convergence of Ukraine with its main trading partners in the European Union
The level of fiscal integration is estimated on the basis of the ratios of budget deficit to GDP and public debt to GDP ( Table 7). The calculations were carried out on the basis of the World Bank data [22]. As mentioned earlier, according to the Maastricht criteria budget deficit should not exceed 3% of GDP and public debt -60% of GDP. As a result of the global financial crisis of 2008 budget expenditures have grown significantly, which led to a sharp increase in the budget deficit. In addition, there was a dramatic increase in the public debt. As a result, no country with a desire for regional monetary integration, met the Maastricht fiscal criteria by the end of 2010.
The assessment of inflationary convergence is conducted by analyzing the correlation, volatility and "sigma convergence" of consumer price indices.  We can make a conclusion about the low synchronization of the inflation dynamics in Ukraine and other countries, as well as a high volatility in consumer prices. These trends suggest a lack of structural homogeneity of the economies of Ukraine and other countries, which can exacerbate the impact of asymmetric shocks in the case of monetary integration. This makes it necessary to conduct an independent currency and monetary policy, which reduces the economic expediency of regional currency integration.
As can be seen from Figure 4, the study of "sigma convergence" of the price dynamics confirms the above conclusions. Accelerated growth rates of consumer prices in Ukraine in 2002-2008 years had an impact on the growth of variance of the consumer price index. However, it should be noted that according to the criterion of "sigma convergence", there has been a gradual synchronization of price dynamics in Ukraine and other countries since 2008. Based on the analysis of correlation and volatility we will analyze the similarity of interest rates dynamics in the surveyed countries. As an object of the analysis we have taken the rate of refinancing of central banks [20], which are the key indicators of the cost of funds on the national money markets.  We can make a conclusion about the existence of close correlation of refinancing rates dynamics in these countries which, on the one hand, creates additional conditions for further economic integration. However, on the other hand, the average refinancing rate in Ukraine during the study period remained very high relative to other countries and amounted to 11.62%, which is 3.2 times higher than the same index of the Eurozone. Moreover, the refinancing rate in Ukraine was characterized by a significant degree of volatility -the correlation coefficient stood at 58.6%. These trends can be interpreted as evidence of the low degree of economic convergence between Ukraine and the European countries.
We will analyze monetary convergence on the basis of our research of volatility and correlation of average monthly rates of the Ukrainian hryvnia (UAH), the euro (EUR), Polish zloty (PLN), Czech koruna (CZK) and Hungarian forint (HUF) to the U.S. dollar (USD) in the period from January 2000 to December 2011 [20].
As shown in Table 10, the highest volatility was typical for the Czech koruna. The variation of its exchange rate to the U.S. dollar reached 29.48%. The variation coefficient of other currencies was comparatively equal (about 18%). It should be noted that in the period of 2000-2011 the exchange rate dynamics of these currencies was characterized by strong mutual correlation.
However, the exchange rate dynamics of hryvnia, unlike other currencies, was characterized by negative correlation. Statistically significant correlation was not found only between the rates of the Ukrainian hryvnia and the Hungarian forint to the U.S. dollar. The success of regional monetary integration depends on the reduction of dollarization of the economies. The assessment of the expansion of foreign currency transactions in the financial sys-tems of the corresponding countries was based on the analysis of the ratio of banks' non-resident liabilities to M3 aggregate on the basis of the IMF data [20] ( Figure 5). The dynamics of this indicator for Ukraine tended to increase in 2005-2008, reaching 55% by the end of the period. However, as a result of the financial crisis the ability of banks to attract funds from external sources was significantly reduced, leading to a gradual decline (28%) in the ratio of banks' non-resident liabilities to M3 aggregate, which corresponds to the value of this indicator for Poland. It should be noted that in most countries the dynamics of this indicator has decreased in recent years. The only exception is Hungary, where this indicator was increasing throughout the study period and reached 71% in 2011.
It is important to emphasize that the U.S. dollar dominates in the structure of external liabilities of Ukrainian banks, which, in our opinion, may create additional difficulties in the regional monetary integration with the surveyed countries. The availability of developed financial markets and banking systems is an important prerequisite for successful monetary integration. We will carry out the calculation of indicators characterizing these criteria on the basis of the World Bank data [22].
As seen in Figure 6, the Eurozone has the most de- it varied in the range from 3% to 30% and by the end of 2011 reached 15.4%, which was almost 3 times higher than in the Eurozone. This indicates a significant vulnerability of the banking system of Ukraine to financial shocks, which adversely affects its ability to act as a kind of anti-crisis buffer in the case of monetary integration.   As seen in Figure 9, since 2004 the amount of gold and foreign exchange reserves in Ukraine exceeds the minimal level set by the IMF [22]. In the recent years, the size of gold and foreign exchange reserves has been gradually decreasing as a result of significant pressures on the currency market of Ukraine. It should be noted that during the analyzed period the size of gold and foreign exchange reserves in the euro area was never sufficient for 2 months import coverage. This situation is explained by the fact that the role of gold and foreign exchange reserves as an instrument for the regulation of the financial and currency markets in the developed countries is gradually declining.

Conclusions
We have assessed the indicators of financial convergence of Ukraine with some countries of the Commonwealth of Independent States (CIS) and the European Union. The results of the data analysis of the criteria for Ukraine, Russia, Kazakhstan and Belarus are presented in Table 11.
We can make a conclusion that the best situation is observed in the financial sectors of Russia and Kazakhstan. On the other hand, the dynamics of certain financial parameters of Belarus and Ukraine can significantly reduce the potential economic benefits of integration.
Despite some differences in the analyzed financial criteria, the majority of indicators reflect the existence of sufficient financial preconditions for economic integration. The only exception is the financial performance of Belarus: among the eight financial criteria two were negative, two positive and three demonstrate only partial convergence (the data is missing for the calculation of one indicator). Therefore, we are uncertain about the overall compliance of Belarus with the criteria of financial convergence. Proportion of positive assessment of financial criteria, % 89 67 7 8 44 Note: Sign "+" is full convergence, sign "+ / -" is partial convergence, sign "-" is absence of convergence.
The paper gives the assessment of the indicators of financial convergence of Ukraine with Eastern European countries (Poland, Hungary and Czech Republic). It also studies the prospects of Ukraine's accession to the Eurozone. The results of the analysis are presented in Table 12.
The results of the assessment suggest that the most desirable would be the monetary integration of Ukraine with the Eurozone, to a lesser extent with Poland. In our opinion, the monetary integration of Ukraine with Hungary and Czech Republic would have negative consequences.
The paper analyzes the costs and benefits of the monetary integration of Ukraine with the Eurozone and Eastern European countries in terms of achieving Ukraine's economic goals. In our view, for the analyzed EU countries, economic integration with Ukraine would bring more losses than benefits.  Note: Sign "+" is full convergence, sign "+ / -" is partial convergence, sign "-" is absence of convergence.
The results of the comparative analysis of financial convergence of Ukraine with countries of the Commonwealth of Independent States and the European Union in the context of the criteria analyzed in this paper are presented in Figure 10. It is important to underline that the dynamics of the most important indicators of the financial convergence of Ukraine (similarity of interest rates, inflationary convergence, and fiscal integration) remains higher for the CIS countries than for countries of the European Union.
There are other fundamental issues related to the future of Ukraine's accession to the euro area: the formation of a single monetary and exchange rate policy. The financial systems of Central and Eastern European countries (including Ukraine) are much less developed than the financial systems of other Eurozone countries while their economies are less stable.
Moreover, countries of the Eurozone and the CIS have different mechanisms of sending signals of the monetary policy to the real sector of the economy. If the Eurozone countries use channels associated with interest rates, the CIS countries have a so-called credit channel (due to the significant predominance of bank lending, rather than financing through capital markets). This difference further complicates the financial integration of Ukraine with the Eurozone countries. For the moment it seems more expedient for Ukraine (in terms of financial convergence) to intensify its economic integration with the biggest CIS countries. However, our findings are based solely on the assessment of the financial component in the creation of integrated interstate formations. In this paper, we have not analyzed the macroeconomic criteria of integration as well as political and sociocultural dimensions of this process. A careful consideration of all the essential aspects is crucial for making an informed decision regarding the ways of Ukraine's economic integration.