Article by: Yuriy Panchenko
In the coming days a new mission of the International Monetary Fund (IMF) will be coming to Ukraine. It will determine the amount of support the Ukrainian economy needs together with Ukraine’s new government.
As Jérôme Vacher, the IMF Resident Representative in Ukraine, told European Pravda, this amount was estimated to be $1.1 billion this summer. Now it will be increased, and the burden of supporting Ukraine will be shared by IMF and other donors, most notably the European Union.
At the same time, IMF representatives say they understand why the Ukrainian government has taken certain actions that directly contradict the country’s obligations to the Fund, such as restrictions on the foreign exchange market. If the new Ukrainian government wishes to implement reforms, the IMF program will not be interrupted even by an aggravation of the situation in the Donbas and even by the possible declaration of a state of war in the country.
First, tell us about the most recent negotiations between the Ukrainian government and the IMF in Washington and about the likelihood for increased funding by the IMF.
First, let me explain the meeting. This is a regular event with the participation of the IMF and the World Bank that is attended by representatives of all 188 IMF member states. Similar meetings take place twice a year, in the spring and autumn. Therefore, holding negotiations with the Ukrainian government was not the main purpose of the recent meeting. However, the opportunity to meet again with representatives of the Ukrainian government and to discuss the current state of economy with them is very helpful.
When it comes to discussing economic reform programs that are supported under the agreement with the IMF, the most appropriate format is a visit by the IMF mission to review the program. We are planning such a visit right after the new Ukrainian government is formed.
This visit will allow us to discuss both the financial indicators and aspects of the economic policy that are part of the program or may be added to it.
Also, it is necessary to clarify Ukraine’s potential needs in financing as well as the possible sources for these funds. In this regard, everything will depend on the development of Ukraine’s economic situation and on our assessment of the economic outlook, including the foreign trade situation, which has a direct impact on the balance of payments.
What kind of position is it?
An assessment of the need for increased funding will depend on the economic situation. The concrete amount of this funding still needs to be determined. Also, it is still unclear to what extent the question regarding the country’s need for increased external financing, if any, could be decided strictly within the context of macroeconomic policy. Once we develop our assessment of the state of the Ukrainian economy, we can begin to discuss ways to support it.
Will the IMF be able to provide such increased financing or will it need a comprehensive program together with the European Commission, as was the case in Greece?
Although we often resort to tight technical cooperation with other international donors and donors who provide support on a bilateral basis, the IMF program is developed and implemented independently. Often, in similar programs, the main condition for funding is successful cooperation with the IMF. However, donors always make those kinds of decisions individually..
As for the IMF, when we see tangible progress in the implementation of reforms in accordance with our agreements, we always encourage donors to provide further support for the government’s program in a country. In Ukraine’s case, as in the case of other IMF borrowers, we naturally take into account possible support from other sources when we assess a country’s financing needs.
What is your reaction to the statement of Ukraine’s Minister of Foreign Affairs Pavlo Klimkin that Ukraine will need over $30 billion in financial help?
We have formulated Ukraine’s financing needs at the launch of the program and during the first review. During the first review, we estimated that the necessary amount of additional funding for the subsequent 12 months would be around $1.1 billion. At that time it was expected that Ukraine would be able to obtain this amount by itself — on the capital market or from another source.
Currently, there are indications that the risks threatening the revival of Ukrainian economy are getting worse. However, as I said, we are still at a very preliminary stage regarding the amount of additional financing.
Ukraine is in a very difficult political situation, and it may need to increase defense spending at any time. What is IMF’s position on these unplanned expenses? And generally, would Ukraine’s cooperation with the Fund continue even if martial war is declared?
We have no specific conditions regarding the funding of defense expenditures. Furthermore, we avoid expressing a position on what percentage of budgetary revenues an IMF member country should spend on defense. Of course, we monitor the dynamics of these expenditures and we examine how they affect the budget taken as a whole. If Ukraine needs to increase its defense spending, we will see how it affects the budget expenditures and if the country will require additional funding.
During the first review of the program, we studied the impact of armed conflict on the economy. At that time we responded to the situation by accounting to some extent for these factors, thereby revising the government’s targets for 2014 in accordance with the much deeper recession that we are observing. However, we have recommended that the government develop a new packet of fiscal measures that will ensure the achievement of the indicators that were adopted in August.
As for the possible imposition of martial law, the IMF does not have formal legal prohibitions that would prevent the continuation of cooperation under such conditions. We have already worked with a number of countries where military conflicts of varying intensity were taking place.
For us it is important for a country to have a plan of reform and for the actions of the government to support its realization. If there is progress in this direction, we are always ready to discuss further cooperation.
And how would you assess the performance of the Ukrainian government’s plan for reform?
Our cooperation with the Ukrainian government is developing well. Even during the development of the program, the Ukrainian authorities clearly understood the kinds of tasks they were facing. This approach allowed us to move from the development of the program on cooperation to its realization very rapidly . The same thing was observed during our first program review. The Ukrainian government has clearly demonstrated that it is prepared to implement reforms. This differed significantly from the two previous IMF programs in Ukraine (during the governments of Yulia Tymoshenko and Mykola Azarov — Ed.). The problem in implementing the program is due largely to the difficult economic situation . In terms of the challenges (Ukraine faces), the situation is truly unique.
However, this does not mean that much has been done. The government absolutely must accelerate the pace of implementation of the reforms. This is especially true in the fight against corruption. We hope that after the elections the new government will mobilize quickly and begin to carry out these tasks.
At present, does the IMF consider that the implementation of the cooperation program has been successful?
During the first few months, the new government had to face difficulties in many areas, especially in the fiscal and financial sectors. The government has carried out reforms that had been ignored for many years — for example, regarding the raising of tariffs for gas and heating. In the financial sector, efforts have been made to identify problem banks.
Additionally, the results of a number of reforms will be visible only after a few years. Steps have been taken to improve the business climate, and now we expect the adoption of a plan on deregulation. We also welcome the adoption by parliament of a package of anti-corruption laws. This is only the first step, but it is a very important one in order to move in the right direction.
Many steps by the government go counter to the IMF recommendations. For example, the current situation in the foreign exchange market, where there is an official and a shadow exchange rate for the dollar.
First, I want to say that the Ukrainian government deserves praise for adopting the floating exchange rate. We have long recommended this step and, furthermore, this step was inevitable, given the gold reserves in January. Already there was an understanding that without this step it would be impossible to restore the competiveness of the Ukrainian economy. With regard to administrative measures, the IMF policy generally does not support or recommend them. We would prefer the normal development of the exchange market. However, we also try to be pragmatic. The current situation on the exchange market is very complex and it presents a challenge for the government. We are aware of that.
We are assessing the situation realistically and this is why we have agreed to the preservation of some restrictions on the currency market. However, we expect the government to propose a schedule for eliminating these restrictions.
However, the country has experienced a rapid devaluation! Won’t this lead to even greater economic shocks than maintaining the exchange rate?
Devaluation also had some positive consequences. It has stabilized the balance of payments and has had a positive impact on the competitiveness of Ukrainian products while also helping Ukraine adjust to significant external economic shocks. However, we can also see that this devaluation is having a negative effect on bank balances, on businesses, and, to a certain extent, on households.
In fact, we can say that devaluation has caused current problems in the financial sector.
The problems in the banks were caused by a number of factors. Many banks have had problems for a long time. The situation was exacerbated by the conflicts in Crimea and Eastern Ukraine. In addition, banking activity has never proceeded smoothly under conditions of an economic recession. Devaluation is only one of these factors.
In this situation, it is worth considering the need to strengthen the control over banks. And besides, they must have sufficient capital to cope with these risks.
However, stress tests have shown that most of the banks tested are in trouble.
Now, after the main problems have been identified, it is most important to have a transparent process of recapitalization. The goal is to make this process as gentle as possible for the state purse.
Moreover, recapitalization will help address the problems of corporate governance in this sector and encourage its modernization. In the coming months, we will pay a great deal of attention to this process. The more promptly these problems are resolved, the more quickly the financial sector will be able to support the economic recovery.
What amount will be required and who will pay for it?
The stress testing of the 15 largest Ukrainian banks has already been conducted by the National Bank of Ukraine (NBU). During the first review of the program, we reviewed the estimated volume of state resources allocated for the support of bank restructuring, changing it from 1% of GDP to the more conservative forecast of 2.8% GDP for the 2014-2015 period, including 0.8% of GDP assigned to support the Deposit Insurance Fund.
How much is the current amount?
That assessment is not yet completed. At this stage, there was greater clarity only regarding the state recapitalization of state banks. As for private banks, it must still be determined how much of the total amount of recapitalization will be provided by the bank owners.
Currently the NBU is spending its reserves to support the exchange rate, but, in fact, the currency is moving to the black market. Does this correspond to the IMF program?
Unfortunately, we see that the situation with the currency has led to the emergence of a black market. Of course, the NBU must spend its reserves very carefully. Therefore, our program includes targets in terms of reserves. In any case, the program provides an opportunity for the NBU to smooth out significant exchange rate fluctuations, which could be potentially destabilizing.
Therefore, neither the administrative regulation of the exchange rate nor other restrictions — for example, the ban on taking currency out of the country — are obstacles for cooperation with the IMF?
For us it is more important for the Ukrainian government to demonstrate that it is clearly committed to reform and also that the macroeconomic policies and structural reforms will lead to more stable economic growth.
We also understand that, as a result of the difficult situation in the Ukrainian economy, a number of indicators in the program may change.
The next tranche of the IMF is expected in December. Wouldn’t a change of government lead to its additional postponement?
The faster the Ukrainian government is formed, the faster the IMF mission will be able to come. This mission is dedicated to reviewing the program and will need to study the situation in the Ukrainian economy and consider all the forecasts and scenarios for the development of the situation. Then we will begin to discuss economic policy for the longer term. For this aspect of work, it is particularly essential to have a government team that is already formed and ready to exchange views on these issues.
The main goal of these negotiations is the adoption of the 2015 state budget. Given that capital markets are closed for Ukraine and that privatization is also difficult, donors are the only source for covering the budget deficit. Is the IMF consulting with the European Commission regarding the extent of financial aid?
You always make certain assumptions in developing a budget . By the way, since you touched upon the topic of privatization, in Ukraine there really is a certain reserve for privatization. Although it should be noted that in recent years the country had very little revenue from privatization. In particular, the events in the East resulted in a very difficult situation that temporarily limited the pool of potential investors. In this area as well, it is important to focus on creating a transparent system of privatization.
Returning to the subject of Ukraine’s other financial partners, there are certain decision-making mechanisms and requirement in the European Union. However, the EU monitors the results of the IMF program implementation very closely.
When we observe that a government is committed to carrying out reforms, we recommend that other donors also provide support, especially when we see a related need for additional funding.
A new review of the programs will give us an excellent opportunity to inform all stakeholders about the progress of reforms in Ukraine and the prospects for the development of the economy. The rest will depend on the consistency of the implementation of the reforms by the Ukrainian government.
Here it is worth noting that the independent steps Ukraine must take to implement the Association Agreement with the EU do not necessarily overlap, but they can become a complement to the program of structural reforms that are supported under the agreement with the IMF. If they are realized together and concurrently, they will facilitate the rapid recovery of the Ukrainian economy.