March 11, 2015
The Executive Board of the International Monetary Fund (IMF) today approved a four-year extended arrangement under the Extended Fund Facility for Ukraine. The arrangement amounts to the equivalent of SDR 12.348 billion (about US$17.5 billion, 900 percent of quota) and was approved under the Fund's exceptional access policy. The Board also took note of Ukraine’s decision to cancel the Stand-By Arrangement (SBA) for Ukraine that was approved on April 30, 2014 (see Press Release No. 14/189).
The authorities’ economic program supported by the Extended Fund Facility (EFF) will build on and deepen reforms launched under the SBA. The program aims to put the economy on the path to recovery, restore external sustainability, strengthen public finances, and support economic growth by advancing structural and governance reforms, while protecting the most vulnerable.
The approval of the extended arrangement under the EFF enables the immediate disbursement of SDR 3.546 billion (about US$5 billion), with SDR 1.915 billion (about US$2.7 billion) being allocated to budget support. Further disbursements will be based on standard quarterly reviews and performance criteria.
Following the Executive Board’s discussion, Mr. David Lipton, First Deputy Managing Director and Acting Chair, said:
“Notwithstanding a strong policy-led adjustment effort in 2014, the Ukrainian economy continues to be affected by the conflict in the East and the attendant loss of confidence. The deep recession and sharp exchange rate depreciation aggravated existing vulnerabilities, weakened bank balance sheets, and raised public debt.
“Demonstrating strong resolve, Ukraine’s authorities have developed a new program to restore macroeconomic stability and address long-standing structural obstacles to growth, including weak governance. The authorities recognize that the resolute implementation of the program is critical to restore confidence and growth, bring inflation to single digits, keep external deficits manageable, and replenish international reserves.
“The authorities recognize that the best support for the hryvnia is the restoration of confidence through strong policies and reforms. To support this new regime, appropriate reserve targets are included in the program. While program policies are taking hold, the authorities plan to maintain monetary policy rates positive in real terms to anchor inflation expectations, and remove capital controls and restrictions at an appropriately calibrated pace as the balance of payments improves.
“The authorities are determined to stabilize the financial system, maintain confidence in banks, and strengthen financial regulation and supervision. To this end, they have made progress toward recapitalizing systemic banks and resolving weak non-systemic banks. The decisive implementation of the banking strategy would be crucial to regain public confidence.
“Recognizing the need for fiscal consolidation, the authorities have launched an expenditure-led adjustment and frontloaded energy price increases to reduce quasi-fiscal losses and set debt on a firm downward path. Policies to underpin the fiscal adjustment include improving the pension system’s sustainability, reforming public employment, and reforming the healthcare and education systems. The planned debt operation would also help secure program financing and restore debt sustainability with high probability. A successful debt operation with high participation will be a key consideration to proceed with the first program review.
“The authorities plan to eliminate the large quasi-fiscal losses of Naftogaz by 2017 by undertaking bold measures to increase tariffs, improve collection rates, and fundamentally restructure the company. Funding to protect the most vulnerable from the impact of the energy price increases will be raised to alleviate social costs and build support for the reforms.
“Addressing deep-rooted structural problems is critical to create an enabling environment for investment and private sector activity. Tackling weak governance and improving the business climate is critical to increase investment and achieve higher growth. A comprehensive strategy to reform state-owned enterprises is important to enhance efficiency and reduce fiscal risks.
“The program is subject to exceptional risks, especially those arising from the conflict in the East, which may affect the country’s ability to sustain the stabilization efforts and deliver the structural overhaul needed to resume growth. On the other hand, the crisis provides an opportunity for the government to make a decisive break from the past and implement reform-oriented and sustainable policies with strong ownership. The authorities’ program responds appropriately to present challenges and deserves strong support. The implementation risks are being mitigated by a critical set of measures adopted as prior actions and by securing broad political support for program objectives and policies. These should help unlock sizable international official assistance and private capital inflows.”
Annex
Recent Economic Developments
Despite the authorities’ policy efforts, the economy fell into a deep recession in 2014. The conflict in Eastern Ukraine had a significant impact on the economy and the financial system, through disruptions in trade and industrial production and loss of confidence, which fueled capital outflows and led to sharp exchange rate depreciation. Banks came under increasing stress, public debt increased, and international reserves fell to low levels. New financing needs emerged.
Under the SBA, the authorities began implementing difficult reforms to tackle unsustainable policies of the past, including fiscal adjustment, greater exchange rate flexibility, and increases in energy prices, as well as simplifying the regulatory environment for business activity and taking steps to improve governance. Despite these efforts, meeting the program objectives became difficult given the size of the new shocks. Restoring external sustainability will now take longer and require even deeper reforms. To address these challenges, the authorities have asked for a cancellation of the SBA and its replacement with a new four year extended arrangement under the EFF.
Program Summary
The authorities’ economic program supported by the Fund aims to secure external and financial stability and restore robust economic growth, while protecting the most vulnerable. Specifically, the policies would aim at:
- Securing financial stability. This includes (i) a strong monetary policy framework to restore price stability; (ii) exchange rate flexibility to cushion the economy against external shocks; and (iii) a comprehensive strategy to strengthen banks’ financial health, through bank recapitalization, reduction of related party lending, and resolution of impaired assets, which are critical to regain public confidence and support economic recovery.
- Strengthening public finances. An expenditure-led adjustment will support fiscal consolidation in the coming years. Together with energy sector reforms and the announced debt operation, this would reduce fiscal imbalances and achieve public debt sustainability with high probability. Social protection schemes would be revamped to protect the poorest and alleviate social costs.
- Advancing structural reforms. Decisive efforts will help revitalize the business climate, attract investment, and enhance Ukraine’s growth potential. This includes governance reforms, including anti-corruption and judicial measures, deregulation and tax administration reforms, and reforms of state-owned enterprises to improve corporate governance and reduce fiscal risks. Broader energy sector reforms, including Naftogaz’s restructuring, would increase energy efficiency and foster energy independence.
Macroeconomic Outlook
In the current difficult environment, real GDP is expected to contract by about 5½ percent in 2015. Inflation is expected to spike temporarily in response to the exchange rate depreciation and gas and heating tariff increases, before subsiding to about 27 percent at end-2015. The current account deficit should fall to about 1½ percent of GDP on the back of the exchange rate adjustment and subdued domestic demand. With sizable international assistance, gross international reserves will be gradually re-built, reaching around 3.3 month of imports coverage at end-2015. The currency devaluation and official borrowing are expected to push public sector debt up to 94 percent of GDP and external debt to 158 percent of GDP in 2015.
Ukraine’s economic prospects will improve in the medium-term. Real GDP growth is expected to rebound to 2 percent in 2016 and rise to 4 percent in the medium term. Buoyed by restored competitiveness, the current account deficit is projected to stabilize at around 1¼ percent of GDP in 2016–18. By end-2018, inflation will fall to mid-single digits and the NBU will build its international reserves to cover nearly 83 percent of short term debt. Following the debt operation and sustained fiscal adjustment, public debt is expected to decline to around 71 percent of GDP by 2020.
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