Ukraine has been cooperating with international lenders since Independence. The key creditor is the IMF, with which Ukraine began working in 1992. During this time, Ukraine has received over USD 38 billion from the fund. In the history of relations with the IMF, no credit program was completed by neither full implementation of Ukraine’s commitments nor full payment of the amount provided by the programs. The situation is repeated today. The cessation of cooperation with the IMF due to non-fulfillment of commitments undertaken by Ukraine could lead to a default and a further crisis.
Stages of Ukraine’s cooperation with the IMF
| Stages | Years | Program title | Scheduled amount from the IMF, USD billion | The amount received from the IMF, USD billion |
| 1 | 1994-1995 | STF-Systemic Transformation Facility | 0,78 | 0,76 |
| 2 | 1995-1998
|
Stand by | 2,9 | 1,9 |
| 3 | 1998-2002 | EFF | 2,6 | 1,6 |
| 4 | 2002- 2008 | Precautionary stand by | 0,6 | – |
| 5 | 2008-2013 | Stand by | 25,7 | 14 |
| 6 | 2014 | Stand by | 17 | 5,6 |
| 7 | 2015-2018 | EFF | 17,1 | 8,7 |
1994-1995 Ukraine received USD 763.1 million under the “STF-Systemic Transformation Facility”, which was aimed at supporting post-Soviet countries. At the same time, Ukraine has accepted and implemented most of the Fund’s recommendations to strengthen its financial policy.
1995-1998 Within the framework of three annual programs “Stand by”, Ukraine received USD 1.9 billion. The main purpose of these loans was to strengthen the hryvnia, reducing the budget deficit. However, the third program was discontinued in March 1998, as the government of Ukraine did not comply with the IMF’s requirements regarding the budget deficit and the maximum growth rate of the monetary base.
1998-2002 Ukraine became a member of the “Extended Fund Facility”, which provided loans for USD 2.6 billion. But it received only USD 1.6 billion. A three-year package of reforms to ensure compliance with the requirements of the IMF was adopted by the government but was not completed by the end.
2002-2008 During this period, Ukraine did not receive any tranche from the IMF, despite the fact that the Board of Directors of the IMF approved the program “precautionary Stand by” for 12 months, which could have received USD 605 million. However, there was no urgent need for IMF funds. Cooperation with the IMF was to provide technical support and advice on macroeconomic indicators in connection with global development projections.
2008-2013 Because of the financial crisis, the Government has applied for a new program of the IMF. At the end of 2008, the board of directors of the fund approved the provision of tranches, the total amount of which is 802% of Ukraine ‘quota in the IMF. Thus, during this period, Ukraine received the largest loans from the IMF – USD 14 billion from the planned USD 25.7 billion.
The first tranche was used to replenish foreign exchange reserves, second and third – replenished the budget of Ukraine. However, the budget in 2009 remained deficit, which contradicted to the credit requirements, so the tranches were again interrupted.
In July 2010, the IMF launched a new program in Ukraine, thereby abolishing all agreements on the previous one. The new program provided USD 15.1 billion for 2.5 years. This time the government received two tranches: USD 1.89 and USD 1.5 billion. Most of the funds were re-transferred directly to support the state budget. And again, the program was interrupted due to non-fulfillment of credit terms.
2014-2018 The new round of relations with the IMF began in 2014. During this period, Ukraine received USD 14.3 billion, which was absolutely necessary to stabilize the financial situation after the critical financial crisis that began in 2014. Immediately after the Revolution of Dignity in 2014, Ukraine and the IMF actually returned to the previous program. The conditions for receiving money were the same: reduction of budget expenditures, gas reform, improvement of the banking system and fight against corruption. In 2014, Ukraine received two tranches – USD 3.2 billion and USD 1.4 billion. After that, the program was changed to the “Extended Financing Mechanism” (estimated allocation of about USD 17 billion). In March 2015, Ukraine received the first tranche of USD 5 billion, in August – another USD 1.7 billion. With lasting pauses, the IMF allocated another UAH 1 billion in 2016 and 2017. The fifth tranche has not yet been allocated. The reason is Ukraine’s failure to comply with IMF requirements.
Is there a real default?
Now Ukraine is in a difficult position, as it needs another tranche to make payments to external creditors. According to various estimates this year, Ukraine has to pay about from USD 4.5 billion to USD 7.4 billion to cover foreign currency debt, most of which is a debt to the IMF.
However, receiving the next tranche from the IMF is questionable because of Ukraine’s failure to comply with the requirements of the IMF. The situation is complicated by future elections – the current government is not ready to take unpopular decisions, which can lead to the loss of electoral votes.
Suspension of cooperation with the IMF can lead to a default and a new acute financial crisis, which will undo the current positive developments in the field of macro-financial stabilization.
International reserves of Ukraine amounted to an equivalent of USD 18.1 billion as of June 1, 2018, according to preliminary data. The volume of international reserves covers 3.2 months of future imports, which is considered an acceptable indicator. In May, reserves decreased by 1.6% due to payments made under a public debt denominated in foreign currency.
First, the National Bank of Ukraine paid USD 455.1 million in favor of the IMF during May.
Secondly, USD 214.4 million was directed by the Government to service and repay public debt, of which USD 126.2 million – maintenance and redemption of T-bills and USD 18.5 million – Ukraine’s servicing of sovereign Eurobonds.
At the same time, the main source of replenishment of reserves in May remained the purchase by the National Bank of currency on the interbank market. It was due to high prices for Ukrainian exports (metals, ore and grain) on foreign markets, as well as an increase in currency supply from banks. Since the beginning of April, the National Bank has extended the ability of banks to conduct foreign exchange transactions on its interbank market.
Thus, the government had sufficient resources to make payments in the first quarter of this year. But by the end of 2019, it is necessary to pay another USD 8.5 billion, which is almost half of the international reserves of the National Bank. Without new currency loans, the reserves of the NBU will fall below the standard safety threshold in the 3 months of imports by the end of 2018. (the critical level in the months of imports is USD 17.5 billion by the end of 2018 and USD 18.2 billion by the end of the first quarter of 2019).
Many politicians say that Ukraine can do without cooperation with the IMF at this stage, justifying it with the threat of deepening of the debt burden and the availability of sufficient volume of foreign exchange reserves.
The size of the gold reserves, which exceeds USD 18 billion is a rather misleading basis for such statements. The case is in the structure of foreign exchange reserves. Most of the NBU reserves are formed at the expense of borrowed funds. Net foreign exchange reserves are hardly more than USD 6 billion. In addition, within USD 18 billion of SDRs – 77%, or USD 14.2 billion, are securities. Directly the currency on accounts and deposits is only USD 1.59 billion, or 9%.
It should be noted that in the forecast of the NBU on the currency, reserve loans from the IMF, the World Bank and the EU amounted to USD 3.4 billion in the third quarter of 2018. However, without the help of the IMF, these USD 3.4 billion should be subtracted. And then at the end of the year it will be less than USD 18.2 billion. This indicator is lower than the critical level. In turn, foreign exchange reserves below a safe level are a bad signal for international lenders and investors. This can bring down the ratings of Ukraine and automatically lead to a rise in the cost of financial resources.
The forecast NBU also took into account the attraction of USD 2.5 billion in 2018 by issuing government Eurobonds. It remains unclear whether this issue is fully laid down in the amount of reserves, or may only be part, since part of the money raised may go to buy back existing securities. However, if there is a significant deterioration in ratings, the planned release of government Eurobonds may not be successful. That is, reserves can melt quickly by the end of 2018.
Thus, without new foreign loans and tranches of the IMF, the reserves of the NBU will not be enough to fulfill obligations to external creditors. Even if world prices for raw materials grow sharply, and afterwards, and the volume of foreign exchange earnings in Ukraine grows, the NBU will not be able to accumulate enough funds in reserves. The growth of exports will lead to increasing of import of raw materials, equipment, and then consumer goods, which will stimulate demand for currency.
Fundraising from private investors looks like a ghastly way to solve current problems, with the breakdown of relations with the IMF. Cooperation with the IMF is as an important signal for international capital markets. Therefore, one of the key points of Ukraine’s cooperation with private investors is its ability to continue reforms and continue cooperation with the IMF, which serves as a kind of litmus test for them. Therefore, the option of attracting funds from private investors instead of working with the IMF seems unrealistic. Without the IMF Ukraine will not be able to successfully enter external markets.
Existing risks
In general, the existing risks of suspending IMF loans can be divided into three time periods.
Short-term – until the fall of 2018. Even in a favorable scenario, it is unlikely that Ukraine will be able to receive a tranche before September-October this year. Ukraine must pass this period without critical events. By September, Ukraine can really do without IMF money. The currency rate at this time interval will be up to 28 UAH per USD. The discount rate will remain unchanged.
The medium-term period – from September 2018 to May 2019. In the absence of tranches, financial risks are significantly increasing, threats of destructive processes are increasing. Permanent depletion of reserves against the backdrop of increased uncertainty ahead of elections and adverse seasonal factors may strongly push devaluation expectations. The pressure on the national currency will increase rapidly, creating a threat of rapid depreciation of the hryvnia. External obligations are fulfilled by a critical reduction in the level of the NBU’s currency reserves, the discount rate goes 20%, the hryvnia exchange rate exceeds the mark of 30 USD per USD. The situation can be sustained by the NBU’s decisive actions – deep currency constraints and tight monetary policy, which can lead to a slowdown in GDP growth to 1-2%, or even a zero mark. Ukraine will also face a fiscal crisis. One of the risks of suspending cooperation with the IMF will be a high probability of non-fulfillment of the budget. The 2018 budget was formed on the basis that Ukraine will remain in the IMF program. Without the IMF, the government will have to suspend significant spending.
Long-term interval – after May 2019. The current IMF co-operation program will be suspended, and only the new program of expanded financing can save Ukraine (the amount of financing has to be adequate to the amount of external debt repayment in 2019-2021). Thus, it will take at least USD 20 billion for three years. In case of failure to agree with the IMF, Ukraine will face a default.
How to prevent a default?
There are several ways to avoid default, which in practice may or even need to be combined.
– Attraction of new loans in foreign currency (IMF loans, placement of Eurobonds)
– Restructuring – partial debt cancellation and / or deferral of payments (as it was in 2015), which is essentially a technical default.
– The attraction of foreign direct investment, which directly depends on the reforms (protection of property rights, improvement of the business environment, protection of economic competition and the fight against monopolies, etc.).
How to satisfy the IMF?
Key issues that require an immediate solution to obtain the next tranche of the IMF is the adoption of the Anti-corruption Court Law, which will meet the requirements of the Venice Commission, regulation of gas prices and the situation with the state budget.
Formally, Ukraine fulfilled one of the requirements. In early June, the Verkhovna Rada adopted the law on the Anti-corruption Court. The main controversial issue concerning the vetoing of candidates for a judge was decided late on election day. The final version of the veto was agreed by the Ukrainian side with the IMF. So far, the IMF has not given an official comment on the adopted bill yet. According to unofficial information, experts of the fund intend to verify the text of the document in the near future on its compliance with the version of the agreement. The IMF’s final response should be expected by the end of the first half of June. Then you can expect the document to be signed by the Verkhovna Rada and transfer it to the President’s signing.
Secondly, the mandatory condition is to raise the price of gas to the level of import parity. Now the issue of gas prices comes to the fore, and if the government fails to negotiate with the IMF, the allocation of the next tranche will be ruined. The gas issue will be resolved after the IMF approval of the anti-corruption court bill. It is expected that the talks from the government will be headed by NJSC “Naftogaz of Ukraine” Andriy Kobolev.
According to preliminary information, a “single price” will be set for all gas consumers, and simply put the price for the population up to the level of prices for industry (now it is UAH 11 thousand per 1,000 cubic meters, from October it is expected to 13-14 thousand).
One more important term to receive a tranche is to cut budget expenditures in January-April, the under-implementation of the plan of budget revenues is UAH 5.1 billion. The Ministry of Finance has already stated that it is not expected to increase the minimum wage, which was scheduled for April. The budget deficit, instead of the planned 2.5%, may exceed 3%. While the sequestration of the budget is not expected, but the management of public finance will be turned into manual mode, that is, one should expect a reduction in the financing of unprotected articles, the introduction of restrictions and increased control over the spending of finances.
The final agreement on all issues with the IMF, should be reached in the best way by the third decade of June, so that technically, taking into account the procedures of the IMF, the board of directors of the fund could consider the decision to allocate the next tranche by mid-July. After all, after fulfilling the requirements, the IMF mission must arrive to fix it and prepare amendments to the memorandum of cooperation.
Then, 2 weeks later, the issue of financing Ukraine should be made directly at the Board of Directors. If the agreement on the gas prices is delayed, then the IMF can technically decide on the allocation of money already in September, as in August, the fund staff are on vacation.