Ukraine: Assessment of the Risks to the Fund and the Fund’s Liquidity Position
Author: International Monetary Fund. European Dept.
Publication Date:
01 May 2014
eISBN:
9781484340370
Language:
English
Keywords:
ISCR; CR; press statement; deposit dynamics; Ukraine; household deposit withdrawal; fund; exposure to Ukraine; debt service to; liquidity position; peak exposure; fund's exposure; Credit; Service exports
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This paper discusses Ukraine’s Request for a Stand-by Arrangement. Ukraine’s economy had been in recession since mid-2012. Inconsistent macroeconomic policies pursued in 2012–2013 aggravated deep-seated vulnerabilities and eventually generated a balance-of-payment crisis. Key objectives of the authorities’ program are to restore macroeconomic stability, strengthen economic governance and transparency, and lay the foundation for robust and balanced economic growth. To achieve these objectives, the government will implement immediate measures aimed at securing stability, combined with deeper reforms to achieve and sustain external sustainability, ensure financial stability, restore sound public finances, rationalize the energy sector, and improve the business environment.

Abstract

This paper discusses Ukraine’s Request for a Stand-by Arrangement. Ukraine’s economy had been in recession since mid-2012. Inconsistent macroeconomic policies pursued in 2012–2013 aggravated deep-seated vulnerabilities and eventually generated a balance-of-payment crisis. Key objectives of the authorities’ program are to restore macroeconomic stability, strengthen economic governance and transparency, and lay the foundation for robust and balanced economic growth. To achieve these objectives, the government will implement immediate measures aimed at securing stability, combined with deeper reforms to achieve and sustain external sustainability, ensure financial stability, restore sound public finances, rationalize the energy sector, and improve the business environment.

Introduction

1. This note assesses the risks to the Fund arising from the proposed Stand-By Arrangement (SBA) for Ukraine and its effects on the Fund’s liquidity, in accordance with the policy on exceptional access.1 The authorities are requesting a 24-month SBA with access of SDR 10.976 billion (800 percent of quota). Proposed access is moderately front-loaded, with SDR 2.058 billion (150 percent of quota) available upon approval, followed by three equal disbursements of SDR 914.7 million each. The remaining access is phased in four quarterly purchases of SDR 1.372 billion (100 percent of quota), and a final purchase of SDR 0.686 billion (50 percent of quota) scheduled for mid-March 2016, following the completion of the eighth review (Table 1).

Table 1.

Ukraine: Proposed SBA—Access and Phasing

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Source: Finance Department.

Starting in July 2014, purchases will depend on the completion of a review and/or compliance with performance criteria as established under the program.

Background

2. Ukraine has had an extensive financial relationship with the Fund since becoming a member in September 1992 (Table 2). GRA credit outstanding to Ukraine is currently at SDR 2.58 billion (187.9 percent of quota). Ukraine’s performance under its past programs with the Fund has been poor. The 2005 ex-post assessment (EPA) covering 13 years of Fund engagement in Ukraine since its independence singled out lack of political consensus to pursue market-friendly reforms as the main cause for repeated program failures.2 In the same vein, the 2011 and 2013 expost evaluations (EPEs) covering the recent two programs under the SBA—approved in November 2008 and July 2010 respectively—also pointed to weak ownership of policies and weak governance as having led to the failure of these programs. Under the 2008 two-year SBA, where disbursements were heavily frontloaded, Ukraine drew SDR 7 billion of the approved total of SDR 11 billion (802 percent of quota). The program went off track after two reviews and was cancelled in mid-2010. In July 2010, the Executive Board approved a 29-month SBA for SDR 10 billion (729 percent of quota). The program was negotiated by a new government that took office in early 2010. Despite the commitment of the new authorities to implement policies and reforms supported by the program, the program went off-track quickly after completion of one review. Overall, two purchases totaling SDR 2.25 billion were made before the program expired in December 2012. Ukraine has met its payment obligations to the Fund in a timely fashion.

Table 2.

Ukraine: IMF Financial Arrangements and Fund Exposure, 1994–2021

(In millions of SDR)

article image
Source: Finance Department.

As of end December, unless otherwise stated.

The Systemic Transformation Facility (STF) was created in April 1993 and allowed to lapse in April 1995.

Completed with delays or waivers.

Figures including transactions under the proposed program are in italics. Fund exposure is derived assuming purchases are made as per the schedule in Table 1 and Ukraine remains current on all its scheduled repurchases.

3. Ukraine’s total external debt is relatively high but the share of the public sector is small (Table 3). At 78 percent in 2013, Ukraine’s total external debt-to-GDP was 10 percentage points lower than the peak level it reached in 2009 following a sharp increase in private sector borrowing between 2005 and 2009 and a sharp GDP decline in 2009. It is expected, however, to increase to 99 percent in 2014, placing Ukraine at the higher end relative to recent exceptional access cases (Figure 1, Panel A).3 About three quarters of the 2014 total external debt is owed by the private sector and most of the debt is long term. Public sector external debt-to-GDP is projected to rise to 27½ percent, 11 percentage points above its low level of end-2013 (Tables 3 and 4).

Table 3.

Ukraine: External Debt Structure, 2005–2013 1/

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Source: Ukranian authorities and IMF staff estimates.

End of year unless otherwise indicated.

Figure 1.
Figure 1.

Debt Ratios for Recent Exceptional Access Arrangements 1/

Citation: IMF Staff Country Reports 2014, 106; 10.5089/9781484340370.002.A002

Source: Ukrainian Authorities and IMF staff estimates, and World Economic Outlook.1/ For arrangements approved since September 2008, estimates as reported in each staff report on the request of the Stand-By Arrangement or Extended Fund Facility. For Ukraine, ratios reflect projected end-2014 data. Asterisks indicate countries that were PRGT-eligible at the time of approval.
Table 4.

Ukraine: Capacity to Repay Indicators 1/

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Sources: Ukrainian authorities, Finance Department, World Economic Outlook, and IMF staff estimates.

Assumes full drawings.

Repurchases follow the obligations schedule.

Includes GRA basic rate of charge, surcharges and service fees. Of the 2014 figure, only SDR 60.7 million is for the period after April 9.

Includes charges due on GRA credit and payments on principal. Of the 2014 figure, only SDR 1670.1 million is for the period after April 9.

Staff projections for external debt, GDP, gross international reserves, and exports of goods and services, as used in the staff report for the request of the proposed SBA.

4. Ukraine’s external debt service is high, with a relatively small share borne by the public sector. The ratio of total external debt service to exports of goods and services more than doubled between 2008 and 2009 as a result of the sharp decline in exports associated with the global financial crisis. It peaked at 61 percent in 2009 and fell subsequently, reaching 49½ percent in 2013. In 2014, it is projected to rise slightly to 52 percent, which is below the level of debt service-to-exports at the time of approval of Ukraine’s 2010 SBA. Nonetheless, it will be at the higher end relative to recent exceptional access cases, whose median ratio of debt service-to exports at the time of approval of the exceptional access arrangements is 34½ percent (Figure 1, Panel C). In percent of GDP, Ukraine’s total external debt service in 2014 is projected at 31¾, of which less than a quarter is borne by the public sector. However, in the absence of comprehensive corrective policies, with associated financing from the official community, Ukraine’s capacity to meet all of its debt obligations would be stressed.

5. Ukraine’s total public debt is moderate but is projected to rise to high levels at end-2014. Over the period 2010–2013, the public debt-to-GDP was unchanged at about 40 percent. The ongoing political turmoil and the weak economy have been exerting pressures on public finances. Public gross financing needs are projected to rise sharply in 2014 as a result of the widening of the fiscal deficit and the rise in quasi-fiscal losses in the energy sector. The associated increase in public external debt mentioned above, together with that of net domestic financing, will drive total public debt to 57 percent of GDP by end-2014. This debt level is 17 percentage points of GDP above the median public debt of recent exceptional access cases (Figure 1, Panel D). Nonetheless, the risks associated with the public debt level are somewhat mitigated by the holding of a substantial share of such debt by the National Bank of Ukraine.

The New Stand–By Arrangement—Risks and Impact on Fund’s Finances

A. Risks to the Fund

6. Access under the proposed arrangement would exceed both annual and cumulative access limits and would be on the high side on a number of indicators.

  • If all purchases were made as scheduled, Ukraine’s outstanding use of GRA resources would rise from about 188 percent of quota at end-March 2014 to peak at nearly 800 percent of quota in March 2016 (Figure 2). This level of access relative to quota would be equal to Jordan’s, in line with the median of the peak levels of exceptional access cases and below several recent exceptional access cases such as Greece, Ireland, Portugal, Romania, Latvia, and Iceland.

  • If all purchases were made as scheduled, Ukraine’s peak debt service burden would be high. Its total external debt service is projected to peak at 31¾ percent of GDP in 2014. As a share of exports of goods and services, Ukraine’s external debt service would peak at 55½ percent in 2014 whereas the median peak level in recent exceptional access cases is 36½ percent. By 2019, under program assumptions, Ukraine’s total external debt service would fall to 13.1 percent of GDP and 26.9 percent of exports of goods and services. Debt service to the Fund would peak at about SDR 4.76 billion in 2019 (Table 4).4 This would be equivalent to 3.5 percent of GDP, 19 percent of gross international reserves, and 7.3 percent of projected exports of goods and services.

Figure 2.
Figure 2.

Credit Outstanding in the GRA around Peak Borrowing 1/

(In percent of quota)

Citation: IMF Staff Country Reports 2014, 106; 10.5089/9781484340370.002.A002

Source: IFS, Finance Department, and IMF staff estimates.1/ Peak borrowing ‘t’ is defined as the highest level of credit outstanding for a member. Repurchases are assumed to be on an obligations basis.2/ Based on post-2008 reform quota. Median credit outstanding at peak is 801 percent of quota; average is 1053 percent of quota.

  • If all purchases were made as scheduled, the Fund’s exposure to Ukraine in terms of GDP, gross international reserves, and total external debt would be in the medium to high range compared to recent exceptional access cases (Figure 3, panels A, C, and E). In terms of GDP and total external debt, the Fund’s peak exposure under the proposed SBA is below the peak exposure under Ukraine’s 2010 SBA. In contrast, at 60.2 percent, the peak Fund exposure in terms of gross international reserves would be about 15 percentage points and 9 percentage points higher than the median of recent exceptional access cases and the corresponding metric under Ukraine’s 2010 SBA, respectively. Peak debt service to the Fund in terms of exports of goods and services or total external debt service would be in the medium to high range compared to recent exceptional access cases (Figure 3, panels D and F).

Figure 3.
Figure 3.

Peak Fund Exposure and Debt Service Ratios for Recent Exceptional Access Cases 1/

Citation: IMF Staff Country Reports 2014, 106; 10.5089/9781484340370.002.A002

Source: Ukrainian authorities and IMF staff estimates, and World Economic Outlook.1/ Asterisks indicate PRGF eligible countries.

7. While the proposed arrangement is expected to unlock financial assistance from other official donors and eventually from the private sector, the Fund would remain the primary official creditor to Ukraine’s public sector. Since 2008, the Fund has, by credit outstanding, been the top official creditor to Ukraine’s government, with an average share of 57 percent during 2008–13. The absence of GRA disbursements to Ukraine in 2011–13 after the 2010 SBA went off-track reduced the Fund’s exposure to Ukraine. At end-2013, the share of outstanding Fund credit to Ukraine in total official lending to Ukraine stood at 42 percent and would have trended down to zero by end-2015 absent the proposed arrangement. During 2014–16, Fund financing under the proposed arrangement would represent 44 percent of the total financing to Ukraine from all its official creditors (see ¶51 of the staff report for the request of the proposed arrangement). Accordingly, the Fund’s exposure will remain the single highest among those of all of Ukraine’s official donors. The relatively high Fund exposure underscores the role non-Fund external finance to Ukraine should play during the program period and beyond to mitigate risks to the Fund, in particular when repayments to the Fund become significantly larger during 2018–19.

B. Impact on the Fund’s Liquidity Position and Risk Exposure

8. The proposed arrangement would have a modest impact on the Fund’s liquidity but would, given the riskiness of the program, add to the Fund’s credit risk exposure.

  • The proposed arrangement would reduce Fund liquidity by about 4 percent (Table 5). Commitments under the proposed arrangement would reduce the one-year forward commitment capacity (FCC) from SDR 274.9 billion as of April 9, 2014 to SDR 263.9 billion.

  • Ukraine is among the top five users of Fund resources and, after the first purchase is made, will move from the fifth to the fourth position, ahead of Romania. Its share of total GRA credit outstanding would increase by 2 percentage points to 5.2 percent (Figure 4). The share of the top five users of Fund resources of total outstanding credit would increase only marginally since Ukraine is already part of this group of borrowers (see Table 5).

Figure 4.
Figure 4.

Exceptional Access Levels and Credit Concentration

Citation: IMF Staff Country Reports 2014, 106; 10.5089/9781484340370.002.A002

Source: Finance Department.1/ Does not include FCL arrangements. Asterisks indicate countries that were PRGT-eligible at the time of approval.2/ Credit outstanding as of April 9, 2014 plus expected first purchase under the proposed arrangement with Ukraine (new access).
Table 5.

Ukraine—Impact on GRA Finances

(Millions of SDRs, unless otherwise indicated)

article image
Sources: Ukrainian authorities, Finance Department, World Economic Outlook, and IMF staff estimates.

As of April 1, 2011, the FCC reflects activation of the expanded NAB for the first activation period through end-September 2011 and subsequent six-month activation periods thereafter. The FCC does not include about US$461 billion in bilateral pledges from members to boost IMF resources. These resources will only be counted towards the FCC once: (i) individual bilateral agreements are effective and (ii) the associated resources are available for use by the IMF, as determined by the IMF Executive Board.

A single country’s negative impact on the FCC is defined as the country’s sum of Fund credit and undrawn commitments minus repurchases one-year forward.

Projected credit outstanding for Ukraine at time of approval of the proposed arrangement program based on the current repayment schedule and including first drawing.

Burden-sharing capacity is calculated based on the floor for remuneration which, under current policies, is 85 percent of the SDR interest rate. Residual burden-sharing capacity is equal to the total burden-sharing capacity minus the portion being utilized to offset deferred charges and takes into account the loss in capacity due to nonpayment of burden sharing adjustments by members in arrears and takes into account the loss in capacity due to nonpayment of burden sharing adjustments by members in arrears.

  • Potential GRA exposure to Ukraine would represent a significant share of the Fund’s current level of precautionary balances (Table 5). The GRA commitment to Ukraine amounts to 83 percent of the Fund’s current level of precautionary balances. Assuming that all purchases will be made as scheduled, Fund exposure to Ukraine as a share of the current level of precautionary balances will rise from 32 percent after the first purchase is made to 77 percent in 2015 and will peak at 83 percent in 2016.

  • At SDR 60.7 million, charges on Ukraine’s GRA arrangement excluding the portion of the charges already paid in the first quarter of 2014, would represent nearly five times the current residual burden sharing capacity of the Fund in 2014. Assuming all purchases will be made as scheduled, these charges will increase during the program period and peak at SDR 278 million in 2017, almost 22 times the Fund’s current residual burden sharing capacity.

Assessment

9. The proposed program aims at supporting near-term stabilization policies and deeper reforms over the medium term to reduce macroeconomic imbalances and promote sustainable growth. Ukraine’s ability to achieve the program’s objectives critically hinges on overcoming the resistance to sustained implementation of overdue structural reforms and a coherent macroeconomic policy mix that had derailed previous programs. While the prior actions represent a good start, this approach did not assure successful program implementation in previous Fund arrangements with Ukraine. It is important to note, however, that the present Government is more determined to implement reforms than its predecessors, and that the prior actions address long-term obstacles to successful program performance. Reliance on two bimonthly reviews in the early months of the program will help ensure very close monitoring of developments in the run-up to the elections and immediately after, thereby providing an opportunity to spot deviations from the agreed policies early so that corrective actions could be implemented promptly. However, program implementation is subject to the risks arising from the conflict with Russia.

10. As Ukraine’s gross fiscal and external financing requirements will remain high during the program period and beyond, the critical importance of the sustained discipline in implementing the following key actions cannot be overemphasized:

  • Maintain a flexible exchange rate to restore competitiveness, and to facilitate macroeconomic adjustments to shocks and safeguard foreign exchange reserves

  • Stabilize the financial system, maintain confidence in the banking sector, and upgrade the financial sector’s regulatory framework to reduce macrofinancial vulnerabilities

  • Reduce the government’s financing needs by stepping up revenue collection efforts and embarking on an expenditure-led medium-term fiscal adjustment path

  • Reform the energy sector through a comprehensive plan aimed at eliminating quasi-fiscal losses and attracting private investment to the sector

  • Implement legal and regulatory reforms aimed at improving the business climate to promote private investment and strong sustainable growth.

11. Financial risks associated with the proposed arrangement for Ukraine are exceptionally high. As indicated above, if purchases under the proposed arrangements are made as scheduled, the Fund’s exposure to Ukraine will represent a significant share of the Fund’s precautionary balances for several years to come. By 2015, Fund credit outstanding to Ukraine as a share of Ukraine’s public external debt would reach 34 percent and trend down afterward. As for debt service to the Fund, it is expected to peak at high levels in 2019 and account for 19 percent of gross international reserves and 35 percent of exports of goods and services. Moreover, as shown in Figure 3, peak Fund exposure and debt ratios under the proposed arrangement generally exceed the median of corresponding peak levels of recent exceptional cases. Furthermore, the program faces significant downside risks and uncertainties that exacerbate the financial risks associated with the proposed arrangement.

12. As discussed in the staff report, the program is subject to considerable downside risks, including some that are difficult for the program to mitigate. Beyond the immediate serious security issues, the program is subject to the following risks:

  • Higher imported gas prices, with pressures for increases already in evidence;

  • a worsening of tensions with Russia that significantly disrupt Russia-Ukraine trade, including in natural gas, and financial flows;

  • as noted in the Staff Report, the political commitment and public support to comprehensive reforms could falter once the initial adjustments are accomplished. Vested interests are likely to resist governance reforms. With presidential elections scheduled for May 25, and a likely run-off on June 15, political pressures could result in incomplete program implementation in the months ahead. Moreover—should a new government be formed following the presidential or possible later parliamentary elections—it could seek to reopen discussions on key program policies. The experience of the last two Fund programs with Ukraine suggests that reforms commitments could weaken significantly as soon as initial reforms unlock market financing and stabilize the economy. On the positive side, the current leadership has publicly, in words and action, shown exceptional transparency and commitment to reform. Moreover, any future government will need to address the deep and persistent economic problems of the country and respond to the public yearning for a break with problematic past governance practices. These dynamics would mitigate the chance of significant reopening of policy discussions.

  • a deterioration in the political and security situation stemming from separatist tensions in the Eastern part of the country or an intensification in the conflict with Russia that could undermine growth and revenue mobilization and add to spending pressures;

  • further weaknesses in banks’ balance sheets that could erode depositor confidence, encourage capital flight, and trigger financial instability.

13. If these risks materialize, they could have deep impacts on Ukraine’s public and external debt ratios, as highlighted in the staff report for the request of the proposed arrangement. For instance, if the growth shocks discussed in the report were to be realized, they would drive both public and external debt up, though the increase in public debt would be sharper and push it beyond the high-risk threshold. By 2016, the public debt-to-GDP ratio would be 24 percentage points higher than in the baseline. External debt would be about 8 percentage points higher than in the baseline in 2015, reaching 107 percent of GDP.

14. These risks could adversely affect Ukraine’s capacity to repay the Fund. The Fund’s exposure to Ukraine is already significant under the baseline. The associated risks would be larger should any of the downside risks discussed above materialize and should financial support from the international community be adversely affected. Therefore, strict adherence to the program, to help sustain assistance from other donors and facilitate access to private finance, is essential to help mitigate risks to the Fund and safeguard Fund resources.

1

See The Acting Chair’s Summing Up of the Review of Access Policy Under the Credit Tranches and the Extended Fund Facility, and Access Policy in Capital Account Crises—Modifications to the Supplemental Reserve Facility and Follow-Up Issues Related to Exceptional Access Policy (BUFF/03/28, 3/5/03).

2

See Ukraine—Ex Post Assessment of Longer-Term Program Engagement, SM/05/379, 10/18/2005.

3

Throughout the paper, recent exceptional access cases refer to arrangements since September 2008. The median external debt-to-GDP at the time of approval of each of these arrangements is almost 53½ percent.

4

Debt service to the Fund is calculated assuming that all repurchases are made as scheduled, i.e., each purchase is repurchased in 8 quarterly installments beginning 3¼ years after each purchase and ending after 5 years. Surcharges apply to outstanding credit above 300 percent of quota.

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Cover IMF Staff Country Reports
Ukraine: Request for A Stand-By Arrangement
Author: International Monetary Fund. European Dept.
Volume/Issue:
Volume 2014: Issue 106
Publisher:
International Monetary Fund
ISBN:
9781484340370
ISSN:
1934-7685
Pages:
126
DOI:
https://doi.org/10.5089/9781484340370.002

Debt Ratios for Recent Exceptional Access Arrangements 1/

Credit Outstanding in the GRA around Peak Borrowing 1/

(In percent of quota)

Peak Fund Exposure and Debt Service Ratios for Recent Exceptional Access Cases 1/

Exceptional Access Levels and Credit Concentration