Front Matter Page

IMF Country Report No. 19/355

December 2019

This Technical Assistance report on Ukraine was prepared by a staff team of the International Monetary Fund. It is based on the information available at the time it was completed in May 2017.

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Front Matter Page

Ukraine

Strengthening Public Financial Management

Miguel Alves, Amanda Sayegh, Alessandro Gullo, Karla Vasquez Suarez, Clemens Mungenast, Philip Kenworthy, and Glen Granger

Technical Report

May 2017

Contents

• GLOSSARY

• PREFACE

• EXECUTIVE SUMMARY

• I. IMPLEMENTING THE MEDIUM-TERM BUDGET FRAMEWORK

• A. Background

• B. State of Play on MTBF Prerequisites and Implementation Strategy

• C. Pilot Medium-Term Budget Framework 2018-20

• D. Developing the Medium-Term Budget Framework Further

• II. STRENGTHENING FISCAL RISK MANAGMENT

• A. Background

• B. Institutional Arrangements

• C. Developing a Comprehensive Fiscal Risk Statement

• D. Macroeconomic Risks

• E. Fiscal Risks Related to State-Owned Enterprises

• F. Long-term Sustainability

• G. Debt-Related Risks

• H. Contingent Liabilities and Implicit Fiscal Risks

• III. STRENGHTENING PUBLIC INVESTMENT MANAGEMENT

• A. Background

• B. Strategic Planning

• C. Project Appraisal and Selection

• D. Coordination

• BOXES

• 1.1. Objectives and Outputs of the PFM Strategy on Medium-term Budgeting

• 1.2. Fixed versus Indicative Ceilings of an MTBF

• 1.3. The Strategic Phase of the Budgeting Process in the UK

• 1.4. Developing the Budget Declaration to a Fiscal Strategy Statement

• 1.5. Gender Responsive Budgeting in Ukraine

• 1.6. Illustrative Example of a Simple Technical Amendments Model

• 1.7. Proposal for Budget Calendar

• 2.1. Legal Issues Related to Fiscal Risk Oversight

• 2.2. Improving the Methodology for Assessing Fiscal Risks of SOEs

• 2.3. Country Approaches to Assessing Credit Risks and Establishing Risk-Based Guarantee Fees

• FIGURES

• 1.1. Assessment of Prerequisites for Effective Medium-term Budget Framework

• 1.2. Phased Approach to Ceilings: Raise Commitment with Gained Credibility:

• 2.1. Volatility of Nominal GDP and Revenue Growth

• 2.2. Net Losses of SOEs by Sector

• 2.3. Profitability and Solvency of the Largest SOEs

• 2.4. Pension System Deficits

• 2.5. Dependency Ratio

• 2.6. Exposure to Forex General Government Debt

• 2.7. Reconciliation of Changes in Government Debt

• 2.8 Stock of State Guarantees

• 2.9 Fiscal Cost of Guarantee Calls

• 2.10. Fiscal Support to the Financial Sector

• 2.11. SOE Loans and Deposits in State-Owned Banks

• 2.12. Subnational Government Liabilities

• 2.13. Size and Self-Reliance of Subnational Governments

• 3.1. Indicative Timeline for Development of a National Infrastructure Strategy

• 3.2. Current Interdepartmental Committee Project Appraisal and Selection Process

• 3.3. MoF Role in the Revised Interdepartmental Committee Process

• TABLES

• 0.1. Recommendations and Action Plan

• 1.1. Template for Reconciliation of Consecutive Vintages of Ceilings

• 2.1. Fiscal Risks in Ukraine

• 2.2. Preparation of Fiscal Risk Statement

• 2.3. Illustration of Sensitivity of Fiscal Aggregates to Real GDP Shock

• 3.1. Different Processes Applied to Project Selection

• 3.2. Progressive Application of the Interdepartmental Committee Process to all Projects

• 3.3. Indicative Thresholds and Processes for Project Appraisal and Selection

• ANNEXES

• I. Indicative List of Legal Reforms to Strengthen PFM in Ukraine

• II. Reserves and Margins in MTBFs

• III. Legal Provisions for Fiscal Risk Management. Country Examples

• IV. Template for Annual Fiscal Risk Statement

• V. Phased Approach to Development of the Fiscal Risk Statement

• VI. Recommendations Mapped to Relevant PIMA Findings

• VII. National Infrastructure or Transport Strategies: Country Examples

• VIII. National Infrastructure Strategy and Longer-Term Capital Budgeting Processes

• IX. Assigned Roles and Responsibilities to the MoF in the PPP Process

GLOSSARY

Preface

In response to a request from the Minister of Finance, Mr. Oleksandr Danyliuk, a technical assistance mission from the Fiscal Affairs Department (FAD) and Legal Department (LEG) of the International Monetary Fund (IMF) visited Kiev, Ukraine during the period March 22-April 4, 2017. The mission was led by Miguel Alves (FAD), and consisted of Amanda Sayegh (FAD), Alessandro Gullo, Karla Vasquez Suarez (both LEG), Glen Granger, Clemens Mungenast, and Philip Kenworthy (FAD short term experts).

The mission met with Ms. Oksana Markarova, First Deputy Minister of Finance; Mr. Vladimir Lozytsky, State Budget Director; Mr. Yuriy Heletiy, Director of the Financial Policy Department; Mr. Vasyl Shkurakov, Director of Debt Policy Department; Mr. Andrey Savenko, Head of the Fiscal Risk Management Division; Ms. Olena Skrypkina, Head of Legal Department; Mr. Olexiy Zhak, Head of Budget and Macroeconomic Indicators Division; and Mr. Mikhailo Bosak, Head of State Budget Planning Division. In the Ministry of Economic Development and Trade the mission met with Ms. Olena Diachenko, Head of the Department of State Property Management; Ms. Iryna Novikova, Head of PPP Division; Ms, Natalia Gorshkova, Director of the Macroeconomic Forecasting Department; and Mr. Oleksandr Zadorzhnyi, Deputy Head of the Industrial Policy Department; and Ms. Oksana Gryshkevych, Deputy Chair of the Investment Department.

The mission also met with the Ms. Liliia Hrynevych, Minister for Education and senior representatives from Education Ministry; Mr. Pavlo Kovtonyuk, Deputy Ministry of Health; Dr. Viktor Dovhan, Deputy Minister for European Integration, Ministry of Infrastructure; Mr. Serhiy Sharshov, Deputy Chair of Local Self-Government Department, Ministry of Regional Development; senior representatives of the Pension Fund of Ukraine, and the National Bank of Ukraine and members of the Budget Committee of the Verkhovna Rada. In addition, the mission met with Ms. Maja Bosnic, Team Leader of the Gender Budgeting in Ukraine Project, Ms. Oleksandra Betliy, Leading Research Fellow of the Institute for Economic Research and Policy Consulting, Mr. Ivan Miklos and Mr. Pavlo Kukhta of the Strategic Advisory Group for Support of Ukraine Reforms, and representatives from the World Bank and the European Commission.

The mission would like to thank the authorities and other participants for their collaboration during the mission. The mission is also extremely grateful for the support given to the team by staff at the IMF office, in particular to Mr. Ihor Shpak for his excellent support in coordinating the mission. The mission is also grateful to Ms. Oksana Burakovska, Mr. Serhiy Kolesnyk and Ms. Nataliia Sinitsyna for their excellent interpretation and translation efforts over the course of the mission.

Executive Summary

After a deep economic crisis caused by a difficult external environment, an armed conflict in the East, and delays in the implementation of structural reforms, Ukraine has been showing some signs of recovery. To achieve a more sustainable fiscal consolidation, the Ukrainian authorities have recently adopted a broad Public Financial Management (PFM) System Reform Strategy, paving the way to decisive action in critical areas including medium-term budgeting, analysis and management of fiscal risks, and public investment management (PIM).

Implementing the Medium-term Budgeting Framework (MTBF)

Fiscal policy in Ukraine has been hampered by the lack of a medium-term orientation for the State Budget. Medium-term macroeconomic forecasts are regularly produced, but these are not well integrated with budget planning, which remains mostly incremental and annual in scope. The Budget Code only requires the preparation of multi-year budget projections (essentially a forecast exercise), with little impact on fiscal discipline. Furthermore, fiscal objectives, absent the conditionality included within the IMF supported program are vague. While the main drivers of fiscal policy are defined in the Spring, there is no systematic strategic approach to budgeting: “top-down” spending envelopes based on a credible fiscal framework.

Recent reform initiatives have prioritized the development of a medium-term budget framework to the forefront of the reform agenda, but additional steps are required for it to be fully implemented. A pilot MTBF exercise, with a clear objective to amend the Budget Code by the end of the year is now underway and, while this approach demonstrates commitment to reform, the current design largely replicates the existing annual budget approach, albeit extended over a three-year horizon. There is still time to improve the credibility of this process, with the objective of preparing all stakeholders to be able to implement a more complete MTBF exercise for the 2019 budget. Specific measures for the pilot could include:

• Adopting a fixed overall expenditure ceiling for the State General Fund for 2018 and indicative ceilings for outer years (i.e., 2019 and 2020) and indicative ceilings for each of the Key Spending Units (KSU) in each year;

• Defining contingency margins for the overall expenditure ceilings and committing to presenting a reconciliation of any changes to the ceilings during the successive stages of the 2018 budget cycle.

For subsequent budget years, the authorities should consider further developing the MTBF process by:

• Integrating the Special Fund into the MTBF and presenting it to include the impact on general government;

• Gradually move toward more fixed ceilings for overall and KSU expenditure as the system matures;

• Expanding the scope of the Budget Declaration, to encourage a more strategic discussion of fiscal policy, aided by a rules-based fiscal framework and enhanced information;

• Developing and implementing a technical amendments model that specifies clear rules for the adjustment of ceilings following macroeconomic changes; and

• Developing and disseminating a methodology for forward baseline estimates to inform the MTBF discussions between the Ministry of Finance (MoF) and KSUs.

Strengthening Fiscal Risk Management

Ukraine’s public finances are exposed to several important fiscal risks. Macroeconomic and geopolitical risks create substantial volatility in nominal GDP and government revenue, while government debt is highly exposed to exchange rate fluctuations. Fiscal exposures emanate from a large and poorly performing State-owned Enterprise (SOE) sector. Liabilities of the largest 100 enterprises are around 25 percent of GDP, and around one-third of these were loss-making in 2015. In this context, government guarantees of SOE borrowing, which amount to around 5 percent of GDP, have a high likelihood of materializing. The financial sector has also been a significant source of fiscal risk in recent years, with fiscal cost of bank bailouts and deposit guarantees amounting to around 11 percent of GDP over the last four years. Finally, Ukraine’s pension system coupled with an ageing population creates large and uncertain fiscal costs.

The lack of a comprehensive fiscal risk management system affects the credibility of the budget, the sustainability of the public debt and the efficient allocation of public resources in accordance with policy priorities. This is exacerbated by a lack of sufficient information about the sources and likelihood of such risks, and by fragmented and inadequate frameworks for SOE oversight (including from a legal standpoint), public guarantees, and asset management.

The authorities should take steps to strengthen the monitoring, management, and reporting of fiscal risks, notably by:

• Strengthening and broadening the fiscal risk management mandate of the MoF, including the development of fiscal risk control and mitigation policies;

• Establishing a comprehensive reporting framework for fiscal risk management; and

• Publishing an annual fiscal risk statement as part of the budget documentation, focusing initially on SOE and macroeconomic related risks and gradually expanding the coverage of and methods used to assess them over time.

Strengthening Public Investment Management

Ukraine has undertaken a range of reforms in public investment management, designed to tackle some of its weaker institutions. Nevertheless, the strategic planning process remains unfit for purpose and does not facilitate prioritization of capital investment projects. Furthermore, a significant share of Ukraine’s public investment continues outside the scope of the improved appraisal and selection process launched in 2015, including its framework for intergovernmental coordination.

The government’s PFM strategy outlines significant reform plans for PIM. These include: the establishment of an independent expert body, the Strategic Council, which will take an advisory role in the strategic planning process; the development of strategic sectoral plans; and development of a medium-term public investment plan. In this context, the authorities should consider taking steps to address PIM institutional gaps by:

• Setting up an Investment Planning Unit under the MEDT, with the responsibility for development of a national public infrastructure strategy, which integrates both sectoral strategic plans and public investment priorities. This would help investors identify investment opportunities in Ukraine;

• Expanding the role of the MoF in the appraisal and selection process, regarding the assessments on “whole-of-life” budget affordability of investment projects and fiscal risks;

• Developing and implementing a single online database of information (including costs) for all investment projects, irrespective of their funding source;

• Gradually extending the new project appraisal and selection process to all major investment projects, irrespective of their funding source, with consideration for materiality and fiscal risks.

Legal Implications

Strengthening all of three areas will require comprehensive legal reforms. Specifically, the MoF needs to be empowered to permit it to effectively execute its functions. Enshrining the MTBF in legislation will grant legal legitimacy, strengthen credibility and clarify the institutional roles of the legislative and executive branches of government. Strengthening the legal mandate of the MoF to monitor, assess, and manage fiscal risks would ensure that adequate mechanisms to facilitate the collection of information necessary for fiscal risk analysis are in place. In addition, the integration between the budgetary regime and the framework for public investment should be improved, and the role of the MoF strengthened for different investment processes, including PPPs. Changes to primary legislation will also need to be accompanied by implementing regulations such as Cabinet resolutions, to allow for flexibility on technical issues and to ensure that the stronger role of the MoF is accompanied by adequate involvement of line ministries through a collegial decision-making process.

Table 0.1 sets out the recommendations of the report and an action plan for their implementation.

Table 0.1.

Ukraine: Recommendations and Action Plan

Table 0.1.

Ukraine: Recommendations and Action Plan

Recommendation		April-December 2017	2018	2019/2020	Responsible Entity
Implementing the Medium-term Budgeting Framework
1.1	Define ceilings for pilot MTBF	Fixed overall expenditure ceiling for 2018 (indicative for outer years) and indicative KSU expenditure ceilings for the General Fund for each year			MoF
1.2	Determine the rules of the pilot	Define margins for the budget year and the subsequent two years Reconcile any changes for the draft budget.	Reconcile any changes in the “Fiscal Strategy Document” for MTBF triennium 2019-2021.	Reconcile any changes in the final accounts.	MoF, KSUs
1.3	Improve design of MTBF	Integrate the Special Fund into the MTBF	Binding overall expenditure ceiling and KSU expenditure ceilings for the General and Special Funds for 2019		MoF, CMU
1.4	Strengthen credibility and transparency of MTBF	Commit to gradual increase in the fixity of ceilings in the Budget Code Develop a technical amendments model Provide for appropriate margins, and the reconciliation of changes to ceilings throughout the whole budget cycle.	Implement the technical amendments model and apply it for MTBF triennium 2019-2021 Increase timeliness and independence of macro-economic forecasts Limit overspending of the Special Fund and reduce the amount of earmarking revenues in the state budget Present MTBF in a general government perspective	Apply technical amendments model for MTBF triennium 2020-2022	MoF, CMU
1.5	Develop a forward-baseline-estimates methodology	Develop a forward-baseline-estimates methodology for the state budget in the MoF. Run an MoF internal test in Autumn 2017	Apply the methodology for the preparation of the Strategic Budget Document 2019-2021. Provide training on the FBE methodology to KSUs.	Apply forward-baseline-estimates methodology	MoF, KSUs
1.6	Amend Budget Code to support MTBF implementation	Include key elements of the MTBF in Budget Code	Prepare and adopt CMU resolutions as to the technical details of the for MTBF triennium 2019-2021		MoF, CMU
Strengthening Fiscal Risk Management
Recommendation		April-December 2017	2018	2019/2020	Responsible Entity
2.1	Strengthen and broaden the fiscal risk management mandate of the MoF	Broaden FRMD’s mandate cover all material fiscal risks Amend BCU to incorporate fiscal risk management functions Transfer oversight of financial and commercial operations from the FRMD to supervisory boards, as established			MoF
2.2	Establish a comprehensive reporting framework for fiscal risk management		Update the functional responsibilities of government departments Establish templates for exchange of information		CMU, MoF
2.3	Prepare and publish an annual fiscal risk statement (FRS)	Amend BCU to include FRS Publish initial FRS	CMU approve responsibilities for producing broader FRS Expand FRS to cover broader set of fiscal risks	Expand coverage and depth of analysis in FRS	FMRD
2.4	Strengthen analysis and disclosure of macroeconomic risks	Publishing a qualitative discussion of macro-fiscal risks in FRS	Publish assessment of past forecast errors in the FRS	Undertake and publish macro-fiscal sensitivity analysis	FRMD, BD, MEDT
2.5	Strengthen the information base and capacity to undertake fiscal risk assessment of SOEs and commence quarterly internal reporting of SOE risks	Expand and approve draft methodology for SOE risk assessment Build capacity to undertake financial ratio analysis Submit first quarterly reports to CMU	Establish a single central database (excel-based initially) of SOE financial indicators and state support Develop capacity to undertake sensitivity and scenario analysis of SOE sector		FMRD, MEDT
2.6	Disclosure of SOE fiscal risks	Preliminary analysis of aggregate SOE risks in FRS, explicit liabilities to them, QFAs and transactions with government	Add analysis of high-risk SOEs and details on individual SOEs (high risk and macro-critical)	Add information on SOE contingent liabilities	FRMD
Recommendation		April-December 2017	2018	2019/2020	Responsible Entity
2.7	Long-term sustainability			Prepare and publish long term estimates of pension costs	Pension Fund, MoF
2.8	Debt Management	Discuss main exposures in FRS	Undertake and publish sensitivity analysis	Undertake and publish debt sustainability analysis	DPD
2.9	Other explicit and implicit contingent liabilities	Disclose fiscal risks related to guarantees and loans to SOEs in FRS	Add legal claims, financial sector exposures, PPPs, local government	Add natural disaster risks	See table 2.2
2.10	Strengthen controls on, and management, of contingent liabilities	Restrict foreign currency subnational borrowing to sub-lending Establish gateway for MoF in risk assessments for PPPs	Develop tracking indicators of fiscal stress for subnationals and require published external audits	Establish methodology for assessing credit risks of guarantees and charge risk-based fees	DPD, DLG, BD
Strengthening Public Investment Management
3.1	Enable the development of a national infrastructure strategy	Set up an Investment Planning Unit under the MEDT. Define the role of the strategy and the process for consideration and acceptance	Begin development of the strategy	Complete the strategy	MEDT, MoF, CMU
3.2	Expand the role of the MoF to include budget affordability and risk assessments of public investment projects	Begin introducing the process in concert with the MTBF pilot	Full MoF assessment conducted for 2019 budget funded items		MoF
3.3	Create a single online database of information for all investment projects.		Commission the building of the database	Database operational	MoF, MEDT
3.4	Extend project appraisal and selection approach to all major national public investments	Extend to PPPs and SoE investment financed by government loans or equity injections	Extend to major projects funded by intergovernmental transfers	Extend to externally financed projects	MEDT
3.5	Adapt requirements to size and risk of projects			Introduce thresholds	MEDT, MoF
3.6	Revise the definition of PPPs		Make revisions in time for the 2019 Budget process		MEDT

View Table

Table 0.1.

Ukraine: Recommendations and Action Plan

Recommendation		April-December 2017	2018	2019/2020	Responsible Entity
Implementing the Medium-term Budgeting Framework
1.1	Define ceilings for pilot MTBF	Fixed overall expenditure ceiling for 2018 (indicative for outer years) and indicative KSU expenditure ceilings for the General Fund for each year			MoF
1.2	Determine the rules of the pilot	Define margins for the budget year and the subsequent two years Reconcile any changes for the draft budget.	Reconcile any changes in the “Fiscal Strategy Document” for MTBF triennium 2019-2021.	Reconcile any changes in the final accounts.	MoF, KSUs
1.3	Improve design of MTBF	Integrate the Special Fund into the MTBF	Binding overall expenditure ceiling and KSU expenditure ceilings for the General and Special Funds for 2019		MoF, CMU
1.4	Strengthen credibility and transparency of MTBF	Commit to gradual increase in the fixity of ceilings in the Budget Code Develop a technical amendments model Provide for appropriate margins, and the reconciliation of changes to ceilings throughout the whole budget cycle.	Implement the technical amendments model and apply it for MTBF triennium 2019-2021 Increase timeliness and independence of macro-economic forecasts Limit overspending of the Special Fund and reduce the amount of earmarking revenues in the state budget Present MTBF in a general government perspective	Apply technical amendments model for MTBF triennium 2020-2022	MoF, CMU
1.5	Develop a forward-baseline-estimates methodology	Develop a forward-baseline-estimates methodology for the state budget in the MoF. Run an MoF internal test in Autumn 2017	Apply the methodology for the preparation of the Strategic Budget Document 2019-2021. Provide training on the FBE methodology to KSUs.	Apply forward-baseline-estimates methodology	MoF, KSUs
1.6	Amend Budget Code to support MTBF implementation	Include key elements of the MTBF in Budget Code	Prepare and adopt CMU resolutions as to the technical details of the for MTBF triennium 2019-2021		MoF, CMU
Strengthening Fiscal Risk Management
Recommendation		April-December 2017	2018	2019/2020	Responsible Entity
2.1	Strengthen and broaden the fiscal risk management mandate of the MoF	Broaden FRMD’s mandate cover all material fiscal risks Amend BCU to incorporate fiscal risk management functions Transfer oversight of financial and commercial operations from the FRMD to supervisory boards, as established			MoF
2.2	Establish a comprehensive reporting framework for fiscal risk management		Update the functional responsibilities of government departments Establish templates for exchange of information		CMU, MoF
2.3	Prepare and publish an annual fiscal risk statement (FRS)	Amend BCU to include FRS Publish initial FRS	CMU approve responsibilities for producing broader FRS Expand FRS to cover broader set of fiscal risks	Expand coverage and depth of analysis in FRS	FMRD
2.4	Strengthen analysis and disclosure of macroeconomic risks	Publishing a qualitative discussion of macro-fiscal risks in FRS	Publish assessment of past forecast errors in the FRS	Undertake and publish macro-fiscal sensitivity analysis	FRMD, BD, MEDT
2.5	Strengthen the information base and capacity to undertake fiscal risk assessment of SOEs and commence quarterly internal reporting of SOE risks	Expand and approve draft methodology for SOE risk assessment Build capacity to undertake financial ratio analysis Submit first quarterly reports to CMU	Establish a single central database (excel-based initially) of SOE financial indicators and state support Develop capacity to undertake sensitivity and scenario analysis of SOE sector		FMRD, MEDT
2.6	Disclosure of SOE fiscal risks	Preliminary analysis of aggregate SOE risks in FRS, explicit liabilities to them, QFAs and transactions with government	Add analysis of high-risk SOEs and details on individual SOEs (high risk and macro-critical)	Add information on SOE contingent liabilities	FRMD
Recommendation		April-December 2017	2018	2019/2020	Responsible Entity
2.7	Long-term sustainability			Prepare and publish long term estimates of pension costs	Pension Fund, MoF
2.8	Debt Management	Discuss main exposures in FRS	Undertake and publish sensitivity analysis	Undertake and publish debt sustainability analysis	DPD
2.9	Other explicit and implicit contingent liabilities	Disclose fiscal risks related to guarantees and loans to SOEs in FRS	Add legal claims, financial sector exposures, PPPs, local government	Add natural disaster risks	See table 2.2
2.10	Strengthen controls on, and management, of contingent liabilities	Restrict foreign currency subnational borrowing to sub-lending Establish gateway for MoF in risk assessments for PPPs	Develop tracking indicators of fiscal stress for subnationals and require published external audits	Establish methodology for assessing credit risks of guarantees and charge risk-based fees	DPD, DLG, BD
Strengthening Public Investment Management
3.1	Enable the development of a national infrastructure strategy	Set up an Investment Planning Unit under the MEDT. Define the role of the strategy and the process for consideration and acceptance	Begin development of the strategy	Complete the strategy	MEDT, MoF, CMU
3.2	Expand the role of the MoF to include budget affordability and risk assessments of public investment projects	Begin introducing the process in concert with the MTBF pilot	Full MoF assessment conducted for 2019 budget funded items		MoF
3.3	Create a single online database of information for all investment projects.		Commission the building of the database	Database operational	MoF, MEDT
3.4	Extend project appraisal and selection approach to all major national public investments	Extend to PPPs and SoE investment financed by government loans or equity injections	Extend to major projects funded by intergovernmental transfers	Extend to externally financed projects	MEDT
3.5	Adapt requirements to size and risk of projects			Introduce thresholds	MEDT, MoF
3.6	Revise the definition of PPPs		Make revisions in time for the 2019 Budget process		MEDT