A. Macroeconomic Risks

Unanticipated changes in macro-economic conditions will cause fiscal forecasts to differ from those presented in the budget declaration. The key risks to the macroeconomic outlook arise from a potential weakening in global economic conditions and depreciation in the exchange rate, difficulties accessing external funding, in particular from multilaterals, structural reforms not being fully implemented or the economy’s response being muted, and an intensification of military conflict in the East of the country.

Three macroeconomic scenarios have been considered and approved by the Cabinet of Ministers and are presented in Table [xx]. These scenarios take into account the performance of the economy in previous years, the current economic situation and assess how external and internal risks could impact on the Ukrainian economy over the period 2019–21.

The first, baseline scenarios provides the basis for the fiscal forecasts contained in the budget declaration. This baseline scenario is premised on a continued, favorable outlook for the world economy. Furthermore, it assumes that the reforms envisaged in the Government’s Medium-Term Plan are successfully implemented, with a moderate, positive response from the economy. Implementation of reforms where consensus has not been reached (e.g., land and tax reforms) have not been included.

The second scenario assumes that implementation of all the reforms, including the land and tax reforms proceeds successfully. The global economic outlook in this scenario is consistent with the assumption of the scenario 1 baseline forecast. However, the assumptions regarding the inflow of investment and loan capital are somewhat better.

The third scenario is a more adverse scenario that considers the performance of the economy under less favorable external economic situation.

[Table to be included presenting the scenarios]

Macroeconomic risks will be mitigated through diligent implementation of the structural reforms in line with the Medium Term Plan. Not only is this anticipated to have a positive impact on the economy, but will also secure the ongoing support of international, official lenders to the Ukraine. Further measures to stimulate growth will be taken, in the event of sluggish economic growth. Implementation of the inflation targeting framework by the National Bank of the Ukraine is expected to contain inflation to 5 percent by 2021.

B. State Debt and Guarantees

Deviations in the macro-economic parameters from forecasts will impact on government debt and debt servicing obligations. In particular, the debt portfolio, which amounts to UAH [xx] billion is susceptible to changes in the external environment and exchange rate shocks, with around [xx] percent of the debt portfolio denominated in foreign currency and around [xx] percent of public debt held by non-residents. The debt portfolio is also subject to some interest rate risk, with around [xx] percent of domestic denominated debt and around [xx] percent of foreign currency debt denominated in floating rate instruments.

The debt portfolio is exposed to refinancing risk, with [xx] percent of the portfolio maturing over the 2019–2021 period. An early termination of the program from the International Monetary Fund, could reduce demon for government debt in the domestic and international capital markets.

There is a total of UAH [xx] billion of state-guaranteed debt, of which UAH [xx] billion secures a loan provided by the IMF to the National Bank of Ukraine and remainders guarantees borrowing by state-owned enterprises (SOEs). An unexpected deterioration in the credit risk of the guaranteed SOEs, requiring that the government service the guaranteed debt, would cause a deviation in the budget indicators. Most of the guaranteed debt is denominated in foreign currency and is therefore exposed to exchange rate risks.

To mitigate the fiscal risks, the composition of debt is being shifted away from private to official creditors, offering longer maturities. Development of the local capital markets will enable an increase in the share of local currency debt in coming years, mitigating the exposure to currency fluctuations. Risk-related fees are charged to the SOEs with guaranteed debt to enable the costs to be recovered, should the Government be required to service the debt.

C. State-Owned Enterprises

SOEs may give rise to fiscal risks where there is a reduction in the taxes, dividends and other receipts from SOEs or an increase in the subvention, loans, or equity injection required from Government versus that which was planned in the budget. This can be the result of a deterioration in the financial performance and position of the SOEs as a consequence of a deterioration in the macroeconomic conditions and depreciation in the exchange rate, reduction in demand, changes in policy, including being assigned responsibility for undertaking noncommercial activities, impairment of assets, penalties, legal action, a weakening of governance, corruption, escalation in geo-political conflict, political unrest, natural disasters and force majeure events.

In accordance with the approved methodology approved by the Cabinet of Ministers of Ukraine, the Ministry of Finance has identified 25 enterprises for close monitoring. These enterprise are state-owned natural monopolies, have assets in excess of UAH 2 billion or are receiving state budgetary support in the form of subsidies, grants, loans or guarantees or have been assessed to have a high risk rating. The full list of 25 enterprises is published on the official website of the Ministry of Finance.

In the event of risks materializing at these companies, the Government’s response will depend on the prevailing circumstances as there is no explicit obligation for the government to support these enterprises. Nevertheless, many of these companies are strategically importance to the country.

The approved methodology was used to assess the likelihood of fiscal risks materializing. The 25 SOEs were classified into risk categories based on the following criteria:

• Risk category 1: SOEs which are unprofitable, either at an operating profit or a net profit level and which have a high debt burden;

• Risk category 2: SOEs which have a high debt burden;

• Risk category 3: SOEs which are unprofitable or have a negative return on equity (ROE);

• Risk category 4: SOE which have a low profitability and a ROE below 1 percent; and

• Risk category 5: all remaining SOEs.

The results of the risk assessment are summarized in Table [xx]. A total of [xx] SOEs were assessed to be of the highest risk (risk category 1), with a further [xx] assessed to be in risk categories 2 and 3. Enterprises in risk categories 1 through 3 account for around [xx] percent of the total liabilities of the 25 SOEs.

[Include updated version of the table below for the 25 SOEs]

Table: Risk Categorization of the largest 48 SOEs (2017)

Table: Risk Categorization of the largest 48 SOEs (2017)

Risk category	Number of entities	Combined Net Debt (percent of GDP)
1	12	5.2
2	20	9.8
3	1	0.1
4	6	2.1
5	9	1.5
Total	48	19.4

View Table

Table: Risk Categorization of the largest 48 SOEs (2017)

Risk category	Number of entities	Combined Net Debt (percent of GDP)
1	12	5.2
2	20	9.8
3	1	0.1
4	6	2.1
5	9	1.5
Total	48	19.4

In addition, scenario analysis has been conducted on three of the largest SOEs.

Traditionally, Naftogaz has been a significant contributor to the budget, with its dividends accounting for [xx] percent of total state revenues and [xx] percent of the proceeds from all SOEs. There is a significant risk of this situation reversing over the medium term and of there being a net outflow from the budget to Naftogaz. The expiration of the contract with Gazprom at the end of 2019 and commissioning of the Nord Stream II and Turkish Stream pipelines would result in a significant reduction in revenues from gas transit from the Russian Federation to Europe is anticipated. An extension of the commitment period for the public service obligations (PSOs) in the absence of any compensation from the budget would exacerbate the risk of fiscal risks materializing. In addition, fiscal risks would arise in the event that Naftogaz is unable to secure adequate liquidity to finance its activities. Adverse economic conditions, including an increase in the price of gas imports would negatively impact on Naftogaz. On the other hand, a favorable decision on the arbitration with Gazprom and successful implementation of reforms to liberalize the gas sector could result in a significant improvement in the company’s financial position, reducing fiscal risk.

In the case of Energoatom, the company is expected to continue to contribute positively toward the budget. However, adverse macro-economic conditions, delays in deregulating the electricity market and requirements for the company to bear the cost associated with universal service supply and being the guaranteed off-taker for renewable power projects would reduce budget inflows. Any penalties imposed for failing to adhere to its licensing conditions would negatively impact Energoatom’s performance.

Although a number of state-owned mining companies are in a weak financial position, state budget expenditure to support these companies must be in line with the requirements of Article 264 of the Association Agreement between Ukraine and the European Union. The European Union does not permit unlimited support of uncompetitive coal mines. Moreover, provisions governing state aid to the coal industry in the Ukraine is contained in the Report on the Results of the Integrated Study of Electricity and Energy Coal Markets approved by the Antimonopoly Committee of Ukraine No 40 of 01.06.2016, which determines among other things:

• Unprofitable and unsustainable coal mines are not eligible for operating and investment state aid;

• State aid for restoration of solvency and restructuring in the coal mining sector is prohibited;

• State aid for the closure of mines is permitted, as well as environmental protection assistance in connection with the closure of mines.

With the aim of mitigating the fiscal risks arising from SOEs, the Government is taking steps to implement the necessary reforms in the sectors in which the SOEs operate, including liberalizing the gas sector and deregulating the electricity market. In addition, SOE governance is being strengthened through corporatizing unitary SOEs that are primarily involved in commercial activities, establishing supervisory board with independent directors, and introducing new procedures for appointing and remunerating the heads of the largest SOEs. The largest SOEs are required to prepare their financial statements in accordance with international financial reports standards (IFRS) and have them independently audited by internationally reputable auditors within [xx] months of the end of the financial year. The financial statements must be published on the company website.

D. Proceeds from Privatization

Privatization of state and communal property is projected to raise UAH [xx] billion. Delays in the planned privatization of state assets would result in the proceeds realized from privatization being lower than anticipated, which would increase government debt compared to budget projections.

On March 7, 2018, the Law of Ukraine No. 2269-VIII “On Privatization of State and Communal Property” was adopted by the Verkhovna Rada of Ukraine, which provided for a new process for privatization. By law, the objects are classified into two groups: small and large. Small-scale objects will be sold exclusively through electronic auctions, which will ensure competition and increase the sale price. The procedure for conducting the auctions through the electronic system “Prozorro” has been approved (Resolution of the Cabinet of Ministers of Ukraine dated May 10, 2018, No. 432). The Order of the State Property Fund dated March 27, 2018 No. 447 approved a list of small-scale privatizations subject to privatization in 2018, which included 749 objects. A condition for Ukraine to receive the first tranche of fiscal assistance from the European Union is the conclusion of at least 200 small-scale privatizations.

On May 10, 2018, the Cabinet of Ministers approved a list of 23 large-scale objects to be privatized. Preparation for the sale of the large-scale objects will be carried out with the assistance of advisers, which will increase interest to domestic enterprises by foreign investors, will ensure fair and transparent privatization. Steps are being taken to restructure and prepare the identified enterprises for privatization so as to increase their investment attractiveness and the value that can be realized through privatization.

E. Financial Sector

Financial sector risks can arise from explicit obligations to provide back-up funding to the deposit insurance fund and to guarantee deposits of state-owned banks, or from government decisions to recapitalize troubled banks, which were not anticipated in the budget forecasts. This may be the required due to a weakening in the financial position of a specific banks or the sector as a whole due to unfavorable economic conditions, a deterioration in the quality of the loans portfolio, and tightening of liquidity or run on deposits. It is more likely to occur where banks are inadequately capitalized.

The Deposit Guarantee Fund (DGF) insures deposits of individuals and sole traders up to a cap of UAH 200,000 per account holder. In addition, all deposits in Oschadbank (around UAH [xx] billion) have been guaranteed by the government.

In the National Bank of the Ukraine’s (NBU’s) assessment the risk arising from the financial sector has declined over the last [period]. The financial performance of the sector continues to improve. However, the proportion of non-performing loans still remains high.

Since the crisis in the financial sector, the government and the NBU have taken a number of steps to strengthen the banking system. These include measures to improve governance of state-owned banks, including through the establishment of independent professional supervisory boards. All unprofitable banks were required to submit restructuring plans and meet capital adequacy requirements. The NBU has also completed diagnostic studies of the top-60 banks and assigned recapitalization schedules for those that needed them. These banks are being closely supervised by the NBU. New mandatory prudential requirements and risk management system aimed at reducing the likelihood of risks arising in the event of a negative economic shock are being phased in.

A. Data Collection

B. Data Input

The worksheets and all cells where data may be input are colored in light green. Data should not be input into any other cells.

C. Reasonability Review

Whilst entering the data, the MoF should check the data for reasonability. In particular, where there are significant deviations from the historical data, the MoF should ensure that there is a justifiable explanation for this.

Having entered all the data, the MoF should again review the input and output data to ensure reasonability of the assumptions.

On the input pages, the forward-looking assumptions or projections should be reviewed and the basis for the assumptions interrogated. Key aspects to analyze include the following:

• Are the assumptions based on well-supported, realistic assumptions in line with previous performance and forecasts of peers?

• Are there credible factors identified that account for any deviations?

The MoF should also ensure that the assumptions in the base case are in alignment with the government’s policy intentions.

The outputs should also be reviewed. Any significant year-on-year changes that are not in line with the assumptions must be interrogated.

Generally, all line items in the Balance Sheet, other than retained income (and possibly equity), will remain positive. Important items to check include Property, Plant and Equipment (PPE); Inventories; Trade Receivables; Cash and Cash Equivalents; Share Capital; Loans and Borrowings (both under non-current and current liabilities); and Trade Payables. Where Cash and Cash Equivalents becomes negative, it means that the assumed level of Loans and Borrowing is too low – additional funding will need to be raised in order to ensure that the company has sufficient liquidity to meet its requirements. Where PPE or Loans and Borrowing are negative it means that the assumed changes provide for more PPE to be sold or loans to be repaid, than the company currently holds. The assumptions will need to be adjusted to rectify this error. If Inventories, Trade Receivables or Trade Payables are negative, this would most likely reflect a situation where the assumptions used are negative, which would be incorrect. The balance sheet check line should also be reviewed to ensure it is zero.

The key ratios and the fiscal risk assessment risk ratings should be reviewed. Where there is a significant improvement or deterioration, the reasons for this should be checked to ensure that there is a reasonable explanation.

Finally, the financial projections should be compared to any other financial projections for the SOE (most commonly the SOE’s own financial plan). Because of the simplification in the line items used in the financial model, there may be variances in specific line items models. In addition, differences in the way in which the projections were developed may also result in discrepancies. However, material differences should be identified as well as the underlying causes of such differences. On the one hand, this may reveal assumptions in the model that need to be adjusted. On the other hand, it may warrant engagement with the SOE (or other stakeholder that produced the model) regarding the validity of the assumptions that they have used.

The analysis of the financial model should also be informed by the SOE’s track record in delivering on its projections. This will require a historical comparison of the company’s projections against its actual results. In many cases there is a tendency toward an “optimism bias”, in which case the SOE’s financial model may be more representative of an upside scenario, rather than the base case. Such analysis should be taken into account when comparing the financial projections produced by the model with those of the SOE.

D. Interpretation

Finally, the model output should be reviewed and interpreted.

The most important aspect, on which to focus is the table and graphs in the Summary Charts sheet showing the net flows to the government. The flow represents the sum of any taxes and dividends received, subsidies paid, increase or decrease in the government’s equity in the company and all call on the government guaranteed debt. Comparing the Stress Scenario to the Baseline Scenario provides an indication of the potential fiscal risk that may arise. The Reform scenario provides an indication of the potential, positive impact that interventions to mitigate the risks may have.

Given that the profitability of the company is an important determinant of the taxes and dividends payable by the SOE, comparing the net profit after tax under the different scenarios can also provide useful insights.

Analyzing and comparing the key financial ratios in each year can also offer insights. The evolution of the ratios over time and the changes in key ratios under the different scenarios can be compared to assess the financial sustainability of the company, even under adverse conditions. Key financial and operational indicators can be benchmarked against local and international peers. Useful ratios to focus on include the following:

• Return on equity (ROE): is calculated as net income over shareholder’s equity. It measures the ability of a firm to generate profits from its shareholder’s investments in the company by earning revenues in excess of the costs it incurs. It is useful to compare the indicator with the ROE generated by other SOEs; the risk-free rate, which represents the cost to the government of the capital invested in the SOE; and the equity returns that similar private sector firms would be required to earn to assess how well the company is performing;

• The debt ratio is calculated as total debt over total assets. It shows a company’s ability to meet its liabilities with its assets or, put differently, the percentage of the company’s financing that comes from debt rather than equity. Companies with higher levels of liabilities compared with assets are considered highly leveraged. They are also riskier, because the company has less financial flexibility as, unlike when the business has a large proportion of equity financing where dividend payments can be adjusted according to the cash generated by the company, debt obligations must be serviced when they fall due. It helps to analysis the overall debt burden on the company as well as the firm’s ability to pay off the debt in future, uncertain economic times.

• The interest coverage ratio is calculated as Earnings before interest and tax (EBIT) over interest expenses. It is a financial ratio that measures a company’s ability to make interest payments on its debt in a timely manner. It helps to identify whether a company is generating sufficient operating cash flows to be able to support additional debt. Investors want to see that their company can service the debt repayments on time without having to sacrifice its operations and profits. Often companies may have a low debt ratios, but still be unable to take on additional debt because the interest coverage is too low;

• The current ratio is calculated as current assets over current liabilities. A company with larger amounts of current assets will more easily be able to pay off current liabilities when they become due without having to sell off long-term, revenue generating assets. This is not only a measure of how much cash a business has. It is also a measure of how easy it will be for the company to convert its assets into cash.

Similarly, analyzing changes in the fiscal risk assessment ratings over time and comparing the fiscal risk ratings across the various scenarios, will demonstrate the company’s resilience and its ability to operate sustainability under a variety of plausible economic scenarios.