Robert Kahn

Macro and Markets

Robert Kahn analyzes economic policies for an integrated world.

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Ukraine and IMF: Step Forward Now

by Robert Kahn
March 27, 2014


The IMF announced today that it has reached an agreement in principle on a two-year program (stand-by arrangement) with Ukraine. The headline numbers are $14-18 billion of IMF money and overall financing of $27 billion, which is lower than some had hoped, but don’t be fooled. This is a three-to-six month program, designed to meet Ukraine’s critical near-term financing needs and to get reforms going. Both are essential tasks, and rightfully the focus. The program will be revised (and likely boosted) after elections. It will be at that point that thorny issues like debt restructuring will be addressed.

The program lays out a roadmap for how the official community would like to see Ukraine reform, and how it expects the economy to respond. That’s a useful anchor for expectations, and an important signal of support for Ukraine, but given the extraordinary political and economic uncertainty it is a wish more than forecast. Still, the program shows IMF leadership at a critical time, and in that sense, is essential as a complement to sanctions and as a Western response to Russian aggression in Ukraine.

A few points about the program:

1. Tough up front actions

Prior actions—those things Ukraine must do before the IMF Board approves the program in April and makes the first disbursement, reportedly includes: (i) a commitment to maintain a flexible exchange rate system, (ii) increases in energy prices by 50 percent, (iii) passage of a budget for 2014, and (iv) a commitment to anti-corruption legislation and improving the business climate. Fixing the banking system is a fifth pillar of the program but it’s too early to know how bad the hole will be. I would have preferred less austerity now, but a full program apparently was the only way to get enough money to Ukraine in the near term. The question now will be the domestic reaction to these measures (which will no doubt be blamed on the former government). The IMF has asked for as much austerity as is reasonable to expect, and perhaps more.

2. Keeps the lights on

The IMF first disbursements aim to trigger the release of $6 billion to $8 billion over the next several months from the EU, the European Bank for Reconstruction and Development (EBRD) and the World Bank. Passage also looks to be imminent for the $1 billion U.S. loan guarantee, along with a small amount of bilateral assistance. That should be just enough to provide critical government services (including safety net payments), service its foreign-currency denominated debt, and purchase gas till the summer. Press reports suggest those payments total $6.2 billion in the second quarter.

What is unusual here is that the IMF has agreed to a set financing gap and allowed its stated financing to vary between $14-18 billion depending on other support.  That makes sense given the uncertainty, but it’s troubling that at the same time the IMF is stepping into the breech, other creditors seem to be stepping back.  This morning, there are reports that European aid other than “emergency” assistance may be delayed until after elections.  The IMF should not be alone in the financial vanguard.

3. Optimism on the economy

The program reportedly assumes a decline in GDP of 3 percent this year (many private economists expect a decline or 5 percent or more) despite substantial fiscal measures and a deepening crisis. The central government deficit will decline, but the overall deficit (including the gas company) should continue to be in the range of the 9 ½ percent of GDP figure from last year (it would have been over 10 percent without new measures).

4. No PSI, for now

It appears that there is no debt restructuring (private sector involvement, or PSI) planned at this time. That means holders of June 2014 eurobonds should be happy. But if I’m right that there will need to be a rethink of the program in the summer, the reprieve may be short lived. Even ahead of that, we shouldn’t underestimate the domestic political desire for burden sharing, if not through a restructuring then through a rollover of bank lines (Vienna Initiative) or new loans from wealthy Ukrainians (e.g., a friends of Ukraine donors conference or patriot bond). So watch the reaction domestically to the sharp rise in energy prices to consumers.

One more point:  the IMF announcement notes that “With no market access at present, large foreign debt repayments loom in 2014-15.”  We are warned.

Markets should respond well to the news. Over the past few weeks, markets have rallied on signals that the IMF program was near and drew support from hopes that Russia would make no further moves against Ukraine. In that sense, I see a substantial disconnect between the markets and many on the political side, who seem far more worried that we could be at an early stage of an escalating confrontation between Russia and the West. That suggests that, at a minimum, markets remain vulnerable to adverse news from Ukraine in coming weeks.


Post a Comment 5 Comments

  • Posted by martin edwards

    Great work, Robert! I really worry about the geopolitical context here. Ukraine has not had a good history of following through with the IMF. One wonders what will happen if the government fails to deliver on some of these prior actions, or misses targets down the road. They also have to know that there will be intense pressure on the Fund to look the other way. How much reform are we actually going to get here?

  • Posted by Robert Kahn

    Martin, I think you are right to be worried. Ukraine’s track record of ownership and delivery of policy commitments under IMF programs is dreadful —that is why I originally believed that it was best to provide bilateral emergency assistance on largely unconditional terms at the start and leave an IMF program for a second stage when leadership and commitment to reform was clearer. Large short term financing needs forced the IMF to act. Ultimately, the answer to your question depends on the elections and what government follows.

    If they don’t deliver on the prior actions, the international community will be in a huge bind because there is a clear understanding of Ukraine’s instability in the face of Russian actions/sanctions. My expectation though is that the interim government believes it has scope to act, and will do the prior actions–energy price hikes, other budget cuts, continued flexibility of the exchange rate, legislation on corruption—to get program approved. But I see a substantial risk that between program approval and the election there is backtracking in the face of broad public discontent and instability. The government said that it would cut the budget spending by around 1.7% of GDP, but revenue will fall and the NaftoGaz CEO has warned that the state gas company could run a deficit of 5.6% of GDP, so the overall deficit could soar to well above 10% of GDP.

  • Posted by Carl Ross

    No question that the short term outlook has improved with the IMF program. But you are right to to cautious about the medium term. I think the medium term outlook for Ukraine depends very much on the actions of Mr. Putin. He is likely to stealthily foment discontent in eastern Ukraine. One way would be to flood Crimea with largesse in the form of financial transfers. Imagine if you are living in eastern Ukraine and being subjected to fiscal austerity demanded from Washington and Kiev, and you see your brothers in Crimea enjoying the benefits of the fatherland. This is going to cause problems.

    Moreover, what companies would invest in eastern Ukraine with the persistent threat of a) social discontent and b) Putin’s tanks? Eastern Ukraine is likely to grow more slowly that western Ukraine, exacerbating the country’s ethnic divide.

  • Posted by SAT GOEL

    Isn’t IMF being too liberal with its money with European nations while it has never extended that size of money to any Asian nation. To me it looks that IMF is over extended in Europe as a region.

  • Posted by Alexis de Pleshcoy

    This is a fine article offering an accurate picture of the present situation in Ukraine. In an ideal world, people should live in the present, and forget about history and geography. But even the present is complicated in the global economy.
    So let’s hope that everybody forgot the Crimean War (in which the armies of an Enlightened Europe, i.e. France and the British Empire (plus Sardinia), joined the Ottoman Empire in holy jihad against the infidels of Imperial Russia) and the sieges of Sevastopol (1854-55, 1941-42).
    The IMF loans have conditions attached to them, which is basically the way it has been forever. It didn’t make the IMF a friend of many EU countries (Greece, Portugal, Spain, Ireland, Cyprus, Hungary, Romania and more); I have yet to see a mass demonstration thanking the IMF, personally to Christine Lagarde that they finally got the price for energy aligned to market prices, or other austerity measures.
    For Ukraine, the price is actually not increased by just 50 per cent; it is an initial increase by 50 per cent, followed by a timetable of increases until 2018. I can’t say this doesn’t make perfect sense, but explain that to the average family that the prices of heating and electrical energy will increase by say 100% until 2018, which will probably mean 30-40% of average salary (winter time). The same energy price increases apply to businesses, factories, anything and anybody.
    The point is that in the process of aligning the energy prices to world market prices the entire economic system becomes unstable, triggering political instability, in an already socio-economic unstable system.
    Moreover, the industry will have to compete in a global economy where the manufacturing hourly rate is around $2.50 (China and Mexico) and will be lower as India develops its infrastructure; the agriculture might be submitted to the EU quota system, in addition to price increases for fuel and more. Add to that that Russia will behave according to her own interests, which are opposite to those of the EU.
    What is hard to understand is the conspicuous absence of the EU in particular and Europe in general in these first steps. The UK (EU) and Norway (Europe) could have stepped in with oil/natural gas (strangely the US was asked to export oil/natural gas, feasible in a couple of years, but again just the US?); Norway has a large sovereign fund which could have easily helped in assembling a generous financial package. Moreover, the EU has more to benefit from a stable, solid new consumer market of more than 40 million people than anybody else.
    It is strange for EU/Western Europe, the wealthiest entity in human history (500 million plus people) to wait for the IMF to provide financing; 100 euros per capita, per year would mean 70 billion dollars).
    In addition, I’m a bit reluctant to push IMF first, which, being an international organization (part of the WWII peace framework), should have waited for elections (while EU and Western Europe would have stepped in).
    In any event, it would be mandatory to determine where the IMF and EU (when applicable) money went.
    So I really hope that what is evolving right now will not be eventually celebrated in a 2018 version of the poem: “The Charge of the Light Brigade”, the first one by Alfred, Lord Tennyson.

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