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.