New IMF Program with Ukraine Approved

March 11, 2015 4:15 PM

The Executive Board of the International Monetary Fund (IMF) has approved an Extended Fund Facility for Ukraine—a 4-year financial stabilization program that provides $17.5 billion in financing, while assessing the total financing needs at $40 billion for the duration of the program. Both the funding and the reforms to which Ukraine has committed will be heavily frontloaded. The funding extension clears the way for Ukraine to adopt and implement an agenda of reform, although its economic and political situation is likely to remain perilous for some time.

The approval, on March 11, was widely expected. The IMF mission in Kiev concluded this agreement with the Ukrainian government on February 12, the same day that the Minsk-2 ceasefire agreement was signed. On March 2, the Ukrainian parliament adopted eight laws required as prior actions by the IMF, and they have been signed into law by President Petro Poroshenko. The most important laws were amendments to the budget, energy price increases, reductions in pensions, and taxes.

The IMF is expected to publish its letter of intent soon, but many details have been leaked. The IMF expects Ukraine’s GDP to contract by 5.5 percent this year after a decline of 6.9 percent last year. From 2016, the Fund anticipates a growth of approximately 4 percent a year. At present, year-over-year inflation runs at 35 percent, but the IMF anticipates that inflation will moderate to 25 percent by year end, the same as last year, and then fall to 10 percent in 2016. The consolidated budget deficit is supposed to be brought down from 10.3 percent of GDP in 2014 to 2.6 percent of GDP in 2018.

The IMF disburses its funds fast, and Ukraine should receive an initial tranche of probably $5 billion on March 12 or the next day. That tranche will be of vital importance, because Ukraine has almost run out of international reserves. On February 28, its reserves had fallen to $5.6 billion, and the country needs at least $10 billion to maintain elementary exchange rate stability. The market exchange rate has duly risen from a low of 40 hryvnia per US dollar in the February 23 panic to 23 hryvnia per dollar on March 10. The IMF has calculated its program with an exchange rate of 21.7 hryvnia per dollar, which is also the basis for the Ukrainian budget. Suddenly that rate seems plausible.

But this funding is only the minimum of what Ukraine needs. The IMF hopes that Ukraine will reach reserves of $17 billion by the end of the year, and this year it intends to disburse about $5.5 billion more itself. The Ukrainian ministry of finance needs to mobilize a large number of more or less committed funding. The United States, the European Union, and the World Bank have each committed about $2 billion this year. Various bilateral donors are likely to provide an additional $1.5 billion. The European Investment Bank and the European Bank for Reconstruction and Development will also contribute substantial amounts, perhaps $2 billion this year. Somewhat unexpectedly, it appears that an old Chinese swap credit of $2.4 billion from China can be activated. This makes for a possible total of credit disbursement of over $22 billion this year.

What attracts the most attention among bond investors is that the IMF expects a "debt operation" of no less than $15 billion from outstanding eurobonds of $18 billion. The Ukrainian government has appointed Lazard Freres to assist in its negotiations with the bondholders, negotiations that are supposed to start very soon and be completed before the first review of the IMF program. The big question is whether these savings will be possible only by prolonging the maturity of the bonds by four years and by cutting the average coupon from 7.5 percent to something like 2.0 to 2.5 percent, or whether a nominal haircut is necessary, which would be much more difficult to accomplish. The common assumption is that the Russian claims that include $3 billion of eurobonds and $2 billion of short-term bank loans will be left for last. Neither the Russian nor the Ukrainian side has spelled out their tactics.

Last April, the IMF adopted a two-year standby program for Ukraine, but it could not be completed for many reasons. Ukraine’s GDP fell by 6.9 percent and not 5 percent as the IMF had presumed. The international funding became far less than anticipated, which led to the rundown of reserves, the collapse in the exchange rate, and high inflation. Then as now, the greatest risk is the Russian military aggression in eastern Ukraine. Nobody outside the Kremlin knows if, when, or where Russian troops will intensify their attacks again.

There are also domestic risks. The greatest domestic risk remains corruption. It is therefore vital that the Ukrainian government not relax but rather intensify its reform efforts. This government has only lasted 100 days, but there was substantial discussion about bringing in the old establishment in the government after the young professionals had organized reforms and IMF funding. Fortunately, the Poroshenko loyalist and parliamentary speaker Volodymyr Groysman denied that such plans were under way yesterday.

Ukraine has a new chance to reform and save itself, but the situation remains precarious.

Anders Åslund is a senior fellow at the Peterson Institute for International Economics and author of the forthcoming book Ukraine: What Went Wrong and How to Fix It.