I spoke at a March 12 Atlantic Council panel organized by Anders Aslund, but including Oleksandr Danylyuk, the former finance minister; Timofiy Milovanov, the former economy minister; and Yulia Kovaliv, chair of the supervisory board of Naftogaz.
The question was whether Ukraine is still in need of an International Monetary Fund lending program.
I thought it useful to write up my own notes.
I think it is clear now that there is a lobby in and around Ukraine arguing that the country can perhaps now survive without the IMF. Partly this argument is encouraged by the fact that the country managed to negotiate through COVID-19 in 2020 with a decent macroeconomic performance under the circumstances.
I think there is also a lobby that also kind of pushes the line that the IMF is too restrictive in its views, and Ukraine should be able to think outside the box, for example around capital amnesties, and more ambitious tax and pro-growth policies. Some of this thinking I think is naive, some well-intentioned, and some I think driven by those who may well wish Ukraine harm (forces in the east) or opposition political or oligarchic forces in Ukraine.
It is though my strong opinion that the IMF program remains critical for Ukraine.
The Atlantic Council’s webinar “Does Ukraine need the IMF?” took place on March 12, 2021.
Two points I would raise here.
First is that Ukraine is still in need of financing as the macroeconomic situation is improved but still not strong enough. And second that without the IMF anchors, reformers would be left exposed to the powerful oligarchic forces which are still alive and kicking and we would see a massive reversal in the reform agenda. That may well already be happening.
First on the macroeconomics, sure the 2020 performance beat expectations but there is no guarantee that this will remain the case in 2021.
I think given the experience of 1997/98 and then the global financial crisis in 2008/9 the assumption might have been that Ukrainian markets and the Ukrainian economy would crumble in response to COVID.
But as opposed to expectations of a 7-8% recession, the economy “only” contracted 4.2% in 2020.
Similarly, while the assumption had been for a budget deficit of 7.2% of gross domestic product, the outturn was a deficit of 5.3% of GDP. Public debt rose, but only from 50% to 60%. The hryvnia remained relatively stable, and foreign-exchange reserves actually rose to $28 billion, or 4.5 months of import cover. Remarkably, Ukraine ran a current account surplus of 4.1% of GDP, which helped anchor the exchange rate and enabled the accumulation of foreign exchange reserves. Ukraine retained access to international capital markets with portfolio inflows and near record-low borrowing costs on Eurobond markets. Ukraine had a good crisis, at least from the macro perspective.
But the above outperformance reflected a number of factors:
* Perhaps expectations were too bearish at the outset, as COVID was such an out-of-the-world experience, forecasts were finger in the air anyway.
* Lockdowns in the Ukrainian context proved relatively weak, which moderated economic dislocation.
* Ukraine was helped by favourable terms of trade, as the China bounce back elevated prices for metals and semifinished products, while grain prices rose and energy prices dropped.
* Global markets remained flush with liquidity as developed market central banks pumped liquidity into the global economy, this meant global borrowing costs were near record highs, and this made high yielding credits like Ukraine extra appealing to foreign fund managers, enough to enable them to look over some of the less positive trends as developments at the NBU, and slow progress on the IMF front, and pump money into Ukraine.
* Remittances defied expectations of a reversal and remained strong, reaching $13 billion last year and helping underpin the current account. The current account was also helped by the recession at home and the deflation of domestic demand and the fact that with tourism out of the country blocked, Ukraine saved $5bn in travel expenditure – some of it its elites going to the Maldives and Dubai! This actually almost equaled the current account surplus.
* The economy was still benefiting from the reforms of 2015-19, the transformation of the National Bank of Ukraine with credible monetary and exchange rate policy, a cleaned-up banking sector and prudent fiscal policy with the creation of a well run debt-management office that knew how to talk to international portfolio managers. Ukraine had the credibility buffer that it used to full effect in 2020.
Now some of the above could easily change in 2021, and indeed some already seem to be reversing. Higher oil and energy prices will undermine the terms of trade. The current push-u in US treasury yields with the US reflation trade has already increased borrowing costs by at least 100bps, and this could easily increase by another 100bps for everyone globally. As the Ukrainian economy returns to growth in 2021, import demand will rise and the current account will likely move back into deficit, likely to 2-3% of GDP, indeed that is the latest NBU forecast.
I won’t say anything about institutional erosion at the NBU, but the interview this week in NV by first deputy governor Rozhkova is clearly a concern.
So I would be wary of this view that Ukraine will continue to benefit from tailwinds in 2021. On almost all fronts things look set to get more difficult at least from the financing perspective.
But there is also this view that even if financing conditions might be challenging in 2021, Ukraine still has time to get its financing in order this year – perhaps the market will be forgiving, especially if the mood music around the IMF is supportive.
Maybe, but the sovereign’s gross financing needs this year are Hr 677 billion. That’s close to $24 billion or 16.5% of GDP, and this crosses the IMF threshold of 15% of GDP.
It’s high and is financeable perhaps as a one-off if the market winds remain supportive. But this ratio is still high. Remember therein I think the 2015 debt restructuring tried to keep the GDP ratio at 10%, and not higher than 12% in any one year. So it is already higher.
But let’s just return to the IMF timetable.
The current IMF agreement lapses in December.
Now to ensure IMF board approval by September, they need a staff-level agreement at least by May or June.
Presumably, the board in September will need comfort that any prior actions before disbursement can be completed to ensure disbursement before the program ends. We are already in mid-March, and the to-do list is still long, and the Rada shows little evidence that it will sign off on IMF-compliant legislation any time soon.
So there is a real prospect of no IMF agreement going into the summer just prior to the debt serving hump in September. If the government leaves it too close to September I think the market will freak out, and might even close to Ukraine or be prohibitively expensive. Time is now of the absolute essence. Failure to get an IMF agreement in place soon will risk a massive increase in borrowing costs and market dislocation which will be damaging to the image of Ukraine. And given the big spike in debt service in September and now the spike in U.S. Treasury yields I think the market will want assurance where the relationship is going with the IMF to fund the country.
So Ukraine needs the IMF to ensure its financing needs are met in a timely and cost-effective manner.
Second, I would argue that Ukraine needs an IMF program as a crucial anchor for reform, and particularly as it relates to the anti-corruption agenda.
Now there is criticism that recent IMF programs have been unfairly harsh on Ukraine in including anti-corruption benchmarks/conditionality which few other country programs have.
Ergh….yes guys. Let’s remember here back to 2014/15, after the EuroMaidan Revolution ended Viktor Yanukovych’s presidency, when the IMF programs were put together.
Civil society and foreign and domestic business were saying then, as were the general population in opinion polls, that corruption was the top problem in Ukraine along with the war in the east.
Governments post-EuroMaidan asked for anti-corruption to be a key component in IMF programs, probably as the reformers realized that without IMF backing nothing would be done on the anti-corruption front, or rather the balance of power between the reformers and the oligarchs and forces of state capture and corruption would be unequal.
The latter has a disproportionate amount of financial ammunition and hence buys political, judicial, and media influence. So the anticorruption agenda is lynchpin to post Euromaydan IMF programmes. It gives the reformers a chance, and at least partially levels up the playing field.
And why is corruption so important?
Because without corruption being reined in, clean business cannot operate in Ukraine, foreign investment will not happen and growth will remain sub-optimal. That’s the experience of the last thirty years in Ukraine – just look at relative per capita GDP in Ukraine versus its peers in the region – it’s a fraction of the likes of Poland, Romania, Bulgaria, and even Russia.
So an IMF program is important as it supports reform, and reformers in Ukraine, and particularly around the key issue of fighting corruption.
But let’s put things a different way.
Imagine Ukraine without an IMF program.
What do we really think would happen on the anti-corruption front, at the National Bank of Ukraine, state-owned enterprises (PrivatBank), the energy market, the banking sector, et al.
Been there done that..the results are plain to see.
Without the IMF do we imagine that any of the reformers would be left at the NBU or Naftogaz, et al?
We have already seen the back sliding on the anti-corruption infrastructure when the old guard is left to their own devices with the IMF somewhat off track. Do we really imagine that without the IMF Ukraine’s elites would think up and implement an effective anti corruption infrastructure?
The point was made that the IMF did not prevent the loss of reformers like Valerie Gontareva, Yakov Smoliy, Serhiy Verlanov, Max Nefyodov, Oleksiy Honcharuk, Oksana Markarova.
Sure, but it’s surely helped save others.
And the question needs to be asked who exactly was behind the removal of these very same reformers?
And are they still in office, and should we assume that they will continue to defend reformers if the eyes of the IMF are still not watching over and keeping its ears to the ground? Have they proven themselves sufficient capable of defending the reformers, up of really understanding the reform challenges?
This is just a naive view in my mind.
Ukraine needs an IMF program as it ensures cheap financing at a time when Ukraine still needs to borrow huge amounts of money on international capital markets, and it needs the IMF to support reform and reformers in Ukraine, who let’s face it have been to often been under attack (often life-threatening).
