There is this complacency I think from the Ukrainian side and perhaps even from the market side that even if the laws required by the International Monetary Fund to get signed off for the first review are not delivered in July, they can wait to be sorted out in the fall. That is not likely if Ukraine wants to tap the remaining $2.9 billion in the loan program by its expiration at the end of the year.
If the whole Verkhovna Rada process is pushed out to September, then the Ministry of Finance gets into the 2022 budget discussion and there is no way any staff-level agreement would be put to the IMF board of directors in Washington, D.C., while the budget process is ongoing.
So given this program ends in December it’s either get everything done in July or the whole program ends – remarkably without even a first review. That would be a pretty abject failure. Now guess it could be extended by six months but what’s the point from the IMF front given that time would be just wasted when it probably would make more sense to work on a new lending program with proper conditionality. The point would be why extend this program when you have failed to deliver even on its light conditionality?
So July looks set to be the key month – now or never!
Interestingly President Volodymyr Zelensky is due to visit U.S. President Biden in the White House later that month. Now either laws are passed before then and Zelensky can enjoy being hailed as a reformer in D.C. Or, Zelensky’s team thinks they can try and negotiate with Biden – holding back from agreeing on some of these laws in the hope of getting some kind of warm words from Biden on NATO. And if Biden fails to deliver on any NATO pledges, then the hope will be that Biden gets the IMF to cut Ukraine some slack on the reform agenda.
It feels more like the second option which could make for a tricky visit – I just cannot see Biden offering any gifts on either the NATO or IMF front, not after the summit with Putin. Biden’s team will probably have the view that the Ukrainian side should get it themselves that delivering on the anti-corruption agenda is a good thing. It helps bolster the economy and ultimately will help in the defence against Russia. Show delivery on this first and that will ultimately boost your case on the issue of NATO. But “quid pro quo” is now an overused phrase in D.C.
So risks here are that we get to July without IMF laws passed, no IMF special-drawing rights money by September or year’s end, and then Ukraine drifts to the end of this program and then risks going into 2022 with no IMF program and likely much more difficult financing conditions.
The messaging from the Zelensky administration is a bit mixed.
On the one part, it is indicating that laws required by the IMF to complete the first review under the loan agreement (agreed as far back as June 2020) will be signed off over the summer, and by the fall at the latest.
The laws passed in the first reading on the National Anti-Corruption Bureau of Ukraine and the High Council of Justice were not IMF/Venice Commission compliant, neither was the revised law on asset declarations with the latter eventually vetoed by the presidency – the latter responding to international financial institution criticism for it being overly easy on offenders. So revised texts, compliant with the Venice Commission and the IMF, have to be tabled and approved over the summer, albeit the Verkhovna Rada, Ukraine’s parliament, goes into recess in the middle of July. The clock is ticking.
On the other, Zelensky recently complained that IMF conditionality is much tougher than has been applied to other emerging-market countries with similar programs. Actually, the agreement had lighter conditionality than a conventional program, as the international financial institutions were worried about the Zelensky administration’s ability to even deliver on a “light” IMF program. The problem for the lender is that the Zelensky administration has gone back on conditions from previous programs – that is the conditions that were promised and delivered to secure past loan disbursements. This is like a case of one step forward, two back in reality. These issues concern energy sector pricing, the National Bank of Ukraine independence and the anti-corruption agenda.
Zelensky is still saying that he will deliver as required by the IMF, but the messaging is that he feels Ukraine is being treated unfairly and its Western backers need to get the IMF to cut Ukraine some slack. The Ukrainian side has certainly felt aggrieved in recent weeks by events at both the NATO and Biden-Vladimir Putin summits. Ukraine was kicked in the teeth by not securing a NATO Membership Action Plan and then inexplicably Biden trying to explain this away by the fact that Ukraine has not delivered on the anti-corruption agenda. Well, the reality is that it has not, but when has NATO membership for any East European new entrants been linked to fighting corruption? Has that been the case with Bulgaria, Romania, North Macedonia, Albania, et al, et al? Indeed, many existing NATO members have significant problems related to corruption and elite capture – see Turkey, and recent Russian “hires” to the boards of its SOEs. Biden’s comments were really unfortunate, ill-conceived, and gives reasons/excuses for those in Kyiv arguing against the anti-corruption agenda.
Indeed, it feels to me that the momentum in Kyiv is shifting away from the IMF – there is a feeling that if the West is not serious about supporting Ukraine through NATO membership, and sets unrealistic targets for reform with the IMF, why bother using scarce domestic capital on things like fighting corruption.
Unfortunately for reform efforts in Ukraine, and the IMF, its own special-drawing rights allocation looming looks set to create a big moral hazard play for Ukraine. Ukraine is set to get $2.7 billion in more or less “free money” from the IMF in September, and this is leading some in Kyiv to argue that the country can now finance itself with this money and by retaining market access, so why deliver on conditionality?
For 2021 this might well be the case, but it depends on still liquid global markets and market access for Ukraine. And I still think it needs some kind of anchor, if not necessarily a funded program from the IMF. Investors need to think that the IMF cavalry is not far over the horizon.
Just looking at the financing math for 2021: the Ministry of Finance plans a budget deficit of 267 billion ($9.8 billion) and faces Hr 429 billion ($15.7 billion) in debt redemptions for the full year, so a gross financing need of Hr 696 billion ($25.5 billion) – a pretty hefty debt. GDP ratio.
Well, the good news is that as of mid-June domestic debt issuance had totaled more than Hr 200 billion ($7.3 billion), and Hr 235 billion ($8.6 billion) including earlier year Eurobond issuance. Assuming $2.7 billion in special drawing rights allocations arrive in September, that would put gross financing at close to Hr 300 billion ($11 billion), still leaving a gap of close to Hr 400 billion ($14.7 billion).
But half this gap could well be covered via domestic issuance, assuming it is maintained at the same run rate as the period through June. That would leave a gap of near Hr 200 billion, or close to $7.3 billion
That sounds large, but the budget year-to-date has been outperforming, with revenue growth running five times higher than the full-year plan as the COVID impact to growth has been weaker. It’s probably possible to imagine the deficit to be sweated to cut the full year to something closer to Hr 200 billion ($7.3 billion). That might suggest a financing gap of nearer to Hr 130 billion or $5 billion.
With “selective” and “optimistic” messaging to the market, likely half of this could be filled via the Eurobond market, and the balance privatization receipts, the drawdown of cash balances, and perhaps some NBU financing. It’s possible to scrape by – but his does depend on local and external markets remaining open, which to an extent depends on the Fed. Recent weeks have seen a drip of more foreign money into the local market.
I mention NBU financing above and the IMF and the former management of the central bank would have been loathed to go down this path. But the surprise decision this week by the NBU not to hike rates leaves me thinking that we are at last seeing an impact from the management changes brought by Zelensky over the past year or so.
Not hiking policy rates from 7.5%, when inflation has hit 9.5%, and when other orthodox central banks are now hiking was inexplicable to me, unless it now presaged a much weaker monetary and exchange rate approach. It does feel that freed from the shackles of the IMF, the Zelensky team will push a weaker monetary and exchange rate stance, in a pro-growth move. This might help the revenue side of the budget, but it might not be compatible with the desire to boost foreign portfolio inflows – the foreign investor base want to see a hawkish, orthodox central bank, crimping inflation and helping to secure the hryvnia.
Signals around state-owned oil and gas company Naftogaz in recent weeks also suggest to me new confidence from the Zelensky team to go it alone, jettisoning foreign advisers (the independent supervisory board’s time seems to be numbered therein), and possibly even the IMF, unless it is willing to be more flexible. As noted above, the key will be can Ukraine still finance itself without the IMF? My response would be — possibly this year, but it will need luck and liquid global markets. Ukraine will be very vulnerable.
I should add here that long term, I think Ukraine going off the IMF program would be a disaster when it comes to prospects for reform and boosting longer-term growth prospects. Without the IMF, I think the anti-corruption agenda would go backward, and with a weak business environment, investment and growth would ultimately suffer. Former macroeconomic imbalances would risk returning, leaving the economy vulnerable again to external and internal shocks.
