The Ukrainian government should seek a new support program with the International Monetary Fund (IMF) of up to USD10bn, with a duration of up to four years, the National Bank of Ukraine (NBU) believes.
“A new program is necessary for Ukraine,” the NBU’s deputy governor Dmytro Sologub says in an exclusive interview with the Central European Financial Observer. He believes that any new agreement should be an Extended Fund Facility (EFF), which is “a more structured” instrument compared to the existing 14-month Stand-By Arrangement (SBA) of USD3.9bn, which the IMF agreed with Kyiv in late 2018.
The SBA replaced the USD17bn EFF agreed between Ukraine and the IMF in 2015 with the aim of supporting the country during a severe financial and economic meltdown, triggered by Russia’s annexation of Crimea and the Donbas military conflict. However, Kyiv obtained only USD8.4bn from this package before the program was suspended due to Ukraine’s foot-dragging on important reforms, in particular in the fight against endemic corruption.
“Usually, an EFF lasts between two-and-a-half to four years, We use these parameters in the central bank’s macro-economic forecasts,” Mr. Sologub said. “The amount of funding depends on a program’s duration. We believe it could be USD5bn-USD10bn.”
According to the NBU’s basic forecast, Ukraine could obtain a first tranche of USD2bn from the IMF by the end of this year, and similar annual amounts in 2020 and 2021. The funding would support the country’s foreign reserves, which stood at almost USD21bn as of early July, during a peak of debt repayments.
Not only the amount matters
The current level of Ukraine’s international reserves is equal to more than three months of import cover, which is above the threshold necessary to prevent the country’s finances from possible external or internal shocks.
“A new IMF program is not so crucially important for the central bank in terms of how much funding we would secure,” Mr. Sologub said. “Today’s level of reserves is enough to smooth out [UAH exchange rate] fluctuations under a floating exchange rate.”
“A new program would be an important signal for other donors. There is a prospect of securing new funding from the European Union (EU) and the World Bank. We are more likely to be successful if we already have a program with the IMF,” the central bank’s deputy governor underlined, adding that the NBU is forecasting around USD1bn annually from other major donors in 2020-2021.
A new agreement with the IMF would also facilitate Ukraine’s access to international capital markets. “Yields on Ukraine’s securities have declined significantly. The country’s economy is not in a bad shape, and that is why the decline was obvious. But yields could decline further if we secure a new program with the IMF, and Ukraine implements structural reforms.”
Indeed, following July’s landslide victory in the parliamentary elections of the party of President Volodymyr Zelenskiy, the yield on Ukraine’s government bond due 2027 dropped to its lowest level since the 2015 debt restructuring. The so-called GDP warrants, which guarantee additional payments to the country’s private creditors if Ukraine’s GDP rebounds strongly in the future, have also been rallying over recent weeks.
In early July, President Zelenskiy told the IMF’s first deputy managing director, David Lipton, that cooperation with the IMF remained a priority for the Ukrainian authorities. “We would like to continue our relations with the IMF. I want to emphasize that,” he said.
Ukraine’s reform agenda
Meanwhile, Mr. Sologub does not expect any “revolutionary” reform obligations as part of a new IMF program. Among the obvious first steps, he sees the approval of a balanced state budget and the start of operations of the nation’s high anti-corruption court, which was formally created earlier this year.
“I don’t see any completely new ideas [in a new IMF program]. Most of these ideas have already been discussed over the past years. We have made serious progress in the implementation of many of them,” the central bank’s deputy governor says. “The macro stabilization has been secured, and now we should not destroy it. The financial sector has been improved. However, much more still needs to be done — we need to address the reform of the state banks, the NPL problem.”
As for the anti-corruption reforms, Mr. Sologub said that Ukraine has created anti-graft infrastructure over the past four years, and that the current goal is to launch the operation of this infrastructure. “Also, the judicial system is a weak part of this reform,” he added.
Mr. Sologub believes that reform of the farmland market could also be on the agenda. However, he does not expect that the IMF would demand that Ukraine’s parliament, the Verkhovna Rada, adopt this reform immediately, though for the World Bank it could be a crucial condition.
“The land is an asset. The banking system is ready to work with the land. For the banking system this [agricultural land reform] would be a good move, because it means an extra asset emerges that could act as [loan] collateral,” the central bank’s deputy governor adds.
In late 2018, the Verkhovna Rada extended its moratorium on the sale of agricultural land until January 2020, despite the IMF’s numerous appeals to create a market for land in the country. The multinational lender said in a report published in October 2016 that while Ukraine has a vast area of arable land, “use of this land is currently limited by legislation, restricting private owners’ ability to sell their land to more efficient users and constraining the use of land as loan collateral”. “Amending the legislation to unlock land-related transactions would generate significant economic gains, including higher incomes and greater tax revenues,” the document reads.
Mr. Solugub adds that the current situation concerning land reform seems to be “an example from a micro economy textbook”. “This market already exists. However, this market remains in the shadows. That is why [farm] land prices are distorted. The reform will put it in order.”
Key rate forecast
In July, the NBU started publishing the forecast for its key policy rate for the period until late 2021. The move marked “an evolutionary improvement” in the transparency of monetary policy at central banks that apply inflation targeting, the regulator said at the time.
“The NBU became the eighth central bank in the world that publishes its key rate forecast. Why do we do this? We aim to communicate our policy to the market in a more detailed and efficient manner,” Mr. Sologub said. “However, this is only our forecast, not a commitment.”
The central bank believes that its key policy rate will reach 15 per cent by the end of this year vs. the current level of 17 per cent, around 9 per cent by late 2020, and 8 per cent by late 2021. At the same time, inflation should decline to 6.3 per cent as of the end of 2019, and reach the medium-term target of 5 per cent at the end of 2020.
Through this move, the regulator will be able “properly structure” different segments of the nation’s financial market, Mr. Sologub added. “Economic agents and investors should understand our forecast when they make decisions about deposits or buying government bonds.”
Meanwhile, delays in implementing key reforms or developments that offset previous achievements, in particular, court rulings or legislative decisions, could increase the vulnerability of Ukraine’s economy and become an obstacle to further cooperation with the IMF, the NBU said in its July’s statement.
“That could affect exchange rate and inflation expectations, as well as access to international capital markets, as Ukraine will face a heavy debt load in coming years,” Mr. Sologub stressed.
The NBU believes that among the remaining “important” risks are: a suspension of Russian gas transit through Ukraine starting in 2020; an escalation of trade wars and rising geopolitical tensions; and an escalation of the Donbas military conflict accompanied by an imposition of new trade restrictions by Russia.