4/8/15: IMF Downgrades Ukraine Growth Outlook

IMF just published its Article IV consultation paper on Ukraine. Here are some key points (I am staying out of extensive commenting on these, but emphasis is added in the quotes).

Before we start, it is important to highlight that IMF notes significant breadth and depth of reforms already undertaken by the Ukrainian authorities, albeit warns about potential slippage in future reforms. Given the overall environment (geopolitical and domestic) in which these reforms are taking place, Ukrainian Government deserves a positive assessment of their work in a number of important areas.

"The 2015 baseline growth projection has been marked down to -9 percent (relative to -5.5 percent at the EFF approval), driven by a delayed pick up in industrial production, construction, and retail trade, and expectations of a weaker agricultural season." Note: this is a massive contraction compared to Programme projections.

"Domestic demand will be somewhat more constrained than anticipated earlier by tighter credit conditions and larger-than-expected decline in real incomes amid higher inflation."

"Growth is expected to start recovering in the second half of the year, supported by growing consumer and investor confidence, gradual rehabilitation of the banking system, and restoration of broken supply chains in metals, mining, and energy production. Later on, manufacturing should also start benefitting from the restored competitiveness of Ukraine’s exports. However, the recovery is expected to take hold only gradually through 2016. Medium-term growth projections remain unchanged." Note: you can see projections for following years in the table at the end of this post.

"The 2015 inflation has been revised upwards to 46 percent at end-2015, compared to
27 percent at program approval, driven by the faster-than-expected pass-through effects of the large exchange rate overshooting in March."

Note: again, this is a massive revision on programme-assumed inflation. Take together with the GDP revision above, it is hard to see how the IMF can continue arguing sustainability case for the programme at this stage, without hoping for massive recovery.

"Inflation is projected to recede quickly in 2016 to around 12 percent as the one-off effects subside and economic stabilization takes hold. Monthly core inflation rates are already well below 1 percent and expected to remain in such territory, as the negative output gap, subdued demand, and the stabilization of the exchange rate will put downward pressure on inflation."

Here's an interesting bit: Inflation 'one off' drivers include IMF-required adjustment in energy prices:

"The rapid pass-through of the large exchange rate depreciation in February and increases in regulated energy prices pushed inflation to 61 percent y-o-y in April. As the hryvnia recovered and stabilized in April–June, prices of some imported goods declined while increases in prices of non-tradables remained moderate. As a result, inflation in June moderated to 0.4 percent m-o-m, or 57½ percent y-o-y. The high y-o-y number masks the sharp disinflation that has already occurred: the seasonally adjusted annualized inflation in May–June 2015 fell to 13 percent."

But energy prices are yet to be fully inflated to their targets, so more is to come: "Gas and heating prices increases. Gas prices for households were increased by 285 percent on average, effective April 1. Heating prices were also increased by 67 percent, effective May 8. Despite these increases, gas and heating prices remain among the lowest in the region. The program aims to reach 75 percent of cost recovery gas and heating prices based on international prices by April 2016 and 100 percent by April 2017."

Which, of course, means there will be much more pain for ordinary Ukrainians, comes winter.

"The overall balance of payments remains broadly unchanged. The current account deficit is expected to widen to 1.7 percent of GDP in 2015, compared to 1.4 percent of GDP at program approval. Both exports and imports are projected to decline considerably this year, driven by (i) falling export prices and larger-than-expected loss of export capacity stemming from the conflict; and (ii) the weaker economy and steeper fall of energy consumption."

"Risks to the outlook remain exceptionally high. Risks to economic growth are predominantly on the downside reflecting (i) uncertainty about the duration and depth of the conflict in Eastern Ukraine; (ii) prolongation of the discussions on the debt operation (which could disrupt capital flows); and (iii) slippages in policy implementation. In addition, confidence could fail to revive due to these factors, or due to a more protracted bank resolution process. Higher-than-expected inflation—due to inflation expectations becoming more entrenched—could reduce domestic demand further. On the upside, an early resolution of the conflict could boost confidence and growth faster than projected."

"…Regarding program implementation, policy reversals, including regarding the flexible exchange rate policy and fiscal/energy price adjustment could lead to continuing balance of payments problems and raise repayment risks."

"Against significant headwinds, the authorities showed again their determination to stay the course of the program. ...However, although domestic support for a new Ukraine is strong, pressures from populist forces and vested interests are growing. Moreover, the local elections in the fall pose a risk that the reform momentum could fade."

Bad news on debt levels are:

Note: Public debt levels assume meeting IMF target for restructuring current debt. There is another dreamy feature to both graphs - as with all IMF programmes, debt peaks out in year one. Given past histories, however, the forecasts don;t quite turn to reality.

Another set of bad news: Non-performing Loans (NPLs) as % of total assets was bad in 2013 and getting massively worse now:

And a summary of macro performance indicators and projections:

31/5/15: IMF slashes Ukraine Economy Outlook

IMF statement on Ukraine with some pretty ugly forecast revisions.

[Note, emphasis in italics is mine]

"Press Release No. 15/243, May 31, 2015

IMF Statement on Discussions with Ukraine on First Review under the Extended Fund Facility Arrangement

An International Monetary Fund (IMF) mission visited Kyiv during May 12-29 to hold discussions on the first review under the Extended Fund Facility Arrangement (EFF) in support of the authorities’ economic reform program (see Press Release No. 15/107).

At the conclusion of the visit, Mr. Nikolay Gueorguiev, mission chief for Ukraine, made the following statement today in Kyiv:
 ...
“The authorities’ commitment to the reform program remains strong. All performance criteria for end-March were met and all structural benchmarks due in the Spring are on course to be met, albeit some with a delay. This good program implementation has been achieved notwithstanding an exceptionally difficult environment, in part related to the unresolved conflict in the East, which took a heavier than expected toll on the economy in the first quarter of 2015.

Accordingly, the mission has revised down growth projections for 2015 to -9 percent and projects end-year inflation at 46 percent. Inflation was mostly driven by one-off pass-through effects of the large exchange rate depreciation in February as well as the needed energy price increases.

“In recent months, signs that economic stability is gradually taking hold are steadily emerging. The foreign exchange market has remained broadly stable. Gross international reserves, although still very low, have increased to US$9.6 billion at end-April. Banks’ deposits in domestic currency have been recovering. The budget outturn in the first months of 2015 was stronger than expected, partly due to temporary factors.

“The authorities recognize that decisive implementation of economic reforms is indispensable for entrenching financial stability and restoring robust and sustainable growth. They are committed to advancing fiscal consolidation and energy sector reforms, including further energy tariff adjustments to eliminate the large losses of Naftogaz, reduce energy consumption, and foster energy independence. They are also moving ahead with the rehabilitation of the banking system, and the improvement of the business environment to enhance the productive potential of the economy.

“The authorities are also determined to complete the ongoing debt operation in line with program objectives. This will ensure that public debt is sustainable with high probability and the program remains fully financed, which are requirements for the completion of the review. More broadly, continued financial support for Ukraine’s reform efforts from official and private creditors is vital for the success of the program.”

Let's hope IMF optimism wins over the reality, but just two and a half months ago, the IMF projected gross international reserves for 2015 at USD18.3 billion, and now they are celebrating reserves at USD9.6bn. IMF programme sustainability analysis was forecasting real GDP decline of 5.5% in 2015 - not 9% decline the Fund now projects. See: http://www.imf.org/external/pubs/ft/scr/2015/cr1569.pdf for more details.

One has to wonder, just how 'flexible' the Fund became in recent years when it comes to 'hard' numbers underpinning it's 'programme sustainability' arithmetic.

2/5/15: IMF to Ukraine: Pain, and More Pain, and Maybe Some Gain

A very interesting IMF working paper on sustainability and effectiveness of fiscal policy in Ukraine that cuts rather dramatically across the official IMF policy blather.

Fiscal Multipliers in Ukraine, by Pritha Mitra and Tigran Poghosyan, IMF Working Paper, March 2015, WP/15/71 looks at the role of fiscal policy (spending and investment) in the Ukrainian economy.

As authors assert, "since the 2008-09 global crisis, which hit Ukraine particularly hard, the government relied on fiscal stimulus to support recovery. In reality, it was the main lever for macroeconomic management… Today, even after the recent float of the Ukrainian hryvnia, fiscal policy remains key to economic stabilization." In particular, "Over the past five years, the government relied on real public wage and pension hikes to stimulate economic activity, sometimes at the expense of public infrastructure spending. Many argue that this choice of fiscal instruments undermined private sector growth and contributed to the economy falling back into recession in mid-2012."

Since the IMF bailout, however, fiscal adjustment is now aiming for a reversal of long term imbalances on spending and revenue sides. In simple terms, fiscal adjustment now became a critical basis for addressing the economic and financial crisis. As the result, the IMF study looked at the effectiveness of various fiscal policy instruments.

The reason for the need for rebalancing fiscal policy in Ukraine is that current environment is characterised by "…the severe crisis, its toll on tax revenues, and financing constraints, necessitate fiscal consolidation. But the challenge is to minimize its negative impact on growth."

In other words, the key questions are: "Will tax hikes or spending cuts harm growth more? Does capital or current spending have a stronger impact on economic activity?"

Quantitatively, the paper attempts to estimate "…the fiscal multiplier – the change in output, relative to baseline, following an exogenous change in the fiscal deficit that stems from a change in revenue or spending policies."

The findings are: "Applying a structural vector auto regression, the empirical results show that Ukraine’s near term fiscal multipliers are well below one. Specifically, the impact revenue and spending multipliers are -0.3 and 0.4, respectively. This suggests that if a combination of revenue and spending consolidation measures were pursued, the near-term marginal impact on growth would be modest", albeit negative for raising revenue and cutting spending.

"Over the medium-term, the revenue multiplier becomes insignificant, rendering it impossible to draw any conclusions on its strength. The spending multiplier strengthens to 1.4, with about the same impact from capital and current spending. However, the impact of the capital multiplier lasts longer. Against this backdrop, the adverse impact of fiscal consolidation on medium-term growth could be minimized by cutting current spending while raising that on capital."

The risks are unbalanced to the downside, however, so the IMF study concludes that "Given the severe challenges facing the Ukrainian economy, it is important that policymakers apply these results in conjunction with broader considerations – including public debt sustainability, investor confidence, credibility of government policies, public spending efficiency. These considerations combined with the large size of current spending in the budget, may necessitate larger near- and long-term current spending cuts than what multiplier estimates suggest."

In simple terms, this means that, per IMF research (note, this is not a policy directive), Ukrainian economy will need to sustain a heavy duty adjustment on the side of cutting public spending on current expenditure programmes (wages, pensions, purchasing of services, provision of services, social welfare, health, etc) and, possibly, provide small, only partially offsetting, increase in capital spending. This would have to run alongside other measures that will raise costs of basic services and utilities for all involved.

The problem, therefore, is a striking one: to deliver debt sustainability, current expenditure and price supports will have to be cut, causing massive amounts of pain for ordinary citizens. Meanwhile, infrastructure spending will have to rise (but much less than the cuts in current expenditure), which will, given Ukrainian corruption, line the pockets of the oligarchs, while providing income and jobs to a smaller subset of working population. Otherwise, the economy will tank sharply. Take your pick, the IMF research suggests: public unrest because of cut-backs to basic expenditures, or an even deeper contraction in the economy. A hard choice to make.

In the end, "More broadly, fiscal multipliers are one of many tools policymakers should use to guide their decisions. Given the severe challenges facing the Ukrainian economy – including public debt sustainability, low investor confidence, and subsequent limited availability of financing – it may be necessary for policymakers to undertake stark consolidation efforts across both revenues and expenditures, despite the adverse consequences for growth."

15/4/15: S&P Ukraine Ratings and Reality Check on IMF Programme

S&P Ratings Services cut long-term foreign currency sovereign credit rating on Ukraine to CC from CCC- with negative outlook and held unchanged the long-term local currency sovereign credit ratings at CCC+.

Per S&P release: "The downgrade reflects our expectation that a default on foreign currency central government debt is a virtual certainty." S&P also warned that any 'exchange offer' - an offer mandated under the IMF latest loan package to Ukraine (http://trueeconomics.blogspot.ie/2015/03/16315-ukraines-government-debt.html) - will constitute default. "Once the distressed exchange offer has been confirmed, we would likely lower the foreign currency ratings on Ukraine to SD and the affected issue rating(s) to D".

Per S&P: "The Ukraine ministry of finance’s debt operation is guided by the following objectives: (i) generate $15 billion in public-sector financing during the program period; (ii) bring the public and publicly guaranteed debt-to-GDP ratio under 71% of GDP by 2020; and (iii) keep the budget’s gross financing needs at an average of 10% of GDP (maximum of 12% of GDP annually) in 2019–2025… The treatment of the eurobond owed to Russia (maturing in December 2015) is likely to complicate matters. The Ukrainian government insists it will be part of the talks, while the Russian government insists that the bond, although issued under international law, should be classified as "official" rather than "commercial" debt given the favorable interest rate and the fact that it was purchased by a government entity. …if Ukraine has to pay the $3 billion in debt redemption this year, it will make it very difficult for Ukraine to find the $5 billion in expected debt relief in 2015 that underpins the IMF’s 2015 external financing assumptions."

Forbes labeled the new rating for Ukraine as "super-duper junk" (http://www.forbes.com/sites/kenrapoza/2015/04/10/ukraine-debt-rating-now-super-duper-junk/)

Beyond the restructuring threat, there is economic performance that is not yielding much consolation: "The negative outlook reflects the deteriorating macroeconomic environment and growing pressure on the financial sector, as well as our view that default on Ukraine’s foreign currency debt is virtually inevitable,”

S&P forecast is for the economy to shrink 7.5% in 2015, following the decline of 6.8% in 2014. The S&P forecasts Ukrainian GDP to grow by 2% in 2016, 3.5% in 2017 and 4% in 2018. Inflation is expected to peak at 35% this year from 12.2% in 2014 and fall to 12% in 2016 and 8% in 2017. Government debt is set to rise from 40.2% of GDP in 2013 to 70.7% of GDP in 2015 and to 93% of GDP this year, declining to 82.6% in 2018.

Meanwhile, ever cheerful IMF is projecting Ukrainian GDP to shrink by 'only' 5.5% in 2015, and grow at the rates similar to those forecast by S&P between 2016 and 2018. IMF sees inflation rising to 33.5% this year. Government debt projections by the IMF are only marginally more conservative than those by the S&P.

Meanwhile, lenders to Ukraine have already pushed out a tough position on talks with the Government: http://www.bloomberg.com/news/articles/2015-04-09/ukraine-creditors-fire-opening-salvos-before-restructuring-talks

As I noted before, this an extraordinary 10th IMF-assisted lending programme to Ukraine since 1991. None of the previous nine programmes achieved any significant reforms or delivered a sustainable economic growth path. In fact, the IMF presided, prior to the current programme over nine restrcturings of the Ukrainian economy that produced more oligarchs, more corruption at the top of the political food chain and less economic prosperity, time after time.

Meanwhile, over the same period of time, world's worst defaulter, Argentina, has managed to have just three IMF-supported lending programmes. Argentine bag of reforms has been mixed, but generally-speaking, the country is now in a better shape than it was in the 1990s and is most certainly better off than Ukraine, as the relative performance chart of two economies over time, based on IMF WEO (April 2015) data, indicates:

Somewhere, probably in the basement of the 700 19th St NW, Washington DC, there exists a data wonk that truly believes that Ukrainian debt is 'sustainable' and that this time, things with 'structural reforms' will be different from the previous nine times. I would not be surprised if the lad collects Area 51 newspapers clippings for a hobby. He's free to do so, of course. But the Ukrainian economy is not free when it comes to paying for the IMF's bouts of optimism. And with it, neither are the Ukrainian people.

What the Ukrainian economy really needs right now is a combination of pragmatic political reforms to bring about real stabilisation, root-and-branch clearing out of corrupt elites, including business elites and not withstanding the currently empowered elites, assistance to genuine (as opposed to corrupt rent-seeking) entrepreneurs, all supported by assisted and properly structured FDI, direct development aid and a real debt writedown. The IMF-led package does not deliver much on any of these objectives. If anything, by passing the cost of reforms onto ordinary residents, it does the opposite - drains investment, saving and demand capacity from the economy, imperilling its ability to create new growth and enterprises.

16/3/15: Ukraine's Government Debt Projections: Smiling IMF, Whinging Private Lenders

Few weeks ago I covered in some details the implications for Ukraine of the latest IMF-led lending package: http://trueeconomics.blogspot.ie/2015/02/18215-imf-package-for-ukraine-some.html. My projection was for the debt/GDP ratio reaching over 100% in the medium term (2016-2017) based on the timing of disbursal of the new loans package and the composition of the package at the time.

The latest IMF forecasts (http://www.imf.org/external/pubs/ft/scr/2015/cr1569.pdf) show debt/GDP ratio peaking at 94.6% of GDP in 2015. IMF latest estimate is based on the assumption that, having posted primary deficit of 1.15% of GDP in 2014, Ukraine will return a primary surplus of 1.1% of GDP in 2015. As IMF notes, average primary balance in 2004-2013 in Ukraine was -2.4% of GDP, so, as some would say... 'good luck' with that.

And the programme is also anchored to the private sector-held public debt restructuring. Here's MOU from the Ukrainian authorities on this: "To secure adequate public sector financing in the coming years, while also putting public debt firmly on a downward path, we intend to consult with the holders of public sector debt on a debt operation to improve medium-term debt sustainability. To facilitate this consultation, and in line with international best practice, we have hired financial and legal advisors (prior action). While the specific terms of the debt operation would be determined following our consultations with creditors, it would be guided by the following program objectives: (i) generate US$15 billion in public sector financing during the program period; (ii) bring the public and publicly guaranteed debt/GDP ratio under 71 percent of GDP by 2020; and (iii) keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–2025. The restructuring is expected to be based on the program baseline macro framework applicable at the time the debt operation is launched. The debt operation is expected to be finalized by the time of the first review." Or in more simple terms, the IMF has already pre-committed to Ukraine cutting USD15.3 billion off its Government debt levels via private sector 'participation' in the programme. Something that is (a) questionable in terms of Ukraine's ability to deliver on, and (b) making a number of very powerful lenders quite unhappy (see http://www.themoscowtimes.com/article.php?id=517502).

And outside the baseline scenario, here is IMF's assessment of risks to Ukraine's debt profile: "Under a growth shock, entailing a cumulative growth decline of over 9 percentage points in 2016–17, the debt-to-GDP ratio reaches nearly 119 percent in 2017. A real exchange rate shock not dissimilar to the one in 2014 would also keep the debt ratio above 100 percent of GDP throughout the projection period. The combined macro-fiscal shock, an aggregation of the shocks to real growth, interest rate, primary balance and exchange rate, produces unsustainable dynamics, sending debt above 200 percent of GDP in 2017. The contingent liabilities shock highlights the risk of a further deterioration of the banking sector and associated higher fiscal costs. Its impact is mitigated by the buffer embedded under the baseline for larger-than-expected bank restructuring costs. By imposing a large associated shock to growth (14 percentage points below the baseline in 2016–17) and given the resulting deterioration in the primary balance together with an increase in interest rates, under the contingent liabilities shock debt peaks at 116 percent of GDP in 2017."

So in simple terms, I will largely stick with my original estimates that around 2016-2017, we are likely to see Ukraine's government debt around 100% of GDP marker.

27/3/2014: Troika of Sorts for Ukraine: IMF's chip are on the table

IMF announced the agreement to provide USD14-18 billion in Stand-by Arrangement with Ukraine.

This is a 'troika'-like arrangement:

• 2 year stand-by line of credit
• Total package of USD27 billion
• IMF share of the package USD14-18 billion
• Main funding vis bi-lateral and multilateral agreements
• Presumably multi-lateral will envolve EU
• Bilateral packages are for US and possibly Russia

Macro analysis:

“Ukraine’s macroeconomic imbalances became unsustainable over the past year. The (until recently) pegged and overvalued exchange rate drove the current account deficit to over 9 percent of GDP, and a lack of competitiveness led to the stagnation of exports and GDP. With significant external payments and limited access to international debt markets, international reserves fell to a critically low level of two month of import in early 2014. The 2013 fiscal deficit was 4½ percent of GDP, and the government accumulated sizeable expenditure arrears. The 2013 deficit of the state-owned gas company Naftogaz reached nearly 2 percent of GDP, driven by the sharp increase in sales at below-cost prices. Without policy action, the combined budget/Naftogaz deficit would widen to over 10 percent of GDP in 2014."

So in other words, 2013 combined deficit was around 6.5% of GDP, but 2014 deficit - following 'some stabilisation' (see below) is to reach 10% of GDP. I wonder why?.. Is it down to expected price increases on gas and oil? Or is it down to the havoc wrecked by Maidan protesters? It is certainly not down to the Crimean crisis, since removal of Crimea off Kiev's books should save the Ukrainian Government money.


“Following the intense economic and political turbulence of recent months, Ukraine has achieved some stability, but faces difficult challenges. To safeguard reserves and address currency overvaluation, the National Bank of Ukraine (NBU) floated the exchange rate in February. Measures implemented in February and March helped stabilize financial markets and ensured that critical budget payments have been met. Nonetheless, the economic outlook remains difficult, with the economy falling back into recession. With no current market access, large foreign debt repayments loom in 2014-15."

Now, key question here is why is Government deficit rising if currency is being devalued? Especially as official debt levels in the Ukraine are relatively low? Is it because Ukraine running huge current account deficit (even with subsidised prices for Russian gas)?


"Monetary policy will target domestic price stability while maintaining a flexible exchange rate. This will help eliminate external imbalances, improve competitiveness, support exports and growth, and facilitate the gradual rebuilding of international reserves.  The NBU plans to introduce an inflation targeting framework over the next twelve months to firmly anchor inflation expectations."

This is pure nonsense. Devaluation is bound to drive inflation up. Rebuilding economy will require lower interest rates, which will further support high inflation. What on earth can NBU do to set price stability as its objective? Dollarise the economy? Tried and failed in the form of pegs, and given the role of Maidan (populist movement) how can vast amount of pain be inflicted on the economy to drive price inflation to reasonable bounds?


"Financial sector reforms will focus on: (i) ensuring that banks are sound, liquid, and well-capitalized; (ii)  upgrading the regulatory and supervisory framework of the NBU, including complying with international best practice and supervision on a consolidated basis,  and (iii) facilitating resolution of non-performing loans in the banking sector."

The above reads like a Cyprus-Greece scenario. Good luck finding Russian oligarchs to hit with a deposit tax.


"The initial stabilization in 2014 will be achieved through a mix of revenue and expenditure measures. For 2015-16, the program envisions a gradual expenditure-led fiscal adjustment—proceeding at a pace commensurate with the speed of economic recovery and protecting the vulnerable—aiming to reduce the fiscal deficit to around 2½ percent of GDP by 2016."

Yes, I know… it is… austerity. Higher taxes, lower spending, followed by lofty lower spending and lower spending. I think we shall recall that the current Government has been installed into place by the populist uprising.


"A key step is the commitment to step by step energy reform to move retail gas and heating tariffs to full cost recovery, along with early action towards that goal."

Read: 40% hike in domestic gas prices is only the beginning.


In conclusion, IMF release focuses on real issues - institutional deficits in terms of governance, corruption, procurement, transparency. All are laudable and much needed.

The key takeaways:

1. The entire package is still up in the air as to bilateral and multilateral funding - sources, costs, etc;
2. The package still needs engagement from Russia - majority of the above fiscal measures will require serious pain to be imposed and this pain can be ameliorated by Russia restructuring Ukraine's debts and providing some transitioning assistance on energy front, as well as continuing to give Ukrainian firms access to its markets;
3. The package is cheap from IMF's point of view (small outlays over short term) but is heavy on Ukrainian reforms side (needed, but how feasible in the current political environment?);
4. This is not a Marshall Plan I called for - it lacks clarity on the final cost of funding (which should be close to zero) and it lacks maturity span (which should be 20 years or so);
5. Overall, the reforms sketched out above are likely to lead to another Orange/Maidan Revolution in few years time and the funding that backs them is unlikely to provide support for political stabilisation.

Let's wait for more details on the above points.




Details here (click on individual image to enlarge):