In response to the recent turmoil in Ukraine, the IMF is working to extend financial assistance but will likely ask for reforms in the public, business and energy sectors.
The International Monetary Fund (IMF) dispatched a “fact finding” mission to Ukraine the first week of March to consult on a financial program to support the new government. Working in Kiev, the mission hopes to negotiate a program of reforms that would be the foundation for financial assistance from the multilateral organization.
In a recent statement, the IMF European Department Director Reza Moghadam noted work was “progressing well,” and stated that he was impressed by the Ukrainian “commitment to an agenda of economic reform and transparency.”
This mission will be just the first step to approving a program, although IMF spokesperson Gerry Rice made clear that the “IMF can move very quickly.” A newly created “rapid financing instrument” could be put to use in this case, which would require less negotiation.
Financial assistance to Ukraine from the IMF is necessary for the government to finance its debt and avoid bankruptcy. Ukraine faces a rising fiscal deficit as its economic output has fallen. From January to September of the past year, GDP fell by 1.25 percent, and the current account deficit shot up to -8.1 percent from reduced exports.
However, loan programs will come at a price. The IMF will likely seek reforms to Ukraine’s heavily-subsidized energy sector, along with improvements to its business competitiveness. Both will be in the context of future steps to curtail its rising fiscal and current account deficits.
The IMF actually finished its yearly Article IV consultation at the end of last year, before former President Viktor Yanukovych fled and the new government took control. The Fund voiced concerns over lower exports and an uncompetitive business sector fueling a rise in the current account deficit, which almost quadrupled in two years. This put pressure on foreign exchange reserves as the Ukrainian central bank attempted to keep its peg of eight hryvnia to the dollar.
Reportedly, the central bank recently gave up on trying to maintain its peg as its reserves dropped dangerously low. (Usually, a central bank will use foreign reserves to prop up the value of a currency.) While a floating exchange is welcome, a depreciated hryvnia will make it harder to repay external debts.
On top of its debt, Ukraine has an “inefficient and opaque” energy sector which is heavily subsidized by the government. In 2012, energy subsidies added up to 7.5 percent of GDP. Low oil and gas tariffs fail to cover the costs the state-owned company Naftogaz faces in providing cheap energy.
In the broader business sector, the World Bank ranked Ukraine 112th out of 189th in its Ease of Doing Business Report, citing problems in investment, paying taxes and trading. This has helped to fuel a shadow economy that the IMF estimates at 50 percent of GDP, one of the biggest in the world. The embezzlement by former President Yanukovych was only emblematic of wider corruption in the economy. Transparency International places Ukraine 144th out of 177 countries in its Corruptions Perceptions Index.
With all these problems, a larger IMF program would have to follow a reduced government budget and wide energy and business reforms. The Ukrainian government has indicated it will cooperate, but a broad financial package might prove slower than the $1 billion which could be provided though the Fund’s rapid financing tool.
Additionally, the US has pledged another $1 billion in aid, while the EU promised €1.6 billion. This would help Ukraine finance itself over the short-term. However, the US wants to do more to bolster Ukraine against Russian influence. This could require the ratification of the 2010 IMF quota reforms which boost the IMF’s funds available for support programs.
So far, the US Congress has refused to pass this legislation, despite renewed pushes by President Barack Obama and Treasury Secretary Jack Lew. Either way, aid to Ukraine will increase pressure to reform a weakening economy, testing the mettle and control of the new government. The fact-finding mission will probably conclude in two weeks, after which the IMF will decide on a program.
