IMF oks Ukraine support plan, but risks could derail it

IMF oks Ukraine support plan, but risks could derail it

The $17 billion package will support fiscal adjustment and increased competitiveness. But the threat of losing control of Eastern Ukraine and risks in implementation make stability far from certain.

The International Monetary Fund (IMF) approved a two-year, $17.01 billion economic support package for Ukraine on April 30, with just over $3 billion slated for immediate disbursement. Ukrainian authorities and IMF officials met over the course of three weeks in March to design a program that would help stabilize the Ukrainian economy, which is now in recession.

Poor fiscal policies have led to high public deficits (4.75% of GDP in 2013), coinciding with losses on the part of the state-owned energy company Naftogaz. An overvalued currency hurts competitiveness and exports. The Russian annexation of Crimea and subsequent threat of outright war further sours the business and investment climate.

In response to these problems, the IMF program lends Ukraine much-needed cash to meet international debt repayments. In order to unlock this money, Ukrainian authorities agreed to a number of reforms designed to boost the economy and put Ukraine in a stronger position over the medium term.

The authorities committed to sustaining a flexible exchange rate and rapidly moving to inflation targeting. They hope to reduce the deficit to 3% of GDP by 2016 and eliminate the Naftogaz deficit two years later. If all goes according to plan, the IMF projects that the Ukrainian economy will grow by 4-4.5% in the medium term after an initial contraction in 2014.

Why the package could fail to stabilize Ukraine

Yet, substantial risks remain, both to the economic outlook and to the future of the program as designed. The continued presence of Russian troops on the border, along with fighting in the east, threatens the sovereignty of Ukraine. The IMF warned in its staff report that, “should the central government lose effective control over the East, the program will need to be re-designed.”

Pro-Russian militants have seized a number of towns in the eastern regions of Luhansk, Donestsk, Kharkiv. These regions, when combined, represent 21.5% of Ukraine’s GDP. Loss of control would result in a substantial loss of revenue and economic output for the new central government. Without that income, Ukraine would not be able to meet the current targets set by the IMF.

Additionally, the implementation of the needed economic reforms will be politically challenging.

First and foremost, Ukraine will hold a presidential election on May 25. This could usher in a new government which may want to reopen negotiations. Many of the reforms — like raising energy prices and reversing public sector wage increases — will hurt the budgets of Ukrainians. A new government could feel pressure to ease the economic burden given the substantial turmoil within the country.

The IMF recognizes this, noting that the “success of the program depends critically on the authorities’ unwavering commitment to macroeconomic adjustment and reforms.” Ukraine’s past two programs with the IMF were suspended after the government failed to meet its commitments. However, the new leadership has been very publicly vocal, in Ukraine and abroad, expressing determination to move forward with reform.

Rose-colored glasses?

One member of the IMF Executive Board, Paulo Batista of Brazil, reportedly viewed IMF projections for Ukraine as “overly optimistic” and worried the IMF was too exposed.

This followed on the heels of a report from the independent auditor for the IMF on its projections. The  report stated that IMF projections “tended to be optimistic in high profile cases characterized by exceptional access to IMF resources.” High growth projections allow the IMF to declare programs sustainable, as high growth with a given level of debt lowers the debt-to-GDP ratio.

Even with the geopolitical risks concerning Ukraine’s economy and the IMF program, the package’s approval represents a positive step. Without it, Ukraine could enter a more severe recession which would likely exacerbate the already high level of unrest.

For Western Europe and the US, the IMF program counteracts Russia’s attempts at destabilization. A weak Ukrainian central government is in Russia’s interest, as it could lead to greater autonomy for the eastern provinces. The IMF program will help the Ukrainian government’s cohesion, and perhaps strengthen its hand in dealing with the litany of other problems besetting the country.

Categories: Economics, Europe

About Author

Ned Pagliarulo

Ned Pagliarulo works for a Japanese press company, reporting on economics and government statistics. Ned received a BA in History with a minor in Japanese from Georgetown University in 2012.