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UKRAINE AND THE IMF

FPP COURSE – OPEN LECTURE

Jerome VacherIMF RESIDENT REPRESENTATIVE IN UKRAINE

October 3, 2014

1. Background: how did we get here ?2. An IMF supported reform program3. Challenges and risks: going forward

Ukraine and the IMF

2

A largely inadequate policy mix:• Large fiscal and quasi fiscal deficit Absent any adjustment and based on budget

adopted in Jan. 2014 combined deficit ＞12 percent of GDP

• Fixed exchange rate• Large current account deficit• Low level of reserves

Background: Unsustainable macroeconomic policies

3

• Growth well below potential since a tepid recovery from the 2008-2009 crisis Pervasive corruptionPoor business environmentLack of FDIProductivity lags

• Lack of commitment on significant economic reforms

Background: Lack of structural reforms

4

Exchange rate policy lacked credibility

Level of reserves was inadequate

Gradual depletion of reserves reflected imbalances

5

10

15

20

25

30

35

40

-5

-4

-3

-2

-1

0

1

2

3

2011 2012 2013 2014

International Reserves

Daily FX interventions

Gross (right scale)

Net (current exchange rates, right scale)

The hryvnia started to float at the end of January

30

60

90

120

150

30

60

90

120

150

2011 2012 2013 2014

Exchange Rates (U.S. dollar pernational currency, Jan., 2008 = 100)

Ukraine Russia Hungary

Turkey Poland

• New authorities in place and cooperating quickly

• Challenging situation (imbalances quickly unwinding, security situation deteriorating)

• Previous experiences with programs with Ukraine calling for a strong reform package

An IMF supported program

9

IMF’s previous lending to Ukraine

Commitment to reforms had been weak

• Stand By Arrangement over 2 years• Exceptional Access• 8 reviews (the first two on a bi monthly basis)

and 9 tranches • 12 prior actions for program approval • Board approval on April 30• First tranche: 3.2 bn USD

Commitment through program design

12

1. Exceptional BoP pressures 2. High probability that public debt is

sustainable in the medium term3. Prospects of gaining or regaining market

access4. Strong prospect of success of policy program

(adjustment plans, institutional and political capacity)

Exceptional access criteria

13

Exceptional access in perspective

Exceptional access in perspective

Exceptional access in perspective

1. Exchange rate and monetary policies2. Financial sector stabilization and reform3. Fiscal adjustment4. Energy sector reform5. Structural reforms

5 key areas

17

1. Maintain a flexible exchange rate to restore competitiveness and foster accumulation of reserves

2. Focus monetary policy on domestic price stability

3. Prepare to move to inflation targeting

Fx and monetary policies

18

1. Maintain confidence in the financial system– Diagnostic and stress tests for the largest banks– Ensure that banks strengthen their balance

sheets, notably through recapitalization

2. Strengthen the infrastructure for financial regulation and supervision, including bank resolution

Financial sector stabilization and reform

19

Pace of fiscal adjustment calibrated to restore confidence in public finances without being overly contractionary

• Expenditure restraint– Suspension of unaffordable wage and pension

increases– Public employment reduction through attrition– Savings on government purchases

Fiscal adjustment

20

• Enhanced revenues and collections– Elimination of fraudulent tax evasion schemes– Higher excises– Closing of VAT loopholes

Fiscal adjustment

21

1. Increased gas and heating tariffs over time2. Accompanied by enhanced social assistance

measures to mitigate the impact on the poorest (shift of subsidies directly to households that need it)

3. Improvements in governance and transparency and reduction in operational costs at Naftogaz

Energy sector reform

22

Gas and heating tariff adjustments are highly needed

1. Stronger emphasis on anti corruption2. Procurement law and improvements in tax

administration3. Improvements in the business environment

(deregulation)4. Diagnostic study with the government on

anti corruption, business environment and the judicial system

Structural reforms

24

• Deeper challenges materialized in the spring:– Crimea– Growing conflict in the East

• Multi faceted impact:Real economy Fiscal Financial sectorBalance of payments

Challenges and risks

25

Activity and commodity prices remain depressed

U l t t i 2014 d t ti

-40

-20

0

20

40

60

80

100

-40

-20

0

20

40

60

80

100

2011 2012 2013 2014

Agriculture, Construction and Retail Trade(YoY percent change, 3 month ma)

Construction outputAgricultural outputRetail trade turnover

Political and economic instability have affected retail trade and construction; agriculture has begun to contract as well.

-30

-20

-10

0

10

20

30

-30

-20

-10

0

10

20

30

2011 2012 2013 2014

Price

Production

Steel Production and Prices(YoY percent change, 3 month ma)

However, steel production rebounded in 2014, despite lower prices and weak demand in Russia.

Domestic demand and confidence are deteriorating

-15

-10

-5

0

5

10

15

20

40

50

60

70

80

90

100

110

2011 2012 2013 2014

Average monthly real wages (12 month change)(rhs)

Consumer confidence index (lhs) 1/

Real Wages and Consumer Confidence

Drop in deposits has been more pronounced

-140

-110

-80

-50

-20

10

40

-140

-110

-80

-50

-20

10

40

Jan Feb Mar Apr May Jun Jul Aug Sep

The political turmoil triggered steady outflow of household deposits in the first half of 2014...Change in Banking System Deposits, 2014

(UAH millions, under fixed ER of 7.993 UAH/US$)

Households

Corporates

Total UAH and FX deposits

-50

-40

-30

-20

-10

0

10

-50.0

-40.0

-30.0

-20.0

-10.0

0.0

10.0

Luhansk Donetsk Ukraine average

... with the heaviest outflows observed in the regions most affected by the conflict.

Household Deposits in Selected Regions(Percent change from end-2013)

Inflation has increased

( ea o yea pe ce t c a ge, u ess ot e se d cated)

-1

0

1

2

3

4

-5

0

5

10

15

20

2011 2012 2013 2014

After an initial strong pick-up, headline inflation has begun to decelerate.

CPI Inflation

Month-on-month change, SA (rhs)12-month change

-3

0

3

6

9

12

15

-3

0

3

6

9

12

15

2011 2012 2013 2014

Broad-based price increases pushed inflation up in March-June 2014...

Contributions to Annual CPI Inflation

ServicesOther goodsProcessed foodFresh food

NBU has adjusted its policy rates

0

5

10

15

20

25

30

35

40

45

50

0

5

10

15

20

25

30

35

40

45

50Overnight Interbank rate (nc)

NBU Discount rate

NBU Overnight secured

NBU CDs, shortest (o/n - 4 days)

Oct 1

NBU provided liquidity support to banks

0

25

50

75

100

125

0

25

50

75

100

125

2011 2012 2013 2014

In early 2014, NBU provided massive liquidity support to banks experiencing deposit outflows.

NBU Claims on Banks

NBU’s role as dominant holder of domestic debt expanded

0

30

60

90

120

150

180

210

240

270

300

330

360

390

0

30

60

90

120

150

180

210

240

270

300

330

360

390 Non-residentsOthers ResidentsBanksNBU

Oct 1

Public debt is increasing at a quicker pace…g

0

20

40

60

80

100

120

0

20

40

60

80

100

120

2011 2012 2013 2014 2015 2016

External debt is projected to exceed 100 percent of GDP in 2014...

External Debt (Percent of GDP)Short-termMedium and long-term

0

10

20

30

40

50

60

70

80

0

10

20

30

40

50

60

70

80

2011 2012 2013 2014 2015 2016

...while the public debt will exceed 70 percent of GDP in 2015, in part because of devaluation effects.

Public Debt (Percent of GDP)

Domestic currency

FX

…though remains sustainable over the medium term

1. Policy response to shocks in 3 main areas:– Fiscal– Fx and monetary policies– Energy

2. Combined with intensified efforts on:– Financial sector strengthening– Business environment and anti corruption

Policy response (1st Review)

35

• Fiscal policy response:– Larger budget deficit target in 2014– Fiscal package (August) – Stronger structural fiscal adjustment over 2014-

2016– More conservative stance toward potential fiscal

costs:• Financial sector• Naftogaz

Policy response (1st Review)

36

• Fx and monetary policy response:– Program path for the NBU’s international reserves

revised downwards– NBU limiting the decline in reserves through

market purchases• Naftogaz:

– Stepped up collection of receivables– Set aside of funds for arrears resolution

Policy response (1st Review)

37

• Ongoing current account adjustment• Episodes of exchange rate volatility and lack of

confidence in the banking system• Security developments continuing to drive

market volatility and access

Ongoing developments

38

Current account is adjusting

-9

-6

-3

0

3

-9

-6

-3

0

3

2011 2012 2013 2014

Current Account Balance

Current account Goods

Services Income and transfers

Fx market continues to be affected by volatility

7,958,358,759,159,559,9510,3510,7511,1511,5511,9512,3512,7513,1513,5513,9514,3514,7515,15

7,958,358,759,159,559,95

10,3510,7511,1511,5511,9512,3512,7513,1513,5513,9514,3514,7515,15

Fx cash market:sellingInterbank :sellingNBU Official

Oct 1

Foreign exchange deposits are still declining

-1.6-1.4-1.2-1.0-0.8-0.6-0.4-0.20.0

Jan-

14

Feb-

14

Mar

-14

Apr-

14

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Households Corporates

Monthly Change in Foreign Exchange Deposits (in billion of US Dollar)

Domestic currency deposits have held up better

-25-20-15-10-505

10152025

Jan-

14

Feb-

14

Mar

-14

Apr-

14

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Households Corporates

Monthly Change in Hryvnia Deposits (in billion UAH)

With high volatility, market access remains difficult

6

8

10

12

14

16

18

20

22

6

8

10

12

14

16

18

20

22

Ukraine 2023 (7.50%)

Ukraine 2015 (6.88%)

Ukraine 2016 (6.25%)

Oct 1

With high volatility, market access remains difficult

0

200

400

600

800

1,000

1,200

1,400

0

200

400

600

800

1,000

1,200

1,400

2011 2012 2013 2014

External Spreads (Basis points)EMBIG: UkraineEMBIG: emerging Europe5-year CDS

1. Extension or worsening in geopolitical tensions– Tensions in the East– Relations with Russia– Gas dispute

2. Financial sector risks3. Program ownership, domestic politics and other

risks4. Financing

Risks are largely on the downside

45

• Continuous assessment of policies and advice • Political timeline (Parliamentary elections)• Some critical discussions expected in

Parliament e.g.:– Anti corruption– 2015 budget (not yet submitted)

• Combined reviews by the end of the year

Next steps

46

• A critical and challenging reform program for Ukraine

• Commitment, program ownership and maintaining the reform momentum will continue to be key

• Support of reforms by the international community also fundamental

• Crisis should be used as a unique opportunity to reform

Conclusions

47

More information atThe IMF Resident Representative Office in Ukraine

Websitehttp://www.imf.org/external/country/UKR/rr/index.htm

Thank you!