Public Information Notice: IMF Concludes Article IV Consultation with Ukraine

April 27, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On March 26, 1999, the Executive Board concluded the Article IV consultation with Ukraine1.


For most of 1998, Ukraine continued to make progress toward economic stabilization. Inflation came down and the output decline that had started in 1991 leveled off. The budget deficit was significantly reduced and monetary policy was broadly appropriate. As the external environment worsened in the second half of the year, some of this progress was lost, but Ukraine adjusted its macroeconomic policy toward the end of the year and managed to maintain a measure of financial stability. Nevertheless, for the year as a whole, inflation rose from 10 percent in 1997 to 20 percent and GDP declined by 1.7 percent. Throughout the year, economic developments in Ukraine were adversely affected by the loss of investor’s confidence in emerging market economies following the developments in Southeast Asia and Russia, and there were significant capital outflows from a pull-out of portfolio investors. Overall public finances remained fragile, and there was uneven implementation of structural reforms, although in a number of areas, such as privatization, significant progress was made.

The government undertook a sizable fiscal adjustment in 1998, most in the second half of the year and partly in response to financing shortfalls. The overall cash deficit of the consolidated government was reduced from 5.6 percent of GDP in 1997 to 2.7 percent in 1998. However, the budgetary situation remained difficult. Cash revenues were weaker than expected partly because of the weak economic situation, but also because of delays in implementing some fiscal reforms. In response, expenditures were reduced by nearly 6 percent of GDP relative to 1997, although budgetary arrears on wages, pensions, and social benefits increased somewhat. In the meantime and in response to the tight budget situation, a major restructuring effort was initiated in late-August that allowed the government to restructure most of the treasury-bill debt held by non-residents and some external debt falling due in 1998.

Monetary policy during the second half of 1998 was broadly appropriate, although it was complicated by continuing pressures on the exchange rate resulting from the capital outflows as well as the need to finance the government budget deficit. The NBU raised interest rates on several occasions and limited banks’ liquidity in order to support the hryvnia within the official band. Despite these efforts, official reserves declined sharply. In early September, the NBU introduced a new exchange rate band of Hrv 2.5 to 3.5 per dollar and permitted the hryvnia to depreciate to Hrv 3.4 per U.S. dollar by end-September to safeguard the level of international reserves. The hryvnia was subsequently kept stable at Hrv 3.43 per dollar, but this was achieved mainly through the introduction of administrative measures to control the demand for foreign exchange. Following the introduction of restrictions, a small offshore market for foreign exchange emerged. The exchange market was subsequently liberalized on March 19, 1999.

In 1998, the overall balance of payments in 1998 deteriorated sharply mainly due to the continuous capital outflows and lack of access to new resources. The external trade and current account deficits did not change much relative to 1997, although exports were significantly lower due to the reduction in demand for Ukrainian products, lower international prices for metals, (Ukraine’s principal exports), and disruptions in trade with Russia. At the same time, imports declined due mainly to lower value and volume of energy imports. Despite the difficult situation, the authorities resisted calls for more protectionism and made further progress in liberalizing the trade system.

The Ukrainian authorities continued to implement structural reforms in an effort to improve the business climate. Progress was made in a number of areas, particularly privatization, deregulation, demonopolization, trade reform, and in reducing the size of the public sector. At the same time, reforms in the agricultural and energy sectors advanced more slowly than had been envisaged and many obstacles remain.

Executive Board Assessment

Executive Directors regretted that Ukraine’s adjustment program had gone off track soon after approval of the Extended Arrangement, but at the same time welcomed the authorities’ efforts to maintain relative stability despite severe external shocks. Directors noted that the overall fiscal deficit of the consolidated government had been reduced significantly in 1998, although some budgetary arrears continued to accumulate. Monetary policy was tightened further in the second half of the year to temper the shocks emanating from abroad, although it was loosened somewhat toward the end of the year and pressures on the hryvnia reemerged.

Directors welcomed the progress that has been made on the structural front in a number of areas, notably in reduction of the number of budgetary employees, privatization,demonopolization, and deregulation, but expressed regret that reform in the agricultural and energy sectors had been inadequate and delayed. They also regretted that progress on other measures agreed to at the inception of the program had not been carried out. Directors considered that Ukraine’s economy remained very fragile and will continue to face important fiscal and external constraints. They also noted that the continued friction between parliament and government adds uncertainty to the economic climate and heightens the risks to the authorities’ program. They therefore emphasized the need for the authorities to strengthen their macroeconomic policies and to fully implement their program of structural reform, in order to preserve economic stability and to strengthen the still fragile market mechanisms in Ukraine.

Directors welcomed the steady improvement in cash revenue collection and considered that parliament’s approval of a budget for 1999, including a provision to reduce expenditure commitment, if necessary to achieve their fiscal objective, was a welcome step forward. Directors felt that, given the financial difficulties faced by Ukraine, a stronger fiscal adjustment was necessary to ensure progress toward macroeconomic stability. Accordingly, they supported the authorities’ plans to reduce the fiscal deficit by more than the amount envisaged in the budget. Directors noted that the projected fiscal adjustment was ambitious and would require a determined efforts by the authorities.

Directors were concerned that fiscal structural measures, such as the revisions to the personal income tax, were not in place. They especially regretted the decision to allow a tax moratorium on agriculture, and to continue zero rating of the value-added taxes on electricity, imported gas, and coal. It was noted that those two measures would have a significant negative impact on revenues and make it more difficult to deal with the precarious fiscal situation. They urged the authorities to continue working with parliament to reverse those measures, as well as to reduce tax exemptions and other structural rigidities such as the earmarking of revenues. There is an urgent need to increase cash revenues not only to strengthen the financial position of the state government, but also to improve the transparency of budgetary operations. Directors also stressed the need to improve the composition of expenditures. They further noted that pressures to settle wage and pension arrears could be strong in the period leading to the presidential elections in October, and urged the authorities to clear arrears to the extent possible without undermining the objectives of the EFF-supported program. They underscored that further efforts to strengthen expenditure control and cash management will be vital to ensure this. Directors also stressed that the use of extrabudgetary accounts was not acceptable and urged the authorities to quickly extend treasury control to those accounts and to make every effort to strengthen the treasury.

Directors noted that the monetary and exchange rate policies adopted by the authorities had helped minimize the inflationary impact of the depreciation of the hryvnia and the Russian crisis. With some return of stability, they now welcomed the recent liberalization of the exchange rate system, which should lead to a more transparent determination of the exchange rate and increase confidence. Directors noted that the tightening of monetary policy that preceded this change had been necessary for exchange rate and price stability, and they urged the authorities to stand ready to tighten it further, if necessary. Directors stressed the importance of strengthening the banking supervision department to enhance its capacity tomonitor the implementation of prudential requirements and emphasized that further delays in approving the needed legislation to restructure the banking system should be avoided. They welcomed the authorities’ commitment to bank restructuring and their willingness to work with the Fund and other international institutions to this end.

Several Directors noted that, over the past few months, the authorities had introduced several exchange restrictions subject to Fund jurisdiction under Article VIII of the Articles of Agreement. While a Director acknowledged that, given the weak external reserve position, those measures had helped keep the financial situation under control, other Directors argued that these restrictions had distorted the allocation of foreign exchange. Directors therefore welcomed the reopening of the interbank foreign exchange market, and the elimination of the restrictions on the provision of trade credit and the limitations on the making of payments on loans with interest rates exceeding a certain cap.

Directors noted that while external shocks played an important role in derailing a resumption of economic growth in 1998, a more determined implementation of reforms could have helped to attenuate the impact of these shocks. They urged the authorities to accelerate the implementation of structural reforms, as outlined under the program, in order to promote private sector development and attract foreign investment and financing, which is essential to the achievement of sustainable economic growth. The acceleration of reforms in the energy, coal, and agriculture sectors, a further downsizing in government and rationalization of the public sector, and more progress in deregulation and privatization should be accorded high priority. Directors also stressed the need to proceed with the restructuring of state enterprises in an open and transparent manner. Efforts need to continue to improve governance and transparency, and to fight corruption. Directors encouraged the authorities to continue to cooperate with the World Bank in those areas.

Directors commended the authorities for the restructuring of the bulk of treasury bills held by nonresidents and some external debt that fell due in 1998. At the same time, they noted that Ukraine faces heavy debt-service obligations in the next few years. Accordingly, vigorous implementation of the program will be essential to ensure continued support from international creditors. Even with full implementation of the authorities’ reform program and with support from international financial institutions and other creditors, Ukraine will still face a challenge given the magnitude of debt service obligations in relation to the level of foreign reserves. Accordingly, Directors encouraged the authorities to initiate timely discussions with foreign creditors to ensure that debt service can continue to be paid in a timely and orderly manner.

Ukraine: Selected Economic Indicators

1995 1996 1997 1998

(Changes in percent)
Real economy
Real GDP -12.2 -10.0 -3.0 -1.7
CPI (end-of- period) 181.7 39.7 10.1 20.0
Money and credit
Base money 132.2 38.0 44.6 21.9
Broad money 117.4 35.1 33.9 25.3
Credit to the economy 116.1 ... 28.9 16.7
NBU refinance rate (end of period) 40.0 35.0 82.0 60.0

(In percent of GDP,unless stated otherwise)
Public finance
Revenues 37.8 36.7 38.0 35.2
Expenditures 42.7 40.4 49.6 37.9
General government balance -4.9 -3.2 -5.6 -2.7
Primary balance -3.4 -1.6 -3.8 -0.4
Balance of payments
Current account -4.4 -2.7 -2.7 -1.5
External debt 23.6 21.2 23.8 26.9
Debt service ratio (in percent of exports) 9.3 6.0 9.4 20.2
Gross international reserves
In millions of U.S. dollars 1,134 1,994 2,375 949
In weeks of imports 3.7 4.8 5.6 2.7
Exchange Rate
Exchange rate regime (as of end-1998) Managed floating
Exchange rate (hryvnia per U.S. dollar, end-of-period) 1.794 1.889 1.899 3.427
Real exchange rate against U.S. dollar (Jan. 1994=100; end-of-period) 156.9 202.6 215.7 138.9

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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