Press Release No. 17/112

On April 3, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Ukraine and completed the third review of Ukraine’s economic program under the Extended Fund Facility (see Press Release No. 17/111 ).

Following a severe crisis in 2014–15, the economy is growing again—by 2.3 percent in 2016—and the flexible exchange rate and tight fiscal and monetary policies have greatly reduced internal and external imbalances. The current account deficit fell sharply, from over 9 percent of GDP in 2013 to 3.6 percent of GDP in 2016 and reserves—while still low—have doubled to US$15 billion. The overall fiscal deficit—including the energy sector’s quasi-fiscal losses—which had increased to 10 percent of GDP in 2014—declined to 2.3 percent of GDP in 2016, supported by strong spending control and the decision to raise energy tariffs to market levels. Inflation has fallen steadily from its peak of 61 percent in April 2015 to 12.4 percent by end-2016, well within the target range of the National Bank of Ukraine (NBU).

However, progress in advancing structural reforms has been mixed. While there have been important achievements in the energy and financial sectors, there was limited progress in reforming and privatizing state-owned enterprises, land and pension reforms, and effectively tackling corruption. Moreover, important economic challenges remain. In particular, public debt, projected to increase to close to 90 percent of GDP in 2017, remains high for an emerging market economy; international reserves, while having increased, are still low by any metric; the financial system remains heavily dollarized; non-performing loans have reached a record high; and the public sector is large and inefficient, while pressures to increase public spending loom strong.

In the coming years, the strength and durability of the recovery depend critically upon the pace and depth of structural reforms. Growth will remain at 2 percent in 2017 due to the impact of the blockade in the eastern part of Ukraine, but is expected to reach 3 percent in 2018 as the economy adjusts, and to around 3½–4 percent over the medium term, subject to a major acceleration in critical structural reforms to improve the business environment and attract investment, increase productivity, and increase labor market participation. Inflation is expected to gradually decline to the NBU’s medium-term target of 5 percent in the coming years, as one-off effects subside, monetary policy remains appropriately tight, and confidence strengthens. Reserve adequacy—as measured by the IMF composite index—is expected to be achieved by end-2018. Public debt is projected to drop below 70 percent of GDP by 2021, assuming the successful completion of the debt operation, the preservation of the fiscal consolidation achieved to date, and a gradual pickup of growth.

Executive Board Assessment [2]

Executive Directors commended the authorities’ decisive policy actions in the past two years that have led to a return to growth, a sharp reduction in inflation, an increase in international reserves, and a reduction in imbalances amid a challenging environment. Directors recognized the authorities’ efforts to tackle a number of long-standing weaknesses, including raising gas and heating tariffs, reigning in large budget deficits, cleaning up the banking system, and maintaining a flexible exchange rate. At the same time, some important structural reforms have lagged, while the challenges facing Ukraine remain daunting. Directors underscored the need to consolidate the progress thus far and make faster progress with critical reforms going forward. Directors were reassured by the authorities’ commitment to address increased risks posed by recent developments in the country.

Directors stressed the need to accelerate reforms to improve the business environment and attract investment. They emphasized the need for more progress in privatization, the development of a land market, and the reform of the large state-owned enterprise sector. Directors welcomed the creation of new anticorruption institutions, but strongly urged the authorities to strengthen these institutions further and to establish an independent anticorruption court to achieve concrete results, in order to support the reform program, attract investment, and achieve faster growth. They noted that more rapid progress in these areas is crucial to achieving the program objectives and the stronger growth needed to lift incomes and allow Ukraine to catch up with its regional peers. An acceleration of structural reforms is all the more important in light of recent developments and the increased risks that they represent.

Directors welcomed the remarkable fiscal adjustment over the past couple of years. They emphasized that continued commitment to fiscal consolidation is needed to place the public debt ratio on a steady downward path. They highlighted the importance of structural fiscal reforms to secure medium-term sustainability. They urged the authorities to adopt without further delay a comprehensive pension reform, including to increase the effective retirement age, to address the pension fund’s large deficits and create room for better pensions. They also emphasized the need to contain the wage bill, improve revenue and public administration, and implement health and education reforms.

Directors welcomed the authorities’ decision to nationalize Ukraine’s largest bank to safeguard financial stability. They recommended pursuing all available means to ensure repayment of loans to minimize the cost to taxpayers. Directors underscored the importance of ensuring that all banks meet capital and regulatory requirements to maintain public confidence in the banking system and reinforce banks’ ability to support growth. They also noted the need to address the high levels of nonperforming loans.

Directors agreed that the National Bank of Ukraine’s (NBU) clear policy mandate and independence were key to the impressive progress in containing inflation and rebuilding international reserves in the context of a floating exchange rate regime. They underlined the importance of preserving the NBU’s strong institutional framework. Directors agreed that further relaxation of monetary policy and administrative measures should be contingent upon continued progress in safeguarding financial stability and increasing reserves.

Directors welcomed the substantial international financial and technical support provided to Ukraine. They stressed the importance of continued efforts to reach an agreement on the restructuring of Ukraine’s debt held by Russia in line with program parameters and the Fund’s policy on lending into arrears to official bilateral creditors.