Transcript of a Press Conference on Executive Board Approval of the Standby Arrangement for UkraineWith Ceyla Pazarbasioglu, IMF Mission Chief for Ukraine
Mark Flanagan, Deputy Mission Chief for Ukraine
Conny Lotze, Deputy Division Chief, IMF Media Relations
Washington, D.C. Thursday, November 6, 2008
MS. LOTZE: Good day, and welcome to this conference call on Ukraine. I'm Conny Lotze of the External Relations Department, and with me are the IMF's Mission Chief for Ukraine, Ceyla Pazarbasioglu, and the Deputy Mission Chief Mark Flanagan.
As you know, the Executive Board yesterday approved a Stand-By Arrangement for Ukraine for US$16.4 billion and you have seen the press release last night announcing the arrangement and outlining the program. This call today is on the record. Ceyla will make some opening remarks and then we will go to your questions.
MS. PAZARBASIOGLU: Thank you. Good day. As mentioned yesterday, the Executive Board approved the 2-year Stand-By Arrangement for Ukraine. Ukraine is a very open economy and has been hit hard with the global economic slowdown and the financial turmoil. The authorities' program is designed to help stabilize the domestic financial system and to facilitate adjustment of the economy to a large trade shock.
I'd like to first provide some background. Ukraine's economy has grown very rapidly since 2000, expanding more than 7 percent on average. However, by mid-2008, the economy was overheating with rapid credit growth, inflation exceeding 30 percent, very high wage growth, and surging imports. This led to a 7 percent of GDP current account deficit in the second quarter of 2008. At the same time, household and corporate borrowing increased and was mainly in foreign currency. With the sharp decline in commodity prices, especially steel, and the global financial turmoil, this had a considerable impact on the real sector in Ukraine as reflected in the sharp 5 percent contraction of the manufacturing sector in September. After the sixth-largest bank was put under receivership, deposit outflows increased, credit ratings were downgraded, and at the same time, confidence in the country's banking system and currency weakened substantially.
To address all these challenges, the authorities' program is designed to respond flexibly to further economic developments in the coming years. The program is based on projections that assume a global recession and continued deleveraging in international credit markets, implying a sharp slowdown in Ukraine with deteriorating exports. We project an impact on output-a 3 percent decline-which is consistent with Ukraine's experience under similar circumstances in 2004-2005. Inflation is expected to decrease to 17 percent by the end of 2009 from the projected 25 percent this year. The current account is expected to compress to about 2 percent the GDP deficit from the mid-2008 level of 7 percent.
We assume a global recovery in the second half of 2009 and with that the Ukrainian economy could be back at its estimated potential growth rate of about 5 to 6 percent by 2011 with inflation at single digits. Current account deficits are projected to remain small in 2010.
The key policies to achieve the authorities' program are focused in three key areas, and these are fiscal policies, monetary and exchange rate policies, and policies in the financial sector. I'd like to just say a few words on these, starting with fiscal policies. The authorities are adopting a prudent fiscal stance while accounting for the need for recession-related social expenditures including higher funding for unemployment insurance and targeted income support for the poor. Under the program, the deficit is expected not to exceed 1 percent of GDP in 2008 and a balanced budget is expected in 2009, excluding potential bank recapitalization costs. Even with the substantial increase of 0.8 percent of GDP in social spending, these fiscal targets are deemed feasible. To achieve these targets, the authorities are determined to correct the pricing policies in the energy sector and pursue a balanced incomes policy by adjusting the minimum wage and other transfers in line with projected inflation. These measures will help guard against higher inflation as well as help Ukraine with its competitiveness. Ukraine has an adequate social safety net in place to protect the most vulnerable against adjustment policies and the authorities are prepared to expand the social safety net should the need arise.
In terms of monetary and exchange rate policies, the program supports the implementation of a flexible exchange rate regime to absorb the external shocks the country is now facing. Base money will be the near-term anchor for monetary policy until an inflation targeting regime can be implemented in 2010. The program also sees that the independence of the NBU will be strengthened and the near-term monetary policy will be tightened to achieve the inflation objective for 2009 which is 17 percent. The program also envisages the elimination of exchange rate controls as soon as possible and measures to improve the operation of the foreign exchange market including cancelling the foreign exchange transaction tax and a more transparent intervention policy.
The program also has a very strong financial sector policy component. It includes recapitalization of banks to cushion the real economy from a potential credit crunch. The authorities have already resolved the sixth largest bank via sale to a strategic investor yesterday. The program further proposes to ensure that viable banks have access to liquidity. Also the authorities have increased deposit insurance coverage to hryvnia 150,000, about 20,000 euros, from the current level of hryvnia 50,000 which will cover 99 percent of individual accounts. The authorities also see that there will be increased monitoring of banks as well as enhanced cross-border supervisory cooperation. They have also taken measures through the anti-crisis legislation to allow for prompt resolution of banks that are not viable.
So with all these policies, we believe that Ukrainian authorities will be able to address the important challenges that they are facing. As we said before, the road ahead is difficult but Ukraine has enormous potential and should be able to reach it with consistent implementation of comprehensive policies. Thank you.
QUESTIONER: You're actually doing this at the same time with the new WEO, so I don't have much time. What is the worst-case scenario for Ukraine under this program? What's the worst that can happen to the country's economy?
MS. PAZARBASIOGLU: Thank you. We realize the new WEO press conference is in 45 minutes but we thought it would be important to answer questions since the Board meeting already ended yesterday.
The worst-case scenario for Ukraine is obviously if the global conditions continue to deteriorate and that there is further deleveraging in terms of the global financial sector. The authority's program already includes a sharp decline in steel prices. The program has actually incorporates most of the new WEO assumptions except the gas and oil prices are higher in the program compared to the new WEO assumptions. So that actually gives a positive impact going forward in terms of higher growth and lower inflation.
Obviously the key issue to watch for is resolute implementation of this comprehensive program which should build confidence. The key is to balance the adjustment in the exchange rate against the balance sheet mismatches. Many households and corporates have borrowed in foreign currency. It is very important to continue with the prudent fiscal policies and monetary policies and at the same time allow gradual adjustment in the exchange rate.
QUESTIONER: Do you see the possibility of a default?
MS. PAZARBASIOGLU: Do you mean default of private sector external debt?
QUESTIONER: Probably the private sector. Whatever is the most dangerous.
MS. PAZARBASIOGLU: The public-sector debt is low compared to other countries; it is about 10 percent of GDP. The private sector does have large external debt service over the coming years. The authorities have been monitoring these carefully. Some of the external debt is from the banks' parents in European countries and the parent banks seem to be committed to their subsidiaries in Ukraine. In our discussions, we were told that they would be rolling over the credit lines to their subsidiaries.
In terms of the corporate sector, a large part of this external debt is actually intracompany loans and that will depend very much on the strength of corporate balance sheets and how many of these loans are actually the companies' own deposits in offshore accounts. This is a difficult component to know exactly in order to calculate rollover assumptions. But with a comprehensive program, especially with a strong bank recapitalization component, there should be possibilities for refinancing for the real sector.
I should also note that the recapitalization is preemptive. The current conditions show the banking system is adequately capitalized according to the NBU inspections. But going forward as the situation changes, there may be a need for higher capital, and precisely because of that the program has a component of preemptive recapitalization to avoid the spiral of capital crunch, credit crunch, which could lead to the corporate sector not being able to refinance their loans.
QUESTIONER: I was wondering what it means for you personally to put this package together. Are you proud? Is it a good time to work at the Fund?
MS. PAZARBASIOGLU: I should say that it was a pleasure to work with the authorities. They have put together these policies. It's their program and the program will only be successful if they take ownership of the program. At the IMF we are very cognizant of this. We have a very strong team. The deputy of the team is actually here as well to answer some questions together with me. The team worked very hard. The engagement of the authorities was very strong. They have already taken as I said a lot of these policies themselves. As you also know, there was IMF engagement with Ukraine for many years in terms of Article IV consultations, technical assistance missions and so on. So a lot of these policies were actually in train. They are just put in a more comprehensive package and the authorities have shown commitment through the passage through the parliament of their anti-crisis legislation which backed parts of this package. I think it would be wrong to take any personal credit for this. It's the authorities' program and the IMF is supporting this program.
QUESTIONER: I'm wondering how long do you think it will for this program and the funding to have a positive impact on Ukraine's economy? Is this more of a process? Should there be some kind of immediate impact? Also how do you see the recapitalization of banks, that part of the program moving forward? Is it something that's going to take a lot of time? I know in the U.S. it's taken some time to actually figure out what banks take ownership in. So I just wanted to see if you could elaborate on those points.
MS. PAZARBASIOGLU: We do hope that there will be confidence-instilling impact of the authorities' program as it is comprehensive, it is forward looking, and they have taken measures much ahead of the shocks really affecting them fully. So in that sense there should be positive implications. But again it will very much depend on how this is communicated to the outside world and it's going to be much dependent on the measures and the actions the authorities take going forward. As we all know, the global background is not very positive right now. Many of the Western financial institutions are going through a deleveraging process.
In terms of the recapitalization, it is actually a program that the authorities are working on and the World Bank, ourselves, and the EBRD are helping them and supporting them with as much technical assistance as is needed. The recapitalization scheme has a diagnostic component which was actually stipulated in the decree that the Cabinet of Ministers took 2 days ago. The diagnostic component will be followed by discussions with the banks of a business plan on how to recapitalize their banks and they can apply for public funds for recapitalization. The decree and the law also includes measures for resolution of banks which accelerates the procedures and gives the central bank more instruments in terms of purchase and assumption and other tools which allow a much more cost-effective way of resolving banks.
This is a comprehensive package, and as you said, it will not be overnight and it won't be that within 15 days that we see results. But as I mentioned before, this is very much of a preemptive scheme. The banks right now are adequately capitalized. It is more as the conditions deteriorate the real sector slows down, exchange rates adjust and so on, that you would see implications on repayment capacity of borrowers. And the whole idea here is to come up with the capital needed and the policies needed to support borrowers if their repayment capacity deteriorates. There could be some voluntary restructuring of their debt or some refinancing of the corporate and household debt so that the borrowers, as well as the lenders could benefit from this approach. But this will take time. Most likely we will see some results in the first quarter of 2009.
QUESTIONER: Actually, I have two questions. The first is about the currency, the hryvnia. You've talked about allowing a greater flexibility while at the same time some sort of central bank intervention is needed. Have you actually discussed or agreed on the level of the hryvnia to the dollar by the end of the year or in 6 months' time or by the end of next year?
My second question has to do with the next tranche of the loan. Do we know anything about what other conditions might be set for it? How big might it be? When would you start negotiating it? Thank you very much.
MS. PAZARBASIOGLU: Let me start with the second part of your component and I'll ask my colleague Mark to answer the first one. In terms of the program's details, the documentation, the staff report and the details of the program, will be published,over the coming and all these details will be available. The next tranche of the loan will depend very much on the policies that the authorities take. But as I said, I think it would be much more fruitful that you see all the details as we make these available over the coming weeks.
MR. FLANAGAN: In terms of the level the hryvnia, the program as indicated supports a flexible exchange rate regime. We discussed with the authorities international reserve targets. The level of the currency will settle where it will subject to these reserve targets. We have no target in the program for the exchange rate and we expect going forward that it will settle wherever it will depending on the shocks hitting the economy and the policies that are implemented. And we think the policies that are to be implemented will help prevent disorderly market conditions and an orderly adjustment to whatever new level will balance the economy in 2009 and beyond.
QUESTIONER: Can you tell me what the reserve targets are?
MR. FLANAGAN: They will certainly be in the published version of the staff report. I think it's a little difficult to get context here, but essentially over the next five quarters or six quarters, we have targets to net international reserves laid out based on keeping the total gross reserve level close to 70 to 75 percent of gross short-term debt by residual maturity due over the next year. That's perhaps the best way to describe how the targets have been set. The numbers themselves, we'd have to go into a lot of technical detail that would be pretty incomprehensible.
QUESTIONER: Could I please ask you why do you estimate that Ukraine's debt rises so significantly next year?
MS. PAZARBASIOGLU: You mean the debt to GDP ratio, the external debt to GDP?
QUESTIONER: Yes, exactly.
MS. PAZARBASIOGLU: The increase in the external debt ratio in 2009 reflects the inclusion of IMF money in public external debt as well as program assumptions on GDP and exchange rate.
MS. LOTZE: Thank you very much. We will conclude the conference call at this point. We will have a transcript of the conference call a little bit later on posted on the website. As Ceyla mentioned, the documents will be published. We don't know when yet, but when we will know, we will let you know and give you a heads up. So thank you very much. We conclude the conference call here.
IMF EXTERNAL RELATIONS DEPARTMENT
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