Transcript of a Conference Call on the Stand By Arrangement with Ukraine

Washington, D.C.,
May 1, 2014

with Reza Moghadam, Director, European Department,
Nikolay Gueorguiev, Mission Chief for Ukraine, European Department, and
Olga Stankova, Senior Communications Officer, Communications Department

MS. STANKOVA: Hello, everybody. Good morning or good afternoon to you. Thank you for joining us for this conference call. The call will be held by Reza Moghadam, Director of the IMF’s European Department and Nikolay Gueorguiev, Mission Chief for Ukraine, also European Department. The call is on the record and it is under embargo. The embargo will be lifted on the content of the call and the Staff Report at 11:00 a.m. Eastern Standard Time. With this, I will turn to Reza for some opening comments.

MR. MOGHADAM: Good morning to you. I'll be very brief so that we have time to answer your questions. As you know, the IMF Board approved a program for Ukraine yesterday. The total amount of the support package is US$27 billion with about US$17 billion from the Fund. The first disbursement is US$3 billion which will be with Ukraine very shortly.

We believe it is a strong program which addresses the underlying economic weaknesses of Ukraine. It is aimed at correcting imbalances and very importantly, it puts in place many governance and structural reforms in order to strengthen Ukraine's capacity to grow in the medium term.

There are many risks to the program. We have tried to be very candid about those in the staff report that you have, and we have also tried to take actions to mitigate some of these risks to the extent that we can. Let me stop there and just simply ask you to raise any questions so that we can go through the details. Thank you.

QUESTIONER: Okay, thanks for taking my question and I apologize in advance. I haven't read through all of the staff report here in Washington but I was wondering about you mentioning that the program will have to be redesigned if the government loses control over the East. So I was wondering if you could elaborate on that. You know, in what way, what will you do and what does that mean to the East or some of its cities. How do you basically deal with those risks because there's obviously a lot of uncertainty there.

And then just a very small question about the debts to the IMF. How are you dealing with the debts owed by Crimea or how will you calculate that? Is that based on what portion of the GDP it is or the population and will you ask Russia to then take on those debts? Thank you.

MR. MOGHADAM: As you mentioned, the degree of uncertainty is very large so it is not possible to really speculate about how or in what way circumstances could change. The key here is if Ukraine’s government is committed to reform and is committed to address the country’s economic problems. If they are, if they continue to show that commitment and pursue reform, then if the circumstances they face change, in those scenarios you would have to have a combination of adjustment and financing. We will make a judgment if circumstances change.

In terms of the debt of Ukraine to the Fund, as I mentioned to you, the program is for US$17 billion for two years. In 2014-15, Ukraine also has to repay US$5 billion to the IMF. They have been making payments to the Fund for the last two programs that we had with them. They will be perfectly able to meet those obligations and indeed obligations to others, not just the IMF.

QUESTIONER: Okay, so basically Crimea doesn't have to pay any part of it necessarily? You're not -

MR. MOGHADAM: The Fund's program is with the Ukraine government and the Ukraine government is responsible for -- they receive the funds and they are responsible to meet the obligations and they continue to do so. They are repaying us. They have been doing that and there has not been any issue.

QUESTIONER: Hi. I think you just mentioned under the program Ukraine will be able to fulfill its obligations to others including private bond holders. Can you just talk a bit about whether there was any discussion of debt restructuring, particularly since the staff report talks about the fact that one of the reasons people were willing to lend to Ukraine in 2012 and 2013 was the prospect of a Fund agreement. I mean, [(inaudible) horrifically] and doesn't it send the wrong signal?

I hear you talk also about the prospect of this unlocking private investment but obviously many uncertainties around Ukraine are high. That seems like a distance prospect at best.

MR. MOGHADAM: Look, every government around the world relies on private credit. So in that sense it is important to have access to the capital markets and it's important to meet your obligations.

Those are important to have the basis for investment and growth. From the IMF perspective, the question we have to ask before we do any lending: is the debt sustainable? And if we are lending large amounts of money in what we call exceptional access, which is more than 600 percent of quota, then we have to ask the question, is the debt sustainable with a high probability?

There is a very detailed assessment on this issue in the annex of the staff report which looks at debt sustainability. Our conclusion is based on the current numbers, including current obligations, and reasonable assumptions on where Ukraine’s economy and the global economy will go. Our conclusion is that debt -- and we do a lot of sensitivity analysis of looking at scenarios which may occur with a low probability but high impact -- our conclusion is that the debt is sustainable with a high probability right now.

When you have a positive answer to that question, the IMF does not ask for any debt restructuring before it's able to lend. And we expect the country to meet its domestic and external obligations to both the private and public sectors.

QUESTIONER: Hi, and thank you for doing this call. I have two questions. The first one is really a short one actually. I just want to make sure that the amount of the program is 17.1 or 17.01. And my question is could you tell us how much of the program of the (inaudible) assistance will be used by Ukraine to reimburse its debt towards Russia. Thank you.

MR. MOGHADAM: I think the number, the correct number is US$17.01. So about US$17 billion. We lend in SDRs and the total package is 800 percent of quota and the quotas are in SDRs so sometimes the exchange rate affects the decimal points but the number to use is US$17 billion almost exactly.

Related to the answer for the previous question, the program expects that Ukraine meets all its obligations including those to Russia. Now, with Russia obviously, as you know, there is a dispute about arrears and future payments on gas because there's a dispute about gas prices. But what the program does is based on a gas price of US$385 per thousand cubic meters (tcm) and provides the Ukrainian government, the Central Bank, with enough financing to make sure that its reserves remain adequate after meeting its obligations.

So the program is adequate to make sure that arrears to Russia for gas payments are cleared and Ukraine remains current on these payments based on a price of US$385 tcm. Now that price is in dispute. Ukraine believes the price should be lower. Russia believes the price should be higher. We have tried to have a realistic assumption based on prices paid by other countries. And that's US$385 tcm. So that's the basis for the numbers in the staff report.

And if you look at box one of the paper it describes that.

QUESTIONER: Yes, please describe the nature of the reforms that you expect the Ukraine government to undertake.

MR. MOGHADAM: Sure and I think first, we believe a floating exchange rate regime is the appropriate one for Ukraine. As you probably know, they have had a fixed exchange rate regime for a number of years. That has led to depletion of reserves that were used to support that exchange rate because it has not been a market-based one, and also competitiveness has been lost in the past few years.

And so, a flexible exchange rate regime to restore competitiveness is the number one priority. Secondly, obviously, it is important in these circumstances to have a stable financial system. And so, a second plank of the program is doing diagnostics on individual banks and bringing the regulatory system up to international standards to make sure that confidence in the financial system remains high and Ukraine has a sound financial system to support its growth in the future.

The third element is ensuring fiscal sustainability. And here to give you one example, without any measures Ukraine would run a deficit both fiscal and quasi-fiscal (including the state-owned energy company Naftogaz) of over 12 percent of GDP this year without measures. And that's simply not sustainable.

So there -- it's a question of maintaining sound fiscal policy which means adjustment, but the program has a fairly gradual adjustment over the course of the program period -- in structural terms two percent of GDP, so there is adjustment but in a measured way. And one issue which we discussed already, the program envisages reform of the energy sector because it is a drain on the economy, a misallocation of resources and a source of concerns on governance.

And so, the program envisages reform of the energy sector which means basically moving the prices to be more in line with international prices and cost recovery, and also increasing transparency in this sector. And finally, the program envisages a large set of governance reforms to bring, to ensure that the business environment in Ukraine is conducive to growth essentially. An example there is that as a prior action for the program, the government put in place a new procurement law to have clarity and transparency in terms of government operations.

So those are the five key elements.

QUESTIONER: Hi, yes. Some of my questions have been answered. Thanks for taking this call. The five billion in debt that is being -- you're -- the IMF is giving Ukraine five billion to repay IMF debt. Isn't that a type of rescheduling and aren't you just helping Ukraine roll that over? Isn't that a type of restructuring?

Secondly, in terms of the risks to the program you talk about in the Debt Sustainability Analysis that you could see a debt to GDP ratio above the critical value of 70 percent, that would mean, I presume you're saying that in that graph that that debt would become unsustainable in that situation?

MR. MOGHADAM: Okay, first on your question, there are two separate things. One is a program that we are giving Ukraine in support of its reform package. That is the program for US$17 billion over the next two years.

So that is calibrated to ensure that reserves remain adequate, that Ukraine is able to meet its domestic and external repayments. Now, one of those repayments is to the Fund. There are many others and the one to the Fund is US$5 billion.

Now, we are providing US$17 billion, the international community is providing another US$15 billion. And they are -- the Ukrainians pay their obligations including to the Fund and others. And one of those obligations is US$5 billion to the Fund.

So we are providing a net injection into the Ukrainian economy of 12 billion over the next two years in support of their reform. There is no rescheduling. It's just making sure Ukraine can meet its obligations including to private and public sector, including to the Fund. So there are two separate issues.

And we would not have lent if the program was not strong enough, if there were not enough reforms. We have not had a program in the last two years with Ukraine and within the last two years they have repaid their obligations. So as you know, with the Fund's status, countries typically almost universally pay the Fund obligations no matter what. So it would not have been dependent on the program.

In terms of debt sustainability, I think you mentioned the threshold of 70 percent but, you know, there are countries with more than that threshold, above that threshold which we consider sustainable. So there is no magic number, but what is important is the debt dynamics and whether, on reasonable shocks that could happen, that trajectory could become upward sloping and therefore unsustainable.

And as you see in the annex that we have provided, in the case of Ukraine, this is Annex 1 called public debt sustainability analysis. If you look at page 3 of that annex and you see the various scenarios on debt sustainability, you'll see that it's very difficult with typical shocks to put Ukraine's debt on an upward trajectory. The public sector debt right now is fairly low, and the external public sector debt is even lower. So shocks do not put it on an unsustainable path right now. This is our assessment.

QUESTIONER: And does that include the debt owed to Russia via (inaudible) and gas (inaudible)?

MR. MOGHADAM: Yes, it does.

QUESTIONER: So you're assuming that's based on a US$385 dollars per TCM?

MR. MOGHADAM: We are assuming they repay their arrears of course so they are not in debt. The financing that is provided ensures that they can pay them. So that's not an issue in that sense.

They will receive financing and they pay their arrears. So they, too, wash out.

QUESTIONER: But based on a price of US$385 per TCM?

MR. MOGHADAM: That's correct.

QUESTIONER: So if it were higher, then it would change that debt, your debt trajectory?

MR. MOGHADAM: But even if you look at the range of prices that are being discussed, the impact on debt sustainability, you have to have very, very high prices, unrealistic prices. If you look at the prices that other countries pay in Europe, that kind of range is not going to make a big difference to debt sustainability.

QUESTIONER: Okay, thank you.

QUESTIONER: Sure, thanks a lot. I'd like to -- I reviewed the staff report and I'm interested in its issue of Crimea's data being included in Ukraine's. It came up, you know, it's come up before and the report says that staff will take, you know, stock of future developments on this matter. (inaudible) the need of feasibility of presenting Ukraine's data with that of Crimea.

And I wonder if you could like in the current situation with, you know, Ukrainian banks ordered out of Crimea and the lack of connection between the two, would you -- would the IMF say the data should be included today or is it included now because it's kind of historical data? And what's that in terms of including it or not including it going forward?

MR. MOGHADAM: Okay, I think that in the staff report numbers, Crimea is included as part of the Ukrainian numbers. As it happens, Crimea is a small part of Ukraine, some three-to-four percent of GDP, so it would have an effect on the numbers but it is not a significant impact.

QUESTIONER: So and just to understand it, I mean, does the IMF still include, for example, Abhasia in the Georgia numbers?

MR. MOGHADAM: I’m afraid Georgia is in a different department to mine so I cannot give you the answer to that.

QUESTIONER: Okay.

MR. MOGHADAM: But we can check and my colleagues in communications can get back to you.

QUESTIONER: Thank you very much.

MS. STANKOVA: Okay, we just have time for one or two more questions.

QUESTIONER: Thank you. I'm wondering if there's rampant corruption in the ousted government of President Yanukovych. Do you see any changes at all under the interim government to try to correct that and control and obviously eradicate rampant corruption, plundering of public assets and the like?

MR. MOGHADAM: Yes. Let me ask Nikolay, our mission chief, to respond to that.

MR. GUEORGUIEV: Yes. In fact, we already see major progress in the area of tax administration on this issue, admittedly from a low starting point. The government has already broken two major fraudulent tax evasion schemes, one of them collecting VAT and excise refunds on non-existing fuel exports and another scheme involving illegal domestic production of alcohol. We mentioned this in the fiscal section of the staff report. Breaking only these two schemes is expected to bring about 0.4 percent of GDP to the budget in a year.

And we just had a discussion on these issues with the government recently. It seems like in April their efforts not only continue but have brought additional results in VAT and excise collections in particular. Thank you.

MR. MOGHADAM: You will find in the fiscal section which starts on page 17, particularly on pages 18 and 19 of the report some description of this.

MS. STANKOVA: Thank you and have a good day. Embargo is released on the call and on the Staff Report at 11 a.m.



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