IMFSurvey Magazine: Interview
EUROPE’S EMERGING MARKETS
Policy Adjustments Move Ukraine Forward
By Archana Kumar
IMF Survey online
May 8, 2009
- Ukraine program back on track with release of second loan tranche
- Program conditions adjusted to Ukraine's current economic realities
- Despite declining growth in early 2009, some encouraging economic signs visible
Reeling from the impact of the global economic crisis that has depressed demand for its steel and manufacturing exports, Ukraine is poised to receive the second installment of a $16.4 billion IMF loan, designed to buttress the economy against the fallout from the worldwide turmoil.
On May 8, the IMF’s Executive Board approved the first review under the Stand-By Arrangement with Ukraine. IMF Survey online spoke with Ceyla Pazarbasioglu, the head of the IMF mission, about key economic and financial issues facing the country and the risks of problems in Ukraine spilling over into the rest of Europe.
IMF Survey online: Why has the second tranche of the loan to Ukraine been increased to $2.8 billion from the originally planned $1.9 billion?
Pazarbasioglu: We have agreed to rephase the disbursements for the remainder of 2009. Accordingly, the second tranche has been increased to $2.8 billion. There are two reasons to increase this next tranche: first, the government has already made good progress; and, second, the first review was delayed for so long that it only seems fair to partially advance the disbursement originally scheduled under the second review.
IMF Survey online: Have some of the loan “conditions” been revised? For example, in this review you have agreed to a budget deficit, which differs from the earlier requirement of a balanced budget.
Pazarbasioglu: Given the sharp decline in growth and fiscal revenues, a balanced budget is neither feasible nor economically justifiable at this time. So, it makes sense to revise the program’s initial target of a balanced budget, and we agreed with the authorities to a budget deficit of 4 percent of GDP in 2009. From the outset of the economic program last fall, we have been saying that the program may have to be adjusted depending on economic developments and realities. Some flexibility should always be maintained in these arrangements.
But don’t forget that this is a two-way street: the authorities have taken corrective fiscal measures that they are confident will bring in the revenue to meet their fiscal targets, while keeping in mind financing constraints. Given these developments, the IMF and the authorities agreed that it is feasible to adjust the fiscal objective under the program.
IMF Survey online: What steps are being taken to protect vulnerable groups in Ukraine?
Pazarbasioglu: Ukraine has a comprehensive social safety net, including lifeline tariffs for utilities and a well-designed unemployment insurance system, which will protect the most vulnerable groups of the population. One of the reasons for the widening of the fiscal deficit target is to make sure that these programs will receive the funds necessary to function effectively during the crisis. Indeed, social expenditure as a percent of GDP is programmed to increase between 2008 and 2009.
Pazarbasioglu: “There are a number of encouraging signs that Ukraine’s economy has started to adjust to the large economic shocks” (IMF photo)
IMF Survey online: Why is the IMF asking for pension reforms?
Pension Fund expenditures will increase from 15 to 16.5 percent of GDP in Ukraine in 2009, among highest in the world, including compared to OECD countries. As in other countries of the region, under current policies this ratio would further increase in the years ahead reflecting the aging of the population. The Pension Fund revenues will finance about 11 percent of expenditures this year, with the remaining deficit (5.5 percent of GDP) provided as budget support. In this context, the IMF recommended measures to avoid a further deterioration of the finances of the Pension Fund. Some of these measures are designed to boost revenues, and others to bring the increase in pension expenditure to a more sustainable rate. Over the past three years, the average pension has increased by 140 percent, which is much more than inflation. The strong economic growth that made it possible in the past to finance such large increases has reversed, so the goal of the proposed adjustments now is to preserve past gains.
IMF Survey online: Why is part of the loan’s first tranche going to support the budget? Doesn’t the IMF usually only support balance of payments difficulties?
Pazarbasioglu: The objective is to alleviate somewhat the financing constraint on fiscal policy. The Fund's Articles of Agreement are framed sufficiently broadly to allow use of IMF resources for budgetary support. Such use is still subject to the "balance of payments need" test, and in the case of Ukraine the Fund's resources are used to meet the public sector's external obligations, thus freeing up resources to finance other spending, such as pensions and health.
IMF Survey online: What is your assessment of the recent recapitalization of seven Ukrainian banks?
Pazarbasioglu: The decision to recapitalize banks is part of the authorities’ strategy to stabilize and strenghten the banking sector. The National Bank of Ukraine undertook an extensive diagnostic study of the banking industry and, as a result of the first part of this study, which includes the largest and systemically important banks, determined the need to recapitalize some banks. The second part of the diagnostic study, which is an analysis of the remaining group of smaller banks, is almost finalized.
But it is important to remember that other than the seven banks that are being recapitalized, remaining banks in this first group were determined to be sound, and that the depositors of all the banks in this group—insured and uninsured—will be protected. The fact that all depositors of these banks will be protected is important, because the people need to be confident that their money is safe, even with some of the banks undergoing restructuring.
IMF Survey online: What is the IMF’s forecast for the Ukrainian economy in 2009?
Pazarbasioglu: Real GDP in 2009 is likely to decline by significantly more than what was assumed in the economic program agreed last year. We currently project a decline of real GDP by more than 8 percent in 2009, and further downward revisions may be needed if regional and global conditions deteriorate further. However, there are a number of encouraging signs that the economy has started to adjust to the large economic shocks. The exchange rate has undergone a sizable adjustment, the current account deficit has declined significantly, and inflation has fallen more than expected.
IMF Survey online: What is the risk of financial problems in Ukraine spilling over into the rest of Europe?
Pazarbasioglu: Spillover risks run in both directions, including from other European countries into Ukraine. But the risk of contagion stemming from Ukraine cannot be excluded. In particular, foreign banks—mostly from the European Union and Russia—make up about half of the Ukrainian banking system. Many of these banks have been involved in lending in foreign currencies to often unhedged households. In the event of deterioration in economic and financial conditions in Ukraine, the quality of assets would also be affected adversely. This would further affect these banks and have repercussions for their activities in other countries.
IMF Survey online: Do you think that Ukraine will get external financing from multilateral institutions or bilateral sources?
Pazarbasioglu: We support the authorities’ efforts to get additional external financing, and are hopeful that, now that the first review is almost completed, external sources will be accessible. We will reassess the adequacy of external financing in the context of the second review.
IMF Survey online: What is Ukraine’s highest priority now in terms of getting out of the crisis?
Pazarbasioglu: The highest priority now is to restore confidence in the banking system and revive the economy. That can be achieved by implementing prudent fiscal policies, comprehensive banking restructuring, and a flexible exchange rate. The way forward is not easy, but if these priorities are pursued in a determined fashion, we are confident that Ukraine can get through this adjustment period and return to sustainable growth. This crisis is certainly manageable, but progress needs to continue.
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