## 1ukrea2019007 - PREFACE ## Source details **Canonical URL:** [1ukrea2019007 - PREFACE](https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019007.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1ukrea2019007.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1ukrea2019007.pdf.json) --- ### Mission and Acknowledgements - A technical assistance mission from the Fiscal Affairs Department (FAD) and Legal Department (LEG) of the International Monetary Fund (IMF) visited Kiev, Ukraine during the period March 22-April 4, 2017. - Mission leader: Miguel Alves (FAD). - Mission experts: Amanda Sayegh (FAD), Alessandro Gullo, Karla Vasquez Suarez (both LEG), Glen Granger, Clemens Mungenast, and Philip Kenworthy (FAD short term experts). - Principal Ukrainian counterparts met: Ministry of Finance (including Mr. Oleksandr Danyliuk, Ms. Oksana Markarova), Ministry of Economic Development and Trade, other ministries and institutions (Education, Health, Infrastructure, Regional Development), Pension Fund of Ukraine, National Bank of Ukraine, Budget Committee of the Verkhovna Rada. - External stakeholders and IMF office support and interpreters listed by name in the source. ### Executive Summary — Key Findings and Recommendations (A–E) - A. Implementing the Medium-term Budget Framework (MTBF) - Findings: - Fiscal policy lacks medium-term orientation; planning is mostly incremental and annual. - Medium-term macroeconomic forecasts exist but are not well integrated with budget planning. - Budget Code requires multi-year projections but has little impact on fiscal discipline. - Strategic, top-down spending envelopes based on a credible fiscal framework are absent. - A pilot MTBF exercise for 2018–20 is underway but largely replicates the annual approach extended to three years. - Pilot MTBF measures recommended for 2018 pilot: - Adopt a fixed overall expenditure ceiling for the State General Fund for 2018 and indicative ceilings for outer years (2019 and 2020). - Adopt indicative ceilings for each Key Spending Unit (KSU) in each year. - Define contingency margins for overall expenditure ceilings and present reconciliations of any changes during successive stages of the 2018 budget cycle. - Further development: - Integrate the Special Fund into the MTBF and present its impact on general government. - Gradually move toward more fixed ceilings for overall and KSU expenditure. - Expand the Budget Declaration scope; develop technical amendments model and forward baseline estimates (FBE) methodology. - B. Strengthening Fiscal Risk Management - Key fiscal risk exposures: - Macroeconomic and geo-political volatility generating substantial volatility in nominal GDP and government revenue. - Government debt highly exposed to exchange rate fluctuations. - Large SOE sector: liabilities of the largest 100 enterprises around 25 percent of GDP; around one-third loss-making in 2015. - Government guarantees of SOE borrowing around 5 percent of GDP with high likelihood of materialization. - Financial sector fiscal costs from bank bailouts and deposit guarantees around 11 percent of GDP over the last four years. - Pension system and ageing population create large and uncertain long-term fiscal costs. - Institutional weaknesses: - Lack of comprehensive fiscal risk management system; fragmented SOE oversight, public guarantees, and asset management frameworks. - Recommended actions: - Strengthen and broaden MoF fiscal risk management mandate; establish comprehensive reporting; prepare and publish an annual Fiscal Risk Statement (FRS); strengthen SOE information base and disclosure; publish sensitivity and debt sustainability analysis. - C. Strengthening Public Investment Management (PIM) - Findings: - Reforms since 2015 improved elements of PIM, but strategic planning remains insufficient for project prioritization. - Significant share of public investment remains outside improved appraisal/selection processes. - Institutional/process reforms: - Establish an Investment Planning Unit under MEDT to develop a national public infrastructure strategy. - Expand MoF role in appraisal/selection, including whole-of-life affordability and fiscal risk assessments. - Develop a single online database for all investment projects; extend appraisal/selection to all major projects. - Propose an independent Strategic Council (advisory) and medium-term public investment plan. - D. Legal Implications - Strengthening MTBF, fiscal risk management, and PIM requires comprehensive legal reforms: - Legally empower MoF to execute monitoring, assessment, and management of fiscal risks. - Enshrine MTBF elements in legislation to grant legal legitimacy and clarify institutional roles. - Strengthen MoF legal mandate to collect information; align budgetary regime and public investment framework; strengthen MoF role in PPP processes. - Complement primary legislation changes with implementing regulations (Cabinet resolutions) for technical flexibility. - E. Action Plan and Timetable (selected items) - Pilot MTBF: Fixed overall expenditure ceiling for 2018 (indicative for outer years); indicative KSU expenditure ceilings — April–December 2017 — Responsible: MoF. - Determine pilot rules: Define margins for budget year and subsequent two years; reconcile changes across budget documents — April–December 2017 through 2018/2019 — Responsible: MoF, KSUs. - Integrate Special Fund and adopt binding overall and KSU ceilings for General and Special Funds for 2019 — 2018 — Responsible: MoF, CMU. - Develop FBE methodology: Develop; run MoF internal test in Autumn 2017; apply for Strategic Budget Document 2019-2021; training to KSUs — April–December 2017 through 2019 — Responsible: MoF, KSUs. - Strengthen MoF fiscal risk mandate; amend Budget Code; transfer oversight of financial/commercial operations from FRMD to supervisory boards — April–December 2017 through 2019/2020 — Responsible: MoF. - Prepare and publish initial FRS; amend BCU to include FRS; expand coverage over time — April–December 2017 through 2019/2020 — Responsible: FRMD, CMU, MoF. - Publish long-term pension cost estimates — 2019/2020 — Responsible: Pension Fund, MoF. ### Debt Management: exposures and disclosure in the FRS - Checklist actions and exposures: - Undertake and publish sensitivity analysis and debt sustainability analysis. - Disclose fiscal risks related to guarantees and loans to SOEs in FRS; add legal claims, financial sector exposures, PPPs, local government, and natural disaster risks. - Strengthen controls on contingent liabilities; restrict foreign currency subnational borrowing to sub-lending. - Establish MoF gateway for PPP risk assessments; develop tracking indicators of fiscal stress for subnationals; require published external audits. - Establish methodology for assessing credit risks of guarantees and charge risk-based fees. - Roles listed: DPD, DLG, BD among responsible entities for measures. ### MTBF prerequisites, design issues, and implementation sequencing - Key context and prerequisites: - PFM Strategy 2017–21 adopted by Cabinet on February 8; law passed March 23 permitting later presentation schedules for Budget Declaration. - Deviations between approved budgets and outturns: averaging around 5 percent of expenditure (state budget) and 20 percent for the special fund. - Forecasts prepared around 10 months before the year; average absolute forecast errors for real GDP growth are 4 percent. - Special Fund represents around 8 percent of total state spending. - Pilot MTBF design notes: - Pilot covers state budget over three years with overall general fund expenditure ceiling and sub-ceilings for KSUs; Special Fund not subject to ceilings in pilot. - Clarify status (fixed or indicative) and legal standing of ceilings; recommend explicit designation. - Suggested sequencing: keep first-year aggregate ceiling fixed; KSU sub-ceilings and outer-year aggregate ceilings indicative. - Use centrally managed margins; international practice margins example: 1 percent in first to 3 percent in third year (see source). - Implementation process improvements: - Introduce top-down assessment of fiscal space and major policy priorities. - Require disclosure of baseline ("no policy change") estimates separately from new policy costs. - MoF should retain negotiation space (“tactical margin”) beyond formal margins. ### Budget Declaration → Fiscal Strategy Statement: content and timeline - Opportunities to expand the Budget Declaration into a Fiscal Strategy Statement: - Add narrative on recent economic context; main fiscal aggregates for state and consolidated budgets; fiscal ratios; fiscal rules in context of macro forecast; optimistic and pessimistic scenarios; note of recent forecast errors; key risks. - Integrate simplified fiscal risk statement focusing on major macro-level risks. - Include MTBF ceilings, rules, margins, technical amendments, reconciliation tables, and performance management information (including gender budgeting statement). - Recommendations for MTBF legal/institutional embedding: - MoF to incorporate MTBF in Budget Code by end-2017; fiscal framework to anchor MTBF; consider combining stock and flow rules and contingency clauses; integrate rules into Budget Declaration for 2020–22. - Steps to depoliticize and professionalize macro forecasts; more timely and independent forecasts before CMU submission. ### Forward Baseline Estimates (FBEs) and budget calendar proposal - Proposed budget calendar highlights: - Feb: Start FBEs; Mar: Macroeconomic projections available; 15. Mar: Baseline estimates available; 30. Mar: Fiscal space determined; 15. Apr: CMU approves overall ceilings; 15. Jun: CMU approves fiscal strategy document; 30. Jun: Verkhovna Rada approves the fiscal strategy document; 31. Jul–31. Aug: MSUs transmit program-level documents and updated FBEs; 15. Sep: CMU approves Budget bill and submits to Verkhovna Rada and President. - FBEs role: - Main technical tool for MTBF; strip temporary effects from past records; MoF and KSUs to develop and refine official FBE models; parameters grounded in secondary legislation; extensive training required. ### Fiscal Risk Management: institutional reforms and FRS development - Institutional gaps: - MoF lacks explicit legal mandate to monitor, assess, and manage fiscal risks; responsibilities dispersed. - FRMD established in 2016 to oversee SOE risks but mandate should be broadened and provided under primary law (Budget Code). - Recommended institutional reforms: - Recommendation 2.1: Amend Budget Code to assign fiscal risk monitoring and assessment responsibility to MoF (end-2017); broaden FRMD mandate; transfer oversight of financial/commercial operations from FRMD to supervisory boards. - Recommendation 2.2: Establish comprehensive reporting framework; update functional responsibilities (March-2018); define information templates (Jan-2018). - FRS development and publication: - Recommendation 2.3: Prepare and publish annual FRS with budget documents; amend Article 38 of Budget Code to require FRS with Budget Declaration (end-2017); define agency responsibilities via CMU resolution (February 2018). - Sequencing: 2017 FRS to focus on SOE and qualitative macro-fiscal risks (June and September 2017); from 2018 expand coverage and include sensitivity/scenario analysis (2019 and 2020 budgets). ### Macroeconomic risk disclosure and illustrative sensitivity analysis - Macroeconomic exposure facts: - Metal and mining account for almost one-third of Ukraine’s exports. - International trade and mineral taxes make up around 10 percent of state budget revenues. - Depreciation over 2014–15 largely drove a 40 percent of GDP increase in general government gross debt. - Nominal GDP growth volatility well above emerging Europe and some CIS peers. - Budget year real GDP forecasts deviate from outcomes by around 4 percentage points on average. - Illustrative sensitivity example (Table 2.3): - Real GDP Forecast (2017–2022): 2.9; 3.1; 3.5; 4.0; 4.0; 4.0. - Real GDP Alternative Scenario (2017–2022): 2.9; -4.0; -3.6; 4.0; 4.0; 4.0. - Increase in Debt (percent of GDP) (2017–2022): 0.0; 11.7; 26.8; 26.0; 24.2; 23.4. - Impact on primary balance (percent of GDP) (2017–2022): 0.0; -1.7; -5.7; 0.0; 0.0; 0.0. - Note: Real GDP shock based on one historical standard deviation in 2018 and 2019; based on IMF staff forecasts prepared for the third review (later updated). ### SOEs: scale, risks, methodology, and disclosure - Scale and performance (end-2015 and 2015 indicators): - Around 3,350 SOEs; around 1,800 generating economic activity. - Top 100 nonfinancial SOEs: total assets around UAH 1.4 trillion (70 percent of GDP); non-equity liabilities around UAH 490 billion (25 percent of GDP). - Four state-owned banks with liabilities worth around 25 percent of GDP. - In 2015, around one-third of SOEs were loss-making; combined losses around 2.9 percent of GDP; sector net loss around 2 percent of GDP; average rate of return around -6 percent. - Detailed 2015 indicators: 15 percent had negative return on assets >10 percent; around one-quarter highly leveraged (debt to equity >1); around one-quarter had negative shareholder equity. - Methodology and improvements: - FRMD draft methodology ranks SOEs into five risk categories based on profitability and leverage; high-risk triggers intense monitoring. - Suggested improvements (Box 2.2): require submission of underlying data, expand foreign currency exposure indicators, add current ratio, move interest coverage ratio to supplement, benchmarking against industry/international rates, replace unreliable self-evaluations with specific risk questions. - Data harmonization and monitoring: - Establish single database (excel-based initially) of SOE financial indicators and state support (March-2018). - Strengthen MoF capacity for financial ratio analysis (end-2017); commence quarterly internal reporting of SOE risks; require high-risk SOEs to prepare action plans (end-2017). - Disclosure recommendations: - Recommendation 2.6: Include preliminary analysis of SOE fiscal risks in Budget Declaration (June 2017); expand to detailed analysis of largest SOEs and contingent liabilities (June 2019); include sensitivity analysis to shocks (June 2020). ### Contingent liabilities, guarantees, and debt-related risks - Debt and guarantees facts: - General government debt around 70 percent of GDP at end-2016. - About three-quarters of debt denominated in foreign currency. - Stock of guaranteed debt at end-2016: UAH 278.9 billion or 12.2 percent of GDP; IMF/NBU-related guarantees comprise around UAH 170 billion or 7.5 percent of GDP. - Stock of guarantees average fiscal cost servicing around 0.7 percent of GDP per year over past five years. - Public debt held by nonresidents about two-thirds. - Small share of debt (around 7 percent) has maturity <1 year; around 30 percent issued in variable interest rate instruments. - Institutional context: - Budget Code Article 18 specifies 60 percent of GDP ceiling on public debt and publicly guaranteed debt (not complied with). - DPD does not currently conduct DSA but interested in developing capacity. - Recommendations: - Include qualitative discussion of main debt exposures in FRS for 2018 Budget (June 2017). - Expand to quantitative sensitivity analysis to exchange/interest rates (June 2018) and debt sustainability analysis along IMF DSA framework (June 2019). - Develop methodology for assessing credit risks of guarantees and amend Budget Code to require risk-based fees (mid-2019). - Disclose guarantees in FRS with stock, servicing costs, fees, recoveries, and descriptions above materiality thresholds. ### Financial sector, deposit guarantee scheme, and explicit liabilities - Deposit Guarantee Fund (DGF) and deposits: - DGF insures deposits up to UAH 200,000 per account holder; government provides back-up funding where required. - Around 80 insolvent banks transferred to DGF; DGF paid out UAH 85 billion to depositors of these banks. - Total volume of deposits guaranteed by scheme around UAH 300 billion (13 percent of GDP). - Total deposits in state-owned Oschadbank around UAH 145 billion (6.4 percent of GDP) guaranteed by government. - Law extending guarantee to Ukreximbank and Privatbank passed by Parliament but not ratified by President. - Interlinkages and concentration: - Almost 90 percent of SOE deposits placed with state-owned banks; these banks finance about two-thirds of SOE borrowing from domestic banking sector. - State-owned banks face concentrated exposure to SOEs. - Financial stability reporting: - NBU publishes bi-annual financial stability reports with diagnostic studies and aggregate stress testing. - Gap: government does not separately report explicit exposures associated with the DGF or deposit guarantees in budget publications. - Fiscal costs of banking sector support: - Fiscal costs of bank bailouts and compensation totaled about 11 percent of GDP over the past four years. - At end-2015, non-equity liabilities of sector about 50 percent of GDP; liabilities of state-owned banks account for around half. ### Subnational governments, PPPs, legal claims, and monitoring - Subnational facts and rules: - Reported liabilities of subnational governments totaled 0.7 percent of GDP at end-2015. - Debt-service costs about 2 percent of local government own-source revenues. - Own-source tax revenues about 30 percent of subnational expenditure; total subnational expenditures around 13 percent of GDP in 2015. - Borrowing rules: local governments limited to 200 percent of forecast local development revenues (400 percent for City of Kiev); Article 74 limits debt servicing to 10 percent of local budgets general fund; State not liable for local government debt. - MoF approval required for borrowing and guarantees, but registry does not report total outstanding amounts; no summary reporting on individual Oblasts/cities. - Recommendations include quarterly monitoring of execution reports and key stress indicators; require annual external financial audits for all Oblasts and cities (end-2018). - PPPs and concessions: - Not a large source of fiscal risk currently; 243 concession agreements at end-2014; only two small projects procured under PPP Law since 2010. - No central database for PPP fiscal commitments; MEDT and State Property Fund registries incomplete. - MoF role limited; fiscal risk assessment methodology exists but not systematically applied. - Recommendation: amend PPP and Concession Laws to establish clear MoF role in budget affordability and fiscal risk assessment (end-2017). - Legal claims: - Repeal of laws establishing social entitlements found unconstitutional; estimated entitlements due around UAH 10 billion (0.4 percent of GDP) with claims of UAH 3.2 billion made. - These amounts not currently factored into fiscal reports; MoF examining financing arrangements. - Disclosure should be careful to avoid prejudicing state position; quantify exposures where determinations already made. ### Public Investment Management: national infrastructure strategy and appraisal - Strategy role and adoption: - National infrastructure strategy should guide all major investment decisions funded or supported publicly (state budget, special funds, local budgets). - Strategy adoption process should allow response/adoption within about 3 months; timeline for delivery 12–18 months with broad consultation. - Investment Planning Unit and Strategic Council: - Recommendation 3.1: set up investment planning unit under MEDT to develop national infrastructure strategy; define mandate and legal basis; establish Strategic Council with majority independent members and robust conflict management. - Resourcing: taskforce of at least 15–20 people with specified skills; MoF to advise on resourcing. - Appraisal and selection reforms: - Strengthen MoF role in appraisal (two-stage fiscal risk and whole-of-life cost assessment) and Interdepartmental Committee process (Recommendation 3.2). - Progressive extension to all major projects (Recommendation 3.4); priority to PPPs/concessions and major SoE projects supported by state-funded loans/equity injections. - Introduce materiality thresholds and differentiated appraisal requirements (Recommendation 3.5): - Indicative thresholds (million UAH): <10m | 10m–30m | >30m with corresponding appraisal and MoF sign-off requirements. - Create single online database for all investment projects irrespective of funding source (Recommendation 3.3). - Strengthen coordination across funding sources including Road Fund, IFI-funded projects, SOE projects. ### Legal reform package (Annex I highlights) - MTBF legal changes: - Repeal Article 33; introduce Fiscal Strategy Document (FSD) with medium-term fiscal framework, macro-fiscal forecasts, expenditure ceilings for General and Special Funds and KSUs, performance management, comprehensive FRS, and adoption/approval procedures (MoF → CMU → Verkhovna Rada timelines). - Define expenditure ceilings legal effects: binding for budget year, indicative for outer years; technical amendment mechanisms and escape clauses. - Transitional provisions for 2019/2020 budget preparation. - Fiscal risk oversight: - Amend Budget Code to assign MoF legal mandate for fiscal risk oversight; require CMU secondary regulation to define roles; grant MoF power to collect information; mandate preparation/publication of FRS with minimum content and timelines. - Amend Article 17 to require risk-based fees for guarantees; restrict subnational foreign currency borrowing; amend PPP and Concession Laws to strengthen MoF role. - PIM legal alignment: - Amend Budget Code, PPP Law, Law on Concessions, Law on Sources of Financing Roads, Law on State Strategic Planning to recognize MoF role in assessing budget affordability and risk management for investment projects regardless of funding source. - Amend Articles 13 and 23 to prohibit reallocation from capital to other expenditure without parliamentary approval. ### Annex IV: Template for Annual Fiscal Risk Statement (FRS) — content outline - 1. Macroeconomic Risks: qualitative discussion; forecast errors; sensitivity analysis on revenue, expenditure, deficit, debt. - 2. Debt Management: main aggregates; exchange rate, interest rate, rollover risks; sensitivity analysis; debt management strategy. - 3. Nonfinancial SOEs: sector size; financial aggregates and indicators; government support; QFAs; contingent liabilities; mitigation measures; Tables 1–3 with specified items. - 4. Guarantees: stock by beneficiary; fiscal costs and fees; description of guarantees above materiality threshold. - 5. PPP Contracts: list of projects; new approvals; cumulative fiscal commitments; gross exposure from guarantees. - 6. Local Governments: total debt and guaranteed debt; financial stress ratios by Oblast and major cities. - 7. Financial Sector: explicit liabilities including DGF; liabilities broken down by state-owned and private banks; past fiscal support; financial soundness indicators. - 8. Natural Disasters: frequency, average costs, fiscal reconstruction costs, mitigation measures. - 9. Long-term Fiscal Pressures: at least 30 year projections for pension entitlements and contributions. - 10. Other Material Fiscal Risks: any other material risks and their potential fiscal impact. - Phased development: 2018 → qualitative disclosures; 2019 → include forecast errors and expanded items; 2020 → include sensitivity, DSA, and fuller coverage per Annex V timelines. *Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019007.pdf* ### PREFACE _________________________________________________________________________________________ 6 ### 1ukrea2019007 - PREFACE ### Mission and Acknowledgements - A technical assistance mission from the Fiscal Affairs Department (FAD) and Legal Department (LEG) of the International Monetary Fund (IMF) visited Kiev, Ukraine during the period March 22-April 4, 2017. - Mission leader: Miguel Alves (FAD). - Mission experts: Amanda Sayegh (FAD), Alessandro Gullo, Karla Vasquez Suarez (both LEG), Glen Granger, Clemens Mungenast, and Philip Kenworthy (FAD short term experts). - Principal Ukrainian counterparts met: - Ministry of Finance: Mr. Oleksandr Danyliuk (Minister of Finance request), Ms. Oksana Markarova (First Deputy Minister of Finance); Mr. Vladimir Lozytsky; Mr. Yuriy Heletiy; Mr. Vasyl Shkurakov; Mr. Andrey Savenko; Ms. Olena Skrypkina; Mr. Olexiy Zhak; Mr. Mikhailo Bosak. - Ministry of Economic Development and Trade: Ms. Olena Diachenko; Ms. Iryna Novikova; Ms. Natalia Gorshkova; Mr. Oleksandr Zadorzhnyi; Ms. Oksana Gryshkevych. - Other ministries and institutions: Ms. Liliia Hrynevych (Education), Mr. Pavlo Kovtonyuk (Health), Dr. Viktor Dovhan (Infrastructure), Mr. Serhiy Sharshov (Regional Development); representatives of the Pension Fund of Ukraine, the National Bank of Ukraine, and members of the Budget Committee of the Verkhovna Rada. - External stakeholders: Ms. Maja Bosnic (Team Leader, Gender Budgeting in Ukraine Project), Ms. Oleksandra Betliy (Institute for Economic Research and Policy Consulting), Mr. Ivan Miklos and Mr. Pavlo Kukhta (Strategic Advisory Group for Support of Ukraine Reforms), World Bank, European Commission. - Mission acknowledgements include IMF office staff support (notably Mr. Ihor Shpak) and interpreters Ms. Oksana Burakovska, Mr. Serhiy Kolesnyk, Ms. Nataliia Sinitsyna. ### Executive Summary — Key Findings and Recommendations A. Implementing the Medium-term Budget Framework (MTBF) - Findings: - Fiscal policy lacks a medium-term orientation; budget planning remains mostly incremental and annual. - Medium-term macroeconomic forecasts exist but are not well integrated with budget planning. - The Budget Code requires multi-year budget projections, but with little impact on fiscal discipline. - Strategic, top-down spending envelopes based on a credible fiscal framework are absent. - A pilot MTBF exercise for 2018–20 is underway with an objective to amend the Budget Code by the end of the year, but its current design largely replicates the annual approach extended to three years. - Pilot MTBF specific measures recommended for the 2018 pilot: - Adopt a fixed overall expenditure ceiling for the State General Fund for 2018 and indicative ceilings for outer years (2019 and 2020). - Adopt indicative ceilings for each Key Spending Unit (KSU) in each year. - Define contingency margins for overall expenditure ceilings and commit to presenting reconciliations of any changes to ceilings during successive stages of the 2018 budget cycle. - Further MTBF development for subsequent years: - Integrate the Special Fund into the MTBF and present its impact on general government. - Gradually move toward more fixed ceilings for overall and KSU expenditure as the system matures. - Expand the scope of the Budget Declaration to encourage a more strategic discussion of fiscal policy, aided by a rules-based fiscal framework and enhanced information. - Develop and implement a technical amendments model specifying clear rules for adjustment of ceilings following macroeconomic changes. - Develop and disseminate a methodology for forward baseline estimates (FBE) to inform MTBF discussions between the Ministry of Finance (MoF) and KSUs. B. Strengthening Fiscal Risk Management - Key fiscal risk exposures: - Macroeconomic and geo-political volatility create substantial volatility in nominal GDP and government revenue. - Government debt is highly exposed to exchange rate fluctuations. - A large and poorly performing State-owned Enterprise (SOE) sector: liabilities of the largest 100 enterprises are around 25 percent of GDP, and around one-third of these were loss-making in 2015. - Government guarantees of SOE borrowing amount to around 5 percent of GDP and have a high likelihood of materializing. - The financial sector has generated significant fiscal risk, with fiscal cost of bank bailouts and deposit guarantees amounting to around 11 percent of GDP over the last four years. - Pension system and ageing population create large and uncertain long-term fiscal costs. - Institutional and information weaknesses: - Lack of a comprehensive fiscal risk management system reduces budget credibility, debt sustainability, and efficient allocation of resources. - Fragmented and inadequate frameworks for SOE oversight, public guarantees, and asset management. - Recommended actions: - Strengthen and broaden the fiscal risk management mandate of the MoF, including development of fiscal risk control and mitigation policies. - Establish a comprehensive reporting framework for fiscal risk management; update functional responsibilities of government departments and establish templates for exchange of information. - Prepare and publish an annual Fiscal Risk Statement (FRS) as part of budget documentation, initially focusing on SOE and macroeconomic risks and expanding coverage and methods over time. - Strengthen analysis and disclosure of macroeconomic risks, publish qualitative discussions of macro-fiscal risks, publish assessments of past forecast errors, and undertake macro-fiscal sensitivity analysis. - Strengthen the information base and capacity to assess SOE fiscal risks: approve methodology for SOE risk assessment, build capacity for financial ratio analysis, commence quarterly internal reporting of SOE risks, and establish a single central database (excel-based initially) of SOE financial indicators and state support. - Enhance disclosure of SOE fiscal risks in the FRS, adding analysis of high-risk SOEs and contingent liabilities. C. Strengthening Public Investment Management (PIM) - Findings: - Reforms since 2015 have improved elements of PIM, but strategic planning remains unfit for purpose and does not facilitate prioritization of capital investment projects. - A significant share of public investment remains outside the improved appraisal and selection process, including intergovernmental coordination mechanisms. - Recommended institutional and process reforms: - Establish an Investment Planning Unit under the Ministry of Economic Development and Trade (MEDT) responsible for developing a national public infrastructure strategy integrating sectoral plans and public investment priorities. - Expand the role of the MoF in appraisal and selection, particularly regarding “whole-of-life” budget affordability assessments and fiscal risk evaluations. - Develop and implement a single online database of information (including costs) for all investment projects, irrespective of funding source. - Gradually extend the new project appraisal and selection process to all major investment projects, irrespective of funding source, considering materiality and fiscal risks. - Government’s PFM strategy proposes establishing an independent Strategic Council (advisory) and developing strategic sectoral plans and a medium-term public investment plan. D. Legal Implications - Strengthening MTBF, fiscal risk management, and PIM requires comprehensive legal reforms: - Empower the MoF legally to effectively execute functions (monitoring, assessing, managing fiscal risks). - Enshrine MTBF elements in legislation to grant legal legitimacy, strengthen credibility, and clarify institutional roles of legislative and executive branches. - Strengthen the legal mandate of the MoF to collect information necessary for fiscal risk analysis. - Improve integration between the budgetary regime and public investment framework; strengthen MoF role in PPP processes. - Changes to primary legislation should be accompanied by implementing regulations (Cabinet resolutions) for technical flexibility and collegial decision-making with line ministries. E. Action Plan and Timetable (Table 0.1 Highlights) - The report maps recommendations to an action plan with timelines including April–December 2017, 2018, and 2019/2020, and identifies responsible entities (MoF, CMU, KSUs, FRMD, BD, MEDT, Pension Fund). - Selected items with exact timing or milestones as specified: - Pilot MTBF: Fixed overall expenditure ceiling for 2018 (indicative for outer years); indicative KSU expenditure ceilings for the General Fund for each year — April–December 2017 — Responsible: MoF. - Determine rules of the pilot: Define margins for the budget year and subsequent two years; reconcile changes for draft budget, Fiscal Strategy Document triennium 2019-2021, and final accounts — April–December 2017 through 2018/2019 — Responsible: MoF, KSUs. - Integrate the Special Fund into the MTBF and adopt binding overall and KSU expenditure ceilings for the General and Special Funds for 2019 — 2018 — Responsible: MoF, CMU. - Develop a forward-baseline-estimates methodology: Develop methodology; run MoF internal test in Autumn 2017; apply for Strategic Budget Document 2019-2021 and provide training to KSUs — April–December 2017 through 2019 — Responsible: MoF, KSUs. - Strengthen and broaden MoF fiscal risk mandate; amend Budget Code of Ukraine (BCU) to incorporate fiscal risk functions; transfer oversight of financial and commercial operations from FRMD to supervisory boards as established — April–December 2017 through 2019/2020 — Responsible: MoF. - Prepare and publish initial Fiscal Risk Statement; amend BCU to include FRS; expand FRS coverage and depth over time — April–December 2017 through 2019/2020 — Responsible: FRMD, CMU, MoF. - Publish long-term estimates of pension costs — 2019/2020 — Responsible: Pension Fund, MoF. *Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019007.pdf* ### 2.8 Debt Management Discuss main exposures in FRS ### 2.8 Debt Management Discuss main exposures in FRS ### Debt management exposures and fiscal risk disclosure (from checklist) - Undertake and publish sensitivity analysis. - Undertake and publish debt sustainability analysis. - DPD (listed as action/responsibility). - Disclose fiscal risks related to guarantees and loans to SOEs in FRS. - Add legal claims, financial sector exposures, PPPs, local government to FRS. - Add natural disaster risks (See table 2.2). - Strengthen controls on, and management, of contingent liabilities. - Restrict foreign currency subnational borrowing to sub-lending. - Establish gateway for MoF in risk assessments for PPPs. - Develop tracking indicators of fiscal stress for subnationals and require published external audits. - Establish methodology for assessing credit risks of guarantees and charge risk-based fees. - DPD, DLG, BD (listed as responsible entities for some measures). ### Roles and sequencing (from checklist) - Strengthening Public Investment Management: actions link to MEDT, MoF, CMU responsibilities in subsequent sections. - Specific sequencing in public investment area (see Section 3.x items in source). *Italic: Source: 1ukrea2019007 - 2.8 Debt Management Discuss main exposures in FRS* ### Key findings on MTBF prerequisites and context (excerpts relevant to fiscal discipline and risk) - The budget reform agenda in Ukraine has been primarily determined by external drivers, including IMF programs and the EU-Ukraine Association Agreement. - A PFM Strategy 2017–21 was adopted by the Cabinet of Ministers of Ukraine on February 8; a law was passed by the Verkhovna Rada on March 23 permitting presentation of a detailed forecast of the state budget for 2018 and 2019 and a draft Budget Declaration for 2018–20 by June 1 (instead of April 1). - Progress since earlier TA missions (2011, 2012, 2014) has been limited; recommendations on cash management, expenditure controls, and fiscal oversight of SOEs were outlined but implementation has been limited. ### Assessment of prerequisites for an effective MTBF (findings and statistics) - Credible annual budgets: - Deviations between Budget plans approved by Verkhovna Rada and reported outturns have been significant, averaging around 5 percent of expenditure in absolute terms for the state budget and 20 percent for the special fund. - Prudent macroeconomic projections: - Forecasts are prepared around 10 months before the year to which they apply and are hampered by a lengthy consultation period of 3 months with Line Ministries. - The average absolute forecast errors for real GDP growth are 4 percent. - Medium-term fiscal framework: - The budget law sets a quantitative target for gross debt as a share of GDP, but operational rules and objectives for fiscal policy have not been developed. - The IMF Extended Fund Facility program provides for annual deficit targets for the general government deficit. - Unified comprehensive budget process: - State budget expenditures (including transfers to local budgets and social security funds) represented about two-thirds of general government activity in 2015. - The special fund currently represents around 8 percent of total state spending. ### Implementation strategy recommendations for MTBF (measured approach) - Adopt a measured implementation strategy comprising three elements: - Continued development of prerequisites for a successful MTBF, progressively closing gaps identified in the PFM strategy. - Deliver a 2018–20 MTBF tailored to Ukraine’s current circumstances; design a specific framework for dealing with macroeconomic volatility (see Section D in source). - From 2019 onwards, progressively refine modalities for control and flexibility within the MTBF to build sophistication and a “ratchet effect” on budget discipline. ### Pilot MTBF 2018–20: design and implementation issues - Pilot design: - Covers the state budget over a three-year period with an overall general fund expenditure ceiling and sub-ceilings for KSUs; rolling MTBF updates presumed thereafter. - The special fund (around 8 percent of state spending) will not be subject to ceilings in the pilot, given its non-discretionary nature. - The MoF has not set an approach for expenditure margins or a methodology to reconcile changes between the MTBF and adopted annual budgets. - Nature of ceilings: - Status (fixed or indicative) and legal standing of overall and KSU expenditure ceilings have not been determined; clarity is required for credibility. - Recommendation: Make explicit whether ceilings are fixed or indicative and for what time period. - Scope and sequencing: - A three-year rolling framework and limited scope to the general fund are reasonable initial steps. - Overambitious commitments can undermine credibility; consider differentiated seniority for ceilings: keep first-year aggregate ceiling fixed, KSU sub-ceilings and outer-year aggregate ceilings could be indicative. - Use of margins: - Margins should account for future policy uncertainty and macroeconomic-driven adjustments. - International practice example: margins ranging from 1 percent in the first to 3 percent in the third year are common. - As a rule, margins should be centrally managed and not distributed ex ante to KSUs. ### Pilot implementation process issues and recommended adaptations - Current pilot approach largely replicates the existing annual budget process extended over three years: - MoF requested three-year spending plans and policy priority statements with KPIs from KSUs. - The process does not require disclosure of baseline ("no policy change") estimates separately from costs of new policies, nor does it change the standard budget preparation process from June onward. - Strategic prioritization: - The pilot contains little time or scope for a strategic prioritization phase and is largely bottom-up. - Recommendation: Introduce a top-down assessment of fiscal space and major policy priorities to enable strategic decisions on consolidation versus prioritization. - Negotiation tactics: - Negotiation of KSU ceilings should aim to defend the overall ceiling; enhance focus on outcomes rather than inputs. - MoF should retain negotiation space beyond a formal margin (a “tactical margin”) to avoid early exhaustion of available resources during negotiation. ### Templates and tools referenced - Template for reconciliation of consecutive vintages of ceilings (showing rows for Ceiling restricted expenditure, “Technical” amendments, New Policy Decisions, Changes in Volume, Other, Ceiling restricted expenditure (draft budget), Margin (draft budget), Ceiling). - KSU-level reconciliation table (columns: Ceiling (budget), “Technical” amendments, Policy, Volume, Other, Outturn). *Italic: Source: 1ukrea2019007 - 2.8 Debt Management Discuss main exposures in FRS* ### 17. The Budget Declaration that includes the pilot MTBF also presents an opportunity ### 17. The Budget Declaration that includes the pilot MTBF also presents an opportunity to improve wider fiscal disclosure ### Key observations and opportunities - The Budget Declaration that includes the pilot MTBF could be enhanced by adding narrative explaining recent economic context, main fiscal aggregates for the state and consolidated budgets, fiscal ratios and other key statistics. - A simplified fiscal risk statement focusing on major macro-level risks could be integrated (see Annex IV for a template referenced in the source). - A strategic document outlining the key tenets of the Government’s fiscal policy and providing enhanced context and transparency could replace the existing Budget Declaration. Examples of additional useful information include: - Explanation of recent economic context. - Addition of main fiscal aggregates for state and consolidated budget and general government, fiscal ratios and other key statistics. - Presentation of fiscal rules in the context of the macro-economic forecast. - Optimistic and pessimistic economic scenarios. - Note of recent forecast errors. - Key risks to the economic outlook. ### Recommendations (pilot MTBF design and rules) - Recommendation 1.1. Define the nature of ceilings in the pilot exercise, with a view to preparing for the implementation of a fully-fledged MTBF, as follows: - A fixed overall expenditure ceiling for the State General Fund for 2018 and indicative overall ceilings in 2019 and 2020. - Indicative ceilings for KSU expenditure for 2018, 2019, and 2020. - Recommendation 1.2. Determine the rules of the pilot concerning General Fund expenditure: define margins for the budget year and the subsequent two years—growing into outer years—and commit to presenting a reconciliation of any changes at each stage of the budget cycle (the draft budget 2018, the finally approved budget 2018, the Budget Declaration 2019 and the outturn for 2018). ### Developing the Medium-Term Budget Framework (MTBF): design, legal and institutional issues - The MoF plans to incorporate a fully-fledged MTBF in the Budget Code by end-2017, building on lessons from the pilot. Key clarifications needed for an effective MTBF include: - A fiscal framework that firmly anchors the MTBF in broader fiscal policy and determines the trajectory of the public finances. - Reconsideration of design features of the MTBF to build on the pilot for increasing specificity and control over time. - Focus on capacity building and mainstreaming new processes to ensure implementability of rules. - Legal reforms are required to embed medium-term budgeting in Ukraine’s budgetary framework. The Budget Code should be revised to reflect the MTBF innovation and provide legal underpinnings to build credibility and legitimacy. - Certain features of Ukraine’s legal system pose challenges: there is no hierarchy in legislative acts of the Parliament, so the Budget Code and the annual budget law have the same ranking. In the absence of constitutional constraints, provisions of the Budget Code (or of the law approving the MTBF) could in principle be superseded by annual budget laws or other laws enacted by Parliament. ### Basic fiscal framework and fiscal rules - In the near future, fiscal targets in the IMF program can act as a surrogate fiscal framework, but Ukraine will require its own fiscal rules in due course. - The MoF should consider, in light of broader economic circumstances, fiscal risks, demographic projections, etc., what combination of stock and flow rules, and contingency clauses will best promote long-term stability. - Ukraine could consider adopting additional operational fiscal rules to complement the existing debt ceiling set in the BCU, and over time align rules with EU fiscal convergence criteria for accession countries in light of the EU-Association Agreement. - Once decided, rules could be integrated into the Budget declaration for 2020–22, to be adopted by the CMU and Verkhovna Rada. - More timely and independent macroeconomic forecasts are needed before submission to CMU. Current practice: the budget declaration utilizes economic projections from February of the year preceding the budget. The requirement to consult KSUs on final macroeconomic forecasts is considered unnecessary; steps to depoliticize and professionalize these forecasts, including independent scrutiny, would be beneficial. - Scrutiny of key macroeconomic and revenue forecasts by competent institutions is a quickly achievable reform that would materially benefit the budgeting process. ### Box 1.4 — Developing the Budget Declaration to a Fiscal Strategy Statement - Current Information: - Macroeconomic forecast and main objectives of fiscal policy (deficit and debt), key fiscal indicators (for budget year plus two). - Priorities of fiscal policies and focus points for draft bill. - Additional Information: - Explain recent economic context. - Add main fiscal aggregates for state and consolidated budget and general government, fiscal ratios and other key statistics. - Present fiscal rules in the context of the macro-economic forecast. - Optimistic and pessimistic economic scenarios. - Note of recent forecast errors. - Key risks to the economic outlook. - MTBF: - Ceilings: overall and KSUs. - Rules of the MTBF, margins, technical amendments etc. - Reconciliation tables and justification of changes to the ceilings. - Performance Management: - Strategic goals and outcomes of KSUs. - Gender budgeting statement. - Fiscal Risk Statement (see Chapter 2). ### Performance budgeting and gender-responsive budgeting - There are significant ongoing efforts to strengthen performance-oriented program budgeting to improve strategic resource allocation and value for money. - The authorities are implementing reforms to strengthen outcome-oriented budgeting, with support from international donors, including an extensive project of gender responsive budgeting. - Box 1.5 — Gender Responsive Budgeting in Ukraine (summary): - The Ministry of Finance initiated gender-based budgeting in 2014 with the "Gender Budgeting in Ukraine" project (2014–18) funded by SIDA. - The CMU approved an updated 2017–20 PFM reform strategy including integration of a gender-based approach to budgeting, and definition of performance indicators to increase efficiency and quality of public services for social groups, including gender groups. - Current results: four pilot ministries (Ministry of Youth and Sports, Ministry of Social Policy, Ministry of Education, Ministry of Health) examined two budget programs and prepared recommendations on inclusion of gender indicators in budget documents; analysis showed the system of statistical indicators needs improved data disaggregation by gender. - Next steps: MoF, with project support, is developing guidance on gender-based budgeting for key spending units and plans workshops to present recommendations. ### MTBF coverage, Special Fund treatment, and ceilings - A fully-fledged MTBF should aim for maximum feasible coverage; the exclusion of the State Special Fund should be avoided because: - It creates unhelpful incentives and distortions in prioritization. - It encourages lobbying for greater earmarking and pushes expenditure outside budget ceilings. - Earmarking allows over-performance in revenue categories to be spent without regard to under-performance elsewhere, increasing pressure on other expenditure adjustments. - Moving to an MTBF that subjects the Special Fund to ceilings will require accommodating budget carry-overs within the framework. Options include margins and/or ceiling design; internalizing carry-overs within margins is preferable for fiscal discipline and transparency. - The relatively small margins typically included in MTBFs are too limited to accommodate the scale of fluctuations observed in the Special Fund in recent years (referenced Figure 1.1., panel b). - Consider progressively reducing the size of the Special Fund and revenue earmarking, up to and including discontinuing the Special Fund, to limit fluctuations. - Integration of a general government perspective is important to enrich macro-fiscal discussions; the MTBF should augment state budget information with a whole-of-government perspective, particularly given recent fiscal devolution and agreed general government deficit targets in the IMF program. ### Ceilings, credibility, legal status and escape clauses - Key MTBF design questions: - What is the appropriate mix of fixed versus indicative ceilings to balance constraint and credibility? - How to make the system adaptive to exogenous volatility and endogenous unpredictability from reforms and capacity issues? - Credibility of expenditure ceilings builds over time by fulfilling commitments. There is scope to progressively increase the degree to which ceilings are fixed as credibility is established. - Following integration of the Special Fund, overall ceilings for the General and Special Funds and corresponding ceilings for KSUs will be required (referenced Figure 1.2. for phased evolution). - An escape clause should be designed to ensure the MTBF does not inhibit an effective government response in force majeure. - After a transitional period, consideration should be given to having the Verkhovna Rada approve fixed ceilings as a law (instead of CMU resolution) to give ceilings legal status equal to the annual budget law, clarify institutional roles, and foster transparency and accountability. Legal technicalities (timing and procedures) would need careful consideration. ### Mechanism to deal with macroeconomic volatility and technical amendments - Recent macroeconomic volatility may compromise MTBF integrity unless predetermined rules to accommodate macroeconomic fluctuations are embedded in the framework. - A technical amendments model can be developed to specify which macroeconomic indicators are allowed (fully or partly) to change budget allocations, feeding through to higher or lower ceilings. All budgets would be considered fixed in policy terms but free to take on predetermined “technical” adjustments. - An alternative is to define a specific category of variable expenditures that are “indicator driven” (e.g., unemployment benefits, indexed pensions), while other spending remains fixed and can only be amended through policy choices. This alternative is noted as inappropriate for Ukraine because the category of indicator-driven policies is not reasonably narrow. - Box 1.6 — Illustrative Example of a Simple Technical Amendments Model: two expenditure categories—wages and goods and services—are adjusted for a new inflation forecast, feeding into a higher KSU ceiling. Key macroeconomic indicators (inflation, interest rates, energy prices, exchange rates) can be independent variables of the model; the degree to which those indicators are permitted to feed into ceilings needs to be determined by analysis. ### MTBF margin rules and sophistication over time - Once the MTBF matures, the approach to the margin can become more sophisticated with rules-based restrictions on usage. - Initially it may be hard to defend maintaining a margin throughout budget execution, but once established, rules can govern when KSUs can access the margin (e.g., only for amendments not specified by the technical amendment framework that are unavoidable, unforeseeable, and urgent). ### Implementation: cycle, roles, and MoF responsibilities - Implementing an MTBF involves embedding a yearly cycle of: - Strategic prioritization phase: use forward baseline estimates (FBEs) to calibrate policy consistency with fiscal targets, determine top-down budgets, and inform negotiations with KSUs. - Iterative implementation phase: after MTBF publication, assess whether KSUs are on track to deliver policies on budget and in compliance with the MTBF; requires close collaboration to track developments, challenge plans, and re-baseline programs. - Special emphasis on large-scale capital investment plans, which are multi-year and have uneven spending profiles; reassessment should lead to reprioritization if KSUs are over-spending to maintain compliance. - The MTBF strengthens the role of the MoF as gatekeeper of public finances: new KSU policies with spending implications must have medium-term impacts costed for MTBF integration. - The legal framework requires draft laws be subject to an assessment of impact on the public finances based on a methodology developed by the MoF; this requirement should be operationalized and strict impact assessments enforced for draft bills from members of the Verkhovna Rada or KSUs. *Source: 1ukrea2019007 - 17. The Budget Declaration that includes the pilot MTBF also presents an opportunity (PDF chapter).* ### 39. Introducing a meaningful strategic phase for the MTBF requires a new budget ### Introducing a meaningful strategic phase for the MTBF requires a new budget ### Proposal for Budget Calendar (Box 1.7) - Feb: Start forward baseline estimate process (prepared by MoF, implemented with LM) - Mar: Macroeconomic projections available - 15. Mar: Baseline estimates available - 30. Mar: Fiscal space determined - 15. Apr: CMU approves overall ceilings according to fiscal framework and consolidation requirements/use of fiscal space: MoF sends out draft ceilings to MSUs - 15. May: MSUs transmit information to MoF; macroeconomic projections update available - Mid-May till mid-Jun: Intensive negotiation phase between MSUs and MoF about ceilings and fiscal measures to comply to theses; integration of macro-economic update - 15. Jun: CMU approves fiscal strategy document - 30. Jun: Verkhovna Rada approves the fiscal strategy document: MoF sends ceilings to MSUs - 31. Jul: MSUs transmit documents on program level within ceilings and proposal for measures to comply to the ceilings; MoF starts 2nd Forward baseline estimate exercise with focus on these measures and updates; Updated macroeconomic projections available - 31. Aug: New baseline estimates available - 15. Sep: CMU approves the Budget bill and submits it along with relevant materials to the Verkhovna Rada and the President of Ukraine ### Forward Baseline Estimates (FBEs): role and implementation - FBEs are the main technical tool for running an MTBF and crucial to both the strategic and the implementation phase of the medium-term budget cycle. - FBEs are the building block through which the government assesses whether medium-term fiscal plans are feasible in their current state or require reform. - FBEs allow MoF and KSUs to strip temporary effects (e.g., one-time spending items due to court decisions or the sale of assets) out of past records to reflect underlying sustainability. Implementation challenges and needs: - The MoF, in collaboration with KSUs, must develop an official model (or series of models) to forecast key lines of spending under current policies. - Models can start relatively simple and be refined over time by adding or flexing variables based on revealed predictive power ex post. - Practical implementation requires extensive training of government officials in FBE modelling. - The official model and its key parameters should be grounded in secondary legislation. ### Recommendations to improve MTBF design and credibility (Recommendations 1.3–1.6) - Recommendation 1.3. Improve the design of the MTBF, by: - Integrating the special fund of the state budget into the MTBF. - Introducing overall ceilings for the General Fund and the Special Fund of the state budget as well as KSUs ceilings for 2019 and commit to progressively fixing both the overall and KSU ceilings, excepting technical amendments or the triggering of an escape clause, for budget formulation and execution in the budget year while retaining their indicative status for all ceilings the two following years. - Recommendation 1.4. Support the credibility and transparency of the MTBF, by: - Expanding the scope of the Budget Declaration, to induce a more strategic discussion of fiscal policy. - Basing it on more timely and independent macro-economic forecasts. - Limiting overspending of the Special Fund and reducing the amount of earmarking revenues in the state budget. - Approving the fixed ceilings (included in the Budget Declaration) as a law enacted by the Verkhovna Rada, from 2020 onwards. - Developing and implementing a technical amendments model with rules that define how specific ceilings can be adjusted when new macroeconomic projections are adopted by the Government. - Providing for appropriate margins, and the reconciliation of changes to ceilings throughout the whole budget cycle. - Presenting the state MTBF in a general government perspective in an annex to the “Strategic Budget Document.” - Recommendation 1.5. Develop a forward-baseline-estimates methodology in the MoF. Test it in Autumn 2017 with a view to introducing it for the preparation of the Strategic Budget Document 2019–21. Provide training on the FBE methodology to KSUs. - Recommendation 1.6. Revise the Budget Code to include the fundamental features of the MTBF, delegating authority to regulate specific aspects in subsidiary regulations to the CMU and the MoF. - The law would need to include key elements required in MTBF, such as preparation and adoption of the multi-year forecast and the fiscal strategy document, and a revised budget calendar that would take into account the interaction between the MTBF and the annual budget laws, including for the purposes of the margin and the reconciliation processes. - Retain flexibility by leaving the decision on a number of technical details to CMU resolutions, such as with respect to margins and reconciliation. ### Strengthening fiscal risk management — Background and key findings - Ukraine’s public finances are exposed to several important fiscal risks: macroeconomic and geo-political risks; government guarantees of borrowing of state-owned enterprises (SOEs) and other exposures from the SOE sector, which is loss-making overall; local government and public private partnerships (PPPs) to a lesser extent; and the financial sector (failure of a large number of banks with deposits backed by government guarantee). - Disclosure of fiscal risks is limited and fragmented; frameworks for their management are underdeveloped. - The budget includes information on some fiscal risks (guaranteed debt of SOEs and partial disclosure of quasi-fiscal activities), but there is no disclosure of risks from macroeconomic shocks, public debt, or the financial sector. - Public debt to GDP in Ukraine is around 70 percent of GDP. - Table 2.1 (summary of disclosures and importance): - Macroeconomic — Not reported — High - State-owned Enterprises — Partially reported in monitoring reports on the top 100 SOEs and annual budget — High - Guarantees — Reported on MoF website — Medium - Public-Private Partnerships — Not reported — Low - Financial Sector Exposure — Partially reported in Financial Stability Report — High - Public Debt Exposures — Debt liabilities disclosed, but risks not reported — High - Local government — Reported in execution reports and government finance statistics — Low - Natural Disasters — Not reported — Medium - Legal claims — Not reported — Medium ### Institutional arrangements: gaps and actions - The MoF does not have an explicit legal mandate to monitor, assess, and manage risks to public finances; responsibilities are dispersed across departments and agencies. - The Fiscal Risk Management Division (FRMD) was established in 2016 with a mandate to oversee SOE risks, but its mandate should be reconsidered due to fragmented SOE ownership and oversight. - The FRMD’s responsibilities currently include monitoring SOE financial performance, analyzing fiscal risks associated with the sector, and providing recommendations. It was also given responsibility for overseeing and improving efficiency of financial and commercial operations of large SOEs and natural monopolies — a function that risks undermining SOE governance reforms. - Legal basis issues: - FRMD’s mandate is established by a ministerial order (Order of the Ministry of Finance of Ukraine, No. 377 of 2016) and complemented by CMU Resolution No. 662 of 2015 and subsequent amendments in CMU Resolution 820 of 2016. - The authority may not be sufficient; the mandate should be provided under the primary law, in the Budget Code. - Authorities are preparing draft amendments conferring MoF a fiscal risk oversight mandate with respect to SOEs, but a broad mandate covering all material fiscal risks is appropriate under the Budget Code. Box 2.1 legal points (summary): - Fiscal risk oversight should be underpinned by a legal framework covering monitoring, analysis, and disclosure. - Legal mandate, powers to collect information, and a legal basis for disclosure (primary law) are important to ensure integration with the budget process, transparency on mitigation, and parliamentary scrutiny. ### Recommended institutional reforms and reporting framework (Recommendations 2.1–2.2) - Recommendation 2.1. Strengthen and broaden the fiscal risk management mandate of the Ministry of Finance. - Amend the Budget Code to assign responsibility for fiscal risk monitoring and assessment to the Ministry of Finance (end-2017). - Broaden the mandate of the FRMD to include coordination of the management of overall fiscal risks among the different departments and government entities through a CMU resolution (end-2017). - Transfer the function of oversight of financial and commercial operations of SOEs from the FRMD to supervisory boards, once they have been established. - Recommendation 2.2. Establish a comprehensive reporting framework for fiscal risk management. - Update the functional responsibilities of government departments to clearly specify their roles and responsibilities in fiscal risk monitoring and management (March-2018). - Define information templates for exchange of information between specialized department in the MoF and other government agencies, and timetable for their submission (Jan-2018). - A comprehensive fiscal risk management reporting framework should be put in place to support FRMD functions, including broad powers for MoF to collect necessary information and development of templates specifying the range of information needed. ### Developing a Comprehensive Fiscal Risk Statement (FRS) - Current disclosure of fiscal risks in budget documentation is limited; Article 38 of the Budget Code requires documents to be submitted with the annual budget bill, including loans and guarantees to SOEs and quasi-fiscal operations, but disclosure is incomplete. - Publication of a comprehensive FRS would: - Help policymakers understand underlying fiscal position and risks to the outlook. - Provide basis for development of risk mitigation strategies. - Underpin credibility and market confidence by signaling government awareness and mitigation plans. - The FRS should be published with the budget declaration in June and updated for material changes in the annual budget. - Initial focus and sequencing: - The FRS should initially focus on the most significant fiscal risks and be broadened over time. - The 2017 budget declaration FRS should focus on disclosure of fiscal risks related to the SOE sector and include a qualitative discussion of macroeconomic risks and public debt exposures. - Over time, broaden to cover all material fiscal risks and provide more detailed analysis about their potential impact. - Annex IV provides a suggested template for a comprehensive FRS; Annex V provides an action plan for developing the FRS over the next three years. *Source: 1ukrea2019007 - 39. Introducing a meaningful strategic phase for the MTBF requires a new budget (IMF).* ### 60. The development of the FRS will also require close cooperation between the FRMD ### The development of the FRS and fiscal risk analysis (excerpt) ### Institutional roles and cooperation for preparing the Fiscal Risk Statement (FRS) - The FRMD should be responsible for compiling the FRS, drawing on data, analysis, and input from the different departments within the MoF and other agencies. - Responsibilities of the various departments and government agencies should be clearly defined by a CMU resolution, or where necessary, memorandums of understanding (for example, with the NBU). - Tentative organization for preparation of the FRS (Table 2.2): - Macroeconomic: Data provision — MFD (macroeconomic scenarios); Analysis — MFD, RFD, BD, FRMD; Drafting — MFD, FRMD. - Debt: Data provision — DPD; Analysis — DPD; Drafting — DPD, FRMD. - SOEs and Guarantees: Data provision — LMs, MEDT, BD, FRMD, DPD; Analysis — FRMD; Drafting — FRMD. - Local Government: Data provision — DLG; Analysis — DLG; Drafting — FRMD. - PPPs: Data provision — MEDT, BD; Analysis — FRMD; Drafting — FRMD. - Financial Sector: Data provision — NBU, FPD; Analysis — FPD; Drafting — FPD. - Legal Claims: Data provision — MoJ; Analysis — MoJ; Drafting — MoJ, FRMD. - Natural Disasters: Data provision — MENR, BD; Analysis — MENR; Drafting — MENR, FRMD. - Note: MFD – Department of Economic Strategy and Macroeconomic Forecasting, MEDT; FRMD – Fiscal Risk Management Division, MoF; RFD – Revenue Forecasting Department, MoF; DPD – Debt Policy Department, MoF; BD – Budget Department of MoF; FPD – Financial Policy Department, MOF; DLG – Department of Local Budgets, MoF; MoJ – Ministry of Justice, MENR; Ministry of Ecology and Natural Resources. ### Recommendations on preparing and publishing the FRS - Recommendation 2.3. Prepare and publish an annual fiscal risk statement as part of the budget documentation. - Amend Article 38 of the Budget Code to require submission of a FRS with the budget declaration and update, as necessary, for submission with the annual budget law (end-2017). - Define, in a CMU resolution, the responsibilities of the various agencies, required inputs, timetable for their provision, and approval processes, to facilitate preparation and publication of the FRS (February 2018). - For 2017, publish a qualitative discussion of macro-fiscal risks, preliminary assessment of SOE-related fiscal risks (including guarantees, transactions with government, and quasi-fiscal activities) in the budget declaration and, update as necessary, for the annual budget (June and September 2017). - From 2018, gradually expand the fiscal risk statement to cover all material fiscal risks to public finances and include sensitivity and scenario analysis and risk mitigation strategies (2019 and 2020 budgets). ### Macroeconomic risks: exposure, volatility, and disclosure gaps - Key findings on macroeconomic risks: - Ukraine’s reliance on global demand and export composition makes it particularly exposed to developments in major trading markets and global commodity prices. - Metal and mining account for almost one-third of Ukraine’s exports. - International trade and mineral taxes make up around 10 percent of state budget revenues. - The ongoing military conflict in the eastern part of Ukraine contributed to a sharp contraction in growth, depreciation in the exchange rate and financial market turmoil. - The depreciation in the exchange rate over 2014–15 was largely responsible for driving a 40 percent of GDP increase in general government gross debt over that period. - Volatility: - Nominal GDP growth volatility is well above that experienced by emerging European and some CIS countries (Figure 2.1; percent, 2005–15). - Budget year real GDP forecasts in Ukraine have deviated from outcomes by a sizeable margin (around 4 percentage points, on average). - Disclosure and analytical gaps: - The budget does not include a discussion of macroeconomic risks or their potential implication for public finances. - Government medium-term scenarios (baseline and alternate) are published as a CMU resolution and on the MEDT’s website but are not accompanied by a discussion of main risks or potential fiscal impacts. - No discussion on risks to the macroeconomic outlook appears in either the budget declaration or annual budget. - Recommended sequencing to strengthen macro-fiscal analysis: - Disclose forecast errors in macroeconomic and fiscal forecasts for previous years, comparing medium-term macroeconomic forecasts (budget year, one-year ahead, and two-years ahead) with outturns; similar analysis for revenue and expenditure with forecast comparisons for the budget year. - Once MTBF is in place, expand analysis to include outer-year forecast comparisons to outcomes. - Expand FRS to include sensitivity analysis or alternative macro-fiscal scenarios as capacity develops. ### Illustrative sensitivity analysis and example impacts - Guidance on sensitivity analysis: - Sensitivity analysis can illustrate how changes in discrete macroeconomic variables (real GDP, inflation, exchange rate, oil prices, interest rates) impact expenditure, revenue, debt and deficit. - Historical evidence can inform shock sizes (e.g., GDP shock equal to one standard deviation of growth observed over the past decade). - Table 2.3 illustrative example (Real GDP shock; change, percentage points of GDP): - Real GDP Forecast (2017–2022): 2.9; 3.1; 3.5; 4.0; 4.0; 4.0. - Real GDP Alternative Scenario (2017–2022): 2.9; -4.0; -3.6; 4.0; 4.0; 4.0. - Increase in Debt (percent of GDP) (2017–2022): 0.0; 11.7; 26.8; 26.0; 24.2; 23.4. - Impact on primary balance (percent of GDP) (2017–2022): 0.0; -1.7; -5.7; 0.0; 0.0; 0.0. - Note: Real GDP shock based on one historical standard deviation in 2018 and 2019. Analysis is based on IMF staff forecasts prepared for the third review. These have since been updated, with real GDP now forecast to grow by 2 percent in 2017 and 3.2 percent in 2018. ### Recommendations to strengthen macroeconomic risk disclosure - Recommendation 2.4. Strengthen analysis and disclosure of macroeconomic risks by: - Publishing a qualitative discussion of macroeconomic risks in the budget declaration and annual budget for 2018 (June 2017). - Including an assessment of past forecast errors in the FRS for the 2019 Budget and expanding this in the 2020 Budget to include macro-fiscal sensitivity analysis for the most fiscally-relevant macroeconomic variables and/or scenario analysis (June 2019). ### Fiscal risks related to State-Owned Enterprises (SOEs): scale and fiscal exposure - Scale and financial position of SOE sector: - Around 3,350 SOEs in Ukraine; around 1,800 of these are generating economic activity (the remainder exist in name only). - MEDT estimate: the largest 100 nonfinancial SOEs account for about 90 percent of total assets and 80 percent of net income of the sector. - Total assets of the top 100 SOEs were around UAH 1.4 trillion (70 percent of GDP) at end-2015. - Non-equity liabilities of the top 100 SOEs were around UAH 490 billion (25 percent of GDP). - Four state-owned banks with liabilities worth around 25 percent of GDP. - State fiscal support and quasi-fiscal exposure: - Direct subsidies from the budget were around 1 percent in 2016, down from 2.5 percent of GDP in 2015. - State budget servicing of guaranteed loans averaged around 0.7 percent of GDP per year in guarantees over the past five years. - Indirect subsidies associated with Naftogaz provision of below-cost energy have been reduced substantially following energy tariff reforms and are no longer envisaged over the medium term. - Implementation of EU state aid requirements from August 2017 will have implications for delivery of new state support to SOEs. - Financial performance and risks: - In 2015, around one-third of SOEs were loss-making, with combined losses amounting to around 2.9 percent of GDP. - The sector as a whole was loss-making in 2015: net loss of 2 percent of GDP in total and an average rate of return of around -6 percent. - Aggregate data for the top 50 companies suggests sector performance is improving (no monitoring reports for 2016 published at the time of the report). - Detailed 2015 indicators for the top 100 nonfinancial SOEs (ranked by liabilities): - One-third of enterprises were failing to make a profit on their operating activities. - 15 percent had a negative return on assets greater than 10 percent. - Around one-quarter were highly leveraged (debt to equity ratio greater than one). - Around one-quarter had negative shareholder equity (liabilities exceeded total assets); some of these were also loss-making. ### Methodology for assessing SOE fiscal risks and suggested improvements - Current draft methodology by FRMD: - Ranks SOEs into five risk categories based on profitability and leverage. - SOEs that are both loss-making and highly leveraged (net debt to earnings ratio exceeds four) are placed in the highest risk category. - Entities whose debts are being serviced by the government or who have received capital injections within the past three years should be automatically assigned to risk category one. - High-risk SOEs should be subject to more intense monitoring and potentially stricter financial controls and required to put in place mitigating measures. - Larger public corporations that are macro-critical should be subject to strict oversight even if assessed risk is low. - Limitations noted: - Financial indicators are a first step; deeper company-specific analysis is needed to determine actual problems and inform mitigating measures. - Box 2.2 — Suggested improvements to the SOE risk assessment methodology: - Require submission of underlying data for ratios: total income, operating income, total expenses, operating expenses, interest costs, short-term liabilities, and current assets. - Expand foreign currency exposure indicators: debt and assets held in foreign currencies, and interest expenses and interest income in foreign currencies. - Add the current ratio (current assets to short-term liabilities); guidance: generally a ratio of two or higher acceptable, ratio less than one is cause for concern. - Move interest coverage ratio (earnings before interest and tax to interest expenses) to supplement one, and remove duplicative financial condition indicators from supplement three. - Benchmarking against industry and international rates of return should show percentage deviation from the benchmark to highlight degree of over- or under-performance and enable comparisons over time. - Replace unreliable self-evaluation requirements by SOEs and LMs (indicators 4–6) with specific questions that may give rise to risks, including: - Information on economic factors that may result in specific activities being loss-bearing. - Non-profit activities conducted for policy purposes. - Liabilities of SOEs where servicing may become a problem. - Information on contingent liabilities of SOEs (pending legal cases, guarantees, letters of comfort). ### Data harmonization, monitoring, and mitigation steps - Data and monitoring: - To minimize reporting burden on LMs and SOEs and ensure consistency, develop a single database encompassing all required information. - Many financial indicators required by MoF are currently collected by MEDT for the top-100 SOE monitoring report; MoF and MEDT should harmonize collection processes and timeframes. - Government steps taken to mitigate SOE fiscal exposure and strengthen transparency: - Reducing quasi-fiscal activities (QFAs) of Naftogaz and requiring disclosure of QFAs for the first time in the 2017 Budget. - Strengthening governance: require supervisory boards with a majority of independent members for SOEs with more than UAH 2 billion in assets or net income exceeds UAH 1.5 billion. - Transparency reforms: publishing quarterly and annual monitoring reports on financial performance of the largest 100 SOEs; requiring large SOEs (as above) to have their financial statements audited by an approved auditor; recommending similar arrangements for unitary enterprises. *IMF staff report (excerpt) — Ukraine: Fiscal Risk Statement and related analysis* ### 79. The disclosure of QFAs is a welcome initiative, but the list is not yet complete. CMU ### 1ukrea2019007 - 79. The disclosure of QFAs is a welcome initiative, but the list is not yet complete. CMU ### Disclosure of Quasi-Fiscal Activities (QFAs) and SOE transparency - CMU resolution No. 692 of 2012 lists thirteen forms of QFAs and agencies responsible for disclosing them, but only 5 categories were disclosed in the 2017 Budget. - Missing disclosure example: QFAs undertaken by railway sector SOEs that charge below-cost prices for passengers and subsidize from cargo operations; the cost of this subsidy is estimated to be around UAH 8 billion. - The Government committed to publishing an assessment of SOE-related risks in the 2018 Budget; this will be a preliminary assessment to be expanded over time. - Initial assessment should include: - aggregate statistics for the size of the sector; key financial performance indicators for the sector (such as earning and rate of return ratios), and total assets and liabilities; - guarantees on SOE debt; - sub-lending to SOEs; - expanded information on QFAs; - transactions with the government (dividends, subsidies etc.); - measures to strengthen SOE performance and minimize fiscal exposures. - Subsequent statements should expand analysis to include debts past due to the government and third parties, and individual assessment of fiscal risks arising from the largest SOEs. - As capacity is developed, adopt more sophisticated risk analysis tools and incorporate into the FRS and internal reports; scenario and sensitivity analysis can be applied to SOE budget plans to determine the impact of sizeable shocks to exchange rates, commodity prices and other key variables. ### Recommendations on SOE fiscal risk assessment and reporting (Recommendation 2.5) - Strengthen the information base and capacity to undertake fiscal risk assessment of SOEs and commence quarterly internal reporting on SOE fiscal risks. - Amend the draft methodology for assessing SOE fiscal risks to include the expanded set of financial indicators outlined in Box 2.2 and codify in a CMU Resolution (June-2017). - Establish a single central database (excel-based initially) of SOE financial indicators and state support (March-2018). - Strengthen capacity in the MoF to undertake financial ratio analysis (end-2017) and, over time, develop sensitivity and scenario analysis to estimate the impacts on the SOE sector and the budget of a variety of shocks (end-2018). - Submit quarterly reports on SOE financial performance and risks to the CMU (including an assessment of financial performance for the sector in aggregate and more detailed analysis of SOEs deemed high risk or macro-critical) and require SOEs in risk category one to prepare action plans to mitigate risks and regularly report on progress (end-2017). - SOE action plans should be reviewed and monitored by the shareholding ministry and FRMD, with this role shifting to supervisory boards as they are established. ### Recommendations on disclosure of SOE-related fiscal risks (Recommendation 2.6) - Improve disclosure by: - Including in the budget declaration preliminary analysis of SOE fiscal risks, including aggregate information on the financial position of SOEs, guarantees and loans to SOEs, QFAs, and budget support provided to SOEs, and updating this as necessary, for the annual budget (June 2017). - Expanding disclosure in subsequent FRS to include more detailed analysis on the financial performance and fiscal risks created by the largest SOEs as well as their contingent liabilities (June 2019). - Including sensitivity analysis to estimate the impacts on the SOE sector and the budget of a variety of shocks, including in particular the exchange rate (June 2020). ### Long-term sustainability — Pension system (Recommendation 2.7) - Key facts: - Ukraine has one of the highest levels of pension spending in Europe despite low average benefit, driven by a very large number of beneficiaries. - Low contribution rate and compliance resulted in a large deficit of the Pension Fund of around 6 percent of GDP in 2016. - Absent policy changes, the pensioner-to-contributor ratio is expected to increase from a ratio of 1 to 1 now, to a ratio of 1.3 pensioners to every contributor in 2040. - Assessments of long-term costs are not systematically conducted or published; Pension Fund actuarial assessments are periodic, ad hoc, and not published. - Recommendation: - Publish long-term estimates of the fiscal costs associated with the pension system. - Publish long-term estimates of pension contributions and pension benefits in the annual report of the Pension Fund and prepare long-dated (at least 30 year) projections of the budgetary costs of financing the Pension Fund deficit for publication in the FRS for the 2020 Budget (June-2019). ### Debt-related risks and debt management (Recommendation 2.8) - Key facts: - General government debt was around 70 percent of GDP at end-2016. - About three-quarters of debt is denominated in foreign currency. - The sharp depreciation in 2014–15 contributed to around a 40 percent of GDP revaluation in the debt portfolio. - The share of public debt held by nonresidents is high (at around two-thirds). - Only a small share of debt (around 7 percent) has a maturity of less than one year. - Around 30 percent of debt is issued in variable interest rate instruments. - Institutional context: - All borrowing is approved by the CMU and authorized by Law. - The Budget Code (Article 18) specifies an aggregate ceiling of 60 percent of GDP on public debt and publicly guaranteed debt, which has not been complied with in recent years. - The MoF reports regularly on the stock of State debt by instrument and by creditor, but there is no current debt management strategy in place (last published for 2013–15). - The Debt Policy Department (DPD) does not currently conduct debt sustainability analysis (DSA) but has signaled interest in developing this capacity. - Recommendations to strengthen disclosure of debt-related fiscal risks: - Include a qualitative discussion of the main debt exposures in the FRS for the 2018 Budget (June 2017). - Expand to include quantitative sensitivity analysis of the debt portfolio to changes in exchange rates and interest rates (June 2018), and debt sustainability analysis along the lines of the IMF DSA framework (June 2019). ### Contingent liabilities — Guarantees - Stock and composition: - At end-2016, the stock of guaranteed debt was UAH 278.9 billion or 12.2 percent of GDP. - A large share relates to loans provided to the NBU from the IMF (around UAH 170 billion or 7.5 percent of GDP), which are guaranteed by the Ukrainian government. - The remainder are guarantees issued to SOEs, with one exception where a guarantee was provided to a private company to ensure fulfillment of a defense contract. - The bulk of state-guarantees are provided for external borrowing. - Fiscal risk and costs: - The likelihood of fiscal risks materializing from state-guarantees is high, with fiscal costs associated with debt-servicing of guaranteed debt averaging around 0.7 percent of GDP over the past five years. - Legal and procedural controls: - Budget Code requires all guarantees, including those issued by local governments, to be approved by the CMU. - Article 18 of the Budget Code imposes an aggregate ceiling on public debt and state guarantees of 60 percent of GDP, though this has been exceeded recently. - Limits on the annual issuance of new guarantees are set in the annual budget law and the current IMF program; the annual budget includes a provision for expected calls on guarantees. - Risk assessment and fees: - CMU resolution No. 131 of 2011 requires risk assessments prior to issuance of guarantees, with MEDT responsible for opinion on financial viability and MoF responsible for credit risk opinion. - There have been cases where the CMU has not abided by the MoF opinion, and some guarantees were approved without an MoF opinion. - No established methodology within the MoF for assessing credit risks associated with guarantees. - Neither the Budget Code nor supporting resolutions require that risk-based fees be charged to beneficiaries of state guarantees; procedures and criteria for charging guarantee fees are not established. - Introduction of state aid regulations from August 2017 is likely to require risk-based fees on guarantees that are not in aid of economic or social-economic development. - Disclosure and reporting: - The MoF is required to maintain a register of state and local government guarantees; registries do not include the outstanding amount of the loan guaranteed, but the MoF regularly discloses the value of outstanding guaranteed debt by creditor on its website. - CMU resolution No. 131 of 2011 requires publication each quarter on the MoF’s official website of basic terms of agreements, rationale for issuance, and risk assessments, but information on the latter is sparse. - Scope to enhance reporting in the FRS by including summary information on the stock of guarantees, fiscal flows associated with guarantees (costs of servicing guarantees, fee revenues received and recoveries), and brief descriptions of guarantees above a materiality threshold (beneficiary, purpose, past performance). ### Financial sector fiscal risks - Key facts: - Fiscal costs of bank bailouts and compensation totaled about 11 percent of GDP over the past four years. - At the end of 2015, the (non-equity) liabilities of the sector amounted to about 50 percent of GDP. - The liabilities of state-owned banks account for around half of the total liabilities of the sector. - Implication: The poor asset quality of the sector means that fiscal risks from the financial sector remain important despite steps taken by the government and NBU to strengthen oversight. *Source: Extracted from the supplied IMF content unit 1ukrea2019007.* ### 98. Explicit liabilities arise from the deposit guarantee scheme and a blanket guarantee ### 1ukrea2019007 - 98. Explicit liabilities arise from the deposit guarantee scheme and a blanket guarantee ### Explicit liabilities from deposit guarantee and blanket guarantee - Deposit Guarantee Fund (DGF) insures deposits of individuals and sole traders up to a cap of UAH 200,000 per account holder and the scheme provides for back-up funding from the government where required. - Since the beginning of the crisis, around 80 insolvent banks were transferred to the DGF, which has paid out UAH 85 billion to the depositors of these banks. - The total volume of deposits guaranteed by the scheme is around UAH 300 billion (13 percent of GDP). - The total deposits in the state-owned Oschadbank (around UAH 145 billion or 6.4 percent of GDP) have been guaranteed by the government. - A law extending this guarantee to Ukreximbank and Privatbank was passed by the Parliament at the height of the crisis, but has not been ratified by the President. ### Interlinkages between nonfinancial SOEs and state-owned banks - SOEs hold a high share in assets and liabilities of State-owned banks. - Almost 90 percent of SOE deposits are placed with state-owned banks and they finance about two-thirds of SOE borrowing from the domestic banking sector. - Concentration risks: State-owned banks face concentrated exposure to SOEs, increasing correlations between problems in the nonfinancial state-owned sector and the state banking sector. - Examples of stresses: - Some SOEs only partially service their debts, compounding challenges in State-owned banks. - Some monopolies redistribute credit liabilities between State-owned banks, compensating payments to one bank with new borrowings at another. - Policy response: CMU approved a Development Strategy for State-owned Banks that: - Requires State-owned banks to lend to SOEs strictly in line with the prudential requirements of the NBU (including compliance with concentration requirements). - Strengthens governance by establishing independent supervisory boards. - Outlines a timetable for the privatization of minority stakes at Oschadbank and Ukreximbank. ### Financial stability reporting and transparency of DGF exposures - The National Bank publishes a bi-annual report on financial stability that: - Analyzes main risks to the financial sector. - Reports past bank recapitalizations and exposures associated with the DGF. - NBU diagnostic work: - Completed diagnostic studies of around 60 banks, with results (including aggregate stress testing) included in the past two stability reports. - Gap in fiscal transparency: - The government does not separately report on its explicit exposures associated with the DGF or the guarantee of deposits in one of the state-owned banks in the budget or other publications. ### Subnational governments: liabilities, controls, and monitoring - Reported liabilities of subnational governments totaled 0.7 percent of GDP at end-2015. - Debt-service costs comprise about 2 percent of local government own-source revenues. - Own-source tax revenues make up only about 30 percent of subnational government expenditure. - Total expenditures of subnational governments were around 13 percent of GDP in 2015. - Borrowing rules and limitations: - Budget Code (Art. 18) limits borrowing of local governments to 200 percent of forecast local development revenues (400 percent limit for the City of Kiev). - Article 74 limits the amount that can be spent on debt servicing in any year to 10 percent of the local budgets general fund. - Budget Code explicitly states that the State is not liable for local government debt. - Only large local authorities (Oblasts) are permitted to borrow from external sources other than international financial organizations; all borrowings require MoF approval. - Local governments must seek MoF approval to issue debt guarantees, but approval is not required for non-loan guarantees such as PPPs. - Reporting and monitoring: - Treasury publishes monthly and annual execution reports that include consolidated flows of subnational governments. - Local governments required to submit regular budget execution reports to their councils. - MoF maintains a registry of local government guarantees, but it does not report total amounts outstanding. - No summary reporting on the financial position of individual Oblasts or cities; no analysis of key financial stress indicators for individual local government budgets. - Need to strengthen monitoring: - Decentralization increases risk of significant fiscal imbalances in some local governments. - Recommendation for quarterly monitoring of execution reports and key financial stress indicators (such as debt-service to revenue ratios). - Strengthening in-year monitoring will require stronger external audit requirements; currently, State Financial Inspection audits are carried out once every three–five years and identify shortcomings too late. - Fiscal autonomy and intergovernmental cooperation: - Local governments are accumulating sizeable deposits as own-source revenues out-perform expectations, partly reflecting difficulties executing investment spending. - Accumulated deposits increase capacity to finance future investment; strong intergovernmental cooperation is needed to achieve fiscal objectives, including general government deficit targets under the IMF extended fund facility program. ### Public-Private Partnerships (PPPs) and concessions - PPPs and concessions are not a large source of fiscal risk in Ukraine. - Most projects with private sector participation require no explicit funding from the government budget and take the form of concession contracts. - At end-2014: - 243 concession agreements had been entered into, compared with 33 projects involving some form of state participation. - Since the passage of the 2010 PPP Law, only two very small projects have been procured under its provisions. - Data and governance gaps: - No central database recording total fiscal commitments (direct and contingent) under PPPs. - MEDT and State Property Fund maintain registries but neither records projects’ direct obligations or contingent liabilities. - Financial information limited to total cost and funding (MoE) and concession fees paid by concessionaire (SPF). - MoF role and fiscal risk management shortcomings: - PPP Law requires fiscal risk assessment and a methodology has been developed and approved, but it is not systematically applied. - MoF role is limited: MoF approval is required only for explicit government funding through direct payments or loan guarantees. - Implicit fiscal risks are often not assessed by the MoF. - Absence of multi-year budgeting and commitment controls, and absence of full lifetime costing and analysis of PPPs, limits MoF’s ability to identify medium- and long-term fiscal impact. - Strengthening the MoF gateway function is necessary as government plans to use PPPs more for development needs. ### Legal claims as fiscal risks - Legal claims are a potentially significant source of fiscal risk. - One known type of claim relates to repeal of various laws establishing social entitlements that were never disbursed; repeal was deemed unconstitutional. - A Law about the Guarantees of the State in relation to Implementation of Court Decisions sets parameters for reimbursement by the State of relevant claims. - A large number of individual claims were submitted and awarded by Ukrainian courts, but the State Treasury has not been able to satisfy the outstanding claims, as they were never budgeted for. - Estimated amounts: - Amount of entitlements due to be paid is estimated to be around UAH 10 billion or 0.4 percent of GDP (of which claims of 3.2 billion have been made). - These amounts are not currently factored into the government’s fiscal reports. - MoF is examining appropriate financing arrangements for outstanding amounts arising from court claims. - Disclosure considerations: - Care needed when disclosing pending legal claims to avoid prejudicing the State’s position in ongoing cases. - For cases where a determination has already been made, it may be possible and desirable to quantify potential exposure even if claims have not yet been made or settled. ### Recommendations on contingent liabilities and related reforms - Recommendation 2.11. Strengthen disclosure of explicit and implicit contingent liabilities by: - Disclosing fiscal risks associated with explicit and implicit contingent liabilities in the fiscal statement commencing in the 2019 Budget, in line with the phased approach suggested in Annex V (June 2018). - Recommendation 2.12. Strengthen controls on, and management, of contingent liabilities by: - Developing and implementing a methodology for assessing credit risks of guarantees, and amend the Budget Code to require that risk-based fees be charged and specify the minimum fee (mid-2019); - Amending the Budget Code to restrict foreign currency borrowing of subnational governments, only to loans issued by international financial institutions (end-2017); - Strengthening monitoring of local government finances through the establishment of tracking indicators of fiscal stress and enhancing reliability of local government reporting by requiring that all Oblasts and cities publish an external financial audit on an annual basis (end-2018); - Amending the PPP and Concession Laws to establish a clear role for the MoF in assessing budget affordability and fiscal risks of PPPs (end-2017). ### Public investment management: strategic planning (background and actions) - Context: - IMF Public Investment Management Assessment (PIMA) in June 2016 noted the urgent need for increased public investment in Ukraine due to continuous decline in public capital stock. - Reforms undertaken: - Creation of an online public procurement portal and development of a new procurement law designed to minimize corruption. - Creation of a project appraisal and selection process for national infrastructure projects, applied to projects funded by the state Budget, including central oversight by the Ministry of Economic Development and Trade (MEDT). - Beginning implementation of a medium-term budget framework, covered in Chapter 1 of the report. - Need for prioritization: - Addressing institutional gaps requires prioritization of the reform agenda; mission focused on strategic planning, appraisal and selection, and coordination. - Strategic planning institutional arrangements in the PFM reform strategy: - Establishing a Strategic Council to maintain balance of interests, coordinate policy documents and strategic planning documents, review them and issue recommendations for the Government. - Developing a consistent procedure and time schedule for line ministries to prepare strategic plans and develop the plans in 2018. - Developing a mid-term public investment plan within the scope of mid-term budget planning (public investment element separate to strategy elements identified in the PFM plan). - Risks and recommended institutional design: - Risk of disconnect between strategic planning documents and public investment plans as actions are not explicitly aligned. - Individual ministry strategic plans risk poor coordination of planned investments; holistic links (e.g., land use, urban planning) across sectors are essential. - Proposal for an investment planning unit under MEDT to produce a national infrastructure strategy that better accounts for government priorities and interacts with MoF to integrate into MTBF; may require legal basis. - Core elements recommended for an integrated strategy: - Methodology for developing the strategy and recommendations for transparency and buy-in. - Identification of objectives, problem/challenge identification, and options to address challenges (including consideration of less expensive low- or no-investment options). - Recommendations and description of investments, including full costing and underlying technical analysis (preliminary or detailed depending on project maturity). *Source: Ministry of Finance; National Bank of Ukraine Financial Stability Report, December 2016; IMF Public Investment Management Assessment (PIMA).* ### 120. The strategy should play a strong role in all major future investment decisions ### The strategy should play a strong role in all major future investment decisions ### Role and adoption of the national infrastructure strategy - The strategy should play a strong role in all major future investment decisions involving public funding or public support, covering: - investment appropriated under the State Budget; - investment financed through special funds (such as the Road Fund); - local government budgets. - Enablement mechanisms: - require decision makers to prioritize investments identified in the national infrastructure strategy; - require decision makers to consider alignment with the national infrastructure strategy when funding other investments. - Response and adoption process: - The strategy could be responded to (ideally within 3 months), and either adopted by the government as presented or with amendments. - The final process for response to and adoption by government and/or other decision makers should be specified at the inception of the strategy and designed to ensure maximum buy-in. ### Costed investment package and investor signaling - Including a suite of costed investments in the national strategy: - would signal Ukraine’s national public investment priorities; - will be valuable in a context of constrained fiscal space and when a substantial proportion of investment is funded by grants and concessional loans by foreign governments and organizations; - will assist as Ukraine looks to ramp up PPP activity. - Use for project appraisals: - Costed investments can facilitate subsequent project appraisals as a valuable input, although they do not usually substitute for a full project appraisal. ### Strategic Council: composition, mandate, and resourcing - Broad buy-in and acceptance of the Strategic Council’s advisory role, membership and mandate are critical for effectiveness; absence of consensus risks advice carrying little weight. - Legal and institutional design should reflect the need for credibility and independence. - Suggested terms of reference and legal basis could: - Give the council authority to request information from the planning unit, line ministries, government bodies and agencies, and regional and local governments on the national investment strategy and investment options put forward. - Set out selection criteria with strict qualification and disqualification criteria, including: - appoint at least seven members, the majority of which should be independent; - emphasize experience drawn from a diverse mix of backgrounds: infrastructure development, operation and financing, economics (credible, experienced business leaders, consultants, academics); - the chair should be completely independent of direct government or business interests and ideally have a minimum of 15 years relevant experience; example: prior experience in management of large infrastructure firms with a strong track record of delivery in key areas such as transport; - require potential council members to declare any real or perceived conflicts of interest and have a robust conflict management strategy, including the basis for disqualification. - Provide the necessary resources for the council to perform its functions. - Appointment process example (international practice): - requiring members of the Strategic Council to be nominated by the Cabinet and approved by the Interdepartmental Committee (consisting of government ministers and parliamentarians) would give Parliament a role. ### Transparency, consultation, and timeline for strategy development - Transparency and broad consultation enhance robustness and credibility and reduce risk of undue influence by special/private interests. - Consultation process recommendations: - publish a brief consultation/discussion document early, outlining engagement process and how feedback will be used, followed by a consultation draft; - disclose the process for reaching solutions/conclusions (e.g., metrics used to rank/assess options); - publish technical and supporting information to the greatest extent possible, and publish a draft strategy; - avoid structuring analysis to preclude transparency (e.g., overreliance on “commercial in confidence” information). - Access to publish consultation and supporting documents should be empowered to the investment planning unit. - Indicative timeline: - International experience suggests a 12- to 18-month timeline would be realistic for delivery of a strategy of this nature, assuming institutional and support arrangements are firmly in place at inception. ### Resourcing and taskforce composition for the investment planning unit - Provide sufficient resources to line ministries via a high-level draft resourcing and project plan (e.g., jointly prepared by the MEDT and MoF), with the MoF making recommendations to government on resourcing needs. - Empower the investment planning unit to recruit a special taskforce through a merit-based process. - Taskforce size and skills: - include at least 15–20 people; - required skills: Governance; Strategic policy development (objectives, options analysis); Technical subject-matter expertise across covered areas; Contract/consultancy management; Project and risk management; Communications and stakeholder management. - Draw on expertise across the Ukrainian Government, private sector secondees, and experts from international organizations. ### Recommendation 3.1 (Enable development of a national infrastructure strategy) - Set up an investment planning unit under the MEDT and empower it to develop a national infrastructure strategy, including clearly defining the mandate, coverage and process for developing the strategy; enshrine this in the appropriate legal instrument. - Describe the role of the strategy, and the process for its consideration and acceptance. - Describe the process for appointment of Strategic Council members in accordance with strict selection criteria to maximize broad based acceptance and credibility. ### Project appraisal and selection: current roles and recommended changes - Current MoF role: - Under the current process for appraising national budget funded projects, the MoF’s role remains limited to setting the overall fiscal ceiling. - In practice, absence of an MTBF results in a multiple gateway assessment as projects must come forward each year for funding. - Strengthening MoF role in appraisal: - The appraisal process should support a stronger role for the MoF in assessing fiscal risks and affordability of projects by: - MoF undertaking a two-stage assessment of fiscal risks and whole-of-life costs for a proposed project: first at the concept stage, and second in parallel with the MEDT’s assessment of project documentation; - including the MoF assessment in the MEDT’s assessment of project merits, provided to the Interdepartmental Committee under the existing process; - intervention points for the MoF to be aligned with the MTBF recommended in Chapter I. - Limitations without MTBF: - Without an MTBF, the MoF cannot hold KSUs accountable to a baseline level of capital spending; project selection processes need to capture all projects for central oversight regardless of size. - Long-term capital planning: - Public investment projects require very long lead times; operating and maintenance costs must be factored in over the entire useful life of the asset. - Example: current Ukrainian project “Restoration and adaptation Mariinsky Palace on ul.Grushevskogo, 5a, Kiev Creating a cultural arts and museum complex ‘Art Arsenal’” is expected to run from 2005 to 2018. - In some jurisdictions, Line Ministries are required to plan capital expenditures up to 10 years into the future. - Longer term capital planning could be prepared by KSUs, overseen by the MoF, going significantly beyond the three-year forward estimates period planned for the MTBF (ideally 10 years), with KSUs required to justify major variations in previously forecasted years. - MoF role in PPPs: - The MoF’s involvement in PPP assessment occurs mostly at the end of the process (after negotiations completed but prior to awarding the contract), limiting MoF capacity to influence planning and selection phases for value for money and budget affordability assessments. - MEDT and Line Ministry capacity: - The MEDT’s current role appears appropriate but practice needs to be well resourced and embedded; MEDT should continue discretion over documentation requirements ahead of formal thresholds. - The appraisal process will need integration with the strategic planning approach; the Interdepartmental Committee will judge which strategy options are sufficiently developed to proceed and which require further work. - Line Ministries need capacity building to understand project appraisal methodology and oversee external experts; KSUs need strengthened abilities to examine merits and prepare cost and implementation elements of appraisal documents. - Existing MEDT plans for capacity building and guidance should be supported with appropriate resourcing to embed the Interdepartmental Committee process and create appropriate institutional arrangements within LMs and KSUs. ### Recommendation 3.2 (Strengthen MoF role in Interdepartmental Committee) - Strengthen the role of the MoF in the Interdepartmental Committee process by introducing a role to review the budget affordability and fiscal risks for specific projects. - In the longer term, as the MTBF matures, strengthen this role further by requiring longer term forecasting and oversight of capital expenditure. ### Coordination across funding sources and subnational governments - Decentralization increases fiscal space for subnational governments to undertake public investments but may complicate coordination; strategic planning must include input from regional and local governments and link future investments to strategy outcomes. - The selection process currently only applies to national projects funded and financed by the national budget; there is a stronger rationale for tailoring appraisal processes to overall project risk and materiality thresholds rather than the source of funds. - Table of different processes applied to project selection (summary of funding/financing sources and processes): - National projects funded by the State Budget: Interdepartmental Committee process described in Section C. - Projects funded by intergovernmental transfers to subnational governments: investment programs supplemented by 3 transfers; projects funded under subventions are not vetted by central government; Article 24 of the Budget Code requires Oblast Councils to submit regional project proposals by May 1 each year; Ministry of Regional Development required to check processes and documentation. - IFI or bilateral concessional loans or grants: Ukrainian government review of proposals is not integrated with the Interdepartmental Committee process; a separate unit reviews externally financed loan or grant projects. - PPPs/concessions: Not subject to systematic appraisal or assessment. - State owned enterprises: Capital plans approved by government through the annual Financial Plan process; capital investments monitored by the Ministry of Finance; major projects are not subject to the Interdepartmental Committee assessment process, including those funded by public resources (such as loans from IFIs). It is unclear whether projects funded by the newly created Road Fund would be subject to the Interdepartmental Committee process. - Road Fund and legal clarity: - Neither Law 47 “On Sources of Financing of Roads Ukraine” nor Cabinet regulation 1731 mentions the Interdepartmental Committee in allocation discussions, although Law 47 notes Cabinet will approve the list of projects of national significance. - The Budget Code statement that the Interdepartmental Committee process should apply to projects funded by the state budget is not qualified; it may be open to interpretation whether it applies to the Road Fund. - Recommendation: clarify that the Interdepartmental Committee process should apply to major projects funded by the Road Fund from 2018, with “major” to be defined by the MEDT and MoF in consultation with the State Roads Agency. - Risk of fragmented oversight: - Investments undertaken by SOEs that use public equity injections or loans are not subject to central oversight and appraisal, providing a potential avenue for government-funded projects to be outside the centrally coordinated process. - Opportunity to integrate processes: - Now that the Interdepartmental Committee process is in place, progressively widen its scope to enhance coordination across multiple funding avenues and ensure scrutiny cannot be avoided by choosing particular funding/financing avenues. ### Recommendation 3.3 (Strengthen coordination and information sharing) - Create a single online database of information (including costs) for all investment projects, irrespective of their funding source. - Use the system by Line Ministries and KSUs to track spending commitments and allow central access by the MEDT and the MoF to avoid duplication and risks of inconsistencies. *Source: IMF — chapter section provided (pages and annex references as in the original document).* ### 142. Recommendation 3.4. Strengthen the newly established project appraisal and selection ### 1ukrea2019007 - 142. Recommendation 3.4. Strengthen the newly established project appraisal and selection approach and gradually extend the Interdepartmental Committee appraisal and selection process to all major public investment projects ### Progressive application of the Interdepartmental Committee process (Recommendation 3.4) - Gradually extend the Interdepartmental Committee appraisal and selection process to all major public investment projects, following Table 3.2. - Table 3.2. Ukraine: Progressive Application of the Interdepartmental Committee Process to all Projects (project types and timing as presented): - Public Private Partnerships and Concessions: Bring into the framework first (implied for 2018-2020 and 2020 Onwards). - Major projects financed by loans or equity injections from the state budget to SoEs: Bring into the framework early (implied priority). - Projects financed by capital transfers to subnational governments: Progressively – starting with the Regional Development Fund. - Concessional external loans: Progressively, starting with donors that have the least robust appraisal and selection processes. - External grant funded projects: (included in progressive application). - Note: Timing in the table is based on assessment of likely risks of each project type and the size of funding streams. PPPs/concessions and major SoE projects supported by state-funded loans or equity injections should be brought into the framework first. - The definition of what constitutes a ‘major’ SoE project should be defined by rules agreed between the MEDT and the MoF, ahead of the introduction of clear thresholds for all projects (see Recommendation 3.5). ### Indicative project materiality and risk thresholds (Recommendation 3.5) - Introduce project materiality and risk thresholds once a mature MTBF is in place; use thresholds to apply differentiated appraisal and selection criteria and processes. - Table 3.3. Ukraine: Indicative Thresholds and Processes for Project Appraisal and Selection (Requirement and threshold (million UAH): <10m | 10m–30m | >30m) - Assessment of costs and benefits: - <10m: Cost ratio analysis/benchmarking of cost rates. - 10m–30m: Cost ratio/benchmarking of cost rates, or cost effectiveness analysis, as directed by the MEDT. - >30m: Cost effectiveness or cost/benefit analysis, as directed by the MEDT. - Centralized review of project case and project risk (MEDT): - <10m: Not conducted unless by specific direction of MEDT. - 10m–30m: Review of business case documentation by MEDT. - >30m: Multi-stage review of business case documentation by MEDT, sign off on project risk ratings. - Fiscal risk/funding source assessment (MoF): - <10m: Picked up through central review of capital plans – MoF to advise MEDT any concerns. - 10m–30m: Reviewed by MoF. - >30m: MoF sign off on fiscal risk ratings. - Note: Levels formulated with reference to existing thresholds specified in Cabinet Resolution 571. - Footnote example for cost ratio benchmarking: cost per square meter of gross floor area (GFA) delivered, measured against an appropriate benchmark rate (e.g. based on the type and location of the GFA delivered). ### Broaden PPP definition (Recommendation 3.6) - Revise the definition of PPPs within the PPP General Law to be sufficiently broad to encompass any long-term arrangement where there is: - (i) private sector execution (service provision) and financing of public investment; and - (ii) risk transfer from the government to the private sector. - Repeat policy point in Annex III and main text: Broaden the definition of Public-private partnership in the PPP General Law to encompass any long-term arrangement where there is: (i) private sector execution (service provision) and financing of public investment; and (ii) risk transfer from the government to the private sector. ### Legal reforms to strengthen MTBF, fiscal risk oversight, and PIM (Annex I: Indicative List of Legal Reforms) - I. MTBF — Amendments to the Budget Code and related legislation to introduce key elements for medium-term economic forecast and strategic fiscal planning, with phased approach. - Fully-fledged MTBF: repeal of Article 33 to introduce a new Section on Medium Term Budget Planning. - Replace the “Main Goals” document with a Fiscal Strategy Document (FSD) including, without limitation: - a. The government’s medium-term fiscal framework with measurable fiscal objectives and key fiscal indicators; - b. Updated and comprehensive medium-term macroeconomic and fiscal forecast covering current developments and multi-year projections; - c. The government’s medium-term budget framework including expenditure ceilings for overall General Fund and Special Fund and corresponding KSUs expenditures; - d. Performance management including strategic goals and outcomes of KSUs; - e. Comprehensive and quantitative fiscal risk statement; and - f. Others as established in secondary regulation by the CMU. - Establishing the procedure for approval of FSD: - a. Presentation of FSD by the MoF to the CMU for approval by June 1; - b. Approval by the CMU by June 15 and submission to the Verhovna Rada; and - c. Approval by the Verhovna Rada by enactment of a law by June 30. - Include provisions on Expenditure Ceilings to: - a. Define scope: General Fund and Special Funds; - b. Define legal effects of the ceilings: i) binding for the overall and KSU ceilings for the budget year, ii) indicative for the outer years; and iii) built-in mechanisms of technical amendments of ceilings for changes in macro- economic indicators (technicalities defined by secondary regulation by the CMU); - c. Require that margins and reconciliation are provided but details to be regulated through secondary regulation by the CMU; and - d. Define escape clauses. - Transitional period (Amendments to Section VI of the Budget Code): - Incorporate transitional provisions to defer application of approval of the FSD by the Verhovna Rada by enactment of a Law for the budget preparation exercise of 2020, subject to verifying what elements of the Budget Declaration would be approved in the main text of the law. - Approval by Verhovna Rada for the 2019 budget preparation period would follow usual procedure according to Article 33 (approval by Verhovna Rada Resolution). - Other amendments in the Budget Code: - i. Article 2 (Definitions): introduce definitions including expenditure ceilings (including definition on fixed and indicative), Fiscal Strategy Document, margins, reconciliation, etc. - ii. Article 7 (MTBF principles) - iii. Article 21 (multi-year forecast) - iv. Articles 34–38 (instructions for budget requests, budget calendar, approval of CMU of draft state budget law) - v. Articles 39–40 (approval of the state annual budget) - Other primary and secondary legislation to amend: - Law “About the Regulation of the Verhovna Rada” - Law on the Cabinet of Ministers of Ukraine - CMU Resolution and Ministerial Order - II. Fiscal Risk Oversight — Amendments to give MoF mandate, powers to collect information, and disclosure responsibilities. - Amend Budget Code to introduce a new Section on Fiscal Risk Oversight: - Assign MoF legal mandate for fiscal risk oversight and specify scope (macroeconomic risks; public debt related risk; government guarantees; SOEs risks—including information on financial position, guarantees and loans to SOEs, QFA, budget support provided to SOEs; local government risks; PPPs; financial sector risk; and natural disasters). - Require secondary regulation (CMU Resolution) to define roles and responsibilities in fiscal risk monitoring and management of all government departments and agencies. - Grant MoF power to collect information from government entities, agencies and SOEs with appropriate safeguards to protect confidential information. - Require secondary regulation to define responsibilities of various agencies, required inputs, timetable for their provisions, approval processes, etc. (Guidelines in Table 2.2 of the report). - Introduce provision dedicated to the Fiscal Risk Statement (FRS): - f. provide the MoF the responsibility for preparation and publication of a FRS; - g. specify minimum content of the FRS: general macroeconomic risks and their implications for public finances, as well as contingent liabilities and other specific fiscal risks that have the potential to materially impact the budget; - h. timeline for its publication—that is, with the FSD and accompanying the budget documents presented with the Draft State Budget Law; and - i. require secondary regulation to provide a template for FRS. - Amend Article 38 of the Budget Code as appropriate. - Other amendments for specific fiscal risks management: - Government guarantee risk: Amend Article 17 to require establishment of a risk-based fee for issuance of government guarantees specifying a minimum fee. - Local Government risk: Amend Article 18 and 74 to restrict foreign currency borrowing for all subnational governments to loans issued by international financial institutions. Amend Section III to require all Oblasts and cities publish an external financial audit annually. - PPPs risk: Amend the PPP and Concession Laws to establish a clear role for the MoF in assessing budget affordability and fiscal risks of PPPs. - Other secondary regulation considered: - CMU Resolution 662 on SOEs efficiency (methodology for analysis of SOEs fiscal risks, mechanisms for collection of information and cooperation among the MoF and other ministries and with the CMU). - CMU Resolution 692/2012 (quasi-fiscal activities). - CMU Resolutions n.131 and 460 of 2011 (state guarantees). - III. Public Investment Management — Legal alignment to integrate PIM with the budgetary framework and MoF role: - Amend pertinent laws including the Budget Code, PPP Law, Law on Concessions, Law on Sources of Financing Roads of Ukraine, Law on State Strategic Planning, and secondary regulations to explicitly recognize the role of the MoF in assessing budget affordability and risk management analysis for investment projects regardless of funding source (state budget, subventions, Regional Development Fund or externally-financed projects). - Amend Articles 13 and 23 of the Budget Code to prohibit reallocation from capital to other expenditure without parliamentary approval. - Broaden the definition of Public-private partnership in the PPP General Law as noted above. - Relevant CMU Resolutions mentioned include n. 571 of 2015 (inter-departmental committee); n. 70 of 2016 (loans from IFIs); and n.196 of 2015 (regional development fund). ### Annex II and III illustrative practices (selected comparative points) - Annex II summarizes approaches to reserves and margins in MTBFs for selected countries; examples preserve numeric ranges and magnitudes: - Canada: MoF adds 0.5% to 1.0% to interest rates; contingency reserve of 1.5% to 2.0% of total spending; MoF targets a surplus of 0.1% of GDP; total 3.5% to 4.0% of total spending. - UK: MoF uses GDP forecast 0.25% below trend; reserves and margins equal to 0.75% to 1.0% of total spending; MoF targets average surplus of 0.2% of GDP; total 2.5% to 3.0%. - Sweden: Budget margin within expenditure ceiling rising from 1.5% to 3.0% of total spending; total 1.0% to 3.0%. - Netherlands: Central contingency reserve of 0.1% of total spending; structural surplus target of 1.0% of GDP; total 1.1% to 2.0%. - Australia: Conservative bias in forward estimates of 0.5% to 1.5% of spending; total 0.5% to 1.5%. - Annex III provides country examples of legal provisions for fiscal risk management, including legislative excerpts and powers to collect information (Cyprus, New Zealand, Colombia, UK, Portugal, Brazil) and disclosure practices (Brazil, New Zealand). *Source: 1ukrea2019007 - 142. Recommendation 3.4. Strengthen the newly established project appraisal and selection approach and related sections in the provided content unit.* ### Annex IV. Template for Annual Fiscal Risk Statement ### Annex IV. Template for Annual Fiscal Risk Statement ### 1. Macroeconomic Risks - Qualitative discussion of the main macroeconomic risks (both, both upside and downside). - Analysis of how macroeconomic and fiscal outcomes have differed from forecasts in recent years, with explanation of the main reasons for these differences. - Sensitivity analysis of the impact on the main fiscal aggregates (revenue, expenditure, deficit and debt) of changes in key economic assumptions (e.g. real GDP, inflation, exchange rate). ### 2. Debt Management - Main debt aggregates: - domestic debt (domestic and foreign currency components); - external debt (including currency composition). - Discussion of key risks: - Exchange rate risk (share of foreign currency debt); - Interest rate risk (share of variable rate debt); - rollover risk (maturity structure and share of short-term debt). - Quantitative analysis: - Sensitivity analysis showing nominal value of debt under different scenarios for key macroeconomic variables, progressing debt sustainability analysis. - Summary of government’s strategy for managing public debt. ### 3. Nonfinancial State-Owned Enterprises (SOEs) - Overview of the size of the SOE sector, including number of entities, total assets and liabilities. - Details of the main financial aggregates (Table 1) and financial performance indicators (Table 2) of the sector as a whole. - Details of government support or explicit contingent liabilities to the sector (including subsidies, capital transfers, guarantees (can cross-reference guarantee section), sub-lending (Table 3)). - Quasi-fiscal activities: - type of activity; - rationale for performing this activity through the SOE rather than the state budget; - cost of activity to the SOE; - mechanism and size of compensation provided. - Contingent liabilities of SOEs, including: - guarantees provided by them to third parties; - letters of comfort; - legal proceedings initiated against the SOE. - Statement of measures to mitigate fiscal risks. - Table 1. Financial Position of SOEs (items to report) - Latest Year, Previous Year, Change (percent) - Total assets; Current assets; Non-current assets - Total Liabilities; Short-term liabilities; Long-term liabilities - Total equity - Total Revenue; Operating revenue; Non-operating revenue - Total Expenses; Operating expenses; Interest paid on debt - Profit before tax; Net profit - Table 2. Financial Performance Indicators for the SOE Sector (items to report) - Latest Year, Previous Year, Change - Profitability: Operating margin / EBITDA margin; Cost recovery ratio; Return on equity; Return on assets - Liquidity: Current ratio - Solvency: Net debt / EBITDA; Interest coverage ratio; Net Worth (total assets less total liabilities) - Table 3. Financial Performance Indicators for the SOE Sector (contingent/support items) - Latest Year, Previous Year, Change - Deferrals of tax liabilities; Tax benefits - Direct budget Subsidies; Recapitalizations (Financial SOEs; Non-financial SOEs) - Sub-lending: Outstanding Stock; New issuance; Repayments made; Payments in arrears - Guarantees: Outstanding Stock; New issuance; Servicing of debt on guaranteed loans; Guarantee fees collected; Recoveries on guarantees - Dividends paid to the budget ### 4. Guarantees - Summary table on the stock of outstanding loan guarantees by beneficiary. - Fiscal costs of servicing guarantees; recoveries; and revenue from any guarantee fees. - Paragraph describing each loan guarantee above a certain materiality threshold, including the amount; reason for granting the guarantee; maturity; and history of past servicing. ### 5. Public-Private Partnership (PPP) Contracts - List of PPP projects. - Details of new PPPs approved since the previous FRS. - Details of the cumulative multi-year fiscal commitments of the PPP program. - Gross exposure from guarantees and other contingent commitments attached to PPP contracts. ### 6. Local Governments - Total debt and guaranteed debt of local governments. - Breakdown of key financial stress ratios (including, debt, payment arrears, debt-servicing to revenue ratios) for individual Oblasts and major cities. ### 7. Financial Sector - Explicit liabilities to the financial sector, including details of the DGF (total insured deposits and total assets) and size of government guarantees provided on deposits in state-owned banks. - Liabilities of the financial sector broken into: - liabilities of state-owned banks explicitly guaranteed; - other liabilities of state-owned banks; - liabilities of private banks. - History of past fiscal support to the banking system. - Summary of financial soundness indicators (with reference to some key financial indicators such as capital adequacy ratios and proportion of non-performing loans) drawing on and referencing the NBU’s latest financial stability report. - Summary of mitigating measures to protect the soundness of the financial system. ### 8. Natural Disasters - Discussion of the main risks from natural disasters, average economic costs resulting from past natural disaster events and their frequency. - Fiscal costs associated with reconstruction and repair and compensation to individuals and businesses from past natural disasters. - Summary of measures to mitigate the risks of natural disasters. ### 9. Long-term Fiscal Pressures - Long-term (at least 30 year) projections for pension entitlements and pension contributions, and the expected amounts to be financed from the budget. ### 10. Other Material Fiscal Risks - Other material fiscal risks may comprise events that are not captured in the budget because their timing or magnitude is not known. - Material fiscal risks are those risks that, if omitted or misstated, could influence the decisions or assessments of users made on the basis of this statement. --- ### Phased Approach to Development of the Fiscal Risk Statement (Annex V highlights) - Macroeconomic Risks (2018 Budget → 2019 Budget → 2020 Budget): - 2018: Qualitative discussion of macroeconomic risks. - 2019: Qualitative discussion and analysis of past forecast errors to highlight uncertainty around macroeconomic and fiscal forecasts. - 2020: Present analysis of past forecast errors and sensitivity or scenario analysis showing the impact on fiscal aggregates of different outcomes for key macroeconomic variables. - Public Debt Exposure: - 2018: Discuss key risks to debt portfolio related to FX exposure; non-resident holdings; interest rates, refinancing and other relevant factors. - 2019: Discussion key risks to debt portfolio and sensitivity analysis of changes in debt to deviations in key variables (exchange rate, interest rates). - 2020: Discussion key risks to debt portfolio and debt sustainability analysis. - Sub-lending: - Disclose sub-lending by borrower and amounts outstanding, with discussion on performance and any restructuring. - SOEs (phased expansion): - Present balance sheet and key financial indicators for SOEs (top 100) in aggregate, and by sector; transactions between SOEs and the budget; expanded list of QFAs; stock of guarantees and loans to SOEs; summary of strategy to strengthen SOE performance and reduce fiscal risk exposures. - Later phases: assessment of higher-risk and macro-critical SOEs including more detailed discussion on the individual entities; contingent liabilities of SOEs; and risk mitigation strategies. - Guarantees: - 2018: Present outstanding stock of guarantees to SOEs (split between domestic and external) and history of performance (past guarantee calls). - 2019–2020: Present outstanding stock of all guarantees (split between domestic and external) at aggregate level, and also present guarantees by beneficiary (above a materiality threshold) along with a brief description of each guarantee and past history of performance. - Local Governments: - 2019–2020: Disclose local government liabilities in aggregate and by municipality, local government guarantees and other contingent liabilities; and discussion of risks related to transfers. - PPPs: - Disclose direct fiscal costs of PPPs over their life cycle; later phases add discussion of each major contract (above materiality threshold) and any associated contingent liabilities. - Financial Sector Exposures: - Disclose explicit obligations to financial sector (deposit scheme); liabilities and performance of state-owned banks; previous fiscal costs associated with bank recapitalizations; discussion of fiscal risks and risk mitigating measures. - Legal Claims: - Disclose current legal proceedings against the state, including brief description and quantification of the past legal determinations which give rise to fiscal obligations, but where claims have not yet been processed. - Pensions: - Include long-term projections for pension contributions, entitlements, and budget funding of the pension deficit. - Natural Disasters: - Discussion of potential fiscal implications from natural disasters and history of past budgetary costs. ### Select Recommendations and Illustrative Evidence (Annex VI excerpts) - PIMA finding: National strategic plans do not prioritize capital investment projects. - Recommendation 3.1: - Development of a national infrastructure strategy by the MEDT’s investment planning unit. - Require the strategy to cover recommendations and description of investments, including costings and underlying technical analysis. - Observations and implementation notes: - Some but not all sectoral strategies include prioritized capital investments with costing information. - The existing strategic planning process is largely dysfunctional, consisting of a myriad of programs that often overlap and pay little heed of the resourcing constraints posed by the budget. - MEDT examination of investment projects focuses on ensuring that the formal criteria for project development and appraisal are complied with, whereas actual selection is based on ad hoc prioritization in the inter-agency committee. - Selection of investment projects is directly linked to the annual budget process, and there is currently no pipeline of projects for subsequent inclusion into the budget. - Starting with the 2016 budget, a list of major public investments is included as an annex to the Budget and includes an estimate of the remaining lifetime costs of the project. However, this relates only to those projects defined as public investments under the Budget code and does not include other capital projects which constitute more than 90 percent of capital expenditure. - Recommendation 3.4: Strengthen the newly established project appraisal and selection approach and extend this to all major state investments. - The new public investment project mechanism (established in 2015) provides a standard methodology for project appraisal in line with international good practice. - For the 2016 budget, 36 projects were prepared and submitted for assessment in accordance with this new mechanism. - The total allocation for these projects in 2016 of 1 billion UAH must be compared to expected total general government capital spending during the year of 30-40 billion UAH. - To date, only a small fraction of government capital projects are covered by the new mechanism, though it covers a large share of new central government investment projects. ### National Infrastructure Strategy Examples (Annex VII highlights) - Victoria’s 30 Year Infrastructure Strategy 2016: - Led by: Seven-person Board comprising an Independent, expert Chair; Deputy Chair; major commercial cruise operator; one academic; and three senior (apolitical) public officials. - Produced by: Infrastructure Victoria. - Coverage: Central/middle/outer Melbourne and regional Victoria; includes population growth, health infrastructure, physical activity and participation, communities, accessibility, social and affordable housing, justice, education infrastructure, freight supply chains, water security, landfill and waste recovery facilities, and environment. - Timeframe: 18 months. - Consultation: Close collaboration with government and private and community sector organizations that have a role in planning, funding and delivering infrastructure. - NSW State Infrastructure Strategy 2012 (updated 2014): - Led by: Eleven-person Board including private sector members and senior public officials. - Produced by: Infrastructure NSW. - Coverage: Global/Greater Sydney and Regional NSW; includes urban roads, bus and light rail, passenger trains, international gateways, regional and interstate transport, energy, water infrastructure, health infrastructure, social infrastructure, and justice. - Timeframe: 18 months. - Consultation: Line departments, private sector proponents and other significant stakeholders including Infrastructure Australia. - The Eddington Transport Study 2006 (updated 2010): - Commissioned by: Chancellor of the Exchequer and the Secretary of State for Transport. - Produced by: Sir Rod Eddington and a team including civil servants from the Department of Transport and the Treasury. - Focus: How transport can contribute to economic success, identifying strategic economic priorities and prioritizing effective policies. - Timeframe: 18 months. - Consultation: Extensive evidence gathering with businesses, logistics operators, transport operators, suppliers and users, regional and local government, and environmental organizations. - Australian Infrastructure Plan 2016: - Led by: Twelve-person Board with private sector and public representatives. - Produced by: Infrastructure Australia. - Coverage: Productive cities and regions, efficient infrastructure markets, sustainability and equitable infrastructure, and better decisions and delivery. - Timeframe: 18 months. - Consultation: Over 100 formal submissions from jurisdictions, industry associations, public interest groups, local government bodies and individuals. ### Roles and Responsibilities of the MoF in the PPP Process (Annex IX) - Planning (Initial prefeasibility study/ initial Value for money assessment): - Role MoF under the Law: None. - Recommended Role for the MoF: - Evaluate pre-feasibility analysis and initial VfM assessment. - Evaluate budget affordability and ensure consistency with overall fiscal goals and priorities, review impact on the macro scenario and undertake initial risk assessment. - MoF should recommend or not to initiate the process. - Selection (Prepare feasibility analysis and update VfM): - Role MoF under the Law: No. - Recommended Role for the MoF: - Evaluate budget affordability. - MoF should recommend the continuation or not of the process. - Design and tender preparation (Prepare tender documents): - Role MoF under the Law: No. - Recommended Role for the MoF: - Approve or reject tender documents – in line with specifications in planning and selection phases. - Bidding and Contract awarding (Receive tender bids/select bidder; Negotiate contract): - Role MoF under the Law: No. CMU has the authority to approve state support to the PPP project. - Recommended Role for the MoF: - Bid documents: Ascertain VfM of the bid. Ascertain fiscal implications of preferred bid and ensure consistency with overall fiscal goals and priorities. MoF should recommend or not to approve issuance of bid documents. - Negotiation: Review VfM of the contract documents. MoF should advise decision making organ to approve/reject contract. - Risk management assessment in case of state support: - Role MoF under the Law: The MoF, according to the current legal framework of state direct support or issuance of government guarantees or borrowing performs the fiscal risk assessment of the project. - Construction and operation; Renegotiation: - MoF recommends approval/rejection of renegotiated contract to ad hoc Government Committee. - Registry: - MEDT; MoF. - Disclosure: - No requirements of disclosure of PPP arrangements in budget documents. *Source: IMF* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019007.pdf_