## 1ukrea2019009 ## Source details **Canonical URL:** [1ukrea2019009](https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019009.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1ukrea2019009.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1ukrea2019009.pdf.json) --- ### PREFACE — mission, meetings, acknowledgements, and executive summary - Mission details: - A capacity development (CD) mission from the Fiscal Affairs Department (FAD) of the International Monetary Fund (IMF) visited Kiev, Ukraine during the period April 15–19, 2019. - The mission was led by Avril Halstead (FAD short-term expert). - Meetings and participants: - In the Ministry of Finance (MoF) met with: Mr Vasyl Shkurakov (Deputy Finance Minister); Mr Andriy Savenko (Head of the Fiscal Risk Management Department (FRMD)); Ms Natalia Yefremova (Lead Specialist in the FRMD); and Mr Validimir Lutak (Lead Specialist for the Monitoring Section). - Representatives from the FRMD participated in a training workshop on using the model developed for performing stress-tests. - Meetings held with representatives from Naftogaz, Ukrainian Railways (UZ), and Energoatom. - Acknowledgements: - Mission thanked the authorities for collaborative engagement. - Specific thanks to: Mr. Ihor Shpak (coordinating the mission and securing meetings with SOEs) and Mr Sergei Kolesnyk (interpretation and translation support). - Executive Summary — key points: - Progress since embedding fiscal risks in the Budget Code in December 2018 includes: - Development of a resolution setting out procedures for assessing different fiscal risks, which was being considered by the Cabinet of Ministers of the Ukraine. - A draft order to establish sanctions where required information is not submitted has been prepared but not yet submitted for approval. - The electronic system for gathering SOE data is operational. - An action plan for enhancing fiscal risk management over the medium term (including creating a fiscal risk register (Q2 2020), and a fiscal risk management committee in the MoF (Q2 2021)) has been developed. - The second annual Fiscal Risk Statement (FRS) is due in September with the 2019 budget; this is an opportunity to build on the first FRS (2018) with a more comprehensive FRS. - Modelling updates and findings: - Naftogaz financial model (refined from October 2018 mission) shows anticipated loss of transit gas revenue will have a significant negative impact on the Ukraine budget from January 2020. Appropriate mitigating action could ameliorate this negative impact, but there will still be a significant reduction in inflows to the budget from Naftogaz. - Naftogaz was experiencing an immediate cash deficit at the time of the mission, requiring decisive action to avoid a gas shortfall during winter. - Simplified models applied to UZ and Energoatom found: - Ukrainian Railways is anticipated to realize losses and experience a significant cash shortfall over the medium term, resulting in the company being a draw on the budget. - Energoatom is expected to remain profitable and continue contributing toward the budget even without significant increases in electricity tariffs; however, outcomes could change depending on approaches to covering the deficit of the Universal Service Supplier and the gap between feed-in and market tariffs for the green market. Planned borrowing by Energoatom could be inadequate to meet cash outflows, producing a cash deficit, though the company has capacity to sustain more debt. - Models are a basis for future modelling and should be periodically updated to reflect new macroeconomic forecasts, policy changes, and developments such as subsequent capital raising by Naftogaz. - Recommended next steps: - Discuss and refine Naftogaz, UZ, and Energoatom models with the SOEs, and expand coverage to other major SOEs (e.g. Ukrenergo, the State Food and Grain Corporation and coal mining companies). - Incorporate information from stress testing and scenario analysis into the September 2019 FRS. ### I. INTRODUCTION — recent progress reported by authorities - Key progress since the October 2018 FAD TA mission: - December 2018: Amendments to the Budget Code adopted by the Verkhovna Rada establishing legal basis for fiscal risk management, powers for the MoF to collect information and monitor fiscal risks, and requirements for line Ministries to submit requisite information. - A draft overarching resolution setting procedures for assessing different fiscal risks was consulted with relevant Ministries and was being considered by the Cabinet of Ministers of the Ukraine (CMU). - A draft order providing for administrative sanctions where required information on fiscal risks is not submitted was under development. - The electronic system for gathering SOE data was operational. - MoF was preparing inputs on fiscal risks for the Budget Declaration (to be finalized in May 2019). - An action plan had been developed for enhancing fiscal risk management over the medium term. ### II. IMPROVING CURRENT PRACTICE — resolution, sanctions, FRS, action plan, and institutional responsibilities - Draft CMU resolution: - Prescribes procedures and responsibilities for analyzing major fiscal risks and identifying mitigating actions; being considered by CMU. - Covers key areas except risks associated with the debt portfolio (addressed under a separate resolution). - Draft lacked sufficient distinction between strengthening analysis/monitoring and potential mitigating policy responses for macroeconomic risks. - Draft order on administrative sanctions: - Details procedures for preparing and considering case reports, applying administrative sanctions, and appealing decisions; based on the Administrative Code of Ukraine on Administrative Offences and required by Budget Code amendments. - Individuals with ultimate responsibility for submitting accurate and timely fiscal risk information were not clearly defined in practice. - Draft order references a broad set of officials including central and local executive authorities, social insurance and pension funds, financial institutions, SOEs, and business entities where the state has majority ownership. - Reported fines: - Around EUR 100 where information was not submitted. - Around EUR 150 where regulatory measures were not implemented. - Mission recommendation: ensure sanctions are sufficiently onerous in cases of willful concealment; typical fiduciary duties for directors and additional sanctions (e.g., prohibition from serving in similar capacity) noted as examples. - Budget Declaration and Fiscal Risk Statement: - MoF intends to include a general overview of fiscal risks in the Budget Declaration, with a more detailed FRS to be produced in September for inclusion in the Budget documents. - Time and data constraints mean only a qualitative discussion of fiscal risks would be possible in the Budget Declaration finalized mid-May. - Action Plan (key elements and timing): - Extend deadline for draft CMU resolution on procedures for assessing fiscal risks from Q2 2018 to Q2 2019. - Annual analysis and inclusion in the Budget Declaration of a general assessment of fiscal risks and their impact on State budget indicators. - Annual preparation of information on fiscal risks and their impact on State budget indicators in the planned budget period. - Creation of a register of fiscal risks for monitoring and mitigation by Q2 2020. - Development of models for stress testing SOEs that pose the highest fiscal risks using the electronic system by Q3 2020. - Strengthening institutional and analytical capacity of the MoF and other public authorities through ongoing training. - Creation of a fiscal risk management committee at the MoF by Q2 2021. - Implementation of an electronic system for monitoring the extended set of fiscal risks by Q4 2021. - Observations: some deadlines could be accelerated; models for UZ and Energoatom developed and Naftogaz model updated during mission; include stress-testing results for select SOEs in September FRS; intention to automate via the electronic reporting system. - Institutional responsibilities and next steps: - MoF must analyze inputs and quantify impacts on key budget indicators (e.g., translate macroeconomic indicator changes into revenue/expenditure implications). - Suggested allocation within MoF: - Revenue risks: revenue forecasting department. - Debt portfolio and guarantee risks: debt department (with FRMD coordinating). - FRMD may need a stronger role where functions are not well-defined. - Fast-tracking creation of the fiscal risk management committee could foster internal collaboration for the FRS. - Ensure appropriate balance between responsibilities and FRMD staffing and training. ### Model development, data inputs, automation potential, and reconciliation issues - Model development and application: - Model enabling scenario analysis and stress testing of SOE financial projections developed during October 2018 STX visit and applied to Naftogaz. - Simplified version applied to UZ and Energoatom during April 2019 mission. - Authorities trained in model usage with intention to expand coverage to other macro-critical and high risk SOEs and incorporate analysis into next FRS. - A detailed guideline for the model developed and included as Annex II. - Data sources and required inputs: - Financial plans submitted by all SOEs: income statement, balance sheet, cash flow statement, capital expenditure, borrowings and payments to the budget. - Actuals for preceding financial year (2017), budget and actuals for current year (2018) and forward looking projections covering the next 5 years (2019-2023). - Quarterly breakdowns for the upcoming financial year (2019). - Reporting caveats and reconciliation issues: - Reporting in financial plans does not always correlate exactly with International Financial Reporting Standards (IFRS), making reconciliation difficult. - Discrepancies to discuss with SOEs: - Detailed breakdown of operating expenditure could not be reconciled to operating expenditure reported in the summary income statement. - Detailed information relating to obtaining and repaying funds could not be reconciled to liabilities in the summary balance sheet (example: UZ total long term liabilities of UAH 30 billion exceeded the total long term liabilities of UAH 21 billion reported in the summary balance sheet as at the end of 2018). - Model outputs require validation with SOEs; results compared with SOEs’ financial plans and key issues noted. ### Scenario analysis and stress-testing framework - Model capabilities: - Multi-factor scenario analysis and single-factor stress test / sensitivity test. - Minimum comparison: outcomes under upside and downside macroeconomic scenarios vs. baseline. - Macroeconomic scenario assumptions summarized: - Baseline: - Baseline economic growth, interest rate, exchange rate and inflation rate assumptions provided by the Ministry of Finance. - Effective average income tax rate of 18 percent. - Stress: - Lower economic growth assumptions provided by the Ministry of Finance. - Interest rates as per baseline. - 10 percent depreciation in the exchange rate. - Higher inflation assumptions as provided by Ministry of Finance. - Effective average income tax rate of 18 percent. - Reform: - Higher economic growth assumptions provided by the Ministry of Finance. - Interest rates as per baseline. - 10 percent appreciation in the currency. - Lower inflation assumptions as provided by Ministry of Finance. - Effective average income tax rate of 18 percent. - SOE-specific scenarios can be modelled (example: termination of the transit gas contract with Gazprom at the end of 2019). ### Naftogaz — findings, scenarios, data issues, and developments - Key findings: - Anticipated loss of transit gas revenue will have a significant negative impact on the budget from January 2020. - Mitigating action (e.g., reforms in the reform scenario) could ameliorate but not eliminate reduction in inflows to the budget from Naftogaz. - Naftogaz was experiencing a significant cash deficit at the time of the mission, risking ability to pump gas for storage ahead of winter peak demand. - Options discussed: international bond issuance, loans from international financial institutions, loans from state-owned banks or recapitalization by the government. - Company has limited capacity to take on additional debt given anticipated falls in revenue and profitability. - Nevertheless, in July 2019, Naftogaz managed to raise capital through two Eurobond issuances in the amount of EUR600 million and USD335 million. - Key assumptions for Naftogaz scenarios: - Baseline: - No change in PSO prices for household consumption or government subsidy. - Collection rates on balancing unauthorized gas remain at 20 percent and there is no improvement in other collections. - Transit revenues fall to zero post 2019 when Gazprom contract ends. - Slow deterioration in gas production due to challenges obtaining licenses. - Dividends of 75 percent of profits are payable from 2020. - Note: "This could be increased to 90 percent to match the stress scenario if current policy is likely to be continued indefinitely." - Stress: - PSO prices and collection rates unchanged from base case. - Transit revenues fall to zero post 2019 when Gazprom contract ends. - Gas import prices 10 percent higher. - Dividends of 90 percent of profits are payable. - Reform: - Liberalization of the gas market allowing market prices for PSOs and reducing unauthorized gas. - Collection rates improve through direct sales to households. - A government subsidy is received for the PSO shortfall in the meanwhile. - Production of local gas increases through access to required licenses and providing a substitute for a portion of the transit gas. - Dividends of 50 percent of profits are payable from 2020. - Naftogaz data issues to discuss: - Missing balance sheet information over the medium term in the financial plan. - Model based on IFRS accounts rather than the financial plan, possibly explaining discrepancies. - Interest rate information on Naftogaz borrowing should be provided. - Significant differences between revenue and cost projections in the model and Naftogaz’s financial model. - Naftogaz anticipates a once-off increase of UAH 75 billion in other revenues in 2020 — source should be explained. - Negligible depreciation assumed by Naftogaz (difference between EBITDA and operating profit). - Naftogaz projects lower financing costs decreasing over time, whereas the model anticipates an increase in financing costs. - Financial plan assumed a massive increase of volumes of 13.5 percent in 2019 despite a declining trend and no rationale provided. ### Ukrainian Railways (UZ) — findings, scenarios, and additional scenario considerations - Key findings: - UZ anticipated to realize losses and experience a significant cash shortfall over the medium term and will continue being a draw on the budget. - Only under the reform scenario is the company projected to generate an operating profit; after financing costs the company is still expected to realize a net loss even under the reform scenario. - Borrowing projected in the financial plan is inadequate to cover cash outflows arising from losses and planned capital expenditure. - The company’s weak financial performance limits its ability to sustain such debt. - Anticipated impact on the budget excludes potential recapitalization needed to keep the company liquid. - Key assumptions for UZ scenarios: - Baseline: - Volumes remain constant. - Tariffs grow at 75 percent of Producer Price Inflation (PPI). - Unit costs increase at PPI + 2 percent. - Operating costs increase by 60 percent in 2019 and decrease by 20 percent in 2020, thereafter growing at Consumer Price Inflation (CPI). - Dividends of 75 percent of profits are payable from 2020. - Stress: - Reduction in volumes of 3 percent per annum. - Tariffs grow at 50 percent of PPI. - Unit costs increase at PPI + 3 percent. - Operating costs increase by 60 percent in 2019, thereafter growing at CPI. - Dividends of 90 percent of profits are payable. - Reform: - Volumes grow 13.5 percent in 2019 and remain constant thereafter. - Tariffs grow at PPI. - Unit costs increase at PPI. - Operating costs increase at CPI. - Capital expenditure is increased by 25 percent. - Dividends of 30 percent of profits are payable. - Additional scenarios to consider (with more data): - Financial impact of decommissioning underutilized network segments (UZ reports only around half the network generates almost all revenues). - Structural shift where freight rail services decline and passenger services increase; implications of raising passenger tariffs or compensating UZ. - Impact of migrating regulated freight rail tariffs toward cost reflective tariffs. - Assessment of ageing rolling stock nearing end of life. - Contextual economic importance: - Underpricing of rail services has constrained other transport development; 70 percent of cargo is transported by rail due to underdeveloped road network relative to peer countries. - Ageing rolling stock and inadequate maintenance slows train speeds, causes breakdowns, and threatens UZ’s capacity with negative economic implications. ### Energoatom — findings, scenarios, data issues, and governance uncertainty - Key findings: - Even without significant tariff increases, Energoatom is expected to remain profitable and continue contributing to the budget. - Liberalization of the wholesale energy sector (introducing a wholesale market) could significantly increase tariffs that Energoatom receives, boosting performance and budget contribution. - An inadequate level of borrowings relative to cash outflows is expected to produce a cash deficit, mainly arising from capital expenditure and working capital changes. - Energoatom has capacity to sustain more debt: gearing and debt cover ratios remain acceptable even under the stress scenario. - Uncertainty over the compensation mechanism for quasi-fiscal costs (e.g., shortfall between market purchase cost and regulated retail tariff for the Universal Services Supplier (USS), and costs of feed-in tariffs for renewables) — options proposed include Energoatom covering costs or spreading costs across all generators; assessing impact requires estimates of total such costs. - Key assumptions for Energoatom scenarios: - Baseline: - Volumes remain constant. - Significant increases in tariffs in 2019 (34 percent) and 2020 (30 percent). - Capital expenditure as per financial plan. - Note: Capital expenditure of UAH 10 billion was assumed in 2019 as no assumption was provided in the financial plan. - Inventories increased to 200 percent of cost of sales. - Dividends of 75 percent of profits are payable from 2020. - Stress: - Volumes remain constant. - Tariffs increase at CPI. - Above inflation increases in operating costs in 2019–21 (20 percent; 10 percent; 10 percent). - No capital expenditure. - Inventories increased to 200 percent of cost of sales. - Dividends of 90 percent of profits are payable. - Reform: - Volumes remain constant. - Significant increases in tariffs in 2019 (34 percent) and 2020 (30 percent). - Capital expenditure as per financial plan. - Inventories increased to 200 percent of cost of sales. - Dividends of 50 percent of profits are payable from 2020. - Energoatom data issues to discuss: - Financial plan for 2019 largely missing; medium-term financial plan details missing beyond income statement. - Balance sheet discrepancy of UAH 131 000 between sum of assets and total reported. - Assumed electricity tariff increases in financial plan were lower than company-assumed tariffs provided to the mission (~UAH1 in the financial plan vs. ~UAH2 expected market tariff). - Significant increase in operating costs forecast in 2019 and 2020 (labor, repairs and maintenance) without clear drivers. - Energoatom’s projected finance costs were almost twice as high as finance costs projected in the model; Energoatom should substantiate their finance cost calculations. - Actual inventories (1 year’s stock) were lower than Energoatom’s reported holdings (2 year’s stock). ### Recommendations and implementation timing - Recommendation 1: Discuss the financial models and outputs and possible mitigating actions with Naftogaz, UZ and Energoatom (within 3 months). - Recommendation 2: Expand the financial model to include other major SOEs (e.g. Ukrenergo, the State Food and Grain Corporation and coal mining companies) (within 6 months). - Recommendation 3: Incorporate information from the stress testing and scenario analysis in the Fiscal Risk Statement that forms part of the Budget Documentation for the 2020 financial year (within 6 months). - Recommendation 4: Finalize the CMU resolution setting out the roles and responsibilities for fiscal risk assessment and reporting (within 3 months). - Recommendation 5: Strengthen the capacity of the FRMD and institutionalize coordination within the MoF, with the Ministry of Economy (MoE) and SOEs (1 year). - Recommendation 6: Integrate the model with the new electronic system for receiving period updates of information from SOEs (6 months). - Mission reiterated advice from previous FAD and STX visits to gradually expand fiscal risk analysis and disclosure to a broader range of risks and to deepen analysis over time. ### Annex I — Draft Overview of Fiscal Risks for Inclusion in the Budget Declaration (highlights) - A. Macroeconomic Risks: - Key risks: potential weakening in global economic conditions and depreciation in the exchange rate; difficulties accessing external funding (in particular from multilaterals); structural reforms not fully implemented or muted response; intensification of military conflict in the East. - Three macroeconomic scenarios (approved by the Cabinet of Ministers) for 2019–21: - Scenario 1 (baseline): basis for fiscal forecasts; premised on continued favorable world outlook and successful implementation of reforms envisaged in the Government’s Medium-Term Plan. - Scenario 2 (upside): assumes implementation of all reforms, including land and tax reforms; somewhat better assumptions regarding inflow of investment and loan capital. - Scenario 3 (downside): more adverse scenario under less favorable external conditions. - Mitigation: implement structural reforms; further measures to stimulate growth in event of sluggish growth; inflation targeting framework expected to contain inflation to 5 percent by 2021. - B. State Debt and Guarantees: - Exposures and vulnerabilities noted with placeholders in the source: Debt portfolio amounts to UAH [xx] billion; around [xx] percent denominated in foreign currency; around [xx] percent held by non-residents; interest rate risk around [xx] percent domestic floating rate and around [xx] percent foreign floating rate; refinancing risk [xx] percent maturing over 2019-2021. - State-guaranteed debt: total UAH [xx] billion with UAH [xx] billion securing an IMF loan to the National Bank of Ukraine and remaining guarantees borrowing by SOEs. - Mitigation: shift composition toward official creditors with longer maturities; develop local capital markets; charge risk-related fees to SOEs with guaranteed debt. - C. State-Owned Enterprises (SOEs): - Nature of risks: reductions in taxes, dividends and other receipts from SOEs or increases in subvention, loans, or equity injections required from Government. - Causes include macro deterioration, exchange rate depreciation, demand reduction, policy changes, asset impairment, penalties, legal action, governance weakening, corruption, escalation in geopolitical conflict, political unrest, natural disasters and force majeure. - Monitoring and coverage: Ministry of Finance identified 25 enterprises for close monitoring (state-owned natural monopolies, assets in excess of UAH 2 billion, receiving state budgetary support, or assessed high risk). - Risk categorization methodology approved by CMU: - Risk category 1: unprofitable and high debt burden. - Risk category 2: high debt burden. - Risk category 3: unprofitable or negative ROE. - Risk category 4: low profitability and ROE below 1 percent. - Risk category 5: all remaining SOEs. - Assessment summary contains placeholders ([xx]) in the source for counts and shares. - Selected SOE-specific risks and prospects summarized for Naftogaz, Energoatom, and state-owned mining companies with specific observations on transit contract expiry, PSO commitment periods, liquidity risks, and EU rules on state aid for coal sector. - Governance and reporting reforms to mitigate risks: - Liberalizing gas sector and deregulating electricity market. - Corporatizing unitary SOEs involved in commercial activities. - Establishing supervisory boards with independent directors. - New procedures for appointing and remunerating heads of largest SOEs. - Largest SOEs required to prepare IFRS financial statements and have them independently audited within [xx] months of the end of the financial year; financial statements must be published on company website. - D. Proceeds from Privatization: - Projection placeholder: Privatization projected to raise UAH [xx] billion; delays would lower proceeds and increase government debt relative to budget projections. - Legal framework: Law No. 2269-VIII adopted March 7, 2018; small-scale objects sold through electronic auctions; Condition for EU fiscal assistance first tranche: conclusion of at least 200 small-scale privatizations. - Cabinet approved list of 23 large-scale objects to be privatized on May 10, 2018. - E. Financial Sector: - Sources of fiscal risk: explicit obligations to provide back-up funding to the Deposit Guarantee Fund (DGF) and to guarantee deposits of state-owned banks; government recapitalization decisions not anticipated in budget forecasts. - Deposit insurance: DGF insures deposits up to UAH 200,000 per account holder. - All deposits in Oschadbank (around UAH [xx] billion) guaranteed by the government. - Sector assessment: risk from financial sector has declined in NBU’s assessment over the last [period]; non-performing loans proportion remains high. - Measures taken: improve governance of state-owned banks; require restructuring plans for unprofitable banks; NBU completed diagnostic studies of top-60 banks and assigned recapitalization schedules; phased-in new mandatory prudential requirements. ### Annex II — Guide for SOE Financial Model (selected requirements and conventions) - Required economic input data for baseline, upside (“reform”) and downside (“stress”) scenarios: - Domestic GDP growth rate. - Interest rates in UAH, USD and EUR; interest rate appropriate to average duration of SOE debt. - Exchange rates from UAH into USD and EUR. - Inflation rate for CPI and PPI. - Average effective income tax rate. - Data sources and coverage: - Provided by MoF and/or MoE. - Historical data for preceding five years and forward-looking data covering projection period of at least 3–5 years. - Baseline and upside/downside scenarios should align with those used for Budget documentation. - Same economic data inputs to be used for all SOEs. - SOE-specific data requirements: - Prefer data collected from SOEs and discussed to understand drivers and SOE-specific scenarios. - Model structured to pull historical data and financial plans from the electronic system; alternatively audited financial statements for preceding 5 years required. - Historical and forward-looking assumptions for drivers of revenues, costs, capital expenditure and financing required. - Linkages and assumptions in generic model: - Prices linked to CPI. - Variable costs (cost of sales), Repairs and maintenance, and Fuel cost linked to PPI. - Employee costs and other expenses linked to CPI. - Revenue, cost segmentation and data input conventions: - Revenues: up to two main segments plus “other revenue”; government subsidies treated separately; for each main segment: volumes and average price (revenue = volumes × average price). - Costs: distinguish variable costs and fixed operating expenses; cost of sales can be broken into two main segments plus other cost of sales; for each segment: amount sold and cost per unit (cost = volumes × unit cost). - Balance sheet, working capital, and financing inputs: - Future net PPE expenditure input (excluding depreciation). - Inventories and Trade Payables linked as percentage of cost of sales; Trade Receivables linked as percentage of revenue. - Record expected changes in equity and debt financing by currency; record amount of debt guaranteed by government. - Scenario setup and adjustments: - Default scenario linkage: Stress and Reform inputs same as baseline unless changed; exchange rates default: Stress = 10 percent depreciation vs base; Reform = 10 percent appreciation vs base. - Historical data entry, year markers, and data input cell color conventions specified. - Risk assessment, reasonability review, and interpretation: - Check for reasonability against historical data; key flags include negative cash, negative PPE or loans, negative working capital items; balance sheet check line should be zero. - Compare model projections with SOE internal plans and account for optimism bias. - Key analytical outputs: - Summary Charts sheet showing net flows to government: taxes and dividends received, subsidies paid, increase/decrease in government equity, calls on government guaranteed debt. - Compare Stress vs Baseline for fiscal risk, Reform vs Baseline for mitigating actions. - Useful ratios: Return on equity (ROE), Debt ratio, Interest coverage ratio, Current ratio. ### Box 1 — Energoatom example of fixed and variable costs (classification and modelling guidance) - Cost classification and treatment: - Cost of sales components vary differently with output: - Nuclear fuel: variable (varies with electricity generated). - Wages, salaries and related charges: relatively constant as electricity generated fluctuates (fixed). - Costs not closely linked to volume should be included under operating costs rather than cost of sales. - Operating costs — five main categories: - Employee benefits. - Repairs and Maintenance. - Fuel. - Loan loss provision. - All other expenses. - Depreciation, financing costs, and PPE: - Reducing balance depreciation method assumed; single input of average depreciation rate required. - Financing costs linked to interest rates in economic assumptions; required input: spread of interest rates paid over base interest rate in UAH, USD and EUR. - PPE changes reflect planned expenditure; net expenditure assumptions exclude depreciation. - Working capital and balance sheet drivers: - Inventories and Trade Payables linked to cost of sales through assumed percentages; Trade Receivables linked to revenue. - Record expected equity changes and breakdown of loans and borrowings by currency and maturity. - Data input conventions and scenario set-up: - All data input cells colored light green; “Years for projections” row uses “H”, “1”, and “0” markers. - First inputs: baseline economic data and baseline tax and dividend rates; then Stress and Reform scenario inputs. - Default scenario behavior for exchange rates: Stress = currency depreciates 10 percent faster than base; Reform = currency depreciates 10 percent more slowly than base. - Historical data inputs and format: - Historical annual financials must be captured manually in standardized format focused on key line items; financial information entered in UAH millions across all SOEs to enable aggregation. - Separate flows between SOE and government (taxes, grants, equity) must be separated for fiscal balance sheet consolidation. - Output checks and interpretation: - Focus outputs on net flows to government and comparison of scenarios; analyze net profit after tax, key financial ratios and changes in fiscal risk assessment ratings across scenarios and time. *Source: 1ukrea2019009 - PREFACE; Sections I, II, 11; Annex I; Annex II; Box 1 (IMF FAD mission report, April 15–19, 2019).* ### PREFACE _________________________________________________________________________________________ 6 ### PREFACE ### Mission details - A capacity development (CD) mission from the Fiscal Affairs Department (FAD) of the International Monetary Fund (IMF) visited Kiev, Ukraine during the period April 15–19, 2019. - The mission was led by Avril Halstead (FAD short-term expert). ### Meetings and participants - In the Ministry of Finance (MoF), the mission met with: - Mr Vasyl Shkurakov, Deputy Finance Minister; - Mr Andriy Savenko, Head of the Fiscal Risk Management Department (FRMD); - Ms Natalia Yefremova, Lead Specialist in the FRMD; and - Mr Validimir Lutak, Lead Specialist for the Monitoring Section. - Representatives from the FRMD participated in a training workshop on using the model developed for performing stress-tests. - Meetings were held with representatives from Naftogaz, Ukrainian Railways (UZ), and Energoatom. ### Acknowledgements - The mission thanked the authorities for collaborative engagement. - The mission acknowledged support from IMF office staff and specifically thanked: - Mr. Ihor Shpak for coordinating the mission and securing meetings with SOEs; - Mr Sergei Kolesnyk for interpretation and translation support. ### Executive Summary — key points - Progress since embedding fiscal risks in the Budget Code in December 2018 includes: - Development of a resolution setting out procedures for assessing different fiscal risks, which was being considered by the Cabinet of Ministers of the Ukraine; - A draft order to establish sanctions where required information is not submitted has been prepared but not yet submitted for approval; - The electronic system for gathering SOE data is operational; - An action plan for enhancing fiscal risk management over the medium term (including creating a fiscal risk register (Q2 2020), and a fiscal risk management committee in the MoF (Q2 2021)) has been developed. - The second annual Fiscal Risk Statement (FRS) is due in September with the 2019 budget; this is an opportunity to build on the first FRS (2018) with a more comprehensive FRS. - Modelling updates and findings: - The Naftogaz financial model (refined from October 2018 mission) shows the anticipated loss of transit gas revenue will have a significant negative impact on the Ukraine budget from January 2020. Appropriate mitigating action could ameliorate this negative impact, but there will still be a significant reduction in inflows to the budget from Naftogaz. - Naftogaz was experiencing an immediate cash deficit at the time of the mission, requiring decisive action to avoid a gas shortfall during winter. - Simplified models applied to UZ and Energoatom found: - Ukrainian Railways is anticipated to realize losses and experience a significant cash shortfall over the medium term, resulting in the company being a draw on the budget. - Energoatom is expected to remain profitable and continue contributing toward the budget even without significant increases in electricity tariffs; however, outcomes could change depending on approaches to covering the deficit of the Universal Service Supplier and the gap between feed-in and market tariffs for the green market. Planned borrowing by Energoatom could be inadequate to meet cash outflows, producing a cash deficit, though the company has capacity to sustain more debt. - Models are a basis for future modelling and should be periodically updated to reflect new macroeconomic forecasts, policy changes, and developments such as subsequent capital raising by Naftogaz. - Recommended next steps: - Discuss and refine Naftogaz, UZ, and Energoatom models with the SOEs, and expand coverage to other major SOEs (e.g. Ukrenergo, the State Food and Grain Corporation and coal mining companies). - Incorporate information from stress testing and scenario analysis into the September 2019 FRS. ### Table 1: Proposed Plan for Implementation of Recommendations (summary actions and responsibilities) - Discuss the financial models, outputs and possible mitigating actions with Naftogaz, UZ, Energoatom — Responsibility: FRMD, Naftogaz, UZ, Energoatom. - Expand the financial model to include other major SOEs — Responsibility: FRMD, SOEs. - Incorporate information from the stress testing and scenario analysis in the 2019 Fiscal Risk Statement — Responsibility: FRMD. - Finalize the CMU resolution setting out the roles and responsibilities for fiscal risk assessment and reporting — Responsibility: FRMD. - Strengthen the capacity of the FRMD and institutionalize coordination within the MoF, with the MoE and SOEs — Responsibility: MoF. - Integrate the model with the new electronic system for receiving periodic updates of information from SOEs — Responsibility: FRMD and MoE. --- ### I. INTRODUCTION — progress reported by authorities - Key progress since the October 2018 FAD TA mission: - December 2018: Amendments to the Budget Code adopted by the Verkhovna Rada establishing legal basis for fiscal risk management, powers for the MoF to collect information and monitor fiscal risks, and requirements for line Ministries to submit requisite information. - A draft overarching resolution setting procedures for assessing different fiscal risks was consulted with relevant Ministries and was being considered by the Cabinet of Ministers of the Ukraine (CMU). - A draft order providing for administrative sanctions where required information on fiscal risks is not submitted was under development. - The electronic system for gathering SOE data was operational. - MoF was preparing inputs on fiscal risks for the Budget Declaration (to be finalized in May 2019). - An action plan had been developed for enhancing fiscal risk management over the medium term. ### II. IMPROVING CURRENT PRACTICE #### A. Draft CMU Resolution on the Procedures for Assessing Fiscal Risks - The draft resolution prescribes procedures and responsibilities for analyzing major fiscal risks and identifying mitigating actions; it was being considered by the CMU. - The resolution covers key areas of fiscal risk except risks associated with the debt portfolio (addressed under a separate resolution). - For macroeconomic risks, the draft lacked sufficient distinction between actions to strengthen analysis/monitoring and potential mitigating policy responses. #### B. Draft Order on Administrative Sanctions - The draft order details procedures for preparing and considering case reports, applying administrative sanctions, and appealing decisions; it is based on the Administrative Code of Ukraine on Administrative Offences and is required by Budget Code amendments. - Individuals with ultimate responsibility for submitting accurate and timely fiscal risk information were not clearly defined in practice; the draft order references a broad set of officials including central and local executive authorities, social insurance and pension funds, financial institutions, SOEs, and business entities where the state has majority ownership. - Reported fines: - Around EUR 100 where information was not submitted. - Around EUR 150 where regulatory measures were not implemented. - The mission recommended ensuring sanctions are sufficiently onerous in cases of willful concealment; typical fiduciary duties for directors and additional sanctions (e.g., prohibition from serving in similar capacity) were noted as examples of stronger enforcement. #### C. Budget Declaration and Fiscal Risk Statement - MoF intends to include a general overview of fiscal risks in the Budget Declaration, with a more detailed FRS to be produced in September for inclusion in the Budget documents. - Including the detailed FRS as part of the Budget Declaration would allow fiscal risks to inform fiscal strategy and expenditure decisions; Budget documentation could include assessment of risks that could materialize during the upcoming fiscal year. - Given time constraints before finalization of the Budget Declaration (scheduled mid-May) and limited data availability (Budget Code amendments approved in December), only a qualitative discussion of fiscal risks would be possible in the Budget Declaration. - A draft overview of fiscal risks for the Budget Declaration (main sources: macro-economy, debt and state guarantee portfolio, SOEs, and financial sector) is included as Annex I (in source). #### D. Action Plan for Enhancing Fiscal Risk Management - The MoF developed an action plan. Key elements (Box 1) include: - Extend deadline for draft CMU resolution on procedures for assessing fiscal risks from Q2 2018 to Q2 2019 due to Budget Code amendment timing. - Annual analysis and inclusion in the Budget Declaration of a general assessment of fiscal risks and their impact on State budget indicators. - Annual preparation of information on fiscal risks and their impact on State budget indicators in the planned budget period. - Creation of a register of fiscal risks for monitoring and mitigation by Q2 2020. - Development of models for stress testing SOEs that pose the highest fiscal risks using the electronic system by Q3 2020. - Strengthening institutional and analytical capacity of the MoF and other public authorities through ongoing training. - Creation of a fiscal risk management committee at the MoF by Q2 2021. - Implementation of an electronic system for monitoring the extended set of fiscal risks by Q4 2021. - Observations: - Some targeted deadlines could be accelerated as elements are already advanced. - Models for stress-testing UZ and Energoatom were developed and the Naftogaz model was updated during the mission. - Including stress-testing results for select SOEs in the September FRS would improve transparency, subject to accompanying discussion to mitigate adverse perceptions and articulate government actions. - Intention to automate this analysis via the electronic reporting system. #### E. Institutional responsibilities and next steps - Accelerating progress requires high-level support and clearer assignment of responsibilities. - The draft CMU regulation defines Line Ministry responsibilities, but MoF must analyze inputs and quantify impacts on key budget indicators (e.g., translate macroeconomic indicator changes into revenue/expenditure implications). - Suggested allocation of responsibilities within MoF: - Revenue risks: revenue forecasting department. - Debt portfolio and guarantee risks: debt department (with FRMD coordinating). - Where functions are not well-defined, FRMD may need a stronger role. - Fast-tracking creation of the fiscal risk management committee could foster internal collaboration for the FRS. - Ensuring appropriate balance between responsibilities and FRMD staffing, alongside training, will assist implementation. *Source: 1ukrea2019009 - PREFACE (IMF FAD mission report, April 15–19, 2019).* ### 11. The MoF’s capacity to assess the fiscal risks arising from SOEs is being improved ### 11. The MoF’s capacity to assess the fiscal risks arising from SOEs is being improved ### Model development and application - During the October 2018 short-term expert (STX) visit, a model enabling scenario analysis and stress testing of SOE financial projections was developed and applied to Naftogaz. - A simplified version of the model was applied to Ukrainian Railway (UZ) and Energoatom during the mission. - The authorities were trained in model usage with the intention to: - expand coverage to other macro-critical and high risk SOEs; and - incorporate the analysis into the next FRS. - A detailed guideline for the model has been developed and is included as Annex II. ### Data sources, automation potential, and reconciliation issues - Data inputs: - Financial plans submitted by all SOEs, including an income statement, balance sheet, cash flow statement, and information on capital expenditure, borrowings and payments to the budget. - Actuals for the preceding financial year (2017), budget and actuals for the current year (2018) and forward looking projections covering the next 5 years (2019-2023). - Quarterly breakdowns for the upcoming financial year (2019). - Reporting caveats: - The reporting in the financial plans does not always correlate exactly with International Financial Reporting Standards (IFRS), making reconciliation difficult. - Discrepancies noted that should be discussed with SOEs: - The detailed breakdown of operating expenditure for the three entities could not be reconciled to the operating expenditure reported in the summary income statement in the financial plan. - The detailed information relating to obtaining and repaying funds could not be reconciled to the liabilities reported in the summary balance sheet. Specifically, in the case of UZ, the total long term liabilities of UAH 30 billion exceeded the total long term liabilities of UAH 21 billion reported in the summary balance sheet as at the end of 2018. - Model outputs still require validation with the SOEs; results were compared with the SOEs’ financial plans and key issues were noted (see Table 2 in source). ### Scenario analysis and stress-testing framework - The model allows assessment of: - multi-factor scenario analysis (range of factors); and - single-factor stress test / sensitivity test. - Minimum comparison: outcomes under upside and downside macroeconomic scenarios vs. baseline. - Macroeconomic scenario assumptions summarized (Table 3): - Baseline: - Baseline economic growth, interest rate, exchange rate and inflation rate assumptions provided by the Ministry of Finance - Effective average income tax rate of 18 percent - Stress: - Lower economic growth assumptions provided by the Ministry of Finance - Interest rates as per baseline - 10 percent depreciation in the exchange rate - Higher inflation assumptions as provided by Ministry of Finance - Effective average income tax rate of 18 percent - Reform: - Higher economic growth assumptions provided by the Ministry of Finance - Interest rates as per baseline - 10 percent appreciation in the currency - Lower inflation assumptions as provided by Ministry of Finance - Effective average income tax rate of 18 percent - SOE-specific scenarios can be modelled (e.g., termination of the transit gas contract with Gazprom at the end of 2019). ### Naftogaz — findings and scenarios - Key findings: - Anticipated loss of transit gas revenue will have a significant negative impact on the budget from January 2020. - Appropriate mitigating action (for instance, by implementing reforms in the reform scenario) could ameliorate but not eliminate the reduction in inflows to the budget from Naftogaz. - Naftogaz was experiencing a significant cash deficit at the time of the mission, risking its ability to pump gas for storage ahead of winter peak demand. - Options discussed: international bond issuance, loans from international financial institutions, loans from state-owned banks or recapitalization by the government. - Company has limited capacity to take on additional debt given anticipated falls in revenue and profitability. - Nevertheless, in July 2019, Naftogaz managed to raise capital through two Eurobond issuances in the amount of EUR600 million and USD335 million. - Key assumptions for Naftogaz scenarios (Table 4): - Baseline: - No change in PSO prices for household consumption or government subsidy - Collection rates on balancing unauthorized gas remain at 20 percent and there is no improvement in other collections - Transit revenues fall to zero post 2019 when Gazprom contract ends - Slow deterioration in gas production due to challenges obtaining licenses - Dividends of 75 percent of profits are payable from 2020 - Note: "This could be increased to 90 percent to match the stress scenario if current policy is likely to be continued indefinitely." - Stress: - PSO prices and collection rates unchanged from base case - Transit revenues fall to zero post 2019 when Gazprom contract ends - Gas import prices 10 percent higher - Dividends of 90 percent of profits are payable - Reform: - Liberalization of the gas market allowing market prices for PSOs and reducing unauthorized gas - Collection rates improve through direct sales to households - A government subsidy is received for the PSO shortfall in the meanwhile - Production of local gas increases through access to required licenses and providing a substitute for a portion of the transit gas - Dividends of 50 percent of profits are payable from 2020 - Naftogaz data issues to discuss (Table 2 highlights): - Missing balance sheet information over the medium term in the financial plan. - Model based on IFRS accounts rather than the financial plan, possibly explaining discrepancies. - Interest rate information on Naftogaz borrowing should be provided. - Significant differences between revenue and cost projections in the model and Naftogaz’s financial model. - Naftogaz anticipates a once-off increase of UAH 75 billion in other revenues in 2020 — source should be explained. - Negligible depreciation assumed by Naftogaz (difference between EBITDA and operating profit). - Naftogaz projects lower financing costs decreasing over time, whereas the model anticipates an increase in financing costs. - Financial plan assumed a massive increase in volumes of 13.5 percent in 2019 despite a declining trend and no rationale provided. ### Ukrainian Railways (UZ) — findings and scenarios - Key findings: - UZ anticipated to realize losses and experience a significant cash shortfall over the medium term and will continue being a draw on the budget. - Only under the reform scenario is the company projected to generate an operating profit; after financing costs the company is still expected to realize a net loss even under the reform scenario. - Borrowing projected in the financial plan is inadequate to cover cash outflows arising from losses and planned capital expenditure. - The company’s weak financial performance limits its ability to sustain such debt. - Anticipated impact on the budget excludes potential recapitalization needed to keep the company liquid. - Key assumptions for UZ scenarios (Table 5): - Baseline: - Volumes remain constant - Tariffs grow at 75 percent of Producer Price Inflation (PPI) - Unit costs increase at PPI + 2 percent - Operating costs increase by 60 percent in 2019 and decrease by 20 percent in 2020, thereafter growing at Consumer Price Inflation (CPI) - Dividends of 75 percent of profits are payable from 2020 - Stress: - Reduction in volumes of 3 percent per annum - Tariffs grow at 50 percent of PPI - Unit costs increase at PPI + 3 percent - Operating costs increase by 60 percent in 2019, thereafter growing at CPI - Dividends of 90 percent of profits are payable - Reform: - Volumes grow 13.5 percent in 2019 and remain constant thereafter - Tariffs grow at PPI - Unit costs increase at PPI - Operating costs increase at CPI - Capital expenditure is increased by 25 percent - Dividends of 30 percent of profits are payable - Additional scenarios that could be considered with more data: - Financial impact of decommissioning underutilized network segments (UZ reports only around half the network generates almost all revenues). - Structural shift impact where freight rail services decline and passenger services increase; implications of raising passenger tariffs or compensating UZ. - Impact of migrating regulated freight rail tariffs toward cost reflective tariffs. - Assessment of ageing rolling stock nearing end of life. - Contextual economic importance: - Underpricing of rail services has constrained other transport development; 70 percent of cargo is transported by rail due to underdeveloped road network relative to peer countries. - Ageing rolling stock and inadequate maintenance slows train speeds, causes breakdowns, and threatens UZ’s capacity with negative economic implications. ### Energoatom — findings and scenarios - Key findings: - Even without significant tariff increases, Energoatom is expected to remain profitable and continue contributing to the budget. - Liberalization of the wholesale energy sector (introducing a wholesale market) could significantly increase tariffs that Energoatom receives, boosting performance and budget contribution. - An inadequate level of borrowings relative to cash outflows is expected to produce a cash deficit, mainly arising from capital expenditure and working capital changes. - Energoatom has capacity to sustain more debt: gearing and debt cover ratios remain acceptable even under the stress scenario. - Uncertainty over the compensation mechanism for quasi-fiscal costs (e.g., shortfall between market purchase cost and regulated retail tariff for the Universal Services Supplier (USS), and costs of feed-in tariffs for renewables) — options proposed include Energoatom covering costs or spreading costs across all generators; assessing impact requires estimates of total such costs. - Key assumptions for Energoatom scenarios (Table 6): - Baseline: - Volumes remain constant - Significant increases in tariffs in 2019 (34 percent) and 2020 (30 percent) - Capital expenditure as per financial plan - Note: Capital expenditure of UAH 10 billion was assumed in 2019 as no assumption was provided in the financial plan. - Inventories increased to 200 percent of cost of sales - Dividends of 75 percent of profits are payable from 2020 - Stress: - Volumes remain constant - Tariffs increase at CPI - Above inflation increases in operating costs in 2019–21 (20 percent; 10 percent; 10 percent) - No capital expenditure - Inventories increased to 200 percent of cost of sales - Dividends of 90 percent of profits are payable - Reform: - Volumes remain constant - Significant increases in tariffs in 2019 (34 percent) and 2020 (30 percent) - Capital expenditure as per financial plan - Inventories increased to 200 percent of cost of sales - Dividends of 50 percent of profits are payable from 2020 - Energoatom data issues to discuss (Table 2 highlights): - Financial plan for 2019 largely missing; medium-term financial plan details missing beyond income statement. - Balance sheet discrepancy of UAH 131 000 between sum of assets and total reported. - Assumed electricity tariff increases in financial plan were lower than company-assumed tariffs provided to the mission (~UAH1 in the financial plan vs. ~UAH2 expected market tariff). - Significant increase in operating costs forecast in 2019 and 2020 (labor, repairs and maintenance) without clear drivers. - Energoatom’s projected finance costs were almost twice as high as finance costs projected in the model; Energoatom should substantiate their finance cost calculations. - Actual inventories (1 year’s stock) were lower than Energoatom’s reported holdings (2 year’s stock). ### Recommendations (timing indicated) - Recommendation 1: Discuss the financial models and outputs and possible mitigating actions with Naftogaz, UZ and Energoatom (within 3 months). - Recommendation 2: Expand the financial model to include other major SOEs (e.g. Ukrenergo, the State Food and Grain Corporation and coal mining companies) (within 6 months). - Recommendation 3: Incorporate information from the stress testing and scenario analysis in the Fiscal Risk Statement that forms part of the Budget Documentation for the 2020 financial year (within 6 months). - Recommendation 4: Finalize the CMU resolution setting out the roles and responsibilities for fiscal risk assessment and reporting (within 3 months). - Recommendation 5: Strengthen the capacity of the FRMD and institutionalize coordination within the MoF, with the Ministry of Economy (MoE) and SOEs (1 year). - Recommendation 6: Integrate the model with the new electronic system for receiving period updates of information from SOEs (6 months). - Mission reiterated advice from previous FAD and STX visits to gradually expand fiscal risk analysis and disclosure to a broader range of risks and to deepen analysis over time. *Source: 1ukrea2019009 - 11. The MoF’s capacity to assess the fiscal risks arising from SOEs is being improved* ### Annex I. Draft Overview of Fiscal Risks for Inclusion in the ### Annex I. Draft Overview of Fiscal Risks for Inclusion in the Budget Declaration ### A. Macroeconomic Risks - Key risks to the macroeconomic outlook: - Potential weakening in global economic conditions and depreciation in the exchange rate. - Difficulties accessing external funding, in particular from multilaterals. - Structural reforms not being fully implemented or the economy’s response being muted. - An intensification of military conflict in the East of the country. - Three macroeconomic scenarios (approved by the Cabinet of Ministers) considered for 2019–21: - Scenario 1 (baseline): Basis for fiscal forecasts in the budget declaration; premised on a continued, favorable outlook for the world economy; assumes successful implementation of reforms envisaged in the Government’s Medium-Term Plan with a moderate, positive response from the economy; implementation of reforms where consensus has not been reached (e.g., land and tax reforms) have not been included. - Scenario 2 (upside): Assumes implementation of all reforms, including the land and tax reforms; global economic outlook consistent with Scenario 1; somewhat better assumptions regarding inflow of investment and loan capital. - Scenario 3 (downside): More adverse scenario considering performance under less favorable external economic conditions. - Mitigation measures and projections: - Macroeconomic risks will be mitigated through diligent implementation of the structural reforms in line with the Medium Term Plan. - Further measures to stimulate growth will be taken in the event of sluggish economic growth. - Implementation of the inflation targeting framework by the National Bank of the Ukraine is expected to contain inflation to 5 percent by 2021. ### B. State Debt and Guarantees - Exposures and vulnerabilities: - Deviations in macro-economic parameters from forecasts will impact government debt and debt servicing obligations. - Debt portfolio amounts to UAH [xx] billion. - Around [xx] percent of the debt portfolio denominated in foreign currency. - Around [xx] percent of public debt held by non-residents. - Interest rate risk: around [xx] percent of domestic denominated debt and around [xx] percent of foreign currency debt denominated in floating rate instruments. - Refinancing risk: [xx] percent of the portfolio maturing over the 2019-2021 period. - An early termination of the program from the International Monetary Fund could reduce demand for government debt in the domestic and international capital markets. - State-guaranteed debt: - Total of UAH [xx] billion of state-guaranteed debt. - UAH [xx] billion secures a loan provided by the IMF to the National Bank of Ukraine; remaining guarantees borrowing by state-owned enterprises (SOEs). - Most guaranteed debt denominated in foreign currency and exposed to exchange rate risks. - Mitigation measures: - Shifting composition of debt away from private to official creditors, offering longer maturities. - Development of local capital markets to increase share of local currency debt. - Charging risk-related fees to SOEs with guaranteed debt to enable costs to be recovered should the Government be required to service the debt. ### C. State-Owned Enterprises (SOEs) - Nature of SOE fiscal risks: - Risks arise from reductions in taxes, dividends and other receipts from SOEs or increases in subvention, loans, or equity injections required from Government relative to budget. - Causes include deterioration in macroeconomic conditions, exchange rate depreciation, reduction in demand, policy changes (including assignment of non-commercial activities), asset impairment, penalties, legal action, weakening of governance, corruption, escalation in geo-political conflict, political unrest, natural disasters and force majeure events. - Monitoring and coverage: - Ministry of Finance identified 25 enterprises for close monitoring (state-owned natural monopolies, assets in excess of UAH 2 billion, receiving state budgetary support, or assessed high risk). - The full list of 25 enterprises is published on the official website of the Ministry of Finance. - Government response: - No explicit obligation for the government to support these enterprises; response will depend on prevailing circumstances; many companies are strategically important. - Risk categorization methodology (as approved by the Cabinet of Ministers of Ukraine): - Risk category 1: SOEs which are unprofitable, either at an operating profit or a net profit level and which have a high debt burden. - Risk category 2: SOEs which have a high debt burden. - Risk category 3: SOEs which are unprofitable or have a negative return on equity (ROE). - Risk category 4: SOE which have a low profitability and a ROE below 1 percent. - Risk category 5: all remaining SOEs. - Assessment summary (placeholders from source): - Results summarized in Table [xx]. - A total of [xx] SOEs assessed as highest risk (risk category 1). - A further [xx] assessed to be in risk categories 2 and 3. - Enterprises in risk categories 1 through 3 account for around [xx] percent of the total liabilities of the 25 SOEs. - Scenario analysis conducted on three of the largest SOEs. - Selected SOE-specific risks and prospects: - Naftogaz: - Historically significant contributor to the budget, with its dividends accounting for [xx] percent of total state revenues and [xx] percent of the proceeds from all SOEs. - Risk of situation reversing over the medium term and of net outflow from the budget to Naftogaz. - Expiration of contract with Gazprom at end of 2019 and commissioning of Nord Stream II and Turkish Stream pipelines anticipated to result in significant reduction in revenues from gas transit from the Russian Federation to Europe. - Extension of commitment period for public service obligations (PSOs) without compensation would exacerbate fiscal risks. - Liquidity risks if Naftogaz unable to secure adequate liquidity; adverse economic conditions and increase in price of gas imports would negatively impact Naftogaz. - Potential upside from a favorable arbitration decision with Gazprom and successful reforms to liberalize the gas sector. - Energoatom: - Expected to continue positive contribution toward the budget. - Adverse macro conditions, delays in deregulating the electricity market, and requirements to bear universal service supply costs and act as guaranteed off-taker for renewable power projects would reduce budget inflows. - Penalties for failing to adhere to licensing conditions would negatively impact performance. - State-owned mining companies (coal sector): - Many in weak financial position; state budget support must comply with Article 264 of the Association Agreement between Ukraine and the European Union. - EU does not permit unlimited support of uncompetitive coal mines. - Report on Results of Integrated Study (Antimonopoly Committee of Ukraine No 40 of 01.06.2016) determines: - Unprofitable and unsustainable coal mines are not eligible for operating and investment state aid. - State aid for restoration of solvency and restructuring in the coal mining sector is prohibited. - State aid for closure of mines is permitted, as well as environmental protection assistance in connection with closure. - Governance and reporting reforms to mitigate risks: - Liberalizing the gas sector and deregulating the electricity market. - Corporatizing unitary SOEs involved in commercial activities. - Establishing supervisory boards with independent directors. - Introducing new procedures for appointing and remunerating heads of the largest SOEs. - Largest SOEs required to prepare financial statements in accordance with international financial reports standards (IFRS) and have them independently audited by internationally reputable auditors within [xx] months of the end of the financial year. - Financial statements must be published on the company website. ### D. Proceeds from Privatization - Projection and risk: - Privatization of state and communal property projected to raise UAH [xx] billion. - Delays in planned privatization would lower proceeds and increase government debt relative to budget projections. - Legal and procedural framework: - Law of Ukraine No. 2269-VIII "On Privatization of State and Communal Property" adopted March 7, 2018; objects classified into small and large. - Small-scale objects sold exclusively through electronic auctions to ensure competition and increase sale price. - Procedure for conducting auctions through “Prozorro” approved by Resolution of the Cabinet of Ministers dated May 10, 2018, No. 432. - Order of the State Property Fund dated March 27, 2018 No. 447 approved list of small-scale privatizations in 2018, including 749 objects. - Condition for Ukraine to receive first tranche of fiscal assistance from the European Union is conclusion of at least 200 small-scale privatizations. - Cabinet of Ministers approved a list of 23 large-scale objects to be privatized on May 10, 2018; preparation for sale to be carried out with advisers; steps to restructure and prepare enterprises to increase investment attractiveness. ### E. Financial Sector - Sources of fiscal risk: - Explicit obligations to provide back-up funding to the Deposit Guarantee Fund (DGF) and to guarantee deposits of state-owned banks. - Government decisions to recapitalize troubled banks not anticipated in budget forecasts. - Triggers include weakening financial position of specific banks or the sector, deterioration in loan portfolio quality, tightening of liquidity or runs on deposits, and inadequate capitalization. - Deposit insurance and guarantees: - DGF insures deposits of individuals and sole traders up to UAH 200,000 per account holder. - All deposits in Oschadbank (around UAH [xx] billion) have been guaranteed by the government. - Sector assessment and reforms: - In the National Bank of the Ukraine’s (NBU’s) assessment the risk arising from the financial sector has declined over the last [period]. - Financial performance of the sector continues to improve; proportion of non-performing loans remains high. - Measures taken since the crisis: - Improve governance of state-owned banks, including independent professional supervisory boards. - Require all unprofitable banks to submit restructuring plans and meet capital adequacy requirements. - NBU completed diagnostic studies of the top-60 banks and assigned recapitalization schedules where needed; these banks are closely supervised. - Phased-in new mandatory prudential requirements and risk management systems aimed at reducing likelihood of risks under negative economic shock. ### Annex II A. Guide for SOE Financial Model — Data Collection (selected requirements) - Economic input data required for baseline, upside (“reform”) and downside (“stress”) scenarios: - Domestic GDP growth rate. - Interest rates in Ukrainian Hryvnia (UAH), United States Dollars (USD) and Euros (EUR); interest rate appropriate to average duration of SOE debt. - Exchange rates from UAH into USD and EUR. - Inflation rate both for consumer prices and producers. - Average effective income tax rate. - Data sources and coverage: - Provided by the Ministry of Finance (MoF) and/or Ministry of Economy (MoE). - Historical data for preceding five years and forward-looking data covering projection period of at least 3–5 years. - Baseline and upside/downside scenarios should align with those used for Budget documentation. - Same economic data inputs to be used for all SOEs. - SOE-specific data requirements: - Prefer data collected from SOEs and discussed to understand drivers and SOE-specific scenarios. - Model structured to pull historical data and financial plans from the electronic system; alternatively, audited financial statements for preceding 5 years required. - Historical and forward-looking assumptions for drivers of revenues, costs, capital expenditure and financing required. - Linkages and assumptions in generic model: - Prices linked to consumer price inflation (CPI). - Variable costs (“cost of sales”); Repairs and maintenance; and Fuel cost linked to producer price inflation (PPI). - Employee costs and other expenses linked to consumer price inflation. - Revenue segmentation and data required: - Revenues can be broken down into up to two main segments plus “other revenue”; government subsidies treated separately. - For each main segment: volumes of goods/services provided; price and forecast increase in price. - For “other revenue”: actual amounts realized and forecast increase. - Actual and forecast amounts of any government subsidies required. - Cost segmentation and data required: - Distinguish variable costs (cost of sales) and fixed costs (operating expenses). - Cost of sales can be broken into two main segments plus “Other cost of sales”. - For each segment: amount of goods/service sold; cost per unit. - Actual amount of any other cost of sales and forecast increases required. *Source: Annex I. Draft Overview of Fiscal Risks for Inclusion in the Budget Declaration.* ### Box 1. Energoatom Example of Fixed and Variable Costs ### Box 1. Energoatom Example of Fixed and Variable Costs ### Cost classification and treatment - Cost of sales in Energoatom's annual financial statements can be broken down into components that behave differently with output: - Nuclear fuel: varies depending on the amount of electricity generated (variable). - Wages, salaries and related charges: remain relatively constant as electricity generated fluctuates (fixed). - Where drivers of underlying costs are not closely linked to volume of output, those costs should be included under operating costs rather than cost of sales. ### Operating costs — five main categories - Employee benefits (any amounts paid as salaries and wages). - Repairs and Maintenance. - Fuel (any forms of electricity, gas, or other fuel consumed by the business). - Loan loss provision (any provision for amounts that will not be collectable or bad debts written off). - All other expenses (residual operating costs not captured above). - For each line item, actual amounts are drawn from the annual financial statements and inputs on forecast increases in these costs are required. ### Depreciation, financing costs, and PPE - A reducing balance depreciation method is assumed; a single input of the average rate of depreciation is required despite heterogeneous asset lives. - Financing costs are linked to interest rates provided in the economic assumptions. - Required input: the spread of the interest rates paid over the base interest rate in each of three currencies, UAH, USD and EUR (to the extent the company has debt in the different currencies). - Changes in Property, Plant and Equipment (PPE) should reflect planned expenditure, acquisition or disposal of PPE (net expenditure assumptions should exclude depreciation, which is calculated separately). ### Working capital and balance sheet drivers - Changes in working capital provided through assumptions on: - Inventories and Trade Payables: linked to the amount of cost of sales through an assumed percentage. - Trade Receivables: linked to the quantum of revenue through an assumed percentage. - Both changes in equity and debt financing are considered: - Expected changes in equity must be provided. - Changes in current and non-current loans and borrowings required, broken down by currency. - Some changes may reflect non-current liabilities becoming current as maturity approaches. - The quantum of loans and borrowings guaranteed by the government must be provided (total of both current and non-current). ### Data input conventions and scenario set-up - All worksheets and cells for data input are colored light green; data must not be input into other cells. - “Years for projections” line: mark historical years with “H”, projection years with “1”, and additional remaining years with “0”. - First inputs: baseline economic data and baseline assumptions for tax rate and dividend rate. - Then input economic and other baseline assumptions for: - Stress Scenario (downside). - Reform Scenario (upside). - Default assumption for scenario inputs: - Stress Scenario and Reform Scenario inputs are the same as baseline unless changed. - Exception: exchange rates — in the Stress Scenario the default is that the currency will depreciate 10 percent more quickly than in the base case, whereas in the Reform Scenario it depreciates 10 percent more slowly. - The same Scenario Input data should be used for all SOEs. ### Historical data inputs and format - Historical annual financial statement information must be captured manually in the Historical Data Input sheet using a simplified, standardized format focused on key line items. - The format accommodates financial and non-financial public corporations and enables aggregation across SOEs; financial information should be entered in UAH millions across all SOEs to enable aggregation. - Separate flows between the SOE and the government (taxes, grants, equity) must be separated for fiscal balance sheet consolidation. - If exact line items from annual statements are not available: - Do not add new line items or change names; aggregate several line items if necessary. - Typical aggregated areas: Operating costs (other expenses), Extraordinary profit (impairments, disposal gains/losses, FX gains/losses), and Other non-current/current assets/liabilities. - Data integrity checks: - Ensure net profit and balance sheet calculated by the model match the financial statements. - Ensure the balance sheet check line item is zero. ### Baseline input — income statement specifics - Historical revenue must be input for each of the two major segments and any other revenue, with associated volumes and average price per segment; revenue per segment must equal volumes × average price. - Record any government subsidies provided and anticipated. - Input assumptions for expected increases in volumes and prices for each segment and increases in other revenues; default linkage is to CPI unless otherwise linked to economic inputs (GDP, CPI, PPI). - Cost of sales inputs: - Record actual cost of sales for each major segment in historical years and any residual under “Other cost of sales.” - Record volumes and average unit cost per major segment; cost of sales per segment must equal volumes × unit cost. - Projected increases in volumes, unit cost, and other cost of sales must be recorded and linked to economic inputs where possible. - Operating expenses: - Historical operating expense data is pulled from the Historical Data Inputs worksheet. - Only need to input assumed year-on-year increases (ideally linked to economic inputs). - Historical average depreciation rate is calculated from Historical Data Inputs; assumptions for the average rate in forward years must be input. - Record average interest rate spread over the base interest rate paid in UAH, USD and EUR in historical and forward-looking years. ### Baseline input — balance sheet specifics - Historical changes to PPE after depreciation are calculated from Historical Data Inputs; only future net expenditure (acquisitions and construction costs less disposals) needs to be input (excluding depreciation). - Input expected inventories and trade payables as a percentage of cost of sales over the projection period; input expected trade receivables as a percentage of revenue. - Historical actual increases/decreases in share capital are calculated from Historical Data Inputs; anticipated net increases/decreases in share capital must be recorded under equity. - Default assumption: all loans and borrowings are denominated in UAH. If not: - Record historical breakdown of current and non-current debt in UAH, USD and EUR. - For any other currency, convert into equivalent value of the currency most closely correlated. - Forward-looking net increase or decrease in debt in each currency must be input (additional loans/borrowing less repayments), reflecting change in capital value only (exclude interest not capitalized). - Record historical and actual amount of debt in each currency that is guaranteed (total of current and non-current). ### Stress Scenario and Reform Scenario inputs - Ensure any changes to relationships between economic assumptions and forward-looking growth assumptions for revenues, costs, assets, equity or liabilities are implemented exactly as in the Baseline Input page. - For simplicity, recommended to use the same assumptions as baseline unless a specific policy change is being tested. - Box examples demonstrate linking Stress/Reform scenario cells directly to Baseline Input cells so changes propagate automatically. ### Adjusting historical and input years - To add a new year of historical data: - On Scenario Inputs sheet, mark new year with “H” in “Year for Projections” row. - In Baseline Input, Stress Scenario Input and Reform Scenario Input sheets, copy data from preceding year to new historical year column. - In Baseline Output, Stress Scenario Output and Reform Scenario Output sheets, copy Income Statement and Balance Sheet data from preceding year to new historical year column to pull in historical data. ### Risk assessment, reasonability review, and interpretation - Risk Assessment Criteria sheet records criteria for fiscal risk assessment calculations; normally does not need change unless methodology changes. - While entering data, the MoF should check for reasonability, particularly significant deviations from historical data and ensure justifiable explanations. - Review inputs and outputs for reasonability: - On input pages: interrogate forward-looking assumptions and their basis. - Key review questions: - Are assumptions based on well-supported, realistic assumptions in line with previous performance and forecasts of peers? - Are credible factors identified that account for deviations? - Ensure base case assumptions align with government policy intentions. - Output checks and common balance sheet flags: - Cash and Cash Equivalents negative → assumed level of Loans and Borrowing is too low; additional funding required. - PPE or Loans and Borrowing negative → assumed disposals or repayments exceed current holdings; adjust assumptions. - Inventories, Trade Receivables or Trade Payables negative → likely incorrect negative assumptions; adjust. - Balance sheet check line should be zero. - Compare financial projections with other SOE projections (e.g., SOE’s internal plan); identify material differences and underlying causes — this may require engagement with the SOE. - Consider SOE’s historical track record (optimism bias) when comparing model projections with the SOE’s projections. ### Interpretation and key analytical outputs - Focus on the Summary Charts sheet showing net flows to the government: sum of taxes and dividends received, subsidies paid, increase/decrease in government equity in the company, and all call on government guaranteed debt. - Comparing Stress Scenario to Baseline Scenario indicates potential fiscal risk. - Reform Scenario indicates potential positive impact of interventions to mitigate risks. - Compare net profit after tax across scenarios to assess implications for taxes and dividends. - Analyze and compare key financial ratios over time and across scenarios to assess financial sustainability under adverse conditions. Useful ratios include: - Return on equity (ROE) = net income over shareholder’s equity. - Debt ratio = total debt over total assets. - Interest coverage ratio = EBIT over interest expenses. - Current ratio = current assets over current liabilities. - Analyze changes in fiscal risk assessment ratings across scenarios and over time to evaluate company resilience and sustainability. *Box 1. Energoatom Example of Fixed and Variable Costs, as provided in the source content.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019009.pdf_