## 1. Estimating Potential Growth and Output Gap in Ukraine ## Source details **Canonical URL:** [1. Estimating Potential Growth and Output Gap in Ukraine](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10262.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10262.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10262.pdf.json) --- ### Introduction and program rationale - Stand-By Arrangement (2008 SBA) set to expire in November 2010; authorities requested a new Fund arrangement through Fall 2012. - 2008 SBA helped restore macroeconomic and financial stability but "foundations for sustainable growth are not firmly established" due to weak policy implementation. - A new SBA intended to: - lend credibility, catalyze financing from markets and the official sector, and provide buffers against adverse external conditions; - support fiscal consolidation, banking sector stabilization, energy sector reforms, and a shift toward a monetary framework focused on price stability. ### Recent economic developments and vulnerabilities - Output and labor: - Unemployment: 9.0 percent. - Construction activity and retail sales remain subdued; a large output gap persists. - External sector: - Steel and agriculture account for 55 percent of exports. - Private debt rollover rates increased recently to about 86 percent (year-to-date). - Current account deficit expected to narrow to around 1 percent of GDP in 2010, compared with 7.1 percent in 2008. - Inflation and monetary stance: - Domestic price inflation: 6.9 percent y-o-y in June. - Key policy rates kept low or negative in real terms; NBU reluctant to exit accommodative stance. - Foreign exchange reserves and exchange rate: - Foreign exchange sales by the NBU totaled US$10.5 billion in 2009; gross reserves declined by about US$5 billion. - Gross reserves currently stand at around US$30 billion. - Since August 2009, the hryvnia broadly stable against the U.S. dollar. - Banking sector: - NPLs: 15 percent (stricter definition) and nearly 42 percent (if all substandard loans are included) of total loans in March 2010. - Extended audits: 61 banks (holding 59 percent of assets) will need about UAH 40 billion of additional capital; UAH 12–18 billion to be provided by the government for banks under state control. - Lending stagnant: -3 percent y-o-y. - Public finances: - Combined general government deficit (program definition, including Naftogaz): 8.7 percent of GDP in 2009. - Budgetary cost from bank recapitalization: about 2.5 percent of GDP. - VAT refund arrears: about 1.0 percent of GDP. - Government direct and guaranteed debt: 35 percent of GDP at end-2009, from 20 percent at end-2008. - 2010 budget targets a general government deficit of 5.3 percent of GDP; cash deficit for first half of 2010 reached 2.2 percent of GDP. - Public sector wages and pension spending projected to absorb more than 70 percent of total general government expenditure in 2010 (driven by nominal spending increases of 24 percent and 22 percent respectively). - Naftogaz and energy: - Government transferred about 2.5 percent of GDP in “recapitalization” bonds to Naftogaz in 2009. - Naftogaz restructured US$1.6 billion of Eurobond and bank debt in October 2009. - Under unchanged policies, Naftogaz deficit could reach 1.5 percent of GDP in 2010. - New multi-year gas contract with Gazprom signed in April 2010 reduces import prices by 30 percent of import price, up to a maximum of $100 per thousand cubic meters. ### Box 1 — Potential growth, output gap, and decomposition (staff estimates) - Main estimates: - Output gap in 2010: -7.5 percent. - Post-crisis potential growth: about 4 percent, compared with 6.2 percent during the recent growth episode. - Output gap is closed by 2015. - Tabulated figures (Percent): - Actual/projected growth: 2008 2.1, 2009 -15.1, 2010 3.7, 2015 4.0 - Potential growth: 2008 3.9, 2009 -4.0, 2010 2.6, 2015 4.0 - Contribution by: - Labor: 2008 0.0, 2009 -0.2, 2010 -0.1, 2015 0.2 - Capital: 2008 3.6, 2009 -1.3, 2010 1.2, 2015 2.7 - TFP: 2008 0.4, 2009 -2.5, 2010 1.5, 2015 1.1 - Output gap: 2008 3.4, 2009 -8.6, 2010 -7.5, 2015 2.7 - Uncertainty note: estimates subject to large uncertainty due to short time series, structural breaks, sensitivity to smoothing parameters, and lack of reliable data on capital stock and capacity utilization. ### Box 2 — Reserve adequacy assessment and exchange rate - Reserve benchmarks and staff calibration: - Jeanne and Ranciere (2006) model “optimal” level: 25 percent of GDP or about $35 billion. - Reserve cover (reserves to short-term debt at remaining maturity): 75 percent in 2010, rising to 90 percent by 2011. - Greenspan-Guidotti rule benchmark: 100 percent. - Emerging market median: 153 percent. - Reserves at 45 percent are above Kapteyn-Wijnholds threshold coverage of 20 percent of broad money. - Reserve cover (months of imports): nearly 5 months, exceeding standard benchmark of 3 months. - Staff view: maintaining reserve cover above 85 percent sufficient to maintain confidence and provide adequate buffers. - Exchange rate assessment (Percent deviation from equilibrium REER, based on April 2010 WEO): - Equilibrium real exchange rate: -1.7 - Macroeconomic balance 2/: 0.9 - External sustainability 3/: -1.8 - Notes: 2/ REER adjustment needed to bring underlying current account to the norm (-3.1 percent of GDP). 3/ REER adjustment needed to stabilize NFA position. ### Box 3 — Social Standards Law (SSL) fiscal and distributional effects - Implementation timeline: - SSL enacted October 2009; implementation began late 2009, interrupted early 2010, resumed after Constitutional Court ruling and 2010 budget adoption with payments retroactive to January 1, 2010. - Wage and pension indexing and cost containment: - SSL indexes wages and pensions to the minimum wage and subsistence levels; measures have led to wage compression. - By end-2010: lowest 7 grades of public sector wage scale (out of 25) set at—and fully indexed with—the minimum wage level. - Government-set 1st grade tariff will increase by 8 percent this year compared to 24 percent for the minimum wage. - Fiscal cost (staff estimates): - Gross cost of the SSL at slightly over 4 of GDP in 2010. - Half is carry-over costs from late 2009 changes; one-third from increase in wage bill; remainder from higher pension expenditures. - Public wage “top-ups” introduced November 2009: cost another 0.8 percent of GDP in 2010 (in addition to the SSL). - Government plans increase in 1st grade tariff end-2010 generating additional cost in 2011 of about 2.3 percent of GDP. ### Box 4 — Gas sector reform measures (program period) - Objectives: - Improve energy efficiency, reduce dependence on imported gas, restore Naftogaz finances, and modernize transit infrastructure. - Price and tariff measures: - 50 percent domestic gas price increases for households and utility companies implemented on July 13, effective August 1. - Further 50 percent increase planned on April 1, 2011, with semi-annual increases thereafter until import parity reached for all consumers (with automatic adjustment mechanism planned). - Industrial prices already at market levels; preferential tariffs for various industries eliminated. - Protecting vulnerable households: - Increase transfers affecting approximately 5 percent of households using established support programs. - Payment discipline and institutional changes: - Create central independent regulator for heating tariffs. - Create distribution account into which all utility payments are made, with automatic drafting to Naftogaz. - July 2010 gas sector law enacted to provide for gradual liberalization, harmonization with EU Directive, and gradual restructuring of Naftogaz with separate cost centers. - Transit infrastructure: - Authorities working toward securing a loan from the World Bank, the EBRD, and the EIB to revamp gas transit infrastructure. ### Fiscal and program framework: 2010–12 targets and measures - Fiscal targets: - Under the program: general government deficit reduced to 5.5 percent of GDP in 2010; combined general government deficit (including Naftogaz) limited to 6.5 percent of GDP in 2010. - Medium-term targets: general government deficit 3.5 percent of GDP in 2011 and 2.5 percent of GDP in 2012. - Naftogaz deficit to be reduced to 1 percent of GDP in 2010 and eliminated in 2011. - 2010 fiscal measures (impacts primarily for 2010): - Increase tax and pension revenue: impact 0.5 percent of GDP (increased excise rates, limited loss deductions, raised contribution rates in simplified taxation). - Reduce government spending: impact 1.5 percent of GDP (supplementary budget with measures equivalent to UAH 16 billion; reductions in current spending, subsidies, administrative appropriations). - Raise Naftogaz revenue and tighten control over spending: impact 0.5 percent of GDP (50 percent gas price increase for utility companies and households, elimination of preferential tariffs, automated drafting system, establishment of independent utility tariff regulator). - Mitigate impact on vulnerable households: impact about -0.1 to -0.2 percent of GDP (support expected to protect about 800,000 households, about 5 percent of total). - Financing: - Temporary Fund financing requested for the budget: SDR 1.35 billion (equivalent to US$2.0 billion), equally split between the first two purchases. - Authorities expect to tap the Eurobond market later in 2010 but financing needs remain considerable. - Selected public finance indicators (percent of GDP): - Revenue: 44.2 (2008 Act), 42.2 (2009 Act), 42.8 (2010 Proj), 42.3 (2011 Proj), 42.3 (2012 Proj). - Expenditure and net lending: 47.3 (2008 Act), 48.5 (2009 Act), 48.3 (2010 Proj), 45.8 (2011 Proj), 44.8 (2012 Proj). - Overall balance: -3.2 (2008 Act), -6.2 (2009 Act), -5.5 (2010 Proj), -3.5 (2011 Proj), -2.5 (2012 Proj). - Combined balance: -3.2 (2008 Act), -8.7 (2009 Act), -6.5 (2010 Proj), -3.5 (2011 Proj), -2.5 (2012 Proj). - Public sector debt: 19.9 (2008), 34.6 (2009), 39.6 (2010 Proj), 42.7 (2011 Proj), 44.4 (2012 Proj). - Memorandum: Cyclically-adjusted primary balance: -4.2 (2008), -1.0 (2009), -0.5 (2010), 1.0 (2011), 1.2 (2012). - Bank recapitalization bonds: 0.0 (2008), 2.6 (2009), 1.8 (2010), 0.0 (2011), 0.0 (2012). - VAT bonds 1/: 0.0 (2008), 0.0 (2009), 1.5 (2010), 0.0 (2011), 0.0 (2012). - Combined balance plus bank recap. bonds and VAT bonds: -3.2 (2008), -11.3 (2009), -9.9 (2010), -3.5 (2011), -2.5 (2012). - Note: 1/ Total amount of bonds used in 2010 as payment for VAT refunds. This includes unrefunded VAT claims accumulated in 2009. ### Banking sector strategy and benchmarks - Priorities: - (i) completing recapitalization or resolution of banks; - (ii) strengthening state-owned banks; - (iii) enacting key financial sector legislation. - Recapitalization and resolution: - Bank recapitalization to be completed by end-2010 (structural benchmark). - NBU to approve recapitalization plans by end-July; private bank recapitalization must be completed by end-2010. - Banks failing to meet capital needs by end-2010 to be promptly resolved. - Nadra Bank: audit to be completed before any decision on final resolution (structural benchmark). - State-controlled banks: - Due diligence studies for remaining two state-owned banks by end-December 2010 (structural benchmark). - Government to retain internationally-reputable financial adviser to assess potential privatization or resolution options. - Legal and supervisory measures: - Amend corporate insolvency and related legislation to facilitate loan workouts by end-June 2011 (structural benchmark). - Strengthen consolidated supervision and require full disclosure of ultimate controllers. ### Monetary policy, exchange rate, and central bank reforms - Monetary objectives: - Maintain near-term core inflation in single digits in 2010 and bring overall inflation to no more than 5 percent over the medium term. - NBU committed to maintain refinancing rates—currently at 8.5 percent—positive in real terms going forward. - Operational measures: - Step up placements of CDs, repos, and outright sales of government securities; require banks to keep required reserves at a separate NBU account. - Monitor program through targets on monetary aggregates (MEFP ¶15) as a key anchor in early stages. - Exchange rate and FX liberalization: - Program supports a shift to a more flexible exchange rate regime to discourage dollarization and focus monetary policy on price stability. - Foreign exchange transactions tax removed effective July 1; to be permanently eliminated by end-December 2010 (structural benchmark). - Full assessment of regulatory restrictions to be completed by the fall and a timetable for elimination agreed by end-October 2010 (structural benchmark). - Foreign currency interventions limited to smoothing operations and to help meet NIR targets; NBU to align official exchange rate with interbank market rate. - NBU institutional reforms: - Amendments to the NBU law (prior action) establish price stability as the primary objective, improve governance with a more professional NBU Council, and strengthen NBU’s financial soundness. - NBU amended Resolution 47 (prior action) to eliminate direct NBU lending to the private sector and tighten emergency liquidity assistance conditions. - Transition toward inflation targeting as conditions permit. ### Program design, access, phasing, and financing - Proposed SBA: - 29-month SBA in amount equivalent to SDR 10.0 billion, or 728.9 percent of quota (about US$14.9 billion). - Rationale: considerable financing needs from reduced international access, still inadequate rollover rates, and need to strengthen reserves. - Gross external financing requirements: about US$31 billion on average in 2010–12. - Phasing (Access and Phasing Under a Proposed Stand-By Arrangement): - July 28, 2010 / 1,250 / 91.1 / Board approval of arrangement - November 30, 2010 / 1,000 / 72.9 / First review and end-September 2010 performance criteria - March 15, 2011 / 1,000 / 72.9 / Second review and end-December 2010 performance criteria - June 15, 2011 / 1,000 / 72.9 / Third review and end-March 2011 performance criteria - September 15, 2011 / 1,000 / 72.9 / Fourth review and end-June 2011 performance criteria - December 15, 2011 / 1,000 / 72.9 / Fifth review and end-September 2011 performance criteria - March 15, 2012 / 1,000 / 72.9 / Sixth review and end-December 2011 performance criteria - June 15, 2012 / 1,000 / 72.9 / Seventh review and end-March 2012 performance criteria - September 15, 2012 / 1,000 / 72.9 / Eighth review and end-June 2012 performance criteria - December 15, 2012 / 750 / 54.7 / Ninth review and end-September 2012 performance criteria - Total / 10,000 / 728.9 - Role of other official partners: - World Bank, European Commission, and EBRD expected to provide up to US$1½ billion in 2010. - For 2011–12, official commitments so far amount to US$1–2 billion a year. ### Exceptional access, debt sustainability, and capacity to repay - Exceptional access assessment: - Staff view: Ukraine meets all substantive exceptional access criteria; proposes upper credit tranche terms. - Criterion 1 (balance of payments pressures): high rollover risks, restricted market access, and relatively weak official reserves. - Criterion 2 (debt sustainability): public and publicly guaranteed debt expected to rise to about 40 percent of GDP in 2010; envisaged fiscal adjustment would set public debt ratio on downward path ensuring sustainability with high probability. - Criterion 3 (prospects of regaining market access): renewed interest from non-residents; successful program implementation expected to improve access. - Criterion 4 (prospect of program success): reforms backed at highest political levels and several prior actions frontloaded, but strong and consistent implementation required. - Capacity to repay: - By end of arrangement in 2012, outstanding credit to the Fund expected to peak at about 14 percent of GDP, or 51 percent of gross reserves. - Combined with outstanding use from previous SBA, debt service to the Fund as ratio of exports of goods and services would peak at 7 percent in 2013. - Peak projected outstanding GRA credit to Ukraine: SDR 14,765.6 in 2012 (GRA credit schedule provided). - Projected Fund debt service burden (if all purchases made as scheduled): - Ukraine’s projected debt service to the Fund would peak at about SDR 4.1 billion in 2013. - Equivalent: 8.7 percent of government revenues; almost three-quarters of public external debt service; 3.6 percent of GDP; 14.3 percent of gross international reserves; 7.0 percent of projected exports of goods and services. - Ukraine’s total external debt service for 2013 projected at 21.3 percent of GDP and 41.3 percent of exports of goods and services. ### Risks, staff appraisal, and policy implications - Key risks: - External: fragile recovery in Europe, volatile financial markets, potential fallout from Stockholm arbitration ruling. - Domestic: rising NPLs, weak business environment and institutions, political pressures ahead of local and parliamentary elections. - Upside: larger-than-expected steel price increases, faster trading partner recoveries, return of political stability. - Staff assessment: - Program is ambitious but achievable if consistently implemented. - Fiscal adjustment must contain spending pressures from Euro 2012 and elections; strengthen fiscal control over local governments and state-owned institutions. - Structural reforms critical: pension reform to address pension system fiscal pressures; energy sector reforms to stabilize Naftogaz finances; banking sector recapitalization and governance reforms to restore confidence. - Strengthening NBU autonomy essential to avoid monetization and allow monetary policy to focus on inflation objectives. ### Monitoring, conditionality, and safeguards - Monitoring and reviews: - Quarterly reviews; initial disbursement SDR 1.25 billion; first review set for November 30, 2010 (end-September 2010 targets). - Performance monitored by quarterly quantitative performance criteria and structural benchmarks. - Prior actions (selected): - Enact supplementary budget with fiscal measures of UAH 16 billion consistent with 5.5 percent of GDP deficit for general government in 2010. - Increase gas tariffs for all households and utility companies by 50 percent (effective August 1). - Enact amendments to the NBU law in line with IMF recommendations. - Amend NBU Resolution 47 (to strengthen emergency liquidity assistance framework and eliminate direct NBU lending to the private sector). - Adopt legislation transferring authority for setting heating tariffs for communal utilities to a new independent regulator. - Selected structural benchmarks and target dates (selected): - Revoke law banning penalties on overdue utility payments for arrears accumulated after October 1, 2010 — By September 30, 2010. - Agree schedule for phasing out FX market restrictions — By October 31, 2010. - Complete audit for Nadra Bank before any decision on resolution — By October 31, 2010. - Enact legislation on pension reforms consistent with MEFP commitments — By December 31, 2010. - All banks meet capital requirements/capital deficient banks increase capital per approved plans — By December 31, 2010. - Amend insolvency law to facilitate out-of-court restructuring — By June 30, 2011. - Safeguards: - Update to the safeguards assessment to be completed by the first review. - NBU to provide auditors’ management letters and allow external review of internal audit; address outstanding 2008 safeguards issues. *IMF staff report: 1. Estimating Potential Growth and Output Gap in Ukraine (excerpt; content unit: _cr10262).* ### 1. Estimating Potential Growth and Output Gap in Ukraine ............................................... 6 ### 1. Estimating Potential Growth and Output Gap in Ukraine ### Introduction - With the current Stand-By Arrangement (2008 SBA) set to expire in November 2010, the authorities have requested a new Fund arrangement spanning the period to the next parliamentary elections—scheduled for Fall 2012. - The 2008 SBA helped restore macroeconomic and financial stability but foundations for sustainable growth are not firmly established; weak policy implementation undermined better outcomes. - A new SBA is expected to lend credibility, catalyze financing from markets and the official sector, and provide buffers against adverse external conditions. ### Recent Developments and Economic Challenges - Output, labor markets, demand: - Unemployment: 9.0 percent. - Construction activity and retail sales remain subdued; a large output gap persists. - External sector and vulnerability: - Steel and agriculture account for 55 percent of exports. - Private debt rollover rates have increased recently to about 86 percent (year-to-date). - Current account deficit expected to narrow to around 1 percent of GDP in 2010, compared with 7.1 percent in 2008. - Inflation and monetary stance: - Domestic price inflation: 6.9 percent y-o-y in June. - Key policy rates kept low or negative in real terms; NBU reluctant to exit accommodative stance. - Foreign exchange reserves and exchange rate: - Foreign exchange sales by the NBU totaled US$10.5 billion in 2009; gross reserves declined by about US$5 billion. - Gross reserves currently stand at around US$30 billion. - Since August 2009, the hryvnia has been broadly stable against the U.S. dollar. - Banking sector: - NPLs reached 15 percent (under a stricter definition) and nearly 42 percent (if all substandard loans are included) of total loans in March 2010. - Extended audits: 61 banks (holding 59 percent of assets) will need about UAH 40 billion of additional capital; UAH 12–18 billion to be provided by the government for banks under state control. - Lending: stagnant (-3 percent y-o-y). - Public finances and fiscal rigidity: - Combined general government deficit (program definition, including Naftogaz): 8.7 percent of GDP in 2009. - Budgetary cost from bank recapitalization: about 2.5 percent of GDP. - VAT refund arrears: about 1.0 percent of GDP. - Government direct and guaranteed debt: 35 percent of GDP at end-2009, from 20 percent at end-2008. - 2010 budget targets a general government deficit of 5.3 percent of GDP. - Cash deficit for the first half of 2010 reached 2.2 percent of GDP. - VAT arrears increased by UAH 8.5 billion. - Public sector wages and pension spending projected to absorb more than 70 percent of total general government expenditure in 2010 (driven by nominal spending increases of 24 percent and 22 percent respectively). - NBU and public debt monetization: - The NBU has emerged as a major holder of Treasury bonds (over 60 percent of total stock), monetizing government bonds issued for bank recapitalization. - Naftogaz and energy sector: - Government transferred about 2.5 percent of GDP in “recapitalization” bonds to Naftogaz in 2009. - Naftogaz restructured US$1.6 billion of Eurobond and bank debt in October 2009. - Under unchanged policies, Naftogaz deficit could reach 1.5 percent of GDP in 2010. - New multi-year gas contract with Gazprom signed in April 2010 reduces import prices by 30 percent of import price, up to a maximum of $100 per thousand cubic meters. ### Box 1 — Estimating Potential Growth and Output Gap - Main staff estimates: - Output gap in 2010: -7.5 percent. - Post-crisis potential growth: about 4 percent, compared with 6.2 percent during the recent growth episode. - Output gap is closed by 2015. - Note on uncertainty: estimates subject to large degree of uncertainty due to short time series, structural breaks, sensitivity to smoothing parameters, and lack of reliable data on capital stock and capacity utilization. - Tabulated figures (Percent): - Actual/projected growth: 2008 2.1, 2009 -15.1, 2010 3.7, 2015 4.0 - Potential growth: 2008 3.9, 2009 -4.0, 2010 2.6, 2015 4.0 - Of which, contribution by: - Labor: 2008 0.0, 2009 -0.2, 2010 -0.1, 2015 0.2 - Capital: 2008 3.6, 2009 -1.3, 2010 1.2, 2015 2.7 - TFP: 2008 0.4, 2009 -2.5, 2010 1.5, 2015 1.1 - Output gap: 2008 3.4, 2009 -8.6, 2010 -7.5, 2015 2.7 - Source: IMF staff estimates and projections. ### Box 2 — Assessment of Reserve Adequacy - Comparison with benchmarks and staff calibration: - Jeanne and Ranciere (2006) model “optimal” level of reserve: 25 percent of GDP or about $35 billion. - Reserve cover (reserves to short-term debt at remaining maturity): 75 percent in 2010 and rising to 90 percent by 2011. - Greenspan-Guidotti rule benchmark: 100 percent. - Emerging market median: 153 percent. - At 45 percent, reserves are above the Kapteyn-Wijnholds threshold coverage of 20 percent of broad money. - Reserve cover (in months of imports): nearly 5 months, exceeding the standard benchmark of 3 months. - Staff view: maintaining reserve cover above 85 percent would be sufficient to maintain confidence and provide adequate buffers. - Exchange rate assessment (Percent deviation from equilibrium REER, based on April 2010 WEO): - Equilibrium real exchange rate: -1.7 - Macroeconomic balance 2/: 0.9 - External sustainability 3/: -1.8 - Notes: 2/ REER adjustment needed to bring underlying current account to the level of the norm (-3.1 percent of GDP). 3/ REER adjustment needed to stabilize NFA position. ### Box 3 — Adjustment in Social Standards - Social Standards Law (SSL) enactment and implementation: - SSL enacted October 2009; implementation began in late 2009, interrupted in early 2010, resumed after Constitutional Court ruling and 2010 budget adoption with payments retroactive to January 1, 2010. - SSL indexes wages and pensions to the minimum wage and subsistence levels; measures to limit costs have led to wage compression. - By the end of 2010: lowest 7 grades of public sector wage scale (out of 25) will be set at—and fully indexed with—the minimum wage level. - Government-set 1st grade tariff will increase by a much smaller extent (8 percent this year compared to 24 percent for the minimum wage). - Fiscal cost: - Staff estimates the gross cost of the SSL at slightly over 4 of GDP in 2010. - Half of this represents carry-over costs from changes in late 2009; one-third from the increase in the wage bill; remainder from higher pension expenditures. - Public wage “top-ups” introduced November 2009: staff estimates cost another 0.8 percent of GDP in 2010 (in addition to the SSL). - Government plans include a significant increase in the 1st grade tariff at end-2010 that would generate an additional cost in 2011 of about 2.3 percent of GDP. ### Box 4 — Gas Sector Reforms - Rationale and high-level objectives: - Ukraine is one of the least energy-efficient countries worldwide and highly dependent on imported gas. - Below-market domestic prices and low payment compliance have weakened Naftogaz’s finances, generating budgetary support needs. - Investment in exploration, extraction, and transportation is insufficient; gas transit infrastructure is at risk. - Reform measures during the program period: - Gradually bring domestic gas prices to import-parity: - 50 percent domestic gas price increases for households and utility companies implemented on July 13, effective August 1 (next billing period). - A further 50 percent increase planned on April 1, 2011, with semi-annual increases thereafter until import parity is reached for all consumers (with automatic adjustment mechanism planned). - Industrial prices already at market levels; preferential tariffs for various industries eliminated. - Strengthen social safety nets: - Increase transfers (affecting approximately 5 percent of households) using established support programs to limit impact on poorest households. - Strengthen payment discipline: - Create a central independent regulator for setting heating tariffs. - Create a distribution account into which all utility payments are made, from which payments to Naftogaz are automatically drafted. - Liberalization and unbundling: - July 2010 gas sector law enacted to provide for gradual liberalization, harmonization with EU Directive, and gradual restructuring of Naftogaz with separate cost centers for gas imports, domestic production, and gas transit. - Modernize transit infrastructure: - Authorities are working toward securing a loan from the World Bank, the EBRD, and the EIB to revamp gas transit infrastructure. ### Fiscal and Program Context - Euro 2012 spending and expectations: - Overall public spending during the five years leading up to the games is projected to reach the equivalent of 6.5 percent of 2010 GDP, including loan guarantees. - Authorities expect private investments of a similar magnitude to upgrade private facilities. - Approved Budget (Billions of Ukrainian hryvnias) summary for Euro 2012 (selected figures): - Public projects totals by year: 2008 3.6, 2009 3.7, 2010 25.2, 2011 31.1, 2012 7.5, Total 71.1 - State budget: 2008 3.1, 2009 3.1, 2010 10.1, 2011 12.0, 2012 6.9, Total 35.3 - Local budgets: 2008 0.5, 2009 0.6, 2010 1.5, 2011 2.8, 2012 0.6, Total 6.0 - Private projects: 2008 6.9, 2009 10.0, 2010 23.8, 2011 28.3, 2012 2.4, Total 71.3 - Total: 2008 10.5, 2009 13.7, 2010 49.0, 2011 59.4, 2012 9.9, Total 142.4 - Source cited: Cabinet of Ministers Resolution No. 357, April 14, 2010, "On Approval of the State Program for Preparation and Staging of Euro-2012." ### Program Rationale and Expected Benefits - A Fund-supported SBA would: - Lend credibility to policies and coalesce support from the official sector and markets. - Signal that sound macroeconomic policies and financing are in place to support adjustment and reforms. - Catalyze financing to cover still sizable external financing needs and provide buffers against worsening external conditions. *IMF staff report: 1. Estimating Potential Growth and Output Gap in Ukraine (excerpt).* ### 11. The new government is determined to tackle these challenges and convert the ### 11. The new government is determined to tackle these challenges and convert the ### Program objectives and key areas of reform - Restore confidence and fiscal sustainability by reducing the general government deficit to 2.5 percent of GDP by 2012 and setting public debt firmly on a downward path below 35 percent by 2015. - Initiate reforms to modernize the gas sector and phase out Naftogaz’s deficit, including through gas tariff increases and a price mechanism that depoliticizes price setting of public utilities. A new gas law adopted in early July will improve efficiency through unbundling production, transit, and distribution to end-users, and allowing new entrants into the domestic gas market. - Restore and safeguard banks’ soundness through completion of recapitalization plans by end-2010 and strengthened supervision. - Develop a more robust monetary policy framework focused on domestic price stability with greater exchange rate flexibility under a more independent NBU. ### Macroeconomic framework: projections and outlook - Real GDP growth: - 3.7 percent in 2010. - Average of 4.6 percent in 2011–12. - 2010 growth hindered by a slow recovery in private consumption, a still-weak banking sector, and the implementation of corrective fiscal measures; industrial and agricultural production to contribute positively. - Inflation: - Core inflation is expected to stay below 10 percent in 2010. - Core inflation expected to continue to decelerate in 2011–12. - Headline inflation will decline more gradually, largely reflecting adjustments in domestic gas and utility prices. - Current account and external financing: - Current account deficit expected to remain at sustainable levels; overall deficit just below 1 percent of GDP in 2010. - Financial account projected to turn significantly positive over the medium term, supporting a reserve build up. - GIR is expected to increase by US$14 billion (and NIR by US$2 billion) during the program period. - Risks: - External risks remain due to fragile recovery in Europe. - Domestic risks include rising NPLs and possible doubts about political commitment to reform ahead of local elections. - Upside risks include larger-than-expected increases in world steel prices, faster rebounds in trading partners, and a return of political stability. ### Fiscal policy: targets, measures, and structural reforms - Short-term targets and baseline: - Combined general government deficit, including Naftogaz, limited to 6.5 percent of GDP in 2010. - Without policy change, combined deficit could approach 9.0 percent of GDP. - Under the program: general government deficit reduced to 5.5 percent of GDP in 2010 and Naftogaz’s deficit to 1 percent of GDP in 2010. - 2010 fiscal measures (impacts are for 2010 unless otherwise noted): - Increase tax and pension revenue (impact 0.5 percent of GDP in 2010): increased several excise rates, limited loss deductions from 2009, and raised contribution rates in the special simplified taxation system. - Reduce government spending (impact 1.5 percent of GDP in 2010): supplementary budget approved with measures equivalent to UAH 16 billion (prior action); reductions in current spending, subsidies, and administrative appropriations. - Raise Naftogaz’s revenue and tighten control over its spending (impact 0.5 percent of GDP in 2010): - Final gas prices for utility companies and households increased by 50 percent on July 13 (prior action). - Eliminated gas price privileges for sugar, fertilizer, and metallurgy industries; committed to maintain gas tariffs to industrial users at import parity. - Established an automated drafting system for utility companies’ payments to Naftogaz and initiated cost-saving and rationalization measures. - Established an independent utility tariff regulator (prior action) with authority to set heating prices for end-consumers. - Mitigate impact on the most vulnerable (impact about -0.1 to -0.2 percent of GDP): existing social assistance programs to cover any utility costs in excess of 20 percent of income for working families (15 percent for pensioners), expected to protect about 800,000 households (about 5 percent of total). Supplementary budget includes full funding for this program. - Improve tax administration and spending monitoring: authorities expect tax collection efforts to yield significant results starting in 2010; budget code gives Finance Minister power to control monthly allocations to meet program deficit target. - Medium-term fiscal path and structural measures: - General government deficit targets: 3.5 percent of GDP in 2011 and 2.5 percent of GDP in 2012. - Naftogaz’s deficit to be eliminated in 2011. - Structural pension reforms to be initiated in 2011 (impact of 0.8 percent of GDP in 2011, and increasing over time); reforms to be enacted by end-2010 (structural benchmark). - Fiscal reforms (amendments to budget and tax codes) to be in place by end-2010; supported by Fund technical assistance. - Public administration reforms to be enacted by end-March 2011 (structural benchmark) to bring on budget a larger part of user fees and improve cost efficiency. - Additional energy sector reforms: gas prices for households and utility companies to be increased by an additional 50 percent in April 2011, with semiannual price increases thereafter; automatic price adjustment mechanism to be in place once import parity is reached. - Financing and Fund support: - Given limited domestic financing and delays in official disbursements, temporary Fund financing for the budget of SDR 1.35 billion (equivalent to US$2.0 billion) has been requested, equally split between the first two purchases. - Authorities expect to tap the Eurobond market later in 2010 but financing needs remain considerable. - Public finance indicators (selected figures from table, percent of GDP): - Revenue: 44.2 (2008 Act), 42.2 (2009 Act), 42.8 (2010 Proj), 42.3 (2011 Proj), 42.3 (2012 Proj). - Expenditure and net lending: 47.3 (2008 Act), 48.5 (2009 Act), 48.3 (2010 Proj), 45.8 (2011 Proj), 44.8 (2012 Proj). - Overall balance: -3.2 (2008 Act), -6.2 (2009 Act), -5.5 (2010 Proj), -3.5 (2011 Proj), -2.5 (2012 Proj). - Naftogaz balance: ... (2008 Act), -2.5 (2009 Act), -1.0 (2010 Proj), 0.0 (2011 Proj), 0.0 (2012 Proj). - Combined balance: -3.2 (2008 Act), -8.7 (2009 Act), -6.5 (2010 Proj), -3.5 (2011 Proj), -2.5 (2012 Proj). - Public sector debt: 19.9 (2008), 34.6 (2009), 39.6 (2010 Proj), 42.7 (2011 Proj), 44.4 (2012 Proj). - Memorandum: Cyclically-adjusted primary balance: -4.2 (2008), -1.0 (2009), -0.5 (2010), 1.0 (2011), 1.2 (2012). - Bank recapitalization bonds: 0.0 (2008), 2.6 (2009), 1.8 (2010), 0.0 (2011), 0.0 (2012). - VAT bonds 1/: 0.0 (2008), 0.0 (2009), 1.5 (2010), 0.0 (2011), 0.0 (2012). - Combined balance plus bank recap. bonds and VAT bonds: -3.2 (2008), -11.3 (2009), -9.9 (2010), -3.5 (2011), -2.5 (2012). - Note: 1/ Total amount of bonds used in 2010 as payment for VAT refunds. This includes unrefunded VAT claims accumulated in 2009. ### Pension reforms (Box 5): rationale and planned measures - Rationale: - Pension expenditures increased from around 9 percent of GDP in 2003 to well above 18 percent in 2009. - Pension Fund revenues have not increased at the same pace; transfers reached over 7 percent of GDP in 2009. - Structural weaknesses: aging population and rising dependency ratio, low retirement age and minimum contribution periods, generous benefits, favorable treatment of working pensioners, early retirement provisions, extensive special pension regimes, and compliance problems on revenue side. - Planned measures for 2011: - Gradually increase the retirement age for women to 60, by 6 months every year. - Increase the qualification period to receive full pension benefits by 10 years. - Increase the minimum insurance period from 5 to 15 years. - Change the base for the 1 percent increase for every additional year worked over 20/25 years for women/men (from total pension to the base pension). ### Monetary and exchange rate policy - Monetary stance and inflation objectives: - Monetary policy will aim to maintain near-term core inflation in single digits and to bring overall inflation down to no more than 5 percent over the medium-term. - NBU committed to maintain refinancing rates—currently at 8.5 percent—positive in real terms going forward. - NBU actions: step up placements of CDs, repos, and outright sales of government securities. - Monitoring and policy framework: - Program will be monitored through targets on monetary aggregates (MEFP ¶15) as a key anchor in early stages. - Program assumes a monetary path consistent with inflation objectives and a modest strengthening of money demand in the remainder of the year. - Exchange rate regime and FX framework: - Program supports a shift to a more flexible exchange rate regime (MEFP ¶18) to discourage dollarization, reduce unhedged risk-taking, provide a buffer against external shocks, and focus monetary policy on price stability. - Foreign exchange transactions tax removed effective July 1 (MEFP ¶10 and 18). - Rules on inward investment eased. - Full assessment of regulatory restrictions to be completed by the fall and timetable for elimination of unnecessary constraints to be agreed by end-October 2010 (structural benchmark). - Foreign exchange transactions tax to be permanently eliminated by end-December 2010 (structural benchmark). - Foreign currency interventions limited to smoothing operations and to help meet NIR targets; NBU will align official exchange rate with interbank market rate. - Central bank independence and institutional reforms: - Amendments to the NBU law (prior action) establish price stability as the primary objective, improve governance with a more professional and less politicized NBU Council under strict fit and proper criteria, and strengthen NBU’s financial soundness. - NBU amended Resolution 47 (prior action), eliminating the possibility of direct NBU lending to the private sector and tightening conditions for emergency liquidity assistance to solvent banks. - As conditions permit, NBU will gradually reorient monetary policy toward inflation targeting; transition facilitated by fiscal consolidation and strengthened NBU institutional framework. NBU will enhance communication of policy intentions to revive transmission mechanism. *Source: IMF staff estimates and IMF staff text from the provided chapter.* ### 25. The program aims to further strengthen the banking sector through actions in ### 25. The program aims to further strengthen the banking sector through actions in ### Banking sector priorities and structural benchmarks - The program focuses on three priority areas: - (i) completing recapitalization or resolution of banks; - (ii) strengthening state-owned banks; and - (iii) enacting key financial sector legislation. - Bank recapitalization - Bank recapitalization will be completed by end-2010 (structural benchmark) (MEFP ¶20). - Full recapitalization through private equity injections was planned to be completed by end 2009, but capital adequacy levels have weakened recently due to rising NPLs. - The NBU has agreed to approve bank recapitalization plans by end-July and private bank recapitalization—based on the findings of the extended audits—must be completed by end-2010 (structural benchmark). - Banks that do not meet their capital needs by end-2010 will be promptly resolved. - For Nadra Bank, which continues to be under temporary administration, an audit will be completed before any decision is taken about its final resolution (structural benchmark). - State-controlled banks - Banks under state control will be strengthened or privatized (MEFP ¶21). - The government will retain an internationally-reputable financial adviser to assess their potential and recommend whether these should be privatized or resolved, with a goal of maximizing recovery value for the state. - For the remaining two state-owned banks, due diligence studies will be completed by end-December 2010, reviewing operations under the existing governance structures and formulating plans to strengthen their financial condition and outlook (structural benchmark). - Oversight and transparency - Measures include: - (i) strengthening consolidated supervision (including supervision across different financial service sectors and cross-border); and - (ii) requiring full and regular public disclosure of ultimate controllers of banks, to enhance transparency and trust in the system (MEFP ¶23). - Legal framework - The legal framework for corporate insolvency and other related legislation will be amended to facilitate loan workouts by end-June 2011 (structural benchmark) (MEFP ¶22). ### Program modalities, access, and phasing - Authorities request a 29-month SBA in an amount equivalent to SDR 10.0 billion, or 728.9 percent of quota (about US$14.9 billion). - Rationale for access: - Ukraine faces considerable financing needs from reduced access to international financing, still inadequate rollover rates from corporates and banks, and the need to continue to strengthen its reserves position. - Gross external financing requirements are high at about US$31 billion on average in 2010–12. - Gross international reserves (GIR) still remain below some reserve adequacy metrics. - Role of the Fund and other official partners: - Fund support expected to help bring Ukraine’s GIR to 96 percent of short-term debt by 2012 through direct balance of payments support and a catalytic role. - The World Bank, the European Commission, and the EBRD are expected to provide up to US$1½ billion in 2010. - For 2011–12, official commitments so far amount to US$1–2 billion a year. - Phasing and schedule (Access and Phasing Under a Proposed Stand-By Arrangement) - Date / Millions of SDRs / Percent of quota / Conditions - July 28, 2010 / 1,250 / 91.1 / Board approval of arrangement - November 30, 2010 / 1,000 / 72.9 / First review and end-September 2010 performance criteria - March 15, 2011 / 1,000 / 72.9 / Second review and end-December 2010 performance criteria - June 15, 2011 / 1,000 / 72.9 / Third review and end-March 2011 performance criteria - September 15, 2011 / 1,000 / 72.9 / Fourth review and end-June 2011 performance criteria - December 15, 2011 / 1,000 / 72.9 / Fifth review and end-September 2011 performance criteria - March 15, 2012 / 1,000 / 72.9 / Sixth review and end-December 2011 performance criteria - June 15, 2012 / 1,000 / 72.9 / Seventh review and end-March 2012 performance criteria - September 15, 2012 / 1,000 / 72.9 / Eighth review and end-June 2012 performance criteria - December 15, 2012 / 750 / 54.7 / Ninth review and end-September 2012 performance criteria - Total / 10,000 / 728.9 ### Exceptional access criteria and assessment - The proposed SBA entails exceptional access. Staff’s view is that Ukraine meets all substantive exceptional access criteria and proposes upper credit tranche terms. - Criterion 1: Exceptional balance of payments pressures - Ukraine continues to face high rollover risks, restricted market access, and relatively weak official reserves. - These generate financing needs beyond what can be financed within normal limits; absent exceptional financing, reserve cover is projected to fall sharply. - Criterion 2: Debt sustainability - Public and publicly guaranteed debt is expected to rise to about 40 percent of GDP in 2010. - The envisaged fiscal adjustment would set the public debt ratio firmly on a downward path, ensuring debt sustainability with a high probability. - With completion of bank recapitalization in 2010, potential contingent liabilities of the government would be relatively limited. - Three-quarters of external debt is concentrated in the private sector, and is projected to decline as a percent of GDP over the medium term. - Stress tests indicate medium-term public and external debt sustainability is dependent on strong growth assumptions. - Criterion 3: Prospects of regaining market access - Non-residents’ interest in Ukrainian fixed-income assets has been rekindled recently. - With successful implementation of a strong program, staff anticipates Ukraine has good prospects of regaining greater access to private capital markets in the near term. - Criterion 4: Prospect of program success - The economic reforms are backed at the highest political levels and several important policy measures have been frontloaded through prior actions. - The government’s institutional capacity will be strengthened by ongoing technical support from the Fund and other IFIs. - Nonetheless, strong and consistent policy implementation is required throughout the program period. ### Capacity to repay and program risks - Capacity to repay - By the end of the arrangement in 2012, outstanding credit to the Fund is expected to peak at about 14 percent of GDP, or 51 percent of gross reserves. - Combined with outstanding use of Fund resources from the previous SBA, debt service to the Fund as a ratio of exports of goods and services would peak at 7 percent in 2013, including both the liabilities of the NBU and the central government to the Fund. - Ukraine’s capacity to repay depends on its ability to deepen market access and strengthen public finances. - Risks to the program - External risks: - External developments remain highly uncertain given the uneven recovery in Europe and still volatile financial markets. - The fallout from the Stockholm arbitration ruling could further strain public finances. - Domestic risks: - Fragile economy and rising NPLs, weak business environment and institutions could undermine confidence and the recovery. - Political risks: local elections and parliamentary elections in the Fall 2012 could create pressures to weaken program implementation. - Upside potential: - Stronger global growth, higher commodity prices, rising steel prices, faster FDI pick-up, and more rapid resumption of external market financing could raise reserves and improve the current account position in 2010. ### Program monitoring, conditionality, and safeguards - Monitoring and reviews - Program performance will be monitored through quarterly reviews. - The initial disbursement will be SDR 1.25 billion. - The first review is set for November 30, 2010 (end-September 2010 targets); the second review is proposed for March 15, 2011 (end-December 2010 targets). - Performance will be monitored by quarterly quantitative performance criteria and structural benchmarks. - Safeguards - An update to the safeguards assessment will be completed by the first review. - Outstanding issues from the 2008 safeguards assessment of the NBU include: - legal amendments to strengthen the NBU’s independence, governance, and financial reporting practices; - introduction of audit oversight by the Council, pending changes to the law; - adoption of an action plan to address recurring accounting and control weaknesses observed by the NBU’s external auditor; and - completion of an external review of the internal audit function. - Conditionality highlights (Box 6: Proposed Stand-By Arrangement) - Access: SDR 10 billion (approximately 730 percent of quota or $15 billion). - Length: 29 months. - Phasing: SDR 1.25 billion upon Board approval; nine subsequent tranches equal SDR 8.75 billion contingent on quarterly reviews starting from November 2010. - Prior Actions: - Enact a supplementary budget with fiscal measures of UAH 16 billion and consistent with a 5.5 percent of GDP deficit for the general government in 2010 and the commitments in the MEFP. - Increase gas tariffs for all households and utility companies by 50 percent (effective August 1, with the coming billing cycle). - Enact amendments to the NBU law in line with IMF recommendations. - Amend NBU Resolution 47 (to strengthen the emergency liquidity assistance framework and eliminate the possibility of NBU lending to the private sector) in line with IMF recommendations. - Adopt legislation transferring the authority for setting heating tariffs for communal utilities to a new independent regulator. - Quantitative and Continuous Performance Criteria include: - Floor on net international reserves; - Ceiling on net domestic assets; - Ceiling on the cash deficit of the general government; - Ceiling on cash deficit of the general government and Naftogaz; - Ceiling on publicly guaranteed debt; - Non-accumulation of external debt payments arrears by the general government. - Quantitative Indicative Targets include: - Ceiling on monetary base; - Ceiling on VAT refund arrears. - Structural Benchmarks (selected dates and actions): - Revoke law “On temporary ban to levy penalties for overdue payments of utility bills” so that arrears accumulated after October 1, 2010 are subject to penalties. By September 30, 2010. - Agree with Fund staff on a schedule for phasing out existing restrictions on the foreign exchange market. By October 31, 2010. - Complete audit for Nadra Bank before any decision on its resolution. By October 31, 2010. - Enact legislation on pension reforms consistent with commitments in the MEFP. By December 31, 2010. - All banks should meet capital requirements and capital deficient banks should increase their capital in line with the approved plans. By December 31, 2010. - Complete due diligence of state-owned banks in line with ¶21 of the MEFP. By December 31, 2010. - Initiate implementation of the reform and restructuring strategy for Naftogaz in accordance with the principles of the Brussels declaration. By December 31, 2010. - Amend the law “On surcharges for the purposes of mandatory state pension insurance” 400/97-BP to permanently eliminate the surcharge on non-cash purchase and sales of foreign currency. By December 31, 2010. - Formulate a comprehensive public administration reform plan aiming to improve the cost efficiency of public service delivery. By March 31, 2011. - Adopt amendments to the Law of Ukraine “On restoring the solvency of the debtor or announcing him/her bankrupt” and related regulations to expedite insolvency proceedings and to facilitate out-of-court restructuring. By June 30, 2011. ### Staff appraisal: assessment and policy implications - Staff view - Staff believes the authorities’ economic program to be supported by the proposed SBA is sufficiently ambitious but hinges on consistent implementation. - The recovery is narrowly based and vulnerable; strong policies are needed to ensure macroeconomic stability and create the basis for higher growth. - The authorities have frontloaded prior actions demonstrating commitment, but sustained strong political backing from the highest levels is needed. - Fiscal policy - The fiscal adjustment under the program is ambitious but achievable. - Spending pressures from Euro 2012 and the October local elections will need to be contained; fallout from the Stockholm arbitration ruling will need to be addressed. - Fiscal control over local governments and state-owned institutions (road fund, agrarian fund) must be strengthened. - Structural reforms - Pension reforms are needed to address long-standing financial problems in the pension system, stabilize contribution rates, increase system enrollment, and encourage longer labor force participation. - Energy sector reforms and adoption of a comprehensive energy strategy, supported by other IFIs, would help strengthen Naftogaz’s finances. - The authorities took politically difficult measures in 2010 while protecting the poorest segments of the population from adverse effects. - Monetary and financial sector policy - Strengthening the NBU’s autonomy is essential for more effective monetary policy and rehabilitation of the banking system. - Amendments to the NBU law will help focus monetary policy on inflation objectives and fend off pressures for monetization of deficits and quasi fiscal activities. - A more flexible exchange rate would better serve Ukraine in facing external shocks and discourage excessive risk-taking by domestic borrowers and foreign lenders. - Proposed banking sector reforms, including recapitalization and strengthened governance and transparency, are critical to restore confidence, bring the banking system back to health, and eliminate the drain on the budget. - Final assessment - The program is fully financed despite the relatively high fiscal deficit target this year, but risks remain on the external side (adverse regional/global developments and shortfalls in assumed official financing) and the domestic side (difficult political environment and implementation risks). *IMF staff report excerpt (cr10262).* ### 43. Implementation of policies consistent with the program provides the best chance ### _cr10262 - 43. Implementation of policies consistent with the program provides the best chance ### Program stance and staff recommendation - Implementation of policies consistent with the program provides the best chance for Ukraine to succeed with reforms, reinvigorate growth, and reduce vulnerabilities. - Staff believes that strict observance of the adjustment program will allow Ukraine to exit from Fund support by the end of the arrangement. - On the basis of the authorities’ recent actions and forward-looking commitments, staff supports the authorities’ request for a new Stand-By Arrangement. ### Real sector: recent performance and projections - Real GDP (percent change): - 2007: 7.9 - 2008: 2.1 - 2009: -15.1 - 2010 (Proj.): 3.7 - 2011 (Proj.): 4.3 - 2012 (Proj.): 4.8 - Nominal GDP (billions of Ukrainian hryvnias): - 2007: 721 - 2008: 950 - 2009: 915 - 2010 (Proj.): 1,083 - 2011 (Proj.): 1,235 - 2012 (Proj.): 1,405 - Contributions to 2009 real GDP contraction: - Domestic demand: -25.6 (contribution) - Consumption: -10.0 (contribution) - Investment: -15.6 (contribution) - Net exports: 10.5 (contribution) - Unemployment rate (ILO definition; percent): - 2007: 6.4 - 2008: 6.4 - 2009: 8.8 - 2010 (Proj.): 8.8 - 2011 (Proj.): 7.9 - 2012 (Proj.): 7.4 ### Inflation, wages, monetary and exchange rate developments - Consumer prices (period average): - 2007: 12.8 - 2008: 25.2 - 2009: 15.9 - 2010 (Proj.): 9.9 - 2011 (Proj.): 10.7 - 2012 (Proj.): 8.3 - Consumer prices (end of period): - 2007: 16.6 - 2008: 22.3 - 2009: 12.3 - 2010 (Proj.): 12.3 - 2011 (Proj.): 9.7 - 2012 (Proj.): 9.2 - Nominal monthly wages (average): - 2007: 29.7 - 2008: 33.7 - 2009: 5.5 - 2010 (Proj.): 16.0 - 2011 (Proj.): 14.1 - 2012 (Proj.): 10.8 - Real monthly wages (average): - 2007: 14.9 - 2008: 6.8 - 2009: -8.9 - 2010 (Proj.): 5.5 - 2011 (Proj.): 2.0 - 2012 (Proj.): 2.3 - International reserves (end of period, billions of U.S. dollars): - 2007: 32.5 - 2008: 31.5 - 2009: 26.5 - 2010 (Proj.): 30.3 - 2011 (Proj.): 38.5 - 2012 (Proj.): 43.4 - Months of next year's imports of goods and services: - 2007: 3.9 - 2008: 6.7 - 2009: 4.8 - 2010 (Proj.): 4.8 - 2011 (Proj.): 5.5 - 2012 (Proj.): 5.6 - Hryvnia per U.S. dollar, end of period: - 2007: 5.1 - 2008: 7.7 - 2009: 8.0 - 2010 (latest data as of end-June, 2010): 7.9 ### Financial sector: intermediation, liquidity, and bank soundness - Base money (percent change, end of period): - 2007: 46.0 - 2008: 31.6 - 2009: 4.4 - 2010 (Proj.): 14.4 - 2011 (Proj.): 13.5 - 2012 (Proj.): 12.5 - Broad money (percent change, end of period): - 2007: 51.7 - 2008: 30.2 - 2009: -5.5 - 2010 (Proj.): 14.7 - 2011 (Proj.): 15.1 - 2012 (Proj.): 14.1 - Credit to nongovernment (percent change, end of period): - 2007: 74.0 - 2008: 71.9 - 2009: -2.2 - 2010 (Proj.): 4.0 - 2011 (Proj.): 14.2 - 2012 (Proj.): 11.9 - Credit to GDP ratio (Table 7, percent): - 2007 (moving average basis): 45.2 - 2008: 59.4 - 2009: 77.7 - 2010 (projection series): 75.8 - 2011 (Proj.): 77.4 - Nonperforming loans (NPLs): - NPLs to total loans (broad definition, selected values): 2007: 17.8; 2008: 13.2; 2009: 17.4; 2010: 24.0; 2011 (Mar): 29.9; later readings up to 41.6 - Provisions (percent of NPLs) and NBU liquidity support remain substantial. - Banking sector indicators (selected): - Regulatory capital to risk-weighted assets: around 14.2–15.6 (various years) - Capital to total assets: around 12.5–14.5 (various years) - Return on assets (after tax; end-of-period) shows deterioration into negative territory in crisis years. ### Fiscal position and public finances - General government balance (percent of GDP): - 2007: -2.0 - 2008: -3.2 - 2009: -6.2 - 2010 (Proj.): -5.5 - 2011 (Proj.): -3.5 - 2012 (Proj.): -2.5 - Overall balance (including Naftogaz operational deficit; percent of GDP): - 2007: -2.0 - 2008: -3.2 - 2009: -8.7 - 2010 (Proj.): -6.5 - 2011 (Proj.): -3.5 - 2012 (Proj.): -2.5 - Privatization proceeds (billions of Ukrainian hryvnias, selected): - 2007: 0.6 - 2008: 0.3 - 2009: 0.2 - 2010 (Proj.): 0.9 - 2011 (Proj.): 0.4 - 2012 (Proj.): 0.2 - Overall balance including Naftogaz and other debt-creating flows (percent of GDP): - 2007: -2.0 - 2008: -3.2 - 2009: -11.3 - 2010 (Proj.): -9.9 - 2011 (Proj.): -3.5 - 2012 (Proj.): -2.5 ### Public debt sustainability (Table 10) - Public sector debt (percent of GDP), baseline: - 2007: 12.3 - 2008: 19.9 - 2009: 34.6 - 2010 (Proj.): 39.6 - 2011 (Proj.): 42.7 - 2012 (Proj.): 44.4 - Of which foreign-currency denominated (percent of GDP): - 2007: 14.1 - 2008: 12.5 - 2009: 9.7 - 2010 (Proj.): 15.0 - 2011 (Proj.): 23.1 - 2012 (Proj.): 23.7 - Change in public sector debt (percent of GDP): - 2009: 14.7 - 2010 (Proj.): 5.0 - 2011 (Proj.): 3.1 - 2012 (Proj.): 1.7 - Identified debt-creating flows (percent of GDP, 2009 and projections): - 2009: 12.5 - 2010 (Proj.): 3.6 - 2011 (Proj.): -1.8 - 2012 (Proj.): -2.8 - Primary deficit (percent of GDP): - 2009: 7.6 - 2010 (Proj.): 5.0 - 2011 (Proj.): 1.9 - 2012 (Proj.): 0.5 - Gross financing need (percent of GDP and billions of U.S. dollars): - 2009: 11.5 percent; 13.5 (billions of U.S. dollars) - 2010 (Proj.): 10.2 percent; 13.8 (billions of U.S. dollars) - 2011 (Proj.): 5.7 percent; 8.6 (billions of U.S. dollars) ### External debt sustainability (Table 11) - External debt (percent of GDP), baseline: - 2007: 56.0 - 2008: 56.4 - 2009: 88.0 - 2010 (Proj.): 79.0 - 2011 (Proj.): 77.8 - 2012 (Proj.): 77.6 - Change in external debt (percent of GDP): - 2009: 31.6 - 2010 (Proj.): -9.0 - 2011 (Proj.): -1.2 - 2012 (Proj.): -0.3 - Identified external debt-creating flows (percent of GDP): - 2009: 29.1 - 2010 (Proj.): -6.6 - 2011 (Proj.): -5.7 - 2012 (Proj.): -5.8 - Current account balance, excluding interest payments (percent of GDP): - 2007: -5.0 - 2008: -1.3 - 2009: 0.7 - 2010 (Proj.): 3.2 - 2011 (Proj.): -4.5 - 2012 (Proj.): -4.5 - External debt-to-exports ratio (percent): - 2007: 89.3 - 2008: 108.5 - 2009: 124.9 - 2010 (Proj.): 190.4 - 2011 (Proj.): 164.9 - 2012 (Proj.): 161.1 - Gross external financing need (billions of U.S. dollars and percent of GDP): - 2009: 48.0 (billions U.S. dollars); 40.8 percent of GDP - 2010 (Proj.): 39.8 (billions U.S. dollars); 29.2 percent of GDP - 2011 (Proj.): 43.2 (billions U.S. dollars); 29.0 percent of GDP ### IMF engagement and financing indicators - Stock of existing and prospective Fund credit (Millions of SDRs, end of period): - 2008: 3,057 - 2009: 7,000 - 2010 (Proj.): 9,250 - 2011 (Proj.): 13,250 - 2012 (Proj.): 14,766 - 2013 (Proj.): 11,109 - 2014 (Proj.): 7,969 - 2015 (Proj.): 4,250 *Source: IMF staff report (content unit: _cr10262 - 43).* ### APPENDIX I: UKRAINE: LETTER OF INTENT ### APPENDIX I: UKRAINE: LETTER OF INTENT ### Program request and overview - Request for a new 29-month Stand-By Arrangement (SBA) with the IMF for the period July 2010 through December 2012. - Requested amount: SDR 10.0 billion (728.9 percent of our quota). - Request that the equivalent of US$2.0 billion be channeled to the budget in 2010. - Request cancellation of the November 2008 SBA, including all remaining disbursements under that arrangement. - Program monitoring: regular reviews, prior actions, quantitative performance criteria and indicative targets, and structural benchmarks. First review by December 2010; subsequent quarterly reviews thereafter. ### Background and macroeconomic framework - 2009 real GDP contraction: 15.1 percent. - 2009 year-end inflation: 12.3 percent. - 2009 current account deficit: narrowed to 1½ percent of GDP. - 2009 fiscal deficit: about 8.8 percent of GDP (6.3 percent of GDP for the general government and 2.5 percent of GDP for Naftogaz). - Bonds for bank recapitalization in 2009: 2.6 percent of GDP. - Public debt in 2009: increased to 25 percent of GDP. - Public and publicly guaranteed debt in 2009: surged to 35 percent of GDP. - 2010 real GDP growth expectation: around 3.7 percent; actual growth in first five months: 6.1 percent. - Core inflation expectation for remainder of 2010: single digits. - Headline inflation expected around 12 percent at end-year 2010. - Medium-term inflation target: gradually fall towards 5 percent by 2014. - Expected financing gap: $16 billion in 2010–12. - Current account deficit expected for 2010: about 1 percent of GDP. ### Program objectives - Entrench fiscal and financial stability and put Ukraine on a path to sustained and balanced growth. - Policy strategy focus: - Consolidate public finances. - Restore banking system soundness. - Develop a more robust monetary policy framework focused on domestic price stability with greater exchange rate flexibility. - Institutional and reform priorities: tax and expenditure policies, pension reforms, energy sector reforms, strengthen central bank independence, rehabilitate the banking system. - Official financing to play an important role until market financing recovers. - Additional financing coordination with the World Bank, the EBRD, the EIB, and the EC. ### Fiscal policy — objectives and targets - Medium-term fiscal consolidation aims: - Deficit fully market-financeable by 2011. - Public and publicly guaranteed debt-to-GDP ratio stabilizing below 35 percent by 2015. - Rely proportionally more on expenditure-saving measures to reduce tax burden. - 2010 combined deficit of general government and Naftogaz expected: 6.5 percent of GDP (does not include bonds for bank recapitalization, no more than UAH 20 billion, and bonds issued to settle past VAT refund arrears). - Overall deficit targets: - 2010: combined deficit 6.5 percent of GDP; general government deficit reduced to 5.5 percent of GDP (prior action). - 2011: overall deficit to 3.5 percent of GDP. - 2012: overall deficit to 2.5 percent of GDP. - Naftogaz deficit target: reduce to 1.0 percent of GDP in 2010 and eliminate thereafter. ### Fiscal measures enacted and planned - Revenue measures: - Increased excise duties for gasoline, filtered cigarettes, and various alcoholic beverages; increased surcharge on radio frequency used by cell phones; limit on carry-over of 2009 losses. - Expected revenue: UAH 6.1 billion in 2010 and an additional UAH 4.2 billion in 2011. - Reduced threshold turnover for qualifying for the Simplified Taxation System to UAH 300,000 for physical persons (effective January 1, 2011). - Suspended surcharge on non-cash purchases and sales of foreign currency and intend to permanently eliminate it by end-December 2010 (structural benchmark). - Strengthened tax administration, widened authority of tax inspection, improved monitoring of tax returns. - Commitment to ensure payment of all VAT refunds accruing in the remainder of the year in full and on time (indicative target). - Expenditure measures: - Supplementary budget reduces expenditure by UAH 16 billion relative to approved budget (reduced subsidies, lower administrative appropriations). - Conditions to avoid increase in general government deficit: - All lending to the Agrarian Fund under Article 77 of the 2010 budget repaid by end-December 2010. - All EURO 2012-related spending included in the budget. - Local governments, the Unemployment Insurance Fund, the Disability Insurance Fund or the Accident Fund to be balanced in 2010. - Pension reforms and measures: - Require legal persons and physical entities in the Simplified Taxation System to pay pension contributions corresponding to the minimum wage surcharges. - Expected pension fund revenue: UAH 3.0 billion in 2011. - Change base for calculating additional 1 percent pension benefits (long service pension benefit base to be the basic working pension). - Expected reduction in pension fund expenditure: UAH 6.2 billion in 2011. - Submit law by end-September 2010, for enactment by end-December 2010 (structural benchmark) to: - Increase minimum required insurance period from 5 to 15 years. - Gradually increase pension age for women from 55 to 60 years by adding 6 months every year starting in 2010, aiming to equalize pension age for all workers. - Increase by 10 years the qualification period for receiving full pension benefits. - Expected improvement in Pension Fund balance: UAH 2.0 billion in 2011. - Contingent liabilities: - State guarantees in 2010 limited to no more than UAH 15 billion (quantitative performance criterion). - Public sector wages and administration reform: - Refrain from increases in 2011 above what is mandated by the inflation indexation mechanism for civil servant wages. - Initiate comprehensive public administration reform by beginning of 2011; comprehensive plan specified by end-March 2011 (structural benchmark). ### Naftogaz-specific measures - 2010 financial plan actions: - Reduced operating costs. - Increased final gas prices for utility companies and all households by 50 percent (prior action), effective the coming billing cycle (August 1). - Households receiving subsidies and compensation will receive additional subsidies fully funded in 2010 with support from international financial institutions. - Eliminated price privileges for sugar, chemical, fertilizer, and metallurgy industries; maintain industrial gas prices consistent with import parity. - Additional household and utility price increase of 50 percent in April 2011; semiannual increases to continue until domestic prices reach import parity; thereafter adjust to reflect market prices. - Legislation adopted to transfer authority for setting heating tariffs for communal utilities to a new independent regulator (prior action); regulator operational no later than end-2010. Interim: NERC empowered to set heating tariffs. - Support to collect payment arrears: - Pass legislation by end-September to revoke the Law “On Temporary Ban to Levy Penalties on Ukraine’s Citizens For Overdue Payments of Utility Bills” so arrears accumulated after October 1, 2010 are subject to penalties (structural benchmark). - Introduce distribution accounts for heating utilities; law adopted by parliament. - Transparency and governance in gas sector: - Gas sector law adopted ensuring compliance with EC Directive 2003/55/EC. - Progress towards joining EITI and the European Energy Community (structural benchmark). ### Monetary and exchange rate policy - Inflation objectives: - Maintain core CPI inflation in single digits in 2010. - Bring overall CPI to no more than 5 percent over the medium term. - Monetary framework and operations: - Focus monetary policy more on policy interest rates and exchange rate flexibility as financial system recovers. - Mop up excess liquidity via stepped up placement of CDs, repos, and outright sales of government securities. - Require banks to keep entire required reserves at a separate account with the NBU. - Increased interest rates on three-month CDs and repos to the 7 to 9 percent range. - Commit to maintain positive real refinancing rates and enhance communication of policy intentions. - Set policy rates during regular and pre-announced NBU Board meetings and publish a statement on the economic reasons on the same day. - Program monitoring and targets: - Monitor program through targets on money aggregates (Table Appendix I.3). - Intend to meet net domestic asset (NDA) ceilings and net international reserve (NIR) floors as specified in Table Appendix I.3 (quantitative performance criteria). - Base money expected to grow by about 14 percent in 2010. - Refrain from changes in reserve requirements and imposing administrative measures without prior consultation with Fund staff. - Strengthening NBU independence and accountability: - Amendments to the NBU law enacted (prior action) in line with IMF recommendations to: - Define precise priority of the NBU goals, making ensuring and maintaining price stability the primary objective. - Improve NBU autonomy (including prohibiting appointment to the NBU Council of persons with conflicts of interest). - Strengthen NBU financial soundness, autonomy and transparency in line with international best practice. *Source: APPENDIX I: UKRAINE: LETTER OF INTENT (Kyiv, July 16, 2010).* ### 17. To ensure consistency with its core mandate, the NBU will amend Resolution 47 ### 17. To ensure consistency with its core mandate, the NBU will amend Resolution 47 ### Amendments to NBU Resolution 47 (Prior Action) - Eliminate stimulation loans. - Limit stabilization loans to exceptional cases for solvent and financially viable banks in times of funding pressures: - maximum term of three months; - limited rollovers (no more than four times or maximum 1 year). - Ensure such loans are backed by adequate, high quality collateral (such as government paper) and penalty pricing, and are subject to appropriate supervisory oversight and measures. - In the absence of a renewed systemic deposit drain, do not grant new emergency liquidity assistance, and withdraw existing exceptional support as quickly as conditions permit. - Existing refinancing loans that meet the criteria in amended Resolution 47 will be rolled into the stabilization loan framework, or wound down. - Will not extend or grant new liquidity support to any insolvent bank. - Recognize losses on the NBU balance sheet in line with IFRS to the full extent. - In implementation of the recapitalization program: - avoid undue monetary expansion; - safeguard the financial position of the NBU. - Government will let the requirement that the recapitalization bonds be subject to mandatory repurchase at their face value by the NBU lapse at end-2010. ### Foreign Exchange Market Functioning and Intervention Strategy - Intervention strategy will allow for greater exchange rate flexibility while gradually rebuilding an adequate international reserves position as market conditions permit. - Official exchange rate policy: - continue to set the official exchange rate equal to the average rate on the interbank market of the previous day with a deviation not exceeding 2 percent. - Eliminate existing exchange rate restrictions under the Fund’s jurisdiction and multiple currency practices; streamline and, as warranted, reduce scope of other regulatory restrictions impacting FX transactions: - undertake a review of current regulations and legislation; - develop by end-October a schedule for phasing out the restrictions which might be eliminated or relaxed without jeopardizing the sustainability of the balance of payment and financial system (structural benchmark). - As a first step, abolished foreign investment registration requirement and removed the ban on early repayment of external obligations. - For exchange restrictions under the Fund’s jurisdiction believed temporarily necessary for balance of payments reasons, request approval from the Fund. - Promote development of forward exchange market by end-March 2011. ### Financial Sector Policies: Resolution, Recapitalization, and Supervision - Center reforms on completing resolution and recapitalization of systemic banks, and enacting key legislation and regulations. - Ensure banks are fully capitalized no later than end-December 2010 (structural benchmark). - Banks completed extended audits in April and have submitted recapitalization plans to be approved by the NBU by end-July. - Private shareholders required to complete injection of committed capital no later than end-2010 or banks will be intervened and if necessary recapitalized or resolved in line with agreed bank restructuring strategy. - Nadra Bank measures: - Conduct audit of end-June financial statements under IFRS and audited under IAS by reputable international auditing firm, with lead auditor from outside Ukraine: - auditing firm to be hired and terms of reference finalized in consultation with the IMF no later than July 30, 2010; - audit to be completed by end-October 2010 (structural benchmark). - Reach agreement with a fit and proper investor that has submitted a viable business plan to restore the bank to profitability by end-November 2010. - Bank shall be fully recapitalized with upfront cash by end-2010. - If not possible, promptly resolve the bank according to the Banking Act at the least cost method to the government. - Strengthening state-owned banks: - Conduct due diligence led by reputable international auditing firm to review operations in the two state banks by end-December 2010 (structural benchmark); terms of reference to be agreed with the IMF. - Due diligence to include assessments of (i) main financial, legal and operational risks; (ii) adequacy of risk management and internal controls; and (iii) future viability under different scenarios. - Retain internationally-reputable financial adviser for the three state-recapitalized banks to assess potential and recommend restructuring for sale or orderly winding down to maximize recovery. - State-recapitalized banks will not engage in lending at below-the interest rate on loans which the bank itself takes plus a reasonable margin. - Bad loan work-outs and insolvency framework: - Develop, in consultation with Fund and World Bank staff and financial sector representatives, a strategy to proactively address mounting nonperforming loans by identifying barriers and necessary legal/regulatory changes. - Enact necessary amendments to laws and regulations by end-June 2011 (structural benchmark), including amendments to the Law of Ukraine “On restoring the solvency of the debtor or announcing him/her bankrupt” and related laws and regulations to speed up insolvency process, make it more transparent, and facilitate out-of-court restructuring, including expedited court approval of restructuring agreements negotiated out-of-court. - Request Fund technical assistance in developing insolvency law amendments to include procedures for expedited approval of restructuring plans negotiated out-of-court and resolving tax and other related issues. - Other measures to strengthen the banking system: - Submit amendments to implement consolidated supervision by end-September 2010 and develop supporting regulatory framework within 6 months of enactment. - Submit legal amendments to enhance disclosure of ultimate controllers of banks, consistent with Fund advice and EU guidelines by end-September, 2010. - Continue strengthening regulations for classification of loans and provisions against loan-related losses. - Continue work on concluding Memoranda of Understanding (MoUs) with foreign banking supervisory authorities in countries where banks have significant presence in Ukraine. - Withdraw and redraft current draft NBU Resolution on “sanation bank” to include the “bridge bank” concept as a failing bank resolution tool. ### Growth-Enhancing Reforms (Overview) - Reduce state involvement in the economy and attract external and domestic investments. - Government procurement: - Enacted a new Law on Government Procurement in broad compliance with EU best practices (in consultation with the World Bank and the EU). - Deregulation and investment: - Cooperate with OECD and World Bank experts to identify and prioritize removal of key regulatory and infrastructure bottlenecks. - Any government-led investment initiatives will be fully accounted for in the budget. - Social protection: - Ensure protection of the poorest and most socially vulnerable groups during reforms, drawing on advice from International Financial Institutions. ### Safeguards - Complete an update to the safeguards assessment of the NBU by the first review of the standby arrangement. - Authorize the NBU’s external auditors to provide IMF staff with all necessary information, including management letters for 2008–09, and to hold discussions directly with Fund staff. - Commit to receiving a safeguards mission and provide it with all necessary information requested without delay, including information related to correspondent banks and foreign reserve placements. - Address outstanding issues from the 2008 safeguards assessment of the NBU: - legal amendments to strengthen NBU independence, governance, and financial reporting practices; - introduction of audit oversight by adoption of an action plan to address recurring accounting and control weaknesses observed by the NBU’s external auditor; - completion of an external review of the internal audit function. ### Program Monitoring, Prior Actions, and Structural Benchmarks (Selected items and dates) - Program monitoring through regular reviews, prior actions, quantitative performance criteria and indicative targets, and structural benchmarks. - Access and phasing under proposed Stand-By Arrangement (dates and amounts): - July 28, 2010: 1,250 Millions of SDRs; 91.1 percent of quota; Board approval of arrangement. - November 30, 2010: 1,000 Millions of SDRs; 72.9 percent of quota; First review and end-September 2010 performance criteria. - March 15, 2011: 1,000 Millions of SDRs; 72.9 percent of quota; Second review and end-December 2010 performance criteria. - June 15, 2011: 1,000 Millions of SDRs; 72.9 percent of quota; Third review and end-March 2011 performance criteria. - September 15, 2011: 1,000 Millions of SDRs; 72.9 percent of quota; Fourth review and end-June 2011 performance criteria. - December 15, 2011: 1,000 Millions of SDRs; 72.9 percent of quota; Fifth review and end-September 2011 performance criteria. - March 15, 2012: 1,000 Millions of SDRs; 72.9 percent of quota; Sixth review and end-December 2011 performance criteria. - June 15, 2012: 1,000 Millions of SDRs; 72.9 percent of quota; Seventh review and end-March 2012 performance criteria. - September 15, 2012: 1,000 Millions of SDRs; 72.9 percent of quota; Eighth review and end-June 2012 performance criteria. - December 15, 2012: 750 Millions of SDRs; 54.7 percent of quota; Ninth review and end-September 2012 performance criteria. - Total: 10,000 Millions of SDRs; 728.9 percent of quota. - Prior actions (selected): - Enact supplementary budget with fiscal measures of UAH 16 billion, consistent with a general government deficit of 5.5 percent of GDP in 2010 (MEFP, paragraph 10). - Increase gas tariffs for all households and utility companies by 50 percent (MEFP, paragraph 12). - Enact amendments to the NBU law in line with IMF recommendations (MEFP, paragraph 16). - Amend Resolution 47 in line with IMF recommendations (MEFP, paragraph 17). - Adopt legislation transferring authority for setting heating tariffs for communal utilities to a new independent regulator (MEFP, paragraph 12). - Structural benchmarks (selected with target dates): - Pass legislation to revoke the Law “On Temporary Ban to Levy Penalties on Ukraine’s Citizens For Overdue Payments of Utility Bills” so that any arrears on utility payments accumulated after October 1, 2010 are subject to penalties — End-September 2010. - Agree with Fund staff on a schedule for phasing out existing restrictions on the foreign exchange market — End-October 2010. - Complete the audit for Nadra Bank before any decision on its resolution — End-October 2010. - Enactment of legislation on pension reforms consistent with commitments in the MEFP — End-December 2010. - All banks should meet capital requirements and capital deficient banks should increase their capital in line with the approved plans — End-December 2010. - Complete due diligence of state-owned banks in line with paragraph 21 of the MEFP — End-December 2010. - Initiate implementation of the reform and restructuring strategy for Naftogaz in accordance with the principles of the Brussels declaration — End-December 2010. - Amend the law "On surcharges for the purposes of mandatory state pension insurance" 400/97-ВР to permanently eliminate the surcharge on non-cash purchase and sales of foreign currency — End-December 2010. - Formulate a comprehensive public administration reform plan aiming to improve the cost efficiency of public service delivery — End-March 2011. - Adopt amendments to the Law of Ukraine “On restoring the solvency of the debtor or announcing him/her bankrupt” and related regulations to speed up the process, make it more transparent, and facilitate out-of-court restructuring — End-June 2011. ### Quantitative Targets and TMU Highlights - Quantitative performance criteria and indicative targets are specified in Table 3 of the MEFP and defined in the TMU. - Program exchange rates (fixed for program computation): - Swiss Franc: 0.9200 dollar. - Euro: 1.2198 dollars. - Pound Sterling: 1.5052 dollars. - Japanese yen: 0.0113 dollars. - Accounting exchange rate for the SDR: 1.4789 per dollar. - Official gold holdings valued at 1,236.00 dollars per fine ounce. - Net international reserves (NIR) definition and level: - On June 30, 2010, the NIR of Ukraine amounted to US$19,172 million (in equivalent). - NIR defined as dollar value of difference between usable gross international reserve assets and reserve-related liabilities to nonresidents, evaluated at program exchange rates. - Usable gross international reserves exclude, inter alia: - any assets denominated in foreign currencies held at, or which are claims on, domestic institutions (including foreign currency claims of the NBU on domestic banks, and NBU deposits held at the Interbank Foreign Currency Exchange Market and domestic banks for trading purposes); - any precious metals or metal deposits, other than monetary gold and gold deposits, held by the NBU; - any assets that correspond to claims of commercial banks in foreign currency on the NBU and any reserve assets that are: (i) encumbered; or (ii) pledged as collateral (in so far as not already included in foreign liabilities, or excluded from reserve assets); or (iii) frozen; - any reserve assets that are not readily available for intervention in the foreign exchange market because of lack of quality or lack of liquidity that limits marketability at the book price. *Source: IMF staff estimates.* ### 6. For the purpose of this program, reserve-related liabilities comprise: ### _cr10262 - 6. For the purpose of this program, reserve-related liabilities comprise: ### Reserve-related liabilities - Reserve-related liabilities comprise: - all short-term liabilities of the NBU vis-à-vis nonresidents with an original maturity of one year or less; - the stock of IMF credit outstanding; and - the nominal value of all derivative positions of the NBU and government, implying the sale of foreign currency or other reserve assets against domestic currency. - Note: "This refers to the notional value of the commitments, not the market value." ### Components of Net International Reserves (Table A) - International reserve asset categories and corresponding NBU account codes (as listed): - Monetary gold in vault - Foreign exchange in cash, including Russian rubles - Demand deposits at foreign banks - Short-term time deposits at foreign banks - Long-term deposits at foreign banks - SDR holdings and Reserve Position in the IMF - Securities issued by nonresidents (accounts 1302, 1305, 1307, 1308, minus 1306) - Short-term liabilities to nonresidents (in convertible currencies) as recorded in NBU accounts: - Correspondent accounts of nonresident banks (3201) - Short-term deposits of nonresident banks (3211) - Operations with nonresident customers (3230, 3232, 3233) - Use of IMF credit (IMF, Finance Department) - Operational notes: - Definitions correspond to the system of accounts in existence on June 30, 2010. - The definitions will be adjusted to reflect any changes in accounting classifications introduced during the program period. - Before receiving monthly IMF Finance Department data, components will be calculated on the basis of preliminary NBU data and memorandum accounts. ### Adjustment mechanism for NIR targets and program disbursements (Table B) - NIR targets will be adjusted upward (downward) by the full amount of the cumulative excess (shortfall) in program disbursements relative to baseline projection (Table B). - Program disbursements are defined as external disbursements from: - official multilateral creditors (World Bank, European Commission, European Investment Bank, European Bank for Reconstruction and Development), - official bilateral creditors (net), - external bond placements usable for financing the overall central government budget. - Technical assumption: Program disbursements (cumulative flows from end-June 2010, in millions of US dollars at program exchange rate): - End-September 2010: 1,850 - End-December 2010: 750 - Q3 2010 components include: Euro bond placement of $1.3 billion, EC disbursement of $0.15 billion, EBRD disbursement of $0.3 billion and other project financing disbursement of $0.1 billion. - Q4 2010 components include: World Bank disbursement of $0.5 billion, EU disbursement of $0.3 billion, other project financing of $0.1 billion; as well as $2 billion repayment of the Russian bridge loan. ### Net Domestic Assets (NDA) of the NBU (Performance Criterion) - Definition: - NDA = monetary base (as defined in section C) minus NIR of Ukraine (as defined above). - For computing the NDA target, NIR is valued at the program exchange rate of UAH 7.9070 per dollar and expressed in hryvnia. - On June 30, 2010, the NDA of the NBU amounted to UAH 67,913 million. - Adjustment mechanism: - NDA targets will be adjusted downward (upward) by the full amount of the cumulative excess (shortfall) in program disbursements relative to the baseline projection (Table B) and evaluated at the program exchange rate. ### Monetary Base of the NBU (Base Money) (Indicative Target) - Definition: - Monetary base comprises domestic currency outside banks and banks' reserves, including cash in vault of commercial banks, and funds of customers at the NBU. - On June 30, 2010, the NBU’s monetary base amounted to UAH 219,506 million. - Detailed composition (accounts referenced explicitly in source): - Currency outside banks: Currency—banknotes and coins—(NBU accounts 3000 (net)+3001 (net)-3007A-3009A-1001A-1004A-1007A-1008A-1009A) minus cash in vault at deposit money banks (DMB accounts 1001A:1005A, and 1007A). - Banks’ reserves: cash in vault at deposit money banks (DMB accounts 1001A:1005A, and 1007A) + DMB correspondent account deposits at the NBU in hryvnia (NBU liabilities accounts 3200, 3203, 3204, and 3206) + funds of customers at the NBU in hryvnia (NBU liabilities accounts 3230, 3232, 3233, 3234, 3250, 4731, 4732, 4735, 4736, 4738, 4739, and 4750) + accrued interest on time deposits of DMBs in national currency (NBU accounts 3208L) + accrued interest on client’s current accounts in national currency (NBU liability account 3238). - Note: Definitions may be modified to include any other accounts identified or created in the future related to domestic currency issue and DMB deposits at the NBU. ### Ceiling on Cash Deficit of the General Government (Performance Criterion) - Definition: - General government comprises central (state) government, all local governments, and all extrabudgetary funds (including Pension, Employment, Social Insurance for Temporary Disability, State Material Reserve, Occupational Accident and Sickness Insurance, State Property Fund, Road Fund (UkrAvtoDor)). - Cash deficit measured from below the line equals the sum of: - total net treasury bill sales (NBU registry), excluding bonds issued to recapitalize Naftogaz when used by Naftogaz to obtain financing; - other net domestic banking system credit to government (monetary statistics provided by the NBU) plus any financing extended by entities not reflected by NBU monetary statistics; - total receipts from privatization received by the State Property Fund and local governments (including change in refundable participation deposits); - difference between disbursements and amortization on any bond issued by the government or the NBU to nonresidents for financing the general government deficit; - difference between disbursements of official foreign credits to the general government and amortization of official foreign credits by the general government (including on-lent project loans, and excluding offset-based amortization with Russia); - net sales of SDR allocation in the SDR department; - net change in government deposits in nonresident banks or institutions; - net proceeds from any promissory note or other financial instruments issued by the general government. - For measuring deficit, all flows to/from the budget in foreign currency will be accounted in hryvnias at the official exchange rate established as of the transaction date. - Adjustment mechanisms: - Automatic adjuster based on deviations of external project financing (disbursements from bilateral and multilateral creditors for specific project expenditure) from program projections (Table C): - If cumulative proceeds from external project financing (in hryvnia evaluated at actual exchange rates) exceed program projections, the ceiling on the consolidated general government deficit will be adjusted upward by 100 percent of the excess. - If they fall short, the ceiling will be adjusted downward by 100 percent of the shortfall. - Table C (cumulative flows from end-December 2009, in millions of hryvnia — technical assumption): - End-September 2010: 1600 - End-December 2010: 2400 - Automatic adjuster for upfront budgetary costs associated with bank recapitalization (excluding subsequent interest payments): adjusted upward by up to UAH 20 billion in 2010. - Automatic adjuster on stock of budgetary arrears on social payments (arrears defined as payments not made thirty days after due date). - Automatic upward adjustment for full amount of bonds used to pay VAT refunds (VAT bonds), with simultaneous downward adjustments: - (i) difference between total bonds used for VAT refunds and VAT refunds arrears at end-2009 (UAH 16.4 billion); - (ii) accumulation of any VAT refund arrears since January 1, 2010 in excess of the ceiling on VAT refund arrears (section E). ### Ceiling on VAT Refund Arrears (Indicative Target) - Ceiling: - UAH 3 billion at end-September 2010 and zero for all other test dates under the program. - Definition: - Stock of VAT refund arrears = claims not settled (cash refund, netting, payment with a government bond (VAT bond), or official decision to reject claim) within 60 days after the VAT refund claim submitted to the STA. - VAT refund claims rejected by the STA but with a court appeal registered are not considered arrears. - Stock of VAT refund arrears as of December 31, 2009: UAH 16.4 billion. ### Ceiling on Cash Deficit of the General Government and Naftogaz (Performance Criterion) - Definition: - Cash deficit = cash deficit of the General Government (as defined above) plus cash deficit of Naftogaz. - Naftogaz definition and cash deficit measurement: - Naftogaz = national joint stock company “Naftogaz of Ukraine”. - Cash deficit of Naftogaz measured from below the line equals the sum of: - net domestic banking system credit to the company (all financing by banks less change in company deposits); - difference between disbursements of private foreign loans to Naftogaz (including private placements) and amortization of such loans; - difference between disbursements of official foreign credits to Naftogaz (including project loans) and amortization of such credits; - disbursements of trade credits from Gazprom to import gas; - difference between disbursements and amortization on any bonds issued by the company; - difference between disbursements and amortization of loans from the Single Treasury Account; - net change in deposits of the company in nonresident banks or institutions; - net proceeds from any promissory note or other financial instruments issued by the company; - total receipts from sale of assets received by the company (including recapitalization or other form of treasury securities issued to the company); - any other forms of financing not identified above. - All flows in foreign currency measured in hryvnias at the official exchange rate on the transaction date. - Adjustment: - Ceiling adjusted upward by financing by multilateral institutions and official bilateral creditors disbursed to Naftogaz for investment projects. - Baseline under the program assumes no such financing for Naftogaz. ### Ceiling on Non-Accumulation of External Debt Payments Arrears by the General Government (Continuous Performance Criterion) - Definition: - External debt payment arrear = payment by the general government not made within seven days after falling due (including grace period, if any). - This performance criterion applies continuously throughout the program period. ### Ceiling on Publicly Guaranteed Debt (Performance Criterion) - Definition and limit: - Applies to guarantees issued in 2010 by the central (state) government to the non-financial private sector and public enterprises. - Program exchange rate applies to all non-UAH denominated debt. - State guarantees in 2010 will amount to no more than UAH 15 billion. ### Other Continuous Performance Criteria - During the Stand-By Arrangement period, Ukraine will not: - (i) impose or intensify restrictions on the making of payments and transfers for current international transactions; - (ii) introduce or modify multiple currency practices; - (iii) conclude bilateral payment agreements that are inconsistent with Article VIII; - (iv) impose or intensify import restrictions for balance of payments reasons. ### Official exchange rate - Determination: - The NBU will, on a daily basis, set the official rate at the average transaction-weighted rate of the preceding day (with intraday adjustments if necessary to keep it within 2 percent of the market rate). ### Reporting requirements — National Bank of Ukraine - Frequency and content of NBU reporting to the IMF: - Monthly (no later than the 25th day of the following month): aggregate balance sheet for the NBU and consolidated balance sheet for deposit money banks. - Weekly (with daily data): stock of net international reserves, at both actual and program exchange rates; weekly and monthly (no later than the 25th of the following month) full breakdown of NBU accounts included in net international reserves (Table A). - Daily: information on official foreign exchange interventions, detailed results of foreign exchange auctions (format agreed with IMF staff). - Continued public posting on NBU website: weekly report on primary treasury bill market, reports on each treasury bill auction; provision to IMF of monthly report on treasury bills and breakdown of treasury bill amortizations by type of T-Bill holders. - Daily: holdings of treasury bills broken down by type of holders at primary market and balance sheets prices; aggregated data on main currency flows, including government foreign receipts and payments by currencies and currency breakdown of interbank market operations; daily information on exchange market transactions including exchange rate. - Weekly: daily data on total financing (including refinancing) issued by NBU to commercial banks, broken down by original maturity, and transactions to absorb liquidity (including CD issuance). - Every 10 days: operational monetary survey of the NBU, including additional information needed to monitor monetary policy and banking sector developments. - Monthly (within three weeks following end of month): net domestic assets data based on monthly balance sheets. - Daily: operational balance sheets of the NBU and commercial banks according to standard reporting forms, including detailed information on banking sector loans to the general government, with weekly detailed breakdown by indebtedness of central and local governments, including national and foreign currency, by loan and by security. - Monthly: projections for external payments falling due in the next twelve months. - Quarterly (within 80 days following end of quarter): data on actual settlement of external obligations, separately reflecting principal and interest payments and actual outturns for public and private sectors. - Quarterly: stock of short- and long-term external debt (including arrears) for both public and private sectors. *IMF staff technical memorandum excerpt as provided in the source content.* ### 32. The NBU will provide to the IMF reports N 381.25; 381.26 with information on ### _cr10262 - 32. The NBU will provide to the IMF reports N 381.25; 381.26 with information on ### National Bank of Ukraine (NBU) reporting and safeguards - NBU will provide to the IMF reports N 381.25; 381.26 with information on reserve requirements and reports on CD operations when performed. - Monthly banking system monitoring indicators, no later than 25 days after the end of the month, in an agreed format; includes inter alia data on nonperforming loans (substandard, doubtful, and loss criterion). - Quarterly, consolidated banking sector data and aggregated data (without specifying the names of the banks) for the largest banks (accounting for at least 80 percent of the total banking system assets), no later than 30 days after the end of the quarter, including: - (i) balance sheet; - (ii) loan classification (standard, watch, substandard, doubtful, loss); - (iii) provisions for all assets (required and actual); - (iv) foreign currency denominated lending and deposits; - (v) capital adequacy ratios for normative and regulatory capital (Tier II and I), normatives H2 and H3; weighted averages based on banks’ total assets; - (vi) liquidity normatives H5 and H6; weighted averages based on banks’ total assets. - Detailed quarterly balance of payments data in electronic format within 80 days after the end of the quarter. - Monthly data on credit to nongovernment units that are guaranteed by the NBU, no later than 25 days after the end of the month. - NBU will inform IMF staff if the Treasury does not pay interest or principal on treasury bills due to the NBU, deposit money banks, or nonbank entities and individuals; in such case, the NBU will provide information on outstanding interest and principal payments. - NBU will inform IMF staff of any changes to reserve requirements for deposit money banks. - NBU will communicate (electronically) to IMF staff any changes in accounting and valuation principles applicable to balance-sheet data and will notify staff before introducing any changes to the Charts of Accounts and reporting forms of both the NBU and the commercial banks. - NBU Internal Audit Department will continue to provide an assurance report and an audited income statement to the Fund, no later than six weeks after each test date, confirming that: - (i) the monetary data are in accordance with program definitions and have been verified and reconciled to accounting records, and - (ii) that there have been no changes to the chart of accounts or valuation methods that would impact the data reporting. - NBU will provide to the Fund a copy of the annual management letter from the external auditor within six weeks of completion of each audit; this requirement remains in effect for the duration of the arrangement and for as long as credit remains outstanding. ### Ministry of Finance reporting requirements - Treasury will continue to provide to the IMF its report on daily operational budget execution indicators, and on a 10-day basis data on revenue of the state, local government, and consolidated budget revenues. - Treasury will provide in electronic form monthly and quarterly treasury reports, no later than 25 and 35 days after the end of the period respectively. - Final fiscal accounts at the end of each fiscal year, no later than March of the following year; reports to include expenditure data by programs and key spending units, and standard functional and economic classifications; quarterly reports to contain standard information on budget expenses to cover called government guarantees. - Monthly reports 1.P0 on actual tax revenue and 1.P6 on tax arrears, no later than 25 days after the end of each month. - Monthly reporting on the public wage bill in line with the template agreed with IMF staff; monthly reports on execution of the Stabilization, Agrarian, and Road Fund. - Monthly reporting, no later than 15 days after the end of the month, of the cash deficit of the general government with details on: - privatization receipts of the state and local governments; - disbursements of external credits (including budget support and project loans for on-lending) to the consolidated budget and amortization of external debt by the consolidated budget; - net domestic borrowing of the general government, including net t-bill issuance, issuance of other government debt instruments, and change in government deposits. - Monthly information on borrowing (disbursements, interests and amortization) for specified state-owned companies or agencies (Naftogaz, UrkAvtoDor, State Mortgage Institution and the National Agency in Charge of preparation and Conduction of Euro-2012 Soccer Championship), in line with the format agreed with IMF staff. - Monthly data on the stock of all budgetary arrears, no more than 25 days after the end of the month, with separate line items for wages, pensions, social benefits, energy, communal services, and all other arrears on goods and services; Treasury to report monthly data on accounts payable for state and local budgets (economic and functional classification). - Monthly information, no later than 25 days after the end of each month, on amounts and terms of all external debt contracted or guaranteed by the general government. - Monthly electronic reporting, no later than 25 days after the end of the month, of: - (a) outstanding stock of domestic and external debt of the state and local budgets (including general and special funds); - (b) standard files planned and actual external debt disbursement, amortization, and interest payments (including general and special funds), broken down by creditor categories as agreed with Fund staff; - (c) report on external debt amortization and interest payments by days and currencies. - Also report accumulation of any budgetary arrears on external and domestic debt service. - Monthly debt (domestic and external) amortization schedules updated on a weekly basis. - Monthly data on external and domestic credit to nongovernment units that is guaranteed by the government (amount of sovereign guarantees extended by executive resolutions and actually effectuated; total amount of outstanding guarantees and list of their recipients), no later than 25 days after the end of the month. - Quarterly data, no later than 50 days after quarter end (each month in case of the Pension Fund), on approved budgets and operational data (daily for the Pension Fund only) on revenue, expenditures, arrears, and balance sheets of: - Pension Fund (detailed breakdown of revenues and expenditure by main categories expected), - Social Insurance Fund, - Employment Fund (detailed breakdown expected), - Occupational Accident and Sickness Insurance Fund, - any other extrabudgetary funds managed at the state level. - Any within-year amendments to budgets of these funds will be reported within a week after approval. Annual financial statements including final fiscal accounts for these funds no later than April of the following year. - Semi-annual data on the number of employees of budgetary institutions financed from the central (state) and local budgets, starting from January 2010. After any public sector wage increase, MoF will provide an estimate of its costs for the current and two subsequent fiscal years, for the state and local government budgets. - Monthly, no later than 15 days after the end of each month, data on budgetary costs associated with the recapitalization of banks, including upfront impact on the cash deficit of the general government and costs associated with payment of interests. - Weekly data (template agreed with IMF staff) on the outstanding balance of the single Treasury account (including its foreign exchange component) compartmentalized into funds ascribed to: - (a) general fund of the state budget; - (b) special fund of the state; - (c) local budgets; - (d) other funds; - and data on net outstanding temporary loans to Pension Fund and local budgets. ### State Tax Administration (STA) reporting - Monthly data, no later than 25 days after the end of the month, on tax arrears, inclusive of deferred payments, interest and penalties outstanding, in specified format including beginning stock, netting out during month, deferrals during month, write-offs, collections, new arrears, ending stock, and breakdowns by total/principal/interest/penalties. - Quarterly, no later than 2 months after the end of the quarter, a listing of all tax exemptions granted, specifying the beneficiary, the exemption provided, the duration, and the estimated subsequent revenue loss for the current fiscal year. - Monthly information, no later than 25 days after the end of the month, on VAT refunds in the specified format: - (i) beginning stock of refund requests; - (ii) refund requests paid in cash; - (iii) refunds netted out against obligations of the taxpayer; - (iv) denied requests; - (v) new refund requests; - (vi) end-of-period stock of requests; - (vii) stock of VAT refund arrears according to the definition in paragraph 16 (unsettled VAT refund claims submitted to the STA more than 60 days before the end-of-period); - (viii) the percentage of VAT refund claims that has been in arrears for less than 30 days (refund claims submitted to STA less than 90 days before the end-of-period), the percentage of VAT refund claims that has been in arrears for more than 30 days but less than 90 days (refund claims submitted to STA more than 90 days but less than 150 days before end-of-period), and the percentage of VAT refund claims that has been in arrears for more than 90 days (refund claims submitted to STA more than 150 days before the end-of-period); - (ix) the percentage of VAT refund arrears that are under investigation, but has not yet been officially rejected. - Note: monthly data could be operational, quarterly figures will be subject to verification and will be final. ### Ministry of Economy and Ministry of Fuel and Energy reporting - Ministry of Economy to provide quarterly information on actual levels of communal service tariffs in all regions for major services (heating, water supply, sewage and rent) and their level of cost recovery. - Ministry of Economy, Ministry of Housing and Municipal Economy of Ukraine, and the National Energy Regulatory Commission to provide the methodology underlying tariff calculations for full cost recovery, including electricity and gas. - Monthly (no later than the 25th of the following month) electronic information (agreed format) on financial indicators in the gas, electricity and coal sectors (sales, tariffs, arrears, payments to the budget, subsidies, and debt) based on inputs from Ministry of Fuel and Energy, Ministry of Economy, STA, MoF, NERC, and Naftogaz. - Monthly (no later than the 25th of the following month) Ministry of Fuel and Energy (based on Naftogaz) to provide IMF staff with information in electronic form on the cash deficit of the company, as defined above. ### State Statistics Committee and Naftogaz reporting - Monthly, no later than 45 days after the end of the month, data on prices, volumes, and payments for imported and exported oil and natural gas by country of origin and destination. ### IMF program, access, phasing, and Ukraine external debt context - Authorities requesting a 29-month Stand-By Arrangement (SBA) with access of SDR 10 billion (729 percent of quota). - Disbursement phasing (proposed SBA—Access and Phasing table as provided): - 2010 July (approval): 1,250.0 SDR mn; 0.091.1 percent of quota; Purchase 1.1 - 2010 November: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 64.0 - 2011 March: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 236.9 - 2011 June: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 309.8 - 2011 September: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 382.7 - 2011 December: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 455.5 - 2012 March: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 528.4 - 2012 June: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 601.3 - 2012 September: 1,000.0 SDR mn; 0.072.9 percent of quota; Cumulative 674.2 - 2012 December: 750.0 SDR mn; 0.054.7 percent of quota; Cumulative 728.9 - Total: 10,000.0 SDR mn; 0.0728.9 percent of quota; Cumulative 728.9 - Note: Starting November 2010 purchases will depend on the completion of a review. - Disbursement mechanics: - Most of the first two scheduled purchases (US$2 billion or approximately SDR 1.3 billion) will go to the Ministry of Finance as budget support— evenly split between the purchase on approval and the first review purchase in November 2010, with the balance of each drawing going to the NBU. All subsequent purchases will be made by the NBU. - Background summary: - GRA credit outstanding to Ukraine is currently at a historic peak of SDR 7 billion. - Ukraine drew SDR 7 billion of the total of SDR 11 billion available under the earlier 2008 SBA; that program went off track a year into the program. - Ukraine’s total external debt has increased to high levels in recent years, mainly due to sharp increases in foreign borrowing by banks and corporations; total external debt is about 80 percent of GDP (projected to decline in 2010). - External debt is primarily long-term and over 70 percent is private sector debt. - Public external debt projected to rise to 22 percent of GDP by end-2010. - Over 60 percent of public external debt represented obligations to the Fund in 2009. - Ukraine has not placed an international bond since 2007. - Total public sector debt has risen rapidly over the past two years on account of consistent budget deficits but remains moderate compared with other exceptional access cases. *International Monetary Fund—Ukraine—Assessment of the Risks to the Fund and the Fund's Liquidity Position (Prepared by the Finance and Strategy, Policy, and Review Departments; Approved by Andrew Tweedie and Lorenzo Giorgianni; July 21, 2010).* ### 3. Ukraine’s external debt service burden is high. ### 3. Ukraine’s external debt service burden is high. ### Deterioration in external debt service to exports - The external debt service to export ratio has deteriorated dramatically since 2008 reflecting rising external debt, but mostly falling exports due to the global crisis. - Ukraine’s nominal exports fell 40 percent in 2009 (Staff Report). - This deterioration increased Ukraine’s external debt service to export ratio to a relatively high level among exceptional access cases, below only Greece’s and Iceland’s (Figure 1, Panel C). - This debt service to export ratio is also significantly higher than the corresponding one for the 2008 SBA. ### Access under the proposed arrangement and peak Fund exposure - If all purchases were made as scheduled, Ukraine’s outstanding use of GRA resources would rise from about 500 percent of quota currently to peak at nearly 1,100 percent of quota in September 2012 (Figure 2). - This level of access relative to quota would be the fourth highest after Greece, Latvia, and Iceland—and well above the median case of Belarus. - If all purchases were made as scheduled, the Fund’s exposure to Ukraine in terms of GDP would peak at a level second only to Iceland, exceeding exposure to Greece (Figure 3, Panel A). - As a share of total external debt, peak exposure would be second only to Armenia and would be just over half of reserves. - If the first purchase was made, Ukraine would become one of the two largest debtors to the Fund: after the first disbursement Ukraine would be one of the largest two debtors to the Fund (along with Romania) at SDR 8,250 million or 17.2 percent of total GRA credit outstanding, given the already existing credit outstanding of SDR 7 billion. - In terms of size, the proposed program would be the fourth largest of the current arrangements after Greece, Romania and Hungary. - Outstanding GRA credit to the Ukraine is projected to peak at SDR 14.8 billion in 2012 (Table 4), equivalent to about 53 percent of total public sector external debt and about 18 of total external debt. ### Projected debt service burden (if all purchases made as scheduled) - Ukraine’s projected debt service to the Fund would peak at about SDR 4.1 billion in 2013 (Table 4). - Equivalent metrics for that peak: - 8.7 percent of government revenues - almost three-quarters of public external debt service - 3.6 percent of GDP - 14.3 percent of gross international reserves - 7.0 percent of projected exports of goods and services - Ukraine’s total external debt service for 2013 is projected to amount to 21.3 percent of GDP and 41.3 percent of exports of goods and services. ### Capacity-to-repay indicators (selected entries from Table 4) - GRA credit to Ukraine (SDR millions): Jul-10 1,250.0; 2010 9,250.0; 2011 13,250.0; 2012 14,765.6; 2013 11,109.4; 2014 7,968.8; 2015 4,250.0. - In percent of quota (GRA credit): 91.1; 674.2; 965.7; 1,076.2; 809.7; 580.8; 309.8. - Charges due on GRA credit (SDR millions): -49.3; 132.5; 176.4; 172.8; 128.7; 90.2. - Debt service due on GRA credit (SDR millions): -98.0; 279.4; 2,650.4; 4,111.4; 3,448.9; 3,899.2. - Total external debt (in percent of GDP): 88.0; 79.0; 77.8; 77.6; 71.4; 67.4; 64.5. - Total external debt service (in percent of GDP): 27.9; 20.6; 19.8; 21.3; 21.3; 19.8; 19.1. - Total external debt service (in percent of Exports of Goods and Services): 60.3; 43.0; 41.0; 41.9; 41.3; 37.9; 35.8. - GRA credit to Ukraine (in percent of Total External Debt): 1.9; 12.8; 17.0; 18.2; 13.7; 9.6; 5.0. - In percent of Total External Debt Service, debt service due on GRA credit: -0.5; 1.4; 11.9; 17.0; 14.2; 15.5. ### Impact on Fund liquidity, prudential measures, and burden sharing - The proposed arrangement would reduce Fund liquidity by about 4 percent (Table 5). - One-year Forward Commitment Capacity (FCC) as of 7/8/2010: 148,300 (millions of SDR). - Impact on FCC on approval: -6,000 (millions of SDR). - Prudential and concentration metrics (as of 7/8/2010): - Fund GRA commitment to Ukraine in percent of current precautionary balances: 137. - Fund GRA commitment to Ukraine in percent of total GRA credit outstanding: 21. - Fund GRA credit outstanding to top five borrowers in percent of total GRA credit outstanding: 70. - Fund GRA credit outstanding to top five borrowers including first Ukraine purchase: 71. - Ukraine's annual GRA charges in percent of the Fund's residual burden sharing capacity for 2010: 221. - Fund's precautionary balances (as of April 30, 2010): 7,320 (millions of SDR). - Fund's Residual Burden Sharing Capacity: 22.2. - Potential burden-sharing strain: - Were Ukraine to accrue arrears on charges under the proposed arrangement, the Fund’s burden sharing capacity would be severely strained. - In 2010, GRA charges on Ukraine’s arrangement would be more than double the residual burden sharing capacity of the Fund. - Charges would peak at about 781 percent of the Fund’s current residual burden sharing capacity in 2011 if purchases were made as scheduled. ### Additional risk factors highlighted - Front-loaded budget support represents additional risks: - Total budget support of US$2 billion or about SDR 1.3 billion (about 100 percent of quota) is scheduled to be disbursed in the first two purchases—after several key prior actions but before the implementation of other critical structural reforms. - Budget support under the 2008 SBA amounted to about SDR 3.1 billion (about 240 percent of quota). - Program vulnerabilities and downside scenarios: - Worsened external conditions: uneven recovery in Europe and volatile financial markets could lead to shortfalls in foreign financing and delayed normalization of access to private capital markets. - Domestic policy risks: narrow-based recovery, rising non-performing loans, structural fiscal rigidities, and Naftogaz’s financial viability could undermine debt-servicing capacity. - Inability of the budget to service obligations to the Fund: central government ability to purchase foreign exchange from the NBU hinges on strong fiscal adjustment. - Weakened political commitment to reform: political pressures (local elections and parliamentary elections in the fall of 2012) could weaken program implementation. - The program aims at a sustained economic recovery and includes deep structural reforms (pensions and energy sector), a strong fiscal adjustment, rebuilding international reserves, and regaining access to private capital markets; the 29-month SBA is intended to fill financing needs and catalyze official financing from other sources. *Source: Ukraine authorities and IMF staff estimates as presented in the IMF staff report section "3. Ukraine’s external debt service burden is high."* ### 11. These risks may adversely affect Ukraine’s capacity to repay the Fund. The ### _cr10262 - 11. These risks may adversely affect Ukraine’s capacity to repay the Fund. The ### Program risks and repayment capacity - The proposed access is described as significant in terms of both Fund resources and the debt service burden on Ukraine. - Key mitigating factors identified: - Authorities’ commitment to consistent implementation of the program. - Prompt response to changes in underlying conditions. - Continued strong political commitment. - These factors are said to be key to mitigating risks and safeguarding Fund resources. ### Legal obligation to repay - From the legal point of view, it is always the member, i.e., the government that has the obligation to repay the Fund. ### Fund relations — snapshot (As of June 30, 2010) - Membership Status: - Joined 09/03/1992; Article VIII - General Resources Account (SDR Million): - Quota 1,372.00 100.00 - Fund holdings of currency 8,372.00 610.20 - Reserve position in Fund 0.02 0.00 - SDR Department (SDR Million %Allocation): - Net cumulative allocation 1,309.44 100.00 - Holdings 7.22 0.55 - Outstanding Purchases and Loans (SDR Million %Quota): - Stand-By Arrangements 7,000.00 510.20 ### Latest financial arrangements (approval, expiration, amounts) - Stand-By: - Approval Date 11/05/08, Expiration Date 11/04/10, Amount Approved (SDR million) 11,000.00, Amount Drawn (SDR Million) 7,000.00 - Stand-By: - Approval Date 03/29/04, Expiration Date 03/28/05, Amount Approved (SDR million) 411.60, Amount Drawn (SDR Million) 0.00 - EFF: - Approval Date 09/04/98, Expiration Date 09/03/02, Amount Approved (SDR million) 1,919.95, Amount Drawn (SDR Million) 1,193.00 ### Projected payments to Fund (Expectations Basis) — (SDR million; based on existing use of resources and present holdings of SDRs) - 2010: - Charges/Interest 75.36 - Total 75.36 - 2011: - Principal 2,234.38 - Charges/Interest 150.11 - Total 2,368.88 - 2012: - Principal 3,500.00 - Charges/Interest 134.50 - Total 3,553.35 - 2013: - Principal 1,265.63 - Charges/Interest 53.35 - Total 1,318.98 (note: totals in source list Total for 2014 separately) - 2014: - Charges/Interest 11.10 - Total 1,276.73 - Footnote: - The schedule presents all currently scheduled payments to the IMF, including repayment expectations and repayment obligations. The IMF Executive Board can extend repayment expectations (within predetermined limits) upon request by the debtor country if its external payments position is not strong enough to meet the expectations without undue hardship or risk. ### Exchange arrangements — historical and classification details - September 1996: authorities introduced the hryvnia (Hrv) at a conversion rate of karbovanets (Krb) 100,000 to HRV 1; rate initially informally pegged to the dollar. - September 1997: peg replaced by a formal band of Hrv 1.7–Hrv 1.9 per U.S. dollar. - Since March 19, 1999: exchange rate determined by the interbank market for foreign exchange. - February 22, 2000: NBU officially confirmed intention to allow the free float of the hryvnia; intervened regularly to limit fluctuations to a small band (around Hrv 5.33 per U.S. dollar, and from March 2005, around Hrv 5.05 per U.S. dollar). - Classification history: - Previously classified as a de facto peg. - Reflecting greater flexibility since April 2008, reclassified as a managed float with no predetermined path for the exchange rate. - As of December 29, 2008, NBU fixed the official exchange rate at HRV 7.7 per U.S. dollar and intervened to keep market rate close to official rate. - Effective February 2, 2009, classification changed from managed floating with no predetermined path to other managed arrangement, retroactively to April 30, 2008, due to revision of classification methodology. - This classification was reaffirmed in April 2010. - Article VIII obligations and controls: - On September 24, 1996, Ukraine accepted the obligations of Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement; two remaining restrictions were eliminated in May 1997. - A number of restrictions on current international transactions were introduced in September 1998 and removed in March 1999. - In October 2008, a number of new exchange controls were introduced, many of which were removed by May 2010. ### FSAP, ROSCs, and safeguards - FSAP participation: - Joint World Bank–IMF FSAP assessment conducted between May 10–24, 2002; update mission between February 18–21, 2003; FSSA considered May 14, 2003. - Standards and codes assessed included: Basel Core Principles for Effective Banking Supervision; Code of Good Practices on Transparency in Monetary and Financial Policies; CPSS Core Principles for Systemically Important Payment Systems; OECD Principles for Corporate Governance; Accounting and Auditing Practices; World Bank’s Principles and Guidelines for Effective Insolvency and Creditor Rights System; and AML/CFT Methodology. - Further update missions: June 11–22, 2007 and July 9–20, 2007; observance assessed: Basel Core Principles for Effective Banking Supervision; and IOSCO Core Principles of Securities Regulation. - Updated FSSA considered as part of the 2008 Article IV consultation. - ROSCs: - Data ROSC Module conducted April 3–17, 2002; considered by the Executive Board on August 5, 2003 (IMF Country Report No. 03/256). - Fiscal Transparency Module (experimental) issued September 1999; update in April 2004 (IMF Country Report No. 04/98). - Safeguard assessment of the NBU: - Most recent assessment completed on April 16, 2009 under the Stand-By Arrangement approved on November 5, 2008. - Findings: - NBU continues to publish externally audited financial statements and has strengthened aspects of its safeguards framework since the 2004 assessment, particularly the internal audit function. - The ongoing economic crisis has significantly increased the NBU's financial and operational risks. - Independence has been impaired by ad hoc legislation. - Weaknesses identified: governance structure, lack of independent audit oversight, non-transparent decision-making. - Recommendations and actions: - External review of the NBU's liquidity support and foreign exchange operations during Q4 2008 was recommended and conducted by Ernst & Young Kiev. - Enactment of legal revisions proposed to strengthen independence and the governance structure, provide for independent audit oversight, and ensure consistency in financial reporting. - To safeguard data integrity and compliance with program definitions, the Internal Audit Department was tasked with reviewing monetary data for the program test dates and reporting its findings to the Fund. - Procedural note: - In accordance with safeguards policy requirements, a new assessment will be completed by the first review of the successor SBA. *International Monetary Fund — UKRAINE Request for Stand-By Arrangement and Cancellation of Current Arrangement—Informational Annex (Prepared by the European Department; July 23, 2010)* ### APPENDIX II: UKRAINE—RELATIONS WITH THE WORLD BANK ### APPENDIX II: UKRAINE—RELATIONS WITH THE WORLD BANK ### Country Partnership Strategy - World Bank Country Partnership Strategy (CPS) for Ukraine endorsed December 6, 2007, covering fiscal years 2008–11. - CPS objectives: improving competitiveness, reforming public finances and the public sector, and improving service delivery. - 2009 CPS progress review focused priorities on: fiscal (particularly structural measures and reforms), business climate (particularly business entry), and banking sector reforms for the remainder of the CPS. - Continued support for large public infrastructure projects, particularly in the transport and energy sectors. - CPS envisages a lending range of US$2 to US$6 billion over the four-year CPS period within a flexible operational framework based on selectivity, flexibility and partnerships. - Up to 50 percent of this envelope is planned through direct budget support (policy lending) operations. ### World Bank Program - New series of Development Policy Loans focusing on fiscal and investment climate structural reforms; first operation tentatively sized at US$500 million. - PFRL policy lending series on banking sector reform: - First operation disbursed in 2009 for US$400 million. - Second operation being prepared, initially sized at US$350 million. - Both subject to agreement with the authorities on key structural reforms. - Ongoing project financing in the public sector includes: - Public Finance Modernization Project: US$50 million. - State Tax Service Modernization Project: US$40 million. - Statistical System Modernization Project: US$32 million. - Rural development: - Rural Land Titling and Cadastre Development Project: US$101.5 million to establish secure registration system enabling efficient land transactions. - Energy sector support and investment loans: - Hydropower Rehabilitation Project and additional financing: US$166.0 million (approved June 2005 and November 2009). - Power Transmission Project: US$200 million (approved August 2007). - New Energy Efficiency Project under preparation: US$250 million. - Further investment operations envisaged to support a long-term Energy Reform and Development Program based on the country’s action plan for stabilization in the energy sector. - Infrastructure: - Roads and Safety Improvement project approved in 2009: US$400 million (currently under implementation). - Urban Infrastructure Project: US$140 million to finance local government and utility investments in water and wastewater. - Railways Modernization project in the pipeline: US$500 million. - Financial sector: - Second Export Development Project (EDP2): US$54 million. - Additional financing for EDP2 under consideration: US$150 million. - Social sector: - Social Assistance System Modernization project (since November 2005): US$99 million to modernize administration of social benefits. - Equal Access to Quality Education project: US$45.3 million to improve efficiency and quality of education and student preparedness for a knowledge economy. - Environmental and local interventions: - Sub-national assistance in Zaporizhiya oblast to reduce health impacts of air pollution from major industrial polluters. - Assistance to benefit from International Emissions Trading and Joint Implementation under the Kyoto Protocol. - Economic and sector work program across: growth, trade, expenditure policy (emphasis on efficiency and budget reallocation), tax policy, intergovernmental fiscal relations, agriculture policy, energy policy, and social sector expenditure and policy. ### Bank–Fund Collaboration - Fund and Bank staff collaborate closely and are in broad agreement on division of labor for macro-critical sectoral issues; collaboration oriented to support Government reform program and coordinate Fund-Bank policy advice. - Bank analysis is shared with the Fund and used as inputs to the fiscal framework, including structural reform measures with fiscal implications (pension reform, energy sector reform, better targeting of social assistance programs). - Areas of particularly close collaboration: - Fiscal: - (i) revenue administration; - (ii) tax policy; and - (iii) public financial management. - Energy: - gas and utility sector reforms. - Financial sector: - (i) bank recapitalization program; - (ii) reforms to consolidated supervision; - (iii) reforms to ultimate controllers framework; - (iv) reforms to strengthen the bank resolution framework; and - (v) measures to facilitate consolidation of the banking system. ### World Bank Contact - Martin Raiser, Country Director (Tel.: 380-44-490-6671). *APPENDIX II: UKRAINE—RELATIONS WITH THE WORLD BANK (July 2010).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10262.pdf_