## _cr1631 ## Source details **Canonical URL:** [_cr1631](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1631.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1631.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1631.pdf.json) --- ### Preface — mission and context; executive summary - Mission: technical assistance mission visited Kiev during January 27–February 11, 2015 to advise the Ukrainian Ministries of Economy and of Finance on finalization of their reform strategy for state-owned enterprises (SOE). - Meetings with senior officials included Mr. Abromavicius, Mr. Pivovarsky, Mr. Kachur, Mr. Fudashkin, Mr. Lisovenko, Mr. Kava, Mr. Yarememko, Mr. Barash, and senior officials from the Ministry of Agriculture, the Presidential Administration, the Council of Ministers, and the State Inspection Service. - Engagements with SOEs and stakeholders: Naftogaz, Antanov, Fininpro, Ukrecoresources, UKR Hydroenergo, UKR Railways; audit and investment banking representatives; World Bank; European Commission. - High-level findings: - Reform of the SOE sector is a high priority in “National Strategy 2020” and the government’s 2014 Coalition Agreement. - Key problems identified: - High levels of direct and indirect state support adding significant fiscal risks, exacerbated by the severe economic situation. - Weaknesses in management of the state’s investment portfolio hindering ability to increase value of state assets. - Oversight and governance require substantial improvement. ### Improving governance arrangements — major findings and recommended governance improvements - Fragmentation and conflicts of interest: - Government simultaneously acts as shareholder, financier, regulator, supervisor, customer, and supplier. - Same institutions often develop sector policy, appoint management, review/approve company plans, and evaluate performance. - Market and competition concerns: - SOEs have not operated in a well-regulated environment, causing competitive distortions. - Reforms should enforce existing competition rules and ensure regulatory controls to reduce monopolistic behavior. - Needed governance improvements (selected): - Establish proper corporate governance arrangements. - Improve performance management frameworks and make SOEs accountable for poor performance. - Reinforce financial and fiscal discipline, improve tax collection, clarify dividend remittance expectations. - Establish independent Boards of Directors for stewardship and oversight. - Improve transparency and reporting to parliament and the public. ### Public sector scale and structure — overview and key statistics - Public sector control and economic footprint: - About half of real estate property is in public hands. - Public expenditure accounts for about half of GDP. - Public enterprises have assets estimated at more than 60 percent of GDP. - Combined revenue of the public sector (general government and SOEs) is above 70 percent of GDP. - SOE counts and activity: - More than one million real estate plots in the hands of the general government (SPF data and MoE data). - Registered public enterprises: 3,350. - Active public enterprises as of end-2014: 1,833. - Sector financials and employment: - Total revenue accrued by the sector: about 20 percent of GDP. - About one quarter of that revenue was generated by the energy company Naftogaz. - Employment: these entities employed more than 1 million people (about 25 percent of the general government staff). - Asset composition: - Energy and coal sectors: about 60 percent of total assets managed by public enterprises. - Infrastructure: about 15 percent of total assets. - Concentration: top 50 public enterprises account for more than 80 percent of total revenue. - Revenue distribution: more than half of SOEs have low revenue streams, below USD 1 million per year. - Land and real estate: - Total land in Ukraine: about 60 million hectares. - State-owned land: about 47 percent of total land. - About 17 percent of the land is covered by forestry. - Agricultural land owned by state: about 10 million hectares. ### Key financials, losses, and budgetary implications - Table 2 snapshot (years: 2012 | 2013 | 2014; 2014 figures based on cumulative data for the first three quarters): - Number of companies: 3,622 | 3,632 | 3,350 - Active companies: 2,255 | 2,109 | 1,833 - Average monthly wage (UAH): 3,911 | 4,202 | 2,801 - Wage arrears (UAH thousands): 479.1 | 259.2 | 656.1 - Assets (UAH billion): 758.3 | 789.0 | 869.9 - Net financial losses (UAH millions): 11,890 | 17,839 | 79,872 - Employees (thousands): 1,164 | 1,112 | 952 - Losses by employee (UAH): 10,215 | 16,042 | 83,899 - Fiscal costs and subsidies: - Budget subsidies directed at SOEs (MoF estimate) in 2014: almost 2.5 percent of GDP. - Indirect subsidies not accounted in the budget (2014): as high as 6 percent of GDP (mostly reflecting recapitalization of Naftogaz). - SOE sector financial losses in 2014 (MoE data on largest public companies): estimated to have reached 5 percent of GDP in 2014 (including Naftogaz); estimated 1 percent of GDP excluding Naftogaz. - Dividends from profit-making SOEs to the budget: estimated about 0.2 percent of GDP. - Profitability: 64 percent of the active SOEs had reported profits in the first three quarters of 2014. ### Transparency, information gaps, and reporting shortfalls - Consolidated reports of public assets — value, yield, and financial performance — are not available. - Estimates of total SOEs and real estate plots are uncertain and not reliably public. - Financial data on capital structure and financial results are not available to the Verkhovna Rada and the public. - Diverging registries: SPF counted 4,500 SOEs in 2014 (many in liquidation or non-operating); MoE/stats coverage incomplete. - Recommendation highlights: prepare full inventory of SOEs and state-owned assets; expand databases to include land and real estate. ### Governance arrangements and institutional fragmentation — legal forms and oversight - Ownership and oversight fragmented among MoE, State Property Fund (SPF), line ministries, and the Council of Ministers. - Approximately 80 percent of SOEs are overseen by seven different institutions. - Legal forms and implications: - Joint-stock companies: commercial entities, subject to corporate governance standards for private companies. - Unitary enterprises (Kazenni and Commercial Entity): fully controlled by the government; Kazenni provided operational management rights; Commercial Entities operate on a for-profit basis. - Deficiencies: - No clear criteria for creating new SOEs or for winding down unviable entities. - SOEs often do not hold legal title to the assets they operate. ### Boards of Directors — role, duties, and international good practice components - Boards perform stewardship and oversight; act as intermediary between executive management and the state; fiduciary duties include duty of care and duty of loyalty. - Board structures: - Unitary boards: mixture of executive and non-executive members. - Two-tier boards: management board and supervisory board. - Components of international good practice on SOE boards (Box 3): - Nomination: codified process aligned with private sector practices. - Composition: balanced mix of experience; enable independent judgement. - Training: induction and continuous training opportunities. - Remuneration: balance to attract and retain qualified individuals and align long-term incentives. - Efficiency: limits on board size and workload per member. - Evaluation: systematic and regular board performance evaluation. ### Transparency, reporting, and disclosure — findings and examples - Disclosure regime: - All Ukrainian SOEs required to publish annual reports under Ukrainian NAS. - Only joint-stock entities required to make audited financial statements publicly available under Article 8 of the 1993 Law of Ukraine on Auditing (amended September, 2006). - Legal framework silent on disclosure of nonfinancial information. - Barriers to transparency: - Law on State Secrets can classify certain unitary SOE information, limiting public access and complicating procurement transparency. - Reporting fragmentation reduces clarity and creates conflicting data (e.g., number of SOEs). - International example (Box 4 — Lithuania’s Transparency Policy for SOEs): consolidated interim/annual reporting deadlines and central institution preparing reports; reporting content requirements enumerated. ### Performance monitoring and fiscal discipline shortcomings - Performance monitoring: - Significant deviation from international good practice; inconsistent application and inaction by line ministries. - MoE empowered to review sector performance but limited capacity; information reliability issues. - Value for money assessments not mandatory; Accounting Chamber lacks remit for regular SOE performance review. - Financial and fiscal discipline weaknesses: - Weak tax collection and dividend remittance; State Tax Administration lacks lien over SOE property. - 2008 MoE report: only 71.4 percent of announced dividends were actually received. - SOE annual financial statements perceived as low quality by commercial banks. - Soft-budget constraints reinforced by banks relying on implicit government guarantees. ### Fiscal risk management — major findings, exposures, and mitigation measures - Capacity to assess fiscal risks from SOEs is weak; no single entity tasked with identification/assessment of fiscal risk and budgetary impact. - Sources of unanticipated budget impacts from SOEs: - Adverse macroeconomic shocks. - Lack of information on underlying financial positions of SOEs. - Potential future recapitalization or increased subsidy requirements from loss-making SOEs. - Government guarantees. - Size and nature of exposures: - Indirect subsidies (e.g., Naftogaz recapitalization) about 6 percent of GDP in 2014. - Government guarantees to SOE loans: large at more than 10 percent of GDP as at end-2014. - MoF assessment: half of contingent liabilities from state guarantees should be considered direct public debt; treating half as direct public debt would increase the ratio of direct public debt to GDP to about 70 percent in 2014, up by almost 10 percent compared to current figures. - Subsidies and sector specifics: - Direct subsidies to SOEs (MoF estimate) in 2014: about 2.5 percent of GDP. - Energy/coal sector accounts for about 1 percent of GDP direct subsidies. - Box 6 — Coal sector key figures: - About 450 SOEs in the sector (314 unitary public enterprises; 140 joint stock companies). - Direct budget cost to finance coal mining support program: about UAH 9 billion in 2014 (almost 1 percent of GDP). - In 2015 implicit budget cost from remaining subsidy rates in coal production estimated in range of UAH 2 to 4 billion (between 0.1 and 0.3 percent of GDP). - Energy subsidy estimates: - Pricing and subsidy estimates: energy subsidies estimated at 7.5 percent of GDP including indirect subsidies; cost of energy subsidies including indirect subsidies estimated to be 6–7 percent of GDP. - Subsidy rate remains high at about 80 percent. - Guarantees, borrowing, and guarantee fees: - About three quarters of guaranteed loans are in foreign currency and exposed to exchange rate risk. - If average guarantee fee was around 500 basis points, foregone revenue would total almost UAH 8 billion (0.5 percent of GDP). - Railway public enterprise debt falling due: UAH 32 billion (2 percent of GDP). - Weak borrowing safeguards: no robust assessment of borrower capacity to repay; no legal limit on new flows of guarantees (a 5-percent threshold based on annual government revenue proposed by MoF was not introduced); overall public and publicly guaranteed debt exceeds 60 percent of GDP and expected to reach almost 90 percent in 2015. - Fiscal impacts of wage and employment policies: - SOE sector employs more than 1 million employees. - Sector accounts for more than 2 percent of GDP in wages, more than one quarter of consolidated government budget wage bill and about 10 percent of SOE revenue from sales. - Wage arrears in SOEs reached over UAH 650 million in the first nine months of 2014 (up from less than UAH 300 million the previous year). - Excess workforce example: railway SOE estimated excess workforce of about 100,000 with extra annual cost of UAH 1 billion. - Employment shock simulation: if one quarter of employees in loss-making companies lost their job, there would be about 300─500 thousand additional unemployed. ### Public sector balance sheet, coverage, and fiscal risk statements - SOEs affect budget flows and the stock of assets and liabilities; limited analysis to traditional budget indicators gives incomplete picture. - Comprehensive public sector balance sheet should include: - all state assets (including government real estate); - assets and liabilities controlled by general government and companies where government has a significant stake or that are relevant for public policies. - Data and coverage challenges: - Different SOE registries provide different counts (range from about 4,500 to less than 1,800). - State assets held by subnational governments may be missing. - No unified register of real estate; existing registers with limited coverage (SLAU cadastre coverage less than 20 percent; SPF register reportedly around 1 million individual properties). - Recommended practical steps: - Provide basic inventories of state assets. - Extend coverage of existing registries. - Prepare statements of fiscal risks, initially for SOE sector, then comprehensive fiscal risks statement to be included with budget documentation. ### Recommended risk mitigation measures (selected) - Align wages, tax and benefits for non-market public corporations currently classified outside general government with the rest of public administration. - Create budget contingencies. - Gradually phase out subsidies, adjust pricing policies to cost recovery levels, make remaining subsidized components explicit in the budget. - Strengthen governance arrangements surrounding SOE borrowing. - Disclose and cap budget indirect subsidies and tax expenditures. - Charge an adequate risk-based price for state guarantees provided to public enterprises. ### State asset management — conceptual strategy, options, and past failures - Causes of past reform failures: - Absence of consolidated professional ownership entity. - Lack of transparency. - Inadequate governance arrangements. - Incomplete information on portfolio size and complexity. - Draft MoE concept note proposals: - Address lack of transparency. - Separate State ownership and regulatory functions. - Introduce value maximization objective for the portfolio. - Create analytical capacity to oversee State interests. - Areas needing elaboration: - Full inventory of SOEs and state-owned assets including real estate (about half of real estate property is public). - Review and rationalize fragmented legal framework. - Separate commercial objectives from government fiscal policy implementation; agencies performing government functions excluded from portfolio-based approach. - Review roles of institutions involved in privatization and market regulation; simplify privatization regulations. - Ensure strong political buy-in and a broad communication strategy. ### Options for ownership vehicle — advantages, disadvantages, and suitability - Potential models discussed: - a) Discrete unit within MoE (or MoF): - Advantages: easy/cheap to establish; oversee financial flows; establish portfolio value. - Disadvantages: lacks active commercial asset management experience; risk of political use; civil service pay constraints; donor-financed staffing risks. - Suitability: short-term measure. - b) External incorporated holding company with professional asset managers: - Advantages: private sector skills; insulation if managers accountable and incentivized. - Disadvantages: requires prerequisites (political insulation, transparency); need for rigorous scrutiny and performance consequences. - Suitability: medium-term objective. - c) “Fondul Proprietatea” model (listed holding with outsourced management): - Advantages: proven portfolio management expertise. - Disadvantages: same prerequisite gaps; medium-term suitability. - d) Series of sectoral holding companies: - Advantages: sector focus; smaller portfolios. - Disadvantages: expensive; requires multiple professional teams; risks re-fragmentation and reduced synergies; limited private sector capacity. - Suitability: least attractive short/medium term. - Incorporation and equity culture: - Urgency to incorporate viable SOEs and move to same conditions as private sector equivalents. - Incorporation should be based on professional business plans; potential to divest non-core assets and realize value from real estate. ### Privatization process findings and communications - Historical impediments to successful privatizations: - Onerous conditions excluding investors; lack of disclosure and due diligence visibility; limited publicity; unclear rationale for strategic exclusions; absence of advisor culture; perceived tailor-made procedures. - SPF acting as advisor rather than active asset manager; lack of distance from state; insufficient professional capacity; negligible transactions since 2009. - Communications strategy: - Reform strategy must include communications to explain objectives: fiscal sustainability; maximization of portfolio value for citizens; promotion of competitive markets. - Communications critical to secure parliamentary, public, and investor buy-in. ### Recommendations and action plan — short-term and medium-term (selected with timing) - Summary areas: Improving Governance Arrangements; Fiscal Risk Management; Strategy for Management and Oversight of State Assets. - Governance (selected; medium-term timing preserved): - Recommendation 2.1 – Develop a single multi-purpose reporting framework under a single institution. (July 2015) - Recommendation 2.2 – Amend the Law on State Secrets to enhance transparency and corporate governance. (September 2015) - Recommendation 2.3 – Implement web-based reporting at SOE and ministerial level. (July 2015) - Recommendation 2.4 – Capacity building plan for transparency, accountability and oversight. (September 2015) - Recommendation 2.5 – Restructure the Antimonopoly Committee to ensure independence and capacity. (September 2015) - Recommendation 2.6 – Define clear criteria for creation and disbanding of SOEs. (September 2015) - Recommendation 2.7 – Enhance parliamentary role via mandatory annual reporting and value-for-money assessments. (September 2015) - Recommendation 2.8 – Eliminate dual SOE corporate governance approach; standardize to private sector alignment. (January 2016) - Recommendation 2.9 – Reform performance management system with standardized KPIs and codified consequences. (September 2016) - Fiscal risk management (selected): - Recommendation 3.1 – Strengthen safeguards for state guarantees, set a limit on new flows, charge risk-based guarantee fees, enhance borrower assessment by MoF Debt Management Unit. (April 2015) - Recommendation 3.2 – Prepare a fiscal risk assessment of SOEs focusing on macroeconomic, commodity price, and conflict-related risks. (April 2015) - Recommendation 3.3 – Prepare and disclose a fiscal risk statement in budget context. (September 2015) - Recommendation 3.4 – Review rationale for SOEs where private market exists; dissolve SOEs performing general government functions and record subsidies explicitly. (September 2015) - Recommendation 3.5 – Strengthen capacity in MoE and MoF to identify and assess fiscal risks. (September 2015) - Recommendation 3.6 – Strengthen public sector database to include nonfinancial assets such as land and real estate. (September 2015) - State asset management strategy (selected): - Recommendation 4.1 – Further develop draft concept note to include full inventory, legal stock-take, separation of commercial/policy objectives, incorporation and equity culture, ownership/management structure options, communications strategy. (March 2015) - Recommendation 4.2 – Include description of key challenges, need for political buy in, and upfront investment costs. (March 2015) - Recommendation 4.3 – Expand MoE information coverage to include all SOEs and real estate; create an inventory and publish monitoring report. (September 2015) - Recommendation 4.4 – Review assignment of legal title of assets operated by SOEs to incentivize better utilization. (Medium term) - Recommendation 4.5 – Review role of SPF in privatization and consider merging privatization and ownership roles. (September 2015) ### Appendices — fiscal risk framework and reporting templates - Appendix I — Fiscal Risks Identification, Reporting and Mitigation Framework: - Fiscal risks defined as deviations of budget outcomes from plans due to unanticipated shocks (macroeconomic, commodity, contingent liabilities). - Recommended contents of fiscal risk statement: macroeconomic risks and sensitivity, public debt sensitivity, contingent liabilities (face value and expected cost), SOE financial position and sensitivity analysis, and risk mitigation measures. - Practical steps: phased compilation of public sector balance sheet, inventories of state assets, and inclusion of fiscal risk analyses in budget documentation. - Appendix III — Selected entries: Outstanding State Guarantees on SOE Debt as at end-2014 (creditor-by-borrower listings with currencies and UAH equivalents). Selected sample entries (amounts preserved exactly as presented): - EBRD — Ukrzaliznytsya (UZ) — USD 120,000,000 — 637,416,000 - EBRD — Energoatom — USD 42,000,000 — 223,720,000 - European Atomic Energy Community — Energoatom — USD 83,000,000 — 441,228,000 - Credit Suisse First Boston — Yanhel Yuzhnyi SDB — USD 150,000,000 — 795,930,000 - Maglin Capital Limited — UZ — USD 700,000,000 — 3,714,690,000 - Deutsche Bank AG London — Ukravtodor — USD 480,000,000 — 2,553,600,000 - Bonds of JSC NJSC Naftogaz — USD 1,595,017,000 — 12,783,742,252 - State Development Bank of China — JSC NJSC Naftogaz of Ukraine — USD 3,656,000,000 — 29,222,408,000 - Ukravtodor Bills — UAH 14,000,000,000 — 14,000,000,000 - 2014: 0 - Appendix IV — Proposed SOE Annual Report structure (selected elements): - Foreword by the President; Introduction by the Prime Minister. - “At a glance” summary financial indicators: market value vs yield and dividend; revenue; operating profit; EBITDA; profit before tax; net profit; return on equity; gross investments; number of employees. - Portfolio overview and aggregated financial statements. - Sectoral overviews, major units one-page snapshots, reform introduction, regulatory environment, other countries’ SOE reform experiences, list and methodology. *Italic: Preface and Executive Summary, _cr1631 — IMF technical assistance mission report (January 27–February 11, 2015).* ### Preface ................................................................................................................ ### _cr1631 - Preface ### Mission and context - A technical assistance mission visited Kiev during January 27–February 11, 2015, at the request of the Ukrainian Ministries of Economy and of Finance, to advise on finalization of their reform strategy for state-owned enterprises (SOE). - The mission met with senior officials including Mr. Abromavicius (Minister of Economic Trade and Development); Mr. Pivovarsky (Minister for Infrastructure); Mr. Kachur (Deputy Minister of Economic Trade and Development); Mr. Fudashkin and Mr. Lisovenko (both Deputy Ministers of Finance); Mr. Kava (Deputy Minister for Infrastructure); Mr. Yarememko (Deputy Chairman of the Accounting Chamber of Ukraine); Mr. Barash (Chairman of the Antimonopoly Committee); senior officials from the Ministry of Agriculture, the Presidential Administration, the Council of Ministers, and the State Inspection Service. - The mission also met with senior management of State-Owned Enterprises including Naftogaz, Antanov, Fininpro, Ukrecoresources, UKR Hydroenergo, and UKR Railways; representatives of the business community including audit and investment banking representatives; and representatives of the World Bank and the European Commission. - The mission thanked IMF office staff, specifically Mr. Shpak, Ms. Burliai, Ms. Semenenko, and Ms. Shulga, for support and interpretation. ### Executive summary — reform priorities and high-level findings - Reform of the SOE sector is a high priority for the government and is reflected in the “National Strategy 2020” and the government’s 2014 Coalition Agreement. - Key problems identified: - High levels of direct and indirect state support are adding to significant fiscal risks from the SOE sector, exacerbated by the severe economic situation. - Weaknesses in management of the state’s investment portfolio hinder ability to increase the value of state assets. - Oversight and governance of the SOE sector need substantial improvement. ### Improving governance arrangements — major findings - Government roles vis-à-vis SOEs are fragmented across multiple institutions, producing overlap and conflicts of interest; government simultaneously acts as shareholder, financier, regulator, supervisor, customer, and supplier. - The same institutions often develop sector policy, appoint management, review/approve company plans, and evaluate performance, generating overlapping and internally conflicting oversight structures. - SOEs have not operated in a well-regulated environment, leading to competitive distortions and lack of effective market oversight; reforms should enforce existing competition rules and ensure regulatory controls to reduce monopolistic behavior. - Needed governance improvements include: - Establish proper corporate governance arrangements. - Improve performance management frameworks and make SOEs accountable for poor performance. - Reinforce financial and fiscal discipline, improve tax collection, and clarify dividend remittance expectations. - Establish independent Boards of Directors for stewardship and oversight. - Improve transparency and reporting to parliament and the public. ### Fiscal risk management — major findings and proposed mitigants - Capacity to assess fiscal risks from SOEs is weak; no single entity is tasked with identification or assessment of fiscal risk or their potential budgetary impact. - Sources of unanticipated budget impacts from SOEs include: - Adverse macroeconomic shocks. - Lack of information on underlying financial positions of SOEs. - Potential future recapitalization or increased subsidy requirements from loss-making SOEs. - Government guarantees. - Public disclosure of fiscal risks can improve budget vulnerability management, economic efficiency, and lower debt service costs. - Recommended initial actions: - Scale up analytical capacity and prepare statements of fiscal risks, initially for the SOE sector and then a comprehensive fiscal risks statement to be included with budget documentation. - Possible mitigation measures to consider: - Align wages, tax and benefits for non-market public corporations currently classified outside general government with the rest of public administration. - Create budget contingencies. - Gradually phase out subsidies, adjust pricing policies to cost recovery levels, and make remaining subsidized components explicit in the budget. - Strengthen governance arrangements surrounding SOE borrowing. - Disclose and cap budget indirect subsidies and tax expenditures. ### Conceptual strategy for state asset management — major findings - Previous reform attempts failed due to: - Absence of a consolidated professional ownership entity. - Lack of transparency. - Inadequate governance arrangements. - Incomplete information on the size and complexity of the portfolio. - A draft concept note prepared by the Ministry of Economy proposes: - Addressing lack of transparency. - Separating State ownership and regulatory functions. - Introducing a value maximization objective for the portfolio. - Creating analytical capacity to oversee State interests. - Areas needing further elaboration include: - Full inventory of SOEs and other state-owned assets, including real estate (about half of real estate property is in public hands). - Review and rationalization of the complex and fragmented legal framework surrounding management of state assets. - Separation of SOEs’ commercial objectives from activities implementing government fiscal policy objectives; agencies performing government functions should be excluded from a portfolio-based approach. - Review and rationalize roles of institutions involved in privatization and market regulation to develop an institutional structure fit for purpose. - Simplify privatization regulations to create a level-playing field and improve governance of the privatization process. - Provide clearer options for ownership and management structures and ensure strong political buy-in and a broad communication strategy for legislature and public. ### Summary recommendations and action plan (high-level) - Table 1 (Summary of Recommendation and Action Plan) provides short-term and medium-term actions across three areas: - Improving Governance Arrangements (selected recs include developing a single reporting framework; amending the Law on State Secrets to enhance transparency; implementing web-based reporting; capacity building; restructuring the Antimonopoly Committee; defining criteria for creation/disbanding of SOEs; enhancing parliamentary role; eliminating dual corporate governance approaches; reforming performance management system). - Fiscal Risk Management (selected recs include strengthening safeguards for state guarantees on SOE loans; preparing a fiscal risk assessment for SOE sector; preparing comprehensive fiscal risk statement for budget documentation; reviewing rationale for SOEs where private market exists; strengthening capacity in economic ministries; strengthening databases to include information on the public sector balance sheet). - Strategy for Management and Oversight of State Assets (selected recs include further developing the draft SOE reform concept note; describing key challenges in the concept note; expanding information coverage by the MOE to include all state assets; reviewing how legal title of assets owned by the state can be assigned to SOEs; reviewing the role of the SPF in managing privatization). ### Introduction — scale and structure of public sector - The public sector controls a large quantity of economic assets: - About half of real estate property is in public hands. - Public expenditure accounts for about half of GDP. - Public enterprises have assets estimated at more than 60 percent of GDP. - The public sector’s forms include government-owned independent ordinary companies, agencies similar to government departments, and public-private joint-stock companies. - SOE functions span social services, utilities, infrastructure, manufacturing (including aircraft manufacturing and petrochemical industry), energy generation and distribution, transportation and logistics, IT industry, and military sector. - Combined revenue of the public sector (general government and SOEs) is above 70 percent of GDP. - SOE governance and oversight are fragmented and the legal framework is not harmonized. *Preface and Executive Summary, _cr1631 — IMF technical assistance mission report (January 27–February 11, 2015)* ### 3. Public assets constitute the largest share of the business sector in the economy. ### 3. Public assets constitute the largest share of the business sector in the economy. ### Overview and size of the public commercial sector - More than one million real estate plots in the hands of the general government (SPF data and MoE data). - Registered public enterprises: 3,350. - Active public enterprises as of end-2014: 1,833. - Total revenue accrued by the sector: about 20 percent of GDP. - About one quarter of that revenue was generated by the energy company Naftogaz. - Employment: these entities employed more than 1 million people (about 25 percent of the general government staff). - Asset composition: - Energy and coal sectors: about 60 percent of total assets managed by public enterprises. - Infrastructure: about 15 percent of total assets. - Concentration: the top 50 public enterprises account for more than 80 percent of total revenue and a similarly high share of assets. - Revenue distribution: more than half of SOEs have low revenue streams, below USD 1 million per year. - Land statistics: - Total land in Ukraine: about 60 million hectares. - State-owned land: about 47 percent of total land. - About 17 percent of the land is covered by forestry. - Agricultural land owned by state: about 10 million hectares. ### Key statistics from Table 2 (Ukraine: Net Financial Losses of Top Loss-Making Public Enterprises) - Year labels: 2012 | 2013 | 2014 (figures for 2014 based on cumulative data for the first three quarters of the year). - Number of companies: 3,622 | 3,632 | 3,350 - Active companies: 2,255 | 2,109 | 1,833 - Average monthly wage (UAH): 3,911 | 4,202 | 2,801 - Wage arrears (UAH thousands): 479.1 | 259.2 | 656.1 - Assets (UAH billion): 758.3 | 789.0 | 869.9 - Net financial losses (UAH millions): 11,890 | 17,839 | 79,872 - Employees (thousands): 1,164 | 1,112 | 952 - Losses by employee (UAH): 10,215 | 16,042 | 83,899 - Sources: MoE data; IMF staff estimates. ### Fiscal costs and budgetary implications - Budget subsidies directed at SOEs (MoF estimate) in 2014: almost 2.5 percent of GDP. - Mostly related to the energy and coal sectors, as well as programs to build infrastructure and public services. - Indirect subsidies not accounted in the budget (2014): as high as 6 percent of GDP. - Mostly reflecting government recapitalization of the loss-making energy company Naftogaz. - SOE sector financial losses in 2014 (MoE data on largest public companies): - Estimated to have reached 5 percent of GDP in 2014 (including Naftogaz). - Estimated 1 percent of GDP excluding Naftogaz. - Dividends from profit-making SOEs to the budget: estimated to have reached about 0.2 percent of GDP. - Profitability: Only 64 percent of the active SOEs had reported profits in the first three quarters of 2014; the remainder reported losses or break-even. ### Transparency, information gaps, and reporting shortfalls - Consolidated reports of public assets — value, yield, and financial performance — are not available. - Estimates about total number of SOEs or number of real estate plots are uncertain and not reliably in the public domain. - Financial data on capital structure and financial results (including losses impacting the budget) are not available to the Verkhovna Rada and the public at large. - Different data providers diverge on basic information (example: State Property Fund counted 4,500 SOEs in 2014, many in liquidation or non-operating). - Data provided by the statistical service of the MoE do not cover public assets comprehensively. ### Governance arrangements and institutional fragmentation - Ownership and oversight are fragmented among multiple stakeholders: MoE, State Property Fund (SPF), line ministries, and formally the Council of Ministers (CoM). - Approximately 80 percent of SOEs are overseen by seven different institutions (administrative burden and resource constraints). - Legal forms of SOEs create a dualistic ownership approach: - Joint-stock companies: commercial entities, subject to corporate governance standards for private companies. - Unitary enterprises subdivided into Kazenni and Commercial Entity: - Kazenni: fully controlled by the government, provided with operational management rights. - Commercial Entities: fully controlled by the government, granted business management rights and operate on a for-profit basis. - No clear criteria for creating a new SOE or assigning functions to SOEs rather than departmental agencies. - Absence of clear procedures for winding down unviable or insolvent SOEs; some entities continue long after their original purpose. ### Performance monitoring shortcomings - Significant deviation from international good practice; inconsistent application and inaction by line ministries when poor performance is detected. - Different performance treatment by legal form: - Joint-stock SOEs: assessed with a mixture of commercial and non-commercial indicators (net profit, average number of employees, payments to social funds, share of profit paid to state budget). - Unitary SOEs: assessed on a broader set (commercial, non-commercial, financial efficiency, innovation, state asset utilization). - MoE is empowered to review sector performance but has limited capacity and faces reliability issues in information reported by SOEs and line ministries. - Value for money assessments of SOEs are not mandatory and must be requested by parliament; Accounting Chamber of Ukraine remit does not extend to regular review of SOE performance. - Recommended components of an effective performance monitoring system (international good practice): - Collection of baseline information on SOE performance to aid comparison. - Setting aims and objectives aligned with government goals. - Development of performance agreements to promote achievement of SOE aims and objectives. - Development of meaningful and relevant key performance indicators. ### Financial and fiscal discipline weaknesses - Weak tax collection and dividend remittance from SOEs; lack of analysis of returns on capital employed. - Past findings: State Tax Administration lacks a lien over property of SOEs, hampering tax collection. - 2008 MoE report: only 71.4 percent of announced dividends were actually received; 17 ministries did not meet net profitability and dividend transfer targets. - Despite requirements to prepare annual financial statements in accordance with National Accounting Standards (NAS), commercial banks perceive these financial statements as low quality and do not use them as a basis for lending decisions. - Anecdotal evidence: banks base lending decisions on non-quantitative factors, such as government as ultimate guarantor, reinforcing soft-budget constraints. - Competition and AMCU: - Competition law largely consistent with international best practices. - Antimonopoly Committee of Ukraine (AMCU) requires modernization to become an independent and powerful competition authority. - AMCU lacks power to obtain evidence without voluntary compliance, limiting confidence in its ability to ensure SOEs compete on equal footing. ### Board structures and political insulation - Governance framework differs by legal status: - Joint-stock SOEs: subject to Commercial Code of Ukraine, requirement for an appointed two-tier board of directors. - Kazenni and Unitary Entities: no requirement to have independent directors or a supervisory board. - Line ministries retain unfiltered influence over unitary enterprises. - Case example (Antonov): - Antonov group SOEs are not required to have a Board of Directors. - Antonov SOEs do not have legal title to the assets they operate; limited capacity to restructure capital. - Antonov SOEs are not permitted to enter into joint ventures. - Antonov has exemptions from aspects of Ukraine’s legal framework (insolvency and bankruptcy). - Recent governance challenge: summary dismissal of Antonov Concern’s President by the government demonstrates lack of political insulation. ### Reform conclusions and priorities (as stated) - The importance of public commercial assets and weaknesses in management and oversight indicate urgent reforms are warranted. - Subsequent sections of the source aim to: - Analyze fiscal risks emanating from the sector and ways to mitigate them. - Advise on a future reform strategy for the sector as a whole. - Identify areas to be strengthened in governance arrangements. - Key reform focal points highlighted: - Strengthen corporate governance (state ownership function, performance monitoring, financial and fiscal discipline, Board of Directors, transparency, reporting and disclosure). - Adopt OECD guidelines on corporate governance of SOEs as benchmark for strengthening governance arrangements. - Centralize and clarify the state ownership function to reduce fragmentation and conflicts of interest. - Standardize performance monitoring across all SOEs with an ultimate objective to maximize value for the state. - Improve quality of financial statements and capacity building to enable commercial lending and reduce soft-budget constraints. - Modernize and strengthen the AMCU to promote competition and ensure competitive neutrality. *IMF staff report (section): 3. Public assets constitute the largest share of the business sector in the economy.* ### 25. Boards of Directors, preferably including independent directors, perform a crucial ### Boards of Directors, preferably including independent directors, perform a crucial ### Role and duties of boards of directors - Boards of directors perform a crucial stewardship and oversight function. - Boards should act as an intermediary between executive management and the state. - Boards provide a vital stewardship function derived from the fiduciary duty they owe to the SOE and its owners. - The nature and duties of boards of directors vary by jurisdiction to fit the specific needs of the country context. - Two forms of boards: - Unitary boards: provide both a strategic and oversight function; typically made up of a mixture of executive and non-executive members. - Two-tier boards: formed of a management board and a supervisory board separating the strategic and oversight functions. - Directors’ duties generally encompass variations on two central themes: a duty of care and a duty of loyalty to the entity and its owners. - International good practice recommends the consistent formation of effective boards of directors in all SOEs. - Board effectiveness is reliant on components embedded in the governance framework of a state. ### Box 3 — Components of International Good Practice on SOE Boards of Directors - The process of nomination and appoitnment should be codified and aligned with private sector practices. (Nomination) - Board effectiveness is inherently linked to the ability to board members to exercise independent judgement. Eligibility policies should provide for boards with a balanced mix of experience centred around the central purpose of the SOE in question. (Composition) - To promote the proper and full discharge of board members' duties it is considered good practice in many countries to provide induction and contiuous training opportunities. (Training) - Remuneration of board members should strike a balance between being at a sufficient level to attract and retain qualified individuals but also to align incentives over the long-term. (Remuneration) - Provisions should be made to promote the efficient running of boards, such as limits to the number of board members and workload per member. (Efficiency) - The performance of the board should be evaluated systematically and regularly to ensure it is fulfilling the extent of the specified remit. (Evaluation) ### Transparency, reporting, and disclosure — findings - The dualism in Ukraine’s SOE governance framework extends to disclosure and reporting requirements. - All Ukrainian SOEs are required to publish annual reports in accordance with Ukrainian NAS, but only joint-stock entities are required to make audited financial statements publically available under Article 8 of the 1993 Law of Ukraine on Auditing (amended September, 2006). - The legal framework remains silent on the disclosure of nonfinancial information. - Stakeholders have expressed concerns regarding the capacity of SOEs to produce timely and relevant reporting. - Oversight and performance management functions are fragmented across a number of different ministries, leading to lack of clarity on responsibilities and conflicting data (even on the number of operational SOEs). - Entities exercising oversight do not have a clear mandate or ability to drive performance improvements; powers (e.g., set remuneration levels, hire and fire management, alter subsidies, recruit external expertise, authorize restructuring) are fragmented and overlapping. - Dismissed managers frequently successfully appeal their termination, often due to direct government intervention, undermining effectiveness of sanctions. - Certain information relating to unitary SOEs can be classified as of significant national importance under the Law on State Secrets, creating a barrier to transparency and public access to information. - Interaction of the Law on State Secrets with the Public Procurement Law can result in opaque public procurement processes in unitary enterprises. - Current SOE corporate governance framework provides different reporting standards for joint-stock and unitary enterprises; only joint-stock SOEs are exposed to the same reporting requirements as the private sector, which is inconsistent with OECD guidelines. - Public access to information could be improved through moderation of the scope of the Law on State Secrets or by requiring publication of financial information on accessible websites (preferably in English as well as Ukrainian). - The current reporting and disclosure framework does not emphasize the role of the legislature in accountability and scrutiny of SOEs; aside from publically available financial accounts, SOEs only report to the line ministries, the MoE and the MoF. - Reporting and disclosure of nonfinancial information is not required. - International good practice establishes the legislature as a key recipient of disclosure by SOEs; forms of reporting to the legislature include periodic reporting, ad hoc reporting, and reporting for approval. ### Examples of international practice (as presented) - Box 4 — Lithuania’s Transparency Policy for SOEs: - Consolidated annual report presented no later than April 30 - Consolidated interim report (3 month) presented no later than May 21 - Consolidated interim report (6 Month) presented no later than September 15 - Consolidated interim report (6 Month) presented no later than November 21 - Consolidated interim report (6 Month) presented no later than March 15 - Reports are prepared by a central institution responsible for formulation and implementation of good governance policy in the SOE sector. - The transparency guidelines require SOEs to present in their 6-month interim and annual reports: Business strategy, financial and non-financial targets, opportunities and threats; Assessment of performance relative to targets; Dividend policy; Description of significant events during the financial year; Description of services or products; Description of major customer groups; Description of investment of fixed assets and future investment plans; Analysis of annual labor costs; Description of ongoing social initiatives and policy; Information about compliance with transparency guidelines. ### Recommendations (Medium-term measures: 6 months to 2 years) - Recommendation 2.1 – Develop a single multi-purpose reporting framework under the responsibility of a single institution, which could satisfy the informational needs of all stakeholders (governing bodies, investors, supervising ministries, budget division of MoF, the tax authorities, the legislature, and the public). This would reduce the volume of ad hoc queries and tailored responses to which SOEs currently need to respond, freeing up reporting capacity within SOEs. (July 2015) - Recommendation 2.2 – Amend the Law on State Secrets to enhance transparency and corporate governance in the sector. (September 2015) - Recommendation 2.3 – Improve transparency of the sector by implementing the requirements for web-based reporting at both the SOE-level and the ministerial level. (July 2015) - Recommendation 2.4 – Develop and implement a capacity building plan at all levels of the SOE institutional framework to promote effective and proper transparency, accountability and oversight of the SOE sector (September 2015). Particular areas of capacity building could include: - Training and empowerment of SOE boards of directors. - Upgrading of financial accounting and reporting skills in SOEs and line ministries. - Increasing human resources in the MoE. - Recommendation 2.5 – Restructure the Antimonopoly Committee to ensure that it is fit for purpose and has the capacity, resources and necessary degree of independence to enable it to conduct thorough investigations of anticompetitive practices including those of SOEs, and of complaints concerning public procurement procedures. (September 2015) - Recommendation 2.6 - Define clear criteria for the creation and disbanding of SOEs. This will prevent the proliferation of SOEs, and also prevent the establishment of SOEs with organizational objectives that would be better satisfied within the framework of existing government ministries and agencies. (September 2015) - Recommendation 2.7 – Enhance the role of the parliament in the SOE governance framework through: - The requirement for mandatory annual reporting by SOEs’ - The submission of annual value for money assessments of SOEs above a predetermined turnover threshold by the Accounting Chamber. (September 2015) - Recommendation 2.8 – Eliminate the dual approach to the SOE corporate governance framework to provide for a standardized approach to the governance of all SOEs that is aligned to that of the private sector. This will enforce the principle of competitive neutrality, will create positive capital market effects for SOEs and will foster good governance throughout the sector. (January 2016) - Recommendation 2.9 – Reform the SOE performance management system to ensure that all SOEs are evaluated on a standardized set of financial and nonfinancial KPIs and that a codified hierarchy of consequences for poor performance is put in place. (September 2016) ### Identifying, reporting and mitigating fiscal risks from SOEs — background and findings - Large fiscal risks emanate from the SOE sector, including: - Direct budget costs related to shrinking dividends and increasing subsidies to cover loss-making activities by non-commercial and commercial SOEs. - Contingent fiscal risks from the outstanding stock of state guarantees on SOE debt. - Serial underinvestment, which could require future capital injections and other obligations by SOEs that could eventually fall on the budget. - In 2014, the authorities intervened with ad hoc measures to support fiscal consolidation to achieve the budget targets; these measures included cost reduction initiatives by SOEs, which were expected to yield savings of about UAH 2 billion through higher dividends to the budget. - The Verkhovna Rada passed a resolution to reduce administrative staff in SOEs and limit wages. - Indirect costs to the budget include foregone income related to assets managed by SOEs. MoE estimates these assets at UAH 870 billion. - Using an opportunity cost equivalent to the long-term growth of nominal GDP (about 8 percent per year), the SOE sector could have provided a budget flow around 5 percent of GDP each year. - In practice the sector is a loss for the budget and a source of potential future fiscal sustainability risks. - Capacity to assess fiscal risks from SOEs is underdeveloped; there is capacity in the MoE to perform analysis, but at present no one is tasked with doing so. - Macroeconomic assumptions for the budget are prepared by the macroeconomic unit in the MoE; medium-term economic forecasts are subject to discussion on credibility and internal consistency and are used as inputs to project budget outcomes and inform fiscal policy formulation. - Sensitivity analysis of the impact on the budget is not disclosed to the Verkhovna Rada or the public, nor are they used as an input to government decisions. - Stress test scenarios are not used to assess the impact on the budget of adverse shocks affecting the performance of SOEs. - SOE financial plans approved by supervising ministries are subject to revisions based on different assumptions of key macroeconomic variables, but no structured process exists to assess risks to SOE performance homogeneously across sectors and investigate their budget impact. - Weaknesses in risk assessment and disclosure weaken informed discussion on fiscal policy, its risks over the short and medium terms, implications for public debt sustainability, and efficient allocation of public resources. - Many countries prepare a fiscal risk document appended to the budget; fiscal risks are assessed based on analysis of the impact of a variety of shocks (including macroeconomic deviations on economic growth, inflation, interest rates, and international commodity prices) using scenario and sensitivity analysis and stress tests of fiscal aggregates. *IMF staff report content as provided in the source document.* ### 41. Information on contingent liabilities, such as state guarantees on public sector ### 41. Information on contingent liabilities, such as state guarantees on public sector loans ### Fiscal risk statements and contingent liabilities - Typical fiscal risk statements report: - the face value of the stock and flows on guaranteed loans; - measures of the expected cost of outstanding guarantees and the likelihood of the guarantees being called; - in some cases, guarantee premia collected. - Gross exposure to risks from public-private partnerships is useful where these projects represent important fiscal risks. - Analysis of public asset-related risks is presented by reporting consolidated fiscal aggregates for the whole public sector, including SOEs, and assessing potential budget risks from adverse shocks hitting the SOE sector. ### SOEs, public sector balance sheets, and coverage - SOEs affect both budget flows and the stock of assets and liabilities managed by the public sector; limiting analysis to traditional budget indicators gives an incomplete picture of fiscal risks. - A complete assessment requires analysis of SOE implications on the government budget (revenues, expenditure, financing) and information on changes in stock positions of assets and liabilities over the financial year, including valuation changes and other flows (e.g., privatization, foreign exchange) to calculate key fiscal sustainability indicators such as Net Public Worth. - Moving to a reporting system that includes public sector balance sheet data compilation is the ultimate strengthening of fiscal policy preparation and execution, but: - data requirements are demanding; - compilation of nonfinancial assets is difficult; and - progress is typically gradual. - Practical steps: provide basic information (inventories of state assets), extend coverage of existing registries, and use public net worth changes to inform fiscal risk assessment and disclosure. - The size of the public sector is subject to large uncertainty: - different SOE registries provide different counts (range from about 4,500 to less than 1,800); - state assets held by subnational governments may be missing; - comprehensive information on land assets and commercial real estate held by public entities is missing. - A comprehensive public sector balance sheet should include: - all state assets (including government real estate); - assets and liabilities controlled by general government and companies where government has a significant stake or that are relevant for public policies; - joint stock companies under state control, unitary SOEs, and companies with minority state stakes. - Compiling a government balance sheet aligns with international statistical standards such as GFS and ESA. ### Subsidies: scale, targeting, and fiscal risks - Direct subsidies from the budget to SOEs: - estimated at about 2.5 percent of GDP in 2014 on MoF estimates; - projected to fall slightly in 2015. - Energy and coal sector is a large recipient: - the coal/energy sector alone accounts for about 1 percent of GDP. - Subsidies have been increasing over time reflecting large SOE losses. - Box 6 — Coal Mining Sector Subsidies (key figures and features): - About 450 SOEs in the sector (314 unitary public enterprises; 140 joint stock companies). - Mining and coal industry: 216 state enterprises. - Energy generation and distribution: 38 companies. - Nuclear energy sector: 28 companies. - Oil and gas extraction, refining and distribution: 32 companies. - Coal price charged to energy generation companies: UAH 800 per tonne in 2014, raised to UAH 1,100 per tonn in 2015. - Production price ranges between UAH 1,000 and UAH 6,000 per tonn depending on quality and extraction complexity. - Wage costs account for between 30 to 60 percent of production costs. - Direct budget cost to finance the coal mining support program was about UAH 9 billion in 2014 (almost 1 percent of GDP). - In 2015 the ministry estimates the implicit budget cost from remaining subsidy rates in coal production to be in the range of UAH 2 to 4 billion (between 0.1 and 0.3 percent of GDP). - Direct budget subsidies to coal were largely discontinued in the 2015 budget. - Broader subsidy statistics and dynamics: - Subsidy rates are estimated at around 60–80 percent in many sectors, including energy, coal, and agriculture (based on price charged versus overall cost of production). - In the 2015 budget, direct subsidies have been limited to 1.3 percent of GDP due to phasing out coal support and reductions in other subsidies. - No structural cost containment measures were implemented in the SOE sector; lower budget support could lead to higher SOE losses and depletion of public assets. - Targeting and process issues: - Subsidies are not well targeted and tend to be negotiated without clear prioritization during budget preparation. - Line ministries prepare subsidy requests; MoF and final budget decisions consider the overall budget envelope and financing constraints rather than clear policy prioritization. - Two major fiscal risks from subsidy programs: - diversion of public resources to non-effective uses to support non-viable SOEs; and - subsidy levels insufficient to cover structural gaps, leading to short-term budget pressure or unfunded liabilities with later fiscal impact. - Indirect subsidies and other fiscal pressures: - Indirect subsidies include transfers of securities from central government to loss-making SOEs as recapitalization, not accounted in the budget but increasing public debt (example: Naftogaz indirect subsidies amounted to about 6 percent of GDP in 2014 and are estimated above 2 percent of GDP in 2015). - Loss-making SOEs produce current losses of more than 1 percent of GDP (excluding Naftogaz). - Losses have been increasing over time and may generate wage arrears and eventual government support via above-the-line subsidies or below-the-line recapitalization. ### Table 4 highlights (Subsidies and Current Transfers to Enterprises in Consolidated Budget; Source: MoE data) - Total: 23.5 - Coal industry: 1.5 - restructuring: 1.2 - rescue measures: 0.2 - Debts service payments: 4.5 - EURO 2012: 2.7 - Cyclone-4: 1.4 - Ukrmedpostach: 0.3 - Financial support for national theaters: 0.5 - National and state art groups, concert and circus organizations: 0.3 - Heat generating plants (except for fuel gas): 0.5 - Special Communication and Information Protection: 0.1 - Affordable housing: 0.2 - housing subsidy for young people and singles: 0.05 - recapitalization of the State Fund for Youth Housing: 0.04 - contributions for housing loans: 0.09 - Contributions to the fund "Shelter" NSC "Vector": 0.7 - Health care: 0.1 - Support for NGOs and disabled veterans: 0.1 - measures for rehabilitation of disabled persons: 0.01 - support of civil society organizations and disabled veterans: 0.08 - Transportation of senior officials: 0.1 - Current transfers to enterprises: 0.4 - activities of civil defense forces: 0.03 - shipping locks: 0.04 - financial support for sport NGOs: 0.03 - land reform: 0.03 - other transfers to enterprises: 0.3 - Local governments total: 14.6 - housing: 5.5 - city improvements: 3.6 - municipal grants Pidprymstvam: 1.5 - coal industry: 0.4 - other housing costs: 0.7 - transportation: 1.3 - current repair and maintenance of roads: 4.7 - theaters, philharmonic, other events: 1.4 - physiotherapy: 0.3 - media support: 0.2 - conservation measures: 0.3 - other local spending: 0.2 ### Financial guarantees and contingent liability magnitude - Government guarantees to SOE loans: - large at more than 10 percent of GDP as at end-2014. - concentrated in the energy sector, food, and infrastructure. - include international bonds issued by Naftogaz (about one third of total guarantees). - include loans by official and private institutions to SOEs for restructuring, investment and liquidity. - about three quarters of the loans are in foreign currency and exposed to exchange rate risk. - Fiscal risks from guarantees: - possible call of contingent liabilities; - foregone revenue from guarantee fees; - borrowing by loss-making and structurally non-viable public enterprises raises questions about debt service ability without budget support. - Example: Fininpro’s debt servicing is provided by budget subsidies amounting to UAH 2.7 billion in 2015; likelihood of repayment for the 65 contracts managed by Fininpro is deemed very low. - MoF assessment: - the MoF estimates that half of the contingent liabilities stemming from state guarantees should be considered direct public debt; - treating half as direct public debt would increase the ratio of direct public debt to GDP to about 70 percent in 2014, up by almost 10 percent compared to current figures. *Italic: IMF country report content unit _cr1631 - 41. Information on contingent liabilities, such as state guarantees on public sector loans* ### 57. Additional budget costs stem from the foregone revenue on guarantee fees. As ### Additional budget costs stem from the foregone revenue on guarantee fees. ### Fiscal risks from guarantees and SOE borrowing - Guarantee fees are not charged at all or are insufficient to cover the risk of non-payment by the borrower, creating high indirect fiscal risks for the budget. - If the average guarantee fee was around 500 basis points, the indirect fiscal cost of these foregone revenue would total almost UAH 8 billion (0.5 percent of GDP). - Debt contracted by the railway public enterprise and falling due in the next years amounts to UAH 32 billion (2 percent of GDP) and in the absence of restructuring could represent a fiscal risk. - Existing borrowing procedures for SOEs lack sufficient safeguards: - No assessment of capacity to repay debt and resilience of the borrower to shocks that differ from SOE financial plan assumptions. - No limits on the flow of new guarantees (a 5-percent threshold based on annual government revenue proposed by the MoF was not introduced in legislation). - The only formal constraint is that overall public and publicly guaranteed debt does not exceed 60 percent of GDP; this threshold has already been exceeded with public and publicly guaranteed debt expected to reach almost 90 percent in 2015. - SOE loans carry implicit government guarantees because SOEs typically do not own assets as collateral; the government is the ultimate risk bearer. - Financial plans are frequently based on unrealistic assumptions, producing optimistic projected performance indicators that hide vulnerabilities and default risk. ### Dividends and SOE returns - Dividend policy governance aims at lowering budget pressure often to the detriment of maximizing SOE value. - Governance is fragmented with absence of economic criteria for dividend plans; dividend plans are often ad hoc lump-sum values not aligned with ex post profit realization and based on biased SOE financial plans. - Dividend flows: - Dividends from public enterprises to the consolidated government budget reached UAH 3.4 billion in 2014. - Face-value assets of SOEs were UAH 870 billion (based on MoE aggregate data for the SOE sector in the third quarter of 2014). - Return underperformance: - Returns in the form of profits and related non-tax revenue underperform benchmarks, including the economic growth rate of the last decade and the cost of borrowing for the sovereign. - Loss-making SOEs generate low returns, limiting resources for investment (e.g., combined investment needs in transport infrastructure and aircraft manufacturing exceeding 1 percent of GDP over the next five years). ### Pricing policy and energy subsidies - Pricing policy is delegated to sector ministries and SOEs. - Energy subsidies: - Estimated at 7.5 percent of GDP, including indirect subsidies. - Subsidies stem from lower prices to final consumers and energy distribution companies and lower sale prices of domestically extracted and refined gas sold on the local market by Naftogaz. - Tariff increases in 2014 partly reduced the subsidy rate but were offset by exchange rate depreciation; subsidy rate remains high at about 80 percent. - The cost of energy subsidies, including indirect subsidies, is estimated to be 6–7 percent of GDP. - Without further price corrections, the government budget would need to fund Naftogaz losses from the subsidy policy. - These subsidies do not benefit the poor and are captured mostly by middle-income and higher income households and urban residents. - Cross-subsidization and rail sector: - Railway SOEs charge higher prices for cargo than for passenger transport. - Subsidy rate in passenger transit varies from 40 percent to 70 percent across sectors; highest for local train transportation, lowest for inter-city high-speed traffic. - Cost of the subsidy is estimated at about UAH 8 billion. - Recent cargo railroad tariff increases by 30 percent decided at the end of January would only offset extra production costs from lower traffic revenue in war-affected regions and exchange rate depreciation and would not reduce the overall subsidy rate. - If cross-subsidization were discontinued and consumer prices not adjusted, Ukrzaliznytsia would face financial losses of about UAH 1 billion, which could eventually fall on the budget. - Cross-subsidization in electricity: industrial users charged more than marginal production cost to subsidize consumers and investment in hydro power and nuclear energy. Cost of this indirect subsidy for the hydro energy sector alone is about UAH 1 billion per year. ### Wage and employment policy and fiscal implications - SOE sector employment and wage burden: - SOE sector employs more than 1 million employees. - Sector accounts for more than 2 percent of GDP in wages, more than one quarter of the consolidated government budget wage bill and about 10 percent of SOE revenue from sales. - Social role and excess employment: - Sector acts as employer of last resort; railway SOE estimated an excess workforce of about 100,000 (one-third of staff) with an extra annual cost of UAH 1 billion. - Wage arrears: - Wage arrears in SOEs reached over UAH 650 million in the first nine months of 2014, up from less than UAH 300 million in the previous year; concentrated in mining and food industry. - Employment shock simulation: - If one quarter of employees in loss-making companies were to lose their job, there would be about 300─500 thousand additional unemployed and higher fiscal risks from increased social spending. - In-kind benefits: - Several SOEs run hospital facilities; for the railway company these cost about UAH 150 million per year. - Wage policy governance: - Decisions by supervising sector ministries with MoE and unions; SOE financial performance and medium-term viability play a minor role in wage setting. - Special allowances can cover as much as one-third of final wage; performance-related components are typically small or non-existent. - Public sector wage cap: - Law approved in December caps wages in the public sector, including SOEs, to 10 times the minimum wage for SOEs that receive subsidies from the budget, except for strategic companies—this may create operational difficulties in commercial enterprises competing with the private sector. - Cross-sector wage comparisons (staff estimates): - Transportation sector average monthly wages: UAH 3,800 in SOEs, UAH 3,400 in government, UAH 3,600 in private sector. - Food processing industry wages: UAH 3,900 in public enterprises and UAH 2,200 in private sector. - Differences of similar magnitude in IT, defense, education and sport; less marked in health care and construction. ### Tax policy, earmarking, and tax expenditures - Revenue earmarking by some SOEs limits budget flexibility and may lead to inefficient spending and over-provision of goods and services. - Example: unitary SOE Ukrecoresources collects about UAH 100 million a year to finance recycling activities, shared with the private sector and some local governments. - Preferential tax regimes and exemptions: - Prevalence unclear due to lack of information; tax exemptions may harm the budget with no clear efficiency motivation. - Land tax exemptions frequent for strategic enterprises (including 11 operating companies managed by the State Space Agency). - UKRhydroenergo benefited from a UAH 300 million profit tax discount until January 2015. - Disclosure and assessment of these exemptions’ amounts and purposes would improve budget transparency and fiscal risk management. ### Managing fiscal risks from SOEs: identification, disclosure, and analytical capacity - Public disclosure of fiscal risks improves management of budget vulnerabilities, economic efficiency, and lowers debt service costs. - Recommendations for improved treatment: - Separate SOEs with commercial activities from non-commercial activities that could be carried out by general government agencies; record subsidies explicitly and separately in entity financial statements and the government budget. - Extend public sector information coverage to include all SOEs where the government has a stake and extend balance sheet information to include all liabilities and assets, including land and real estate. - Scaling up analytical capacity: - Use risk assessment tools including scenario and sensitivity analysis of budget plans based on shock assumptions and likelihood/impact assessment. - Include fiscal risk analysis as an annex to budget documentation to identify contingencies and mitigation actions. - Risk mitigation actions that could be included in the fiscal risk statement: - (i) Policies to align wages, tax and benefits for non-commercial entities with the rest of public administration. - (ii) Creation of contingencies in the budget to absorb potential shocks. - (iii) Phasing out energy subsidies and gradually moving to cost recovery for other services, such as transportation. - (iv) Strengthening governance around SOE borrowing by setting debt limits that account for the risk of state guarantees being called. - (v) Disclosing on-budget indirect subsidies and tax expenditures and making them contingent on available budget funds. - (vi) Charge an adequate risk-based price for state guarantees provided to public enterprises. ### Recommendations (selected; timing and specifics preserved) - Short-term measures (1-6 months) - Recommendation 3.1 – Strengthen safeguards to provide state guarantees on public enterprise loans, including setting a limit in the budget on new flows of guarantees (for example 5 percent of general government revenue as in the Fund-supported program targets), charging a risk-based guarantee fees and enhancing the assessment of borrowers' ability to repay debt by the MoF Debt Management Unit when issuing such guarantees. (April 2015) - Recommendation 3.2 – Prepare a fiscal risk assessment of SOEs focusing on macroeconomic risks (including exchange rate risks), impacts of adverse commodity prices and conflict-related factors on SOE performance and ability to repay debt and their ultimate budget impacts. (April 2015) - Medium-term measures (6 months to 2 years) - Recommendation 3.3 – Prepare a fiscal risk statement on the basis of good international practices and disclose the information in the context of the budget preparation, including risk mitigation actions and measures triggered by materialization of risks to the budget. (September 2015, in time for 2016 budget preparation) - Recommendation 3.4 – Review the rationale for the existence of SOEs in areas where a private market exists or for non-commercial activities; dissolve SOEs performing general government functions and put operations on the budget; record explicitly government subsidies for community service obligations in entity financial statements and the government budget. (September 2015) - Recommendation 3.5 – Strengthen capacity in the economic ministries (MoE and MoF) to identify and assess fiscal risks through specific analysis tools to estimate budgetary impacts of shocks and contingent liabilities; disclose tax expenditure costs and fiscal risks; decide ministry in charge based on economic analysis capacity (at present the greatest capacity is in the MoE). (September 2015) - Recommendation 3.6 – Strengthen the public sector database to include more detailed information on the public sector balance sheet, including nonfinancial assets such as land and real estate. (September 2015) *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 74. A number of reports have identified the need to improve the management and ### 74. A number of reports have identified the need to improve the management and oversight of state assets. ### Findings from prior reports and diagnosis - Multiple reports (World Bank, 2011; FAD’s 2014 PFM report) conclude the state asset ownership and management framework is decentralized, fragmented, and includes numerous conflicting roles and responsibilities at different levels of government. - The legal framework surrounding ownership is complex and often contradictory, likely hampering transparency, coherent management, and the stalled privatization program. - FAD’s July 2014 report recommended prioritizing three areas: reforming the legal framework; agreeing an ownership structure to maximize value; and introducing policies to ensure transparency. ### Reasons past reform attempts failed - Key failures and missing elements: - Absence of a consolidated ownership structure with capacity to manage a complex portfolio of corporate and other state-owned assets. - Absence of necessary pre-conditions: lack of transparency and control over assets; weaknesses in governance arrangements; absence of a comprehensive register of assets. - Underestimation of the importance of political buy-in at the highest level. - Absence of a communications strategy; reforms occurred in secrecy, failing to win public and stakeholder support. - Consequence: prior reform entities lacked comprehensive control and failed to address core issues of portfolio management and transparency. ### Draft conceptual strategy for improving SOE management (MoE, January 2015) - The draft concept note (high level) includes many elements needed for reform and, if fully developed and politically supported, should form the basis for comprehensive reforms. - Main principles highlighted in the concept note: - Improving transparency of the portfolio, articulating reform objectives, identifying the ownership unit, and addressing individual management of enterprises. - Separation of the state's ownership and regulatory functions. - Introducing value maximisation for the portfolio of state assets as well as the individual SOEs. - Creating sufficient SOE analytical capabilities. - Timing and publication plan: - The concept note is the first step toward a full reform strategy due to be completed by end-May 2015. - MoE intends to publish an “Annual Review” offering a first “best efforts” overview of the portfolio in April 2015. - Initial focus: the largest SOEs, expanding in a second report intended for September 2015 to cover all State Assets potentially including the government’s real estate portfolio. - The MoE intends to produce its first report on the status of SOEs by the end of April 2015. ### Suggested additions to the concept note / strategy considerations - Include acknowledgement of the need for a full inventory of SOEs and other state-owned assets. - Conduct a stock-take of existing legislation surrounding management of state assets. - Separate commercial and policy objectives; define SOEs by commercial or non-commercial status. - Move toward incorporation and an equity culture. - Clarify options for ownership and management structures for the portfolio. - Include a communications strategy within the overall reform framework. ### Full inventory of state assets: scope, phasing, and real estate - Current MoE database work: - Initial focus on the top 100 SOEs, estimated to cover 90 percent of total revenues generated by the SOE sector (based on very incomplete data). - Need to broaden scope: - A comprehensive register should cover all SOEs, including revenues, expenses, assets, liabilities, payables and receivables. - Smaller SOEs and entities in liquidation may still hold value; absence of information does not imply no value. - Phased approach recommended: - Prepare a phased inventory, finalizing analysis of the largest SOEs for inclusion in the first sector status report, with a view to completing a full inventory for the second report in September 2015. - Government real estate: - Government real estate currently estimated to consist of more than one million assets and forms a large part of the state asset portfolio. - No unified register of real estate exists; multiple incomplete registers exist (see Box 8 in source). - Existing registers: - State Land Agency of Ukraine (SLAU) cadastre: includes land plot technical data and ownership; coverage less than 20 percent. - State Register of Property Rights to Real Estate (Ministry of Justice): registers ownership where transactions have been included. - State Property Fund (SPF) register: based on State Register of Rights to Real Estate; reportedly around 1 million individual properties in the register. - A national register and balance sheet approach would facilitate identification of alternative uses and yield from the portfolio. ### Separation of commercial and non-commercial entities - The concept note correctly highlights separation of ownership and regulatory functions; line ministries should focus on policy and regulation. - After a full inventory, perform an audit to classify entities as governmental or commercial; this classification should be a primary objective in the concept note. ### Review of existing legislation - Legal framework constituents: 2004 Commercial Code of Ukraine (CCU); 2006 Law on the Management of State Property (“State Property Law”); CoM resolutions; and regulations/procedures from MoE, MoF, SPF, and line ministries. - Additional sector-specific laws govern railways, utilities, pipelines, seaports, and inter-city road infrastructure. - Problems identified: - Corporate legal code is overcomplicated, ambiguous, and sometimes internally contradictory. - Compliance varies; significant gaps in performance evaluation requirements. - Legally mandated dividend remittances sometimes do not occur; line ministries can extract dividends from profitable SOEs and effectively exempt other SOEs within their portfolios. - SOEs do not have legal ownership of assets they operate (assets remain state-owned), creating disincentives for efficient reinvestment and utilization and allowing state control over day-to-day management. ### Separation of ownership and regulation: governance model options - The concept note identifies the need to separate ownership and regulation but does not clearly specify options. The July 2014 FAD report recommended a MoF unit to manage portfolio risks and financial flows and consideration of a single arms-length entity for active ownership, financial control, and privatizations over the medium term. - Since July 2014, MoE has taken charge of the reform process and established a working group of public administration and private sector actors to prepare and oversee implementation. - Possible models (each with advantages and disadvantages): - a) Discrete unit within MoE (or MoF) - Advantages: relatively easy and cheap to establish; would oversee financial flows, establish portfolio value, and manage ownership with a single value-maximization objective. - Disadvantages: public administration lacks active commercial asset management experience; risk of political use of portfolio for policy objectives; civil service pay guidelines hinder hiring skilled staff; donor-financed temporary staffing risks skill evaporation when funding ends. - Suitability: appropriate as a short-term measure to establish the framework, unlikely effective long-term. - b) External incorporated holding company with professional asset managers - Advantages: private sector skills; insulation from political interference if managers are accountable and incentivized to maximize portfolio value. - Disadvantages: past failures due to missing prerequisites (political insulation, clear objectives, transparency); requires rigorous scrutiny, performance assessment, and concrete consequences for failure. - Suitability: medium-term objective pending prerequisites. - c) Variant: “Fondul Proprietatea” model (Romanian example) - Features: listed holding company with management outsourced to an international professional asset manager; portfolio management expertise is tried and tested; owner can seek severe damages against outsourced manager. - Disadvantages: suffers same prerequisite gaps; suitable for medium term. - d) Series of sectoral holding companies - Advantages: allows managers to manage smaller, sector-focused portfolios. - Disadvantages: likely extremely expensive; requires multiple professional management teams and qualified staff; limited private sector capacity may be a constraint; risks re-fragmenting ownership and reducing synergies; makes government oversight complex. - Suitability: appears least attractive in short or medium term. *Source: IMF staff assessment and draft concept note discussion in the provided text.* ### 98. The conceptual strategy would benefit if the different options were included to ### _cr1631 - 98. The conceptual strategy would benefit if the different options were included to ### Overview of options and choice of vehicle - The conceptual strategy should include the different options to promote a full debate on the appropriate option or mix of options to be considered. - Whichever option is chosen will ultimately be decided by government, but it is important that the government is informed of the advantages and disadvantages of each of the possible solutions before any decision is made. - The choice of vehicle reflects political reality and political will. - Experience elsewhere: - A gradual approach can take almost a decade to fulfill as resistance builds-up instantly with the announcement of a plan to change the social contract in society. - A “big bang” approach (i.e., creation of an arms-length holding company) requires extraordinary circumstances to convince the political leadership to take on vested interests. - Regardless of vehicle choice, the unit charged with owning and managing the portfolio should have an independent role with the sole objective of maximizing the value of the portfolio(s). - Establish a business plan for the manager and for individual entities that make up the platform. - Perform duties as if incorporated, including putting together a consolidated business plan for all assets and proper financial accounts, audited by an international audit firm. - A fully integrated business plan for the entire portfolio yields scale effects: lower transaction and operational costs, facilitates efficient development and possible privatization, and enables merging related assets to create attractive investment profiles. ### Incorporation and move towards an equity based culture - Urgency to incorporate all viable SOEs and move away from the current complex public sector framework and multiple legal structures. - Incorporated SOEs should be on the same conditions as private sector equivalents. - Rationalize current system of management and oversight arrangements based on legal form so all commercial enterprises are managed on a similar basis with same reporting, auditing, and governance arrangements. - Incorporation efforts should be based on professional business plans demonstrating commercial viability. - SOEs should have a competitive capital structure and asset base relevant to meet business objectives; achieving this will require a new legal framework and culture of management. - Incorporation and business-plan assessments can generate additional income sources for the shareholder: - Divestiture of non-core businesses and assets including off-loading surplus real estate could offset expected restructuring costs. - Network industries (energy and transportation) are examining unbundling the value chain, though this will be extremely difficult in the existing legal environment. - Box 9 (Swedish Railways example) documents steps including: - Separation of infrastructure from operations (forming Banverket and SJ). - Phased opening to competition (local/regional traffic in 1990 and 1992; interregional traffic delayed to 2010). - Later splitting SJ into passenger, cargo (“Green Cargo”), and a holding company for non-core operations (Swedcarrier). - Appointment of separate board/management to Swedcarrier with restructuring/divestiture expertise. - Concentration of large real estate portfolio in Jernhusen to realize hidden values. - Sale of non-core support services and other operations prior to incorporation. ### Privatization process — findings on past practice in Ukraine - Privatizations in Ukraine historically have been unsuccessful across objectives: restructuring the economy, generating non-tax revenue for the budget, developing the domestic capital market, attracting foreign investors, and achieving targeted valuations. - Identified root causes: institutional, structural, and implementation-process weaknesses; complex privatization regulations that can undermine competitive principles. - Specific impediments observed: - Conditions imposed on potential participants often excluded investors (e.g., onerous social commitments, very specific requirements such as possessing a special license or specific experience). - Lack of visibility and disclosure about privatization targets limiting bidders’ ability to conduct due diligence. - Limited publicity for intended privatizations (e.g., announcements limited to an official governmental newspaper in Ukrainian or on inopportune dates). - Lack of transparency and unclear rationale for listing SOEs as strategic and excluded from privatization. - No culture of appointing advisors to assist in privatizations, reducing international investor trust. - Absence of internationally acceptable qualification criteria; procedures often perceived as tailor-made for specific buyers. - The existing institutional framework with a privatization agency (SPF) acting as an advisor rather than an active asset manager has seldom proven successful: - Lack of distance from the state. - Absence of professional capacity and resources to invest in or develop assets, undertake pre-privatization financing, and prepare assets to be financeable. - Result: number of transactions negligible and since 2009 have virtually come to a halt. ### Communications strategy - Government must ensure the public is well informed about ultimate reform objectives: - Fiscal sustainability. - Maximization of the value of the portfolio for citizens’ benefit rather than for those with inside access. - Helping create thriving and competitive markets without disadvantaging other market participants. - A communication strategy should be an integrated part of the reform strategy. - The concept note should include a communication strategy as an essential element of the overall reform plan. - A well thought out and executed communication strategy is critical to promote buy-in from the Verkhovna Rada, the general public, and the international investor community for ambitious and complex reforms. ### Challenges in implementation - Full support of senior policy makers is essential: - This includes the President, Prime Minister, Ministers of key economic ministries and of key pectoral ministries. - The MoE must ensure these stakeholders are fully informed and required to make policy decisions endorsing the reform strategy and implementation plans. - Completing reform will involve up-front costs with likely budgetary implications; donors may be unable or unwilling to bear some costs. - Potential costs include capacity building at the ownership level in individual SOEs and retaining private sector experts (investment banks, real estate experts, auditors, lawyers) to assure private-sector standards. - Some SOEs may require significant up-front investment to prepare for privatization or to remain viable as commercial entities within the public sector. ### Recommendations Short-term measures (1-6 months) - Recommendation 4.1 – Further develop the draft concept note to include more details of the likely direction of the reform strategy for SOEs. This should include: - a full inventory of SOEs and other state-owned assets; - a stock-take of the existing legislation surrounding management of state assets; - separation of commercial and policy objectives and defining SOEs in accordance with their commercial or non-commercial status; - incorporation and moving towards an equity culture; - a clearer view of the options in developing an ownership and management structure of the portfolio; and - a communications strategy within the framework of the overall strategy. (March 2015) - Recommendation 4.2 – Include in the concept note a description of the key challenges that need to be addressed if the reform strategy is to be successful, including the need for political buy in and the need to consider upfront investment costs associated with implementation of the reform strategy. (March 2015) - Recommendation 4.3 – Expand the coverage of information collected by the MoE on public sector institutions to include all SOEs and all real estate. Create an inventory of SOEs and introduce a database maintenance process. Collect information on public finance operations, including revenue from sales, wages, and employment, net financial profits and losses, assets and liabilities, including wages arrears. Consolidate this information in a monitoring report of SOEs and publish the report on a timely basis. (September 2015) Medium-term measures (6 months to 2 years) - Recommendation 4.4 – Review how legal title of assets currently operated by SOEs but owned by the state can be assigned to SOEs, to incentive better utilization of assets, thereby improving financial and fiscal discipline, and increasing the value and attractiveness of SOEs as potential candidates for future privatization. - Recommendation 4.5 – Review the role of the SPF in managing the privatization process as part of the overall reform strategy. Consideration should be given to merging the privatization role with that of the ownership role. (September 2015) *Source: _cr1631 - 98. The conceptual strategy would benefit if the different options were included to* ### Appendix I. Developing a Fiscal Risks Identification, Reporting and ### Appendix I. Developing a Fiscal Risks Identification, Reporting and Mitigation Framework ### Definition and primary sources of fiscal risks - Fiscal risks are defined as deviations of budget outcomes from plans, stemming from unanticipated shocks. - Sources of fiscal risks include: - macroeconomic shocks to real economic variables such as economic growth, interest rates, and exchange rate; - shocks to commodity prices, such as oil and gas prices, and their impacts on the budget aggregates and the stock of public debt; - shocks originating from calls on contingent liabilities, such as debt guarantees and implicit liabilities, including the obligation of the government in the bailout of non-viable financial and nonfinancial public institutions, and private institutions with systemic macroeconomic impacts. - Fiscal risks include effects of temporary and permanent shocks: - Temporary shocks call for fiscal policy adjustments through the operations of stabilizers. - Permanent shocks require a more permanent correction of underlying fiscal policy to ensure debt sustainability over the medium term. - Shocks can offset or compound each other; example effects cited: - Exchange rate depreciation can lead to higher imported inflation, higher expenditure (including debt service if liabilities are foreign-exchange denominated), and lower revenue, thereby worsening the fiscal position. ### Channels and mechanisms by which shocks affect the budget - Macroeconomic shocks: - Deviations of macroeconomic outcomes from plans affect the budget directly and indirectly via entities linked to the general government budget, such as public enterprises and financial institutions. - Forecasting biases (often optimistic growth forecasts) may make revenue performance appear better at budget time than realized. - Lower-than-forecast growth tends to weaken budget outcomes, worsen key fiscal indicators (ratios of public debt and fiscal deficit to GDP), weaken SOE sector performance, raise unemployment, increase population at-risk of poverty, and call for higher social expenditure and automatic stabilizers—putting financial pressure on the budget and potentially increasing borrowing costs. - Compound effects can feed back into interest rates on government securities and inflation, further worsening the fiscal position. - Exchange rate shocks: - Unanticipated exchange rate movements can cause direct budget effects, especially in countries with exports/imports denominated in foreign exchange. - Exchange rate depreciation makes imported goods and services more expensive, can increase price inflation, affect taxes and price-indexed public expenditures (wages, social benefits), and is typically associated with significant worsening of key fiscal indicators. - Exchange rate changes can affect SOEs with large export/import activity and can increase local-currency value of foreign currency liabilities, pressing debt service capacity. - These developments can trigger calls on contingent liabilities (e.g., state-guaranteed SOE loans) or require recapitalization of loss-making public sector companies, threatening debt sustainability unless preventive measures and budget contingencies exist. - Commodity price shocks: - In commodity exporting economies: associated with lower growth, reduced foreign-currency inflows, loss of international market shares, and both short-term and more permanent risks to fiscal sustainability that may require sizable fiscal corrections. - In commodity importing economies: sharp price adjustments can limit access to key inputs, reduce economic growth and worsen budget outcomes, alter relative price ratios of tradeables, and raise consumer prices for utilities and services (oil, gas, food). - Distributional impacts: subsidy costs may rise, reallocating budget resources toward subsidies and limiting scope for targeted social safety nets; the poor may be most affected, prompting budget pressure to compensate. - Public sector companies may incur losses from higher input prices, slower growth, and inflationary pressures. - Financial variables: - Unanticipated interest rate shocks can affect government and SOE debt service capacity, make financing more difficult and expensive, reduce economic growth via higher cost of capital, and create balance-sheet effects increasing risk that government guarantees are triggered. - Coverage and public sector scope: - Lack of understanding or incomplete coverage of the public sector perimeter can produce unforeseen obligations for the budget. - Incomplete public sector information systems that exclude entities under government control but outside the general government perimeter increase risk (noted examples: experiences in Portugal and Greece). - Partial coverage in fiscal accounts and public sector reports can obscure important sources of budget risks and undermine mitigation strategies. ### Assessment, disclosure, and mitigation practices - Importance of identifying and assessing sources of risks during budget preparation: - Risk assessment raises awareness about the size and source of budget risks, their likely impact and expected fiscal effects, enabling planning of risk mitigation actions. - Assessment typically includes indirect effects (e.g., macroeconomic shocks’ indirect impact on SOE finances that could necessitate recapitalization or subsidies). - Full disclosure of fiscal risks supports transparent discussion of fiscal policy and its risks over the short and medium term and can inform decisions on fiscal stance and reforms to limit risk occurrence or minimize impact. - Fiscal risk statements (Appendix II): - Fiscal risk statements are documents containing information on budget risks from a variety of shocks; they can be a separate note or embedded in the budget document. - The document contains sensitivity analysis of budget estimates and public debt projections to key macroeconomic assumptions and a range of contingent fiscal liabilities, including from SOEs. - Practical considerations: - The types of budget risks disclosed typically depend on the relative size of risks, likelihood of events, and availability of information. - While all fiscal risks should, in principle, be disclosed, documents typically limit the scope to balance comprehensive disclosure with minimizing moral hazard and avoiding disruption to market confidence. - Disclosure of contingent liabilities should be crafted to avoid implying unconditional future government underwriting (especially for the financial sector). - Risk mitigation actions typically reported: - Budget contingencies set aside to cushion adverse shocks. - Risk-sharing mechanisms to minimize budget impact of negative scenarios. - Automatic stabilizers to operate when risks materialize. - Prudent macroeconomic assumptions during budget formulation. - Preparation and monitoring of the fiscal risk document and mitigation strategy is generally the responsibility of a central authority in the government with authority and accountability to identify risks, monitor them, and propose remedial actions. ### Recommended contents of a fiscal risk statement (international good practice) - Macroeconomic risks and budget sensitivity: - Discussion of macroeconomic forecasting accuracy in the past and sensitivity analysis of budget estimates to changes in individual macroeconomic assumptions and combinations thereof. - Presentation of a fan chart with uncertainty surrounding budget estimates could be included. - Public debt: - Sensitivity analysis of public debt dynamics to alternative macroeconomic and contingent liability scenarios. - Report ratios of public debt to GDP and debt service indicators; disaggregate debt dynamics into fiscal policy and macroeconomic components where possible. - Contingent liabilities: - Present face value of guarantee portfolios (e.g., loan guarantees to public enterprises) and scenarios to assess likely budget costs if guarantees are called using an ex ante probability distribution. - Report banking sector risks, budget impacts from natural events and disasters, and fiscal obligations from public-private partnerships both as face values and expected losses when feasible. - State-owned enterprises (SOEs): - Describe SOE policy framework (pricing policy, dividend policy, subsidies). - Include financial position of the consolidated sector and of the largest (or riskiest) SOEs. - Provide sensitivity analysis of key SOE financial indicators (net losses, borrowing needs) under alternative scenarios and assess likely impacts on budget aggregates and public sector liabilities indicators. - Risk mitigation: - Describe the risk management strategy and specific planned actions to limit budget impact of identified adverse shocks (examples: automatic measures triggered by shocks, contingency funds, provisions to adjust fiscal policy parameters). ### Appendix III (selected entries): Outstanding State Guarantees on SOE Debt as at end-2014 - The appendix provides creditor-by-borrower listings of loans/credits guaranteed by the state with currency, amount in foreign currency, and amount in UAH (UAH equivalent calculated based on the effective date of the contract). - Selected entries (as presented): - EBRD — Ukrzaliznytsya (UZ) — High-speed passenger trains — USD 120,000,000 — 637,416,000 - EBRD — Energoatom — Nuclear plants — USD 42,000,000 — 223,720,000 - European Atomic Energy Community — Energoatom — Nuclear plants — USD 83,000,000 — 441,228,000 - Credit Suisse First Boston — Yanhel Yuzhnyi SDB — Cyclone-4 project — USD 150,000,000 — 795,930,000 - Maglin Capital Limited — UZ — Road bridge — USD 700,000,000 — 3,714,690,000 - Deutsche Bank AG London — Ukravtodor — Kyiv-Odessa highway — USD 480,000,000 — 2,553,600,000 - 2004 aggregate line shown: 8,366,584,000 - 2005 aggregate line shown: 661,063,100 - 2006 aggregate line shown: 3,520,578,289 - 2007 aggregate line shown: 5,891,795,600 - 2008 entry: SMI Bonds — SMI — Liquidity — UAH 1,000,000,000 — 1,000,000,000 - 2009 selected entries: - Canadian export agency — Ukrkosmos SE — USD 292,433,560 — 2,333,795,269 - Credit Suisse International — Ukravtodor — Refinancing Agreement — USD 465,000,000 — 3,580,500,000 - Bonds of JSC NJSC Naftogaz — USD 1,595,017,000 — 12,783,742,252 - 2010 selected entries: - Bonds of FININPRO SE — 2012 European Football Cup infrastructure — USD 568,000,000 — 4,497,821,600 - VTB Capital PLC — Ukravtodor — USD 440,800,000 — 3,499,378,960 - Export-Import Bank of Korea — Southern Railway — USD 260,950,000 — 2,077,057,620 - 2011 selected entries: - Bonds of FININPRO SE — USD 690,000,000 — 5,496,126,000 - Sberbank of Russia — Ukravtodor — USD 376,000,000.0 — 2,997,133,600 - Sberbank of Russia — Yanhel Yuzhnyi SDB — USD 260,000,000.0 — 2,073,682,000 - EBRD — Ukreximbank — Energy Efficiency Project — USD 200,000,000.0 — 1,596,140,000 - 2012 selected entries: - EBRD — Ukreximbank — USD 150,000,000.0 — 1,198,455,000 - SMI Bonds — SMI — Liquidity — UAH 2,000,000,000 — 2,000,000,000 - Bonds of FININPRO SE — USD 550,000,000 — 4,396,150,000 - State Development Bank of China — JSC NJSC Naftogaz of Ukraine — USD 3,656,000,000 — 29,222,408,000 - Exim Bank of China — State Food and Grain Corporation — USD 1,500,000,000 — 11,989,500,000 - Ukravtodor Bills — Public roads — UAH 14,000,000,000 — 14,000,000,000 - 2013 selected entries: - Ukravtodor Bills — Public roads — UAH 5,000,000,000 — 5,000,000,000 - PJSC Oshchadbank — The Ministry of Energy and Coal Industry — Dniester PSP — UAH 1,500,000,000 — 1,500,000,000 - SMI Bonds — SMI — Liquidity — UAH 5,000,000,000 — 5,000,000,000 - Bonds of JSC NJSC Naftogaz — Repayment of debt — UAH 4,800,000,000 — 4,800,000,000 - OJSC Gazprombank — JSC NJSC Naftogaz — Working capital injection — USD 500,000,000 — 3,996,500,000 - 2014: 0 - Note: "1/ UAH equivalent is calculated based on the effective date of the contract." *Italic: Appendix I. Developing a Fiscal Risks Identification, Reporting and Mitigation Framework — (content unit)._ ### Appendix IV. SOE Annual Report Content: Proposed Structure and Content ### Appendix IV. SOE Annual Report Content: Proposed Structure and Content ### Foreword - 1. Foreword: by the President, (highlighting the importance for the country and to unite public support) ### Introduction - 2. Introduction: by the Prime Minster, explaining the main goal and targets (to demonstrate unity of purpose in reforming the sector across government) ### At a glance: Summary of financial indicators - 3. At a glance: Summary of financial indicators including: - 3.1. market value vs yield and dividend, - 3.2 revenue, operating profit, EBITDA, profit before tax, net profit, return on equity, gross investments, number of employees etc. ### The portfolio of state commercial assets - 4. The portfolio of state commercial assets: describing the portfolio commensurate to a privately held assets portfolio to include; structure, purpose, such as introduction of an equity culture etc. ### Overview of the financial results of the portfolio - 5. Overview of the financial results of the portfolio: - 5.1 General information (breakdown of, major sectors, vision, strategy with ownership in that sector and market analysis, as well as key developments/events which impacted the results) - 5.2 Summary Financial Statements of the portfolio (aggregated Balance Sheet and Income Statement) - 5.3 Overview of value drivers (key drivers of change in current period vs. prior one). - 5.3.1 Market value: how to create value? - 5.3.2 Operational strategy: including revenue and profit, profitability. - 5.3.3 Capital structure strategy: including debt/equity ratio, dividend policy - 5.3.4 Business development strategy: including focus on core business, liquidating obsolete assets, real estate strategy. ### Overview of the financial results by industry sector - 6. Overview of the financial results of by industry sector: - 6.1 Industry sector overview- (Background: vision, strategy with ownership in that sector and market analysis, major competitors, as well as key developments/events which impacted the results) - 6.2 Aggregate sector financial statements (aggregated Balance Sheet and Income Statement for the portfolio of each sector/sub-sector). - 6.3 Gap analysis with private sector (market value, capital structure and operational efficiency). - 6.4 Strategic view on potential performance improvement and value optimization ### Major units in brief (one page snapshots) - 7. Major units in brief (one page snapshots covering individual performance of selected SOEs): - 7.1 Operations details (business overview, key transactions, products, markets etc.). - 7.2 Market, objectives and achievements and goals - 7.3 Financial performance, including dividends - 7.4 Management (top management details). ### Introduction of the reform to SOE sector - 8. Introduction of the reform to SOE sector (prerequisite of reforms, summary of ongoing and planned reforms etc.). ### SOE regulatory environment - 9. SOE regulatory environment (summary of the governance structure, reporting requirements, legislation etc.). ### Other countries’ SOE reform experiences - 10. Other countries’ SOE reform experiences (success stories of selected economies in implementation of SOE reforms). ### List and methodology - 11. List of SOEs (company name, percent of state ownership, industry sector etc.). - 12. Notes on methodology/approach to compilation of SOE financial information, valuation methodology. *Appendix V. SOE Legal Framework and Regulations — A. General Laws (Applicable to all SOEs) — F. Laws Applying to Joint-Stock Corporations with State Share (listed in source).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1631.pdf_