## _cr16319 - introduction of new exchange restrictions. ## Source details **Canonical URL:** [_cr16319 - introduction of new exchange restrictions.](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16319.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16319.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16319.pdf.json) --- ### Program approval, scope, and financing - Four-year, SDR 12.348 billion arrangement (about US$17.5 billion at the time of approval) approved on March 11, 2015. - Staff supports completion of the second review and authorities’ requests for waivers of missed performance criteria, rephasing of access, and financing assurances review. - Purchase available upon completion of this review: SDR 716.110 million, bringing total purchases under the EFF to SDR 5,444.21 million. - Date of executive summary: September 2, 2016. ### Assessment by the Managing Director (Ms. Christine Lagarde) - Ukraine showing recovery signs: activity picking up, inflation receded, confidence improving, gross international reserves and bank deposits risen. - Key policy drivers of progress: sound macroeconomic policies; energy tariffs to cost-recovery levels; measures to rehabilitate the banking system. - Priorities highlighted: - Further fiscal reforms and avoidance of tax changes that increase deficits. - Parametric pension reform to reduce pension fund structural deficit. - Continue reducing inflation and rebuilding international reserves to allow gradual removal of administrative measures. - Strengthen banking system via recapitalization, unwinding related-party lending, resolution of impaired assets. - Combat corruption, improve governance, restructure and divest SOEs, prosecute high-level corruption cases. - Note on 2014–15 SBA ex-post evaluation: the 2014 SBA served as an important policy anchor despite not achieving many goals. ### Economic developments and outlook — stabilization and nascent recovery - Growth: - Growth expected to reach 1.5 percent in 2016. - Real GDP projected to grow by 1.5 percent in 2016 (against 2 percent expected at first review). - Labor market and wages: - Unemployment estimated to have peaked at around 9.9 percent in Q1 2016 (from 7.3 percent in 2013). - Real wages declined by 18½ percent in 2015; wages in dollar terms fell to around 30 percent of their peak in 2013. - Inflation: - Inflation peaked at 61 percent year-on-year in April 2015. - 12-month inflation declined to 7.9 percent in July 2016. - Inflation projected to pick up slightly to around 13 percent toward end-2016 (owing to tariff increases) before gradually tapering off. - Monetary policy and reserves: - NBU absorbed excess liquidity mainly via certificates of deposit; discount rate brought down gradually to 15.5 percent in July 2016. - Key interest rates have remained positive in real terms on a forward-looking basis. - Gross reserves: US$13.3 billion by end-December 2015; rose to US$14.2 billion in August 2016 (equivalent to about 3.5 months of imports and 55 percent of the ARA metric). - NBU purchased more than US$3.1 billion in the interbank market since program approval. - Projected gross reserves: US$16¾ billion by end-2016, and US$31 billion by end-2018. - External sector: - Current account deficit narrowed to about 0.3 percent of GDP in 2015 (from 4 percent in 2014). - Exports and imports each shrunk by about a third in 2015. - Current account deficit expected to widen to 1½ percent of GDP in 2016. - Outlook risks: - Domestic: political instability, policy reversals, slow program implementation, anti-corruption impatience, banking resolution delays, conflict escalation. - External: weaker global recovery, weaker terms of trade, slowdown in major emerging markets. ### Fiscal outturn and key drivers (2015) and 2016 budget - Fiscal outturn 2015: - General government and Naftogaz combined deficit: 5.2 percent of GDP in 2015 (first review) from 8.0 percent of GDP in 2014 (actual) as presented in fiscal accounting lines. - General Government deficit: 3.0 percent of GDP in 2015 (first review) from 3.4 percent of GDP in 2014 (actual). - NBU profit transfer: 0.0 percent of GDP in 2015 (from 1.7 percent in 2014). - Other revenue (includes one-off revenue): 1.3 percent of GDP in 2015 (from 0.3 percent in 2014). 1/ Includes one-off revenue of 1.3 percent of GDP related to import duty surcharge in 2015. - Non-interest expenditure: 0.7 percent of GDP in 2015 (from 2.3 percent in 2014). - Interest: 1.1 percent of GDP in 2015 (from -0.9 percent in 2014). - Naftogaz contribution to fiscal balance: 2.2 percent of GDP in 2015 (from 4.6 percent in 2014). - External factors contribution: 2.0 percent of GDP in 2015 (from 4.4 percent in 2014). - Import bill: 1.5 percent of GDP in 2015 (from 2.8 percent in 2014). - Transit revenue: 0.5 percent of GDP in 2015 (from 1.6 percent in 2014). - Domestic factors contribution: 0.2 percent of GDP in 2015 (unchanged from 2014). - Overall fiscal over-performance in 2015: outturn was 1.2 percent of GDP implying a structural adjustment of around 3 percentage points. - Authorities used part of room under fiscal targets to: - advance partial indexation of pensions and public sector wages to September 1, 2015; - increase defense spending; - pay part of January 2016 pensions in December 2015. - 2016 budget target: general government deficit of 3¾ percent of GDP (prior action). - Fiscal arithmetic (all figures in percent of GDP): 1. 2016 budget balance on unchanged policies: -5.7 2. Lowering SSC rate to 22 percent: -4.0 3. Increased allocation for capital spending: -0.7 4. Approved budget balance: -3.7 5. Adjustment measures needed to close the gap (4-3-2-1): 6.7 - a. Revenue measures: 3.6 (breakdown includes Unify personal income tax at 18 percent: 1.1; Expand corporate income tax base from lower SSC: 0.5; Reform simplified tax regime: 0.2; Bring agriculture under general VAT regime: 0.2; Increase excise taxes: 0.7; Increase property taxation: 0.3; Other specified items summing to 3.6) - b. Spending measures: 3.1 (breakdown includes Improve targeting and efficiency of social assistance: 1.0; Improve targeting of non-pension benefits: 0.6; Advance part of January 2016 pension payment to 2015 (temporary): 0.6; Other specified items summing to 3.1) - Supplemental budget (May 2016): increased household utility subsidies by 0.2 percent of GDP and wages, pensions and social assistance by less than 0.1 percent of GDP; increase offset by higher gas-related revenues. ### Naftogaz and energy sector developments - Naftogaz cash deficit fell to less than 1 percent of GDP in 2015 (target was 3.1 percent). - Drivers of improvement: consumption decline (~25 percent), lower import prices, higher transit revenues, gas and heating tariff increases of 285 percent and 67 percent implemented in April–May 2015. - 2016 energy-related social assistance: fiscal envelope increased to UAH 40.3 billion (1.8 percent of GDP), higher than previously budgeted UAH 35 billion. - Tariff policy: - Tariffs to be fully liberalized no later than April 1, 2017. - Interim quarterly adjustment mechanism to be introduced (structural benchmark end-October 2016). - Price Naftogaz pays for domestically produced gas raised to market levels. - Structural reforms: gas market law enables unbundling of Naftogaz; EBRD action plan to establish independent transmission system operator by 2017. ### Debt restructuring and sovereign arrears - Debt exchange launched September 22, 2015 for sovereign and sovereign-guaranteed Eurobonds: - Eligible external liabilities nominal total: US$22.3 billion. - PPG restructuring amounted to US$19.1 billion (including US$3 billion held by Russia). - Sovereign Eurobond restructuring: 20 percent nominal haircut; coupon 7.75 percent for new bond series; issuance of nine new bonds maturing 2019–27; NPV haircut at exit yield of 10 percent estimated at about 28 percent (excluding VRI). - City of Kyiv and selected SOE debt also restructured; some SOE restructurings involved extended maturity without nominal haircut and increased coupons by about 100 basis points. - Russia did not participate and the Russia-held Eurobond is in arrears; litigation in London is underway. - Restructuring outcomes and targets: - Restructuring reduces external debt service payments by US$15.7 billion during program period (program target US$15 billion). - Debt/GDP projected to reach 72.7 percent by 2020 under revised macroframework; projected to fall below 70 percent by 2021. - Average gross financing needs during 2019–25 projected at about 9.5 percent of GDP. - Official and multilateral support: disbursements since program approval reached US$3.6 billion; further US$1.8 billion expected soon after review completion. ### Debt Sustainability Analysis (DSA) — baseline, risks, scenarios, and stress tests - Baseline: - Public and publicly guaranteed debt reached 80 percent of GDP by end-2015 (compared to 94 percent projected at first review). - Public debt projected on downward path, reaching 72.8 percent of GDP by 2020 (staff view: sustainable with high probability). - Real GDP growth projections: 2015: -9.9 percent; 2016: 1.5 percent; growth to reach 4 percent by 2020. - Exchange rate stabilized around UAH24–25 per dollar in projections. - Inflation (GDP deflator) projected: recede quickly in 2016 to about 13½ percent; steady state about 6 percent. - Cyclically-adjusted primary surplus of general government projected at about 2 percent of potential GDP from 2017 onwards. - Key debt-creating/reducing flows: - Banking system support fiscal costs: 2.3 percent of GDP in 2015; public funds for banking support rephased to 7.3 and 1.6 percent of GDP for 2016 and 2017. - Naftogaz recapitalization bonds issued in 2015: 1.5 percent of GDP; program assumes additional 1.4 percent of GDP financing support in 2017 to clear Gazprom arrears. - Privatization proceeds: 0.5 percent of GDP in 2015; program assumes 0.8 percent of GDP per year for 2016–20. - Stress tests and scenarios: - Growth shock (one historical standard deviation): debt-to-GDP could reach 117 percent in 2018. - Real exchange rate shock (replicating half 2014 FX pressures): debt ratio could reach 116 percent by 2018. - Combined macro-fiscal shock: debt above 160 percent of GDP in 2018. - Contingent liabilities shock: debt peaks at 112 percent of GDP in 2018. - Historical-scenario: debt around 98 percent of GDP. - External DSA: - External debt peaks at 145 percent of GDP in 2016; declines to about 98.4 percent by 2021 (baseline). - Gross external financing need (percent of GDP) sample baseline values by year include: 47.6; 52.8; 53.1; 53.0; 43.8; 39.9; 40.0; 40.0; 36.6. - Fan charts and tests indicate substantial downside risks; mitigants include shift toward official creditors, long maturities, and lower gross financing needs post-restructuring. ### Financial sector policy and banking system repair - Banking sector actions and outcomes: - NBU suspended licenses of almost 80 banks since 2014 (accounting for 25 percent of banking system assets). - New diagnostics found 14 out of the 20 largest banks needing additional capital (accounting for 78 percent of system assets); all 14 brought capital to at least zero under June 2016 framework. - Number of operating banks declined to just over 100 from 180 in early 2014. - Of the 39 largest banks, diagnostics showed material capital shortages in 28 banks. - Recapitalization and timelines: - Deadline for first 20 largest banks to reach CAR 5 percent of RWA extended to end-September 2016. - Next 19 largest banks to reach 5 percent CAR by end-February 2017. - Banks with related-party exposures in excess of limits required to unwind within three years; unwinding plans with quarterly targets are in place. - Requirement to dispose non-core assets through end-2018 as part of recapitalization. - Legal and insolvency reforms: - New legislation to improve corporate insolvency regime by end-September 2016 (modified structural benchmark); further credit enforcement and tax regime changes by end-December 2016. - Law on Financial Restructuring adopted in June 2016 for out-of-court corporate restructuring; mortgage loan restructuring framework to be adopted by end-September 2016. - DGF and state banks: - Fiscal provision for bank restructuring included in program: around 10½ percent of GDP; 9 percent of GDP remains available in case of future bank needs. - Principles for state-owned banks: eventual privatization, supervisory boards, and commercial operations. ### Structural reforms: anticorruption, transparency, judicial reform, SOE reform, and business climate - Anticorruption: - NABU operational in late 2015; head anticorruption prosecutor and two deputies appointed (prior action). - Electronic asset declaration system launched September 1, 2016; high-level officials to file within 60 days (structural benchmark end-October 2016). - By end-July 2016: NABU sent 24 cases to court; two court decisions required restitution of US$45 million; seized more than US$175 million in assets. - Implementation challenges: no high-level official convictions to date; budget received only US$4,000 of confiscated proceeds in 2015; prosecutorial and judicial weaknesses persist. - Judicial reform: - Constitutional amendment and new law on the judiciary adopted to align with ECHR standards; implementation challenging; measures to strengthen discipline and fees in courts. - SOE reform and privatization: - Triage of SOEs, establishment of supervisory boards, mandatory audits and transfer of assets to the privatization fund. - Targets: independent supervisory boards in at least five large SOEs by end-October 2016 and 10 more by end-December 2016. - Privatization milestones: Odessa Portside Plant auction by end-October 2016; Centrenergo sale aimed by end-March 2017. - Business climate and deregulation: - Action plan to remove regulatory impediments; updated RIA methodology adopted; draft law on agricultural land circulation to be submitted by end-September 2016 (structural benchmark). ### Exchange system, remaining restrictions, and Article VIII issues - Status: several prior exchange restrictions and multiple currency practices removed, but some remain and are subject to Fund approval under Article VIII, Section 2(a) and 3. - Remaining exchange restrictions: - Absolute limits on availability of foreign exchange for certain non‑trade current international transactions. - Partial ban on transfer abroad of dividends received by nonresident investors from foreign investments in Ukraine. - Remaining MCPs: - Use of multiple price foreign exchange auctions by NBU without mechanism to prevent spread deviation of more than 2 percent between auction and market rates. - Requirement to transfer any gains from purchase of foreign exchange to state budget if unused and resold. - Eliminated measures: - Tax clearance requirement for import payments eliminated on September 8, 2015. - Certain MCPs eliminated effective July 1 and June 2, 2016. - September 2015 regulation banning FX purchases for certain import payments has been removed. - Staff supports approval of retention of exchange restrictions and MCPs for a period of 12 months on grounds they are non‑discriminatory, imposed for balance of payments reasons, and temporary. ### Program monitoring, conditionality, and staff recommendations - Monitoring instruments: LOI, MEFP, TMU, performance criteria (PCs), indicative targets (ITs), structural benchmarks, prior actions. - Waiver requests supported by staff for non‑observance of: - End‑December 2015 PC on NBU net international reserves; - Continuous PC on non‑accumulation of external debt arrears; - PC on non‑imposition of restrictions on payments and transfers for current international transactions (measure removed). - Structural conditionality highlights (selected): - Fiscal: Adopt 2016 budget — PA — Done; Adopt parametric pension reform — SB — End‑December 2016. - Energy: Raise gas and heating tariffs to cost recovery — PA — Done; Introduce automatic tariff adjustment — SB — End‑October 2016. - Anticorruption: Appoint anticorruption prosecutors — PA — Done; High‑level officials asset declarations — SB — End‑October 2016. - SOE and business environment: Strengthen corporatization and insolvency — SBs with end‑Sept to end‑Dec 2016 deadlines. - Staff appraisal conclusions and recommendations: - Program broadly on track; key accomplishments include fiscal adjustment, gas tariff increases, banking cleanup, and debt operation. - Priorities: accelerate structural reform, complete pension reform, strengthen tax and customs administration, rebuild reserves, complete bank recapitalization and unwinding related-party lending, intensify anticorruption and SOE restructuring. - Staff recommends completing the second review and the financing assurances review; supports waivers and rephasing of access; considers Fund financing in line with policy on lending into arrears to official bilateral creditors given criteria satisfied. ### Key quantitative program figures and reporting metrics (selected exact values) - Arrangement amounts and purchases: - Total arrangement: SDR 12,348. - Total US$ equivalent at approval: 17,185 US$. - Schedule examples: March 11, 2015: 3,546.000 SDRs; June 15, 2015: 1,182.100 SDRs; September 15, 2015: 716.110 SDRs; November 15, 2016: 952.487 SDRs; February 15, 2017: 1,418.479 SDRs. - Ukraine's previous quota: SDR 1,372 million; new quota effective February 2016: SDR 2,011.8 million. - Program exchange rates (program accounting): - Hryvnia per U.S. dollar: 15.7686. - Euro: 1.2141 dollars. - SDR: 0.690224 per dollar. - Official gold: 1,206.00 dollars per fine ounce. - Reserve and financing indicators: - NBU net FX purchases since end-February 2015: US$3.1 billion. - Swaps/credit lines with Sweden and Poland equivalent to US$1.5 billion. - Gross reserves: US$13.3 billion end-December 2015; US$14.2 billion August 2016; projected US$16¾ billion end-2016; US$31 billion end-2018. - Public debt and financing risks: - Public and publicly guaranteed debt: 80 percent of GDP by end-2015. - Projected outstanding Fund credit by end of arrangement: about 17.6 percent of GDP, or 59 percent of gross reserves. - Repayments to the Fund over next five years peak at 8.1 percent of reserves in 2018. - Debt service to the Fund as ratio of exports of goods and services peaks at 5 percent in 2018. - Fiscal and macro targets and TMU sample values (selected): - Ceiling on the cash deficit of the general government (Table 2b examples): 35,000 (September PC); 84,900 (December PC); 15,000 (March PC); 29,000 (June IT). - Floor on cumulative change in net international reserves (millions of U.S. dollars): 1,776; 2,317; 2,288; 3,498 (selected reporting dates). - Ceiling on cumulative change in net domestic assets of NBU (sample values): -2,886; 9,923; 22,584; 32,075. - Ceiling on publicly guaranteed debt sample values: 28,200; 28,200; 15,000; 15,000. - VAT refund arrears ceiling: UAH 0 billion. - Program accounting exchange rate repeated across reporting periods: 15.7686. *International Monetary Fund — _cr16319 - introduction of new exchange restrictions.* ### introduction of new exchange restrictions. ### _cr16319 - introduction of new exchange restrictions. ### Program approval, scope, and financing - Ukraine’s four-year, SDR 12.348 billion arrangement (about US$17.5 billion at the time of approval of the arrangement) was approved on March 11, 2015 (see Press Release No. 15/107) to support the government’s economic program, which aims to put the economy on the path to recovery, restore external sustainability, strengthen public finances, maintain financial stability, and support economic growth by advancing structural and governance reforms, while protecting the most vulnerable. - The Executive Board also discussed the ex-post evaluation of the Stand-By Arrangement (SBA) with Ukraine that was approved in April 2014 (see Press Release No. 14/189). - Staff supports the completion of the second review, and the authorities’ requests for waivers of the missed performance criteria, rephasing of access, and financing assurances review. - The purchase available upon completion of this review would be equivalent to SDR 716.110 million, bringing total purchases under the EFF to SDR 5,444.21 million. - Date of executive summary: September 2, 2016. ### Assessment by the Managing Director (Ms. Christine Lagarde) - “Ukraine is showing welcome signs of recovery, notwithstanding a difficult external environment and a severe economic crisis. Activity is picking up, inflation has receded quickly, and confidence is improving. Gross international reserves and bank deposits have risen. While the social and economic cost of the crisis has been high, growth is expected to be higher in the period ahead. This progress owes much to the authorities’ program implementation, including sound macroeconomic policies, bold steps to bring energy tariffs to cost-recovery levels, and measures to rehabilitate the banking system. Determined policy implementation, however, remains critical to achieve program objectives, given the significant challenges ahead. - “Further progress in fiscal reforms is key to ensure medium-term sustainability. The authorities need to avoid tax policy changes that lead to higher deficits. The focus should be on improving tax and customs administrations. Moreover, parametric pension reform is crucial to reduce the pension fund’s large structural deficit, help reduce fiscal deficits and public debt, and create room to bring pensions to sustainable levels over time. - “Monetary policy has been skillfully managed and financial sector reforms have started to yield results. Priority should continue to be given to reducing inflation and rebuilding international reserves, also to make room for the gradual removal of remaining administrative measures. The authorities need to further strengthen the banking system through recapitalization, unwinding of related-party lending, and resolution of impaired assets. - “A sustainable recovery requires completing the structural transformation of the economy, where much remains to be done, including combating corruption and improving governance. Creating a level-playing field and ensuring equal application of the rule of law is essential to raise investment. A decisive start needs to be made with the restructuring and divestiture of state-owned enterprises, and prosecuting high-level corruption cases. - “Ukraine’s international partners have contributed to efforts to strengthen the economy with considerable financial and technical support. These remain important for the success of the program. The completion of the restructuring of sovereign debt held by private bondholders was an important step to put debt back on a sustainable path. It is important that the resolution of remaining sovereign arrears proceeds promptly. - “The ex-post evaluation of exceptional access under the 2014–15 Stand-By Arrangement notes that while the program faced substantial risks from the outset and did not achieve many of its goals, it served as an important policy anchor in an uncertain environment.” ### Executive summary — progress, priorities, and requests - Notwithstanding a delay in completing the second review, important policy measures have been taken since the last review, including: - a sizable fiscal adjustment; - a successful completion of the debt operation with private bondholders; - the increase in gas and heating tariffs to full cost recovery; - decisive steps to rehabilitate the banking system. - Areas where progress has been slower than envisaged: - tackling corruption; - privatizing state-owned enterprises (SOEs); - advancing pension reform, due to significant political resistance. - Near-term policy aims: - (i) further strengthen public finances via expenditure consolidation—including pension reform—and improvements in tax administration; - (ii) continue to improve banks’ financial health; - (iii) maintain prudent monetary policy and exchange rate flexibility; - (iv) speed up structural reforms to overhaul the SOE sector, improve the business climate, and tackle corruption. - The policy agenda is described as ambitious, and timely implementation remains critical. ### Economic developments and outlook — stabilization and nascent recovery - Macroeconomic stabilization is taking hold following a deep recession. - Growth: - Growth is expected to reach 1.5 percent in 2016, supported by recovering consumer and investor confidence and a gradual easing of credit conditions. - Labor market: - Unemployment is estimated to have peaked at around 9.9 percent in Q1 2016 (from 7.3 percent in 2013). - Real wages declined by 18½ percent in 2015; wages in dollar terms fell to around 30 percent of their peak in 2013. - Inflation: - Inflation peaked at 61 percent year-on-year in April 2015. - 12-month inflation declined to 7.9 percent in July 2016. - Monetary policy: - The NBU absorbed banks’ excess liquidity mainly through the issuance of certificates of deposit. - The NBU started easing monetary policy in April 2016 after keeping rates on hold since summer 2015, bringing the discount rate gradually down to 15.5 percent in July 2016. - Key interest rates have remained positive in real terms on a forward-looking basis. - External sector: - The current account deficit narrowed to about 0.3 percent of GDP in 2015, from 4 percent in 2014. - Both exports and imports shrunk by about a third in 2015. - Gross reserves reached US$13.3 billion by end-December 2015 and rose further to US$14.2 billion in August 2016. This is equivalent to about 3.5 months of imports and 55 percent of the composite metric of reserve adequacy (ARA metric). - Within the framework of the exchange restrictions, the NBU allowed the exchange rate to adjust to changing balance of payments conditions; the NBU purchased more than US$3.1 billion in the interbank market since the program’s approval. - Fiscal outcomes: - The combined deficit of the general government and Naftogaz was reduced sharply to 2.1 percent of GDP—compared to a target of 7.3 percent of GDP in the program—supported by higher external and one-off revenues (an exceptionally large central bank profit transfer and the temporary import duty surcharge) and a lower gas import bill. ### Debt restructuring and sovereign arrears - The completion of the debt operation with private bondholders: - The debt exchange of sovereign and sovereign-guaranteed Eurobonds, launched in September 2015, provided significant debt service relief for the next four years and was a major step toward restoring debt sustainability and securing adequate financing of the program. - Russia: - Russia did not participate in the debt exchange and the Russia-held Eurobond, which has been recognized as an official bilateral claim by the Fund, is now in arrears. - Litigation is underway in London, while in parallel the two sides have been discussing the restructuring of this bond. - Official and multilateral support: - Disbursements since program approval from other multilateral and official bilateral creditors reached US$3.6 billion, and a further US$1.8 billion is expected to become available soon after completion of this review. ### Political context and implementation risks - A new government was appointed in April 2016 after a fracture of the governing coalition; the new coalition has a slim and fragile majority in parliament, posing a risk of early elections and challenging policy implementation. - The authorities affirm commitment to accelerate reforms, but progress on politically sensitive items (pensions, SOE divestiture, anti-corruption prosecutions) faces significant political resistance. *International Monetary Fund — _cr16319 - introduction of new exchange restrictions.* ### 1.2 percent ### _cr16319 - 1.2 percent ### Fiscal outturn and key drivers (2015) - General government and Naftogaz combined deficit: 8.0 percent of GDP in 2014 (actual) to 5.2 percent of GDP in 2015 (first review) as presented in fiscal accounting lines. - General Government deficit: 3.4 percent of GDP in 2014 (actual) to 3.0 percent of GDP in 2015 (first review). - NBU profit transfer: 1.7 percent of GDP (2014) to 0.0 percent of GDP (2015). - Other revenue (includes one-off revenue): 0.3 percent of GDP (2014) to 1.3 percent of GDP (2015). 1/ Includes one-off revenue of 1.3 percent of GDP related to import duty surcharge in 2015. - Non-interest expenditure: 2.3 percent of GDP (2014) to 0.7 percent of GDP (2015). - Interest: -0.9 percent of GDP (2014) to 1.1 percent of GDP (2015). - Naftogaz contribution to fiscal balance: 4.6 percent of GDP (2014) to 2.2 percent of GDP (2015). - External factors contribution: 4.4 percent of GDP (2014) to 2.0 percent of GDP (2015), including import bill and transit revenue changes: - Import bill: 2.8 percent of GDP (2014) to 1.5 percent of GDP (2015). - Transit revenue: 1.6 percent of GDP (2014) to 0.5 percent of GDP (2015). - Domestic factors contribution: 0.2 percent of GDP (2014) to 0.2 percent of GDP (2015), including: - Gas sales (higher tariffs): 0.8 percent of GDP (2014) to -0.1 percent of GDP (2015). - Domestic gas costs (UGV price): -0.7 percent of GDP (2014) to -0.2 percent of GDP (2015). - Other: 0.1 percent of GDP (2014) to 0.5 percent of GDP (2015). - Overall fiscal over-performance in 2015: outturn was 1.2 percent of GDP implying a structural adjustment of around 3 percentage points. This over-performance reflected mainly higher revenues due to higher 2015 inflation, and lower interest payments due to lower issuance of new debt and the capitalization of interest as part of the debt restructuring. - Authorities used part of the room under fiscal targets to: - advance partial indexation of pensions and public sector wages to September 1, 2015 (from December 1), - increase defense spending, - pay part of the January 2016 pensions already in December 2015. ### Naftogaz and energy sector developments - Naftogaz cash deficit fell to less than 1 percent of GDP in 2015, compared to a target of 3.1 percent. - Drivers of Naftogaz improvement: - Much lower import volumes as consumption declined by about 25 percent. - Lower import prices, especially in the second half of the year. - Higher transit revenues. - Gas and heating tariff increases of 285 percent and 67 percent, respectively, implemented in April–May 2015, helped raise domestic revenue broadly in line with expectations. - To mitigate gross reserves shortfall, the NBU activated currency swaps with China and Sweden. ### Public debt and banking sector repair - Public and publicly guaranteed debt reached 80 percent of GDP by end-2015 (compared to 94 percent projected at the time of the first review), driven by delays in official financial assistance but also by strong fiscal performance and observance of bank recapitalization targets without large injections of public resources to date. - Banking sector actions and outcomes: - The NBU suspended the licenses of almost 80 banks since 2014, accounting for 25 percent of banking system assets. - A new round of diagnostics (covering first half of 2015) found 14 out of the 20 largest banks needing additional capital (accounting for 78 percent of system assets) agreed with the NBU on three-year plans to address capital needs and unwind related-party exposures; two were resolved; the remaining four banks did not need a capital increase. - All of these 14 banks have now brought their capital to at least zero on the basis of the June 2016 regulatory framework. - With balance sheet repair underway, confidence and deposits started to recover; credit to the economy expanded for the first time in the last quarter of 2015—mostly to enterprises—albeit at a very slow pace. - Liquidity conditions in the banking system improved considerably. ### Outlook and risks (macro framework revisions) - Growth - Real GDP is projected to grow by 1.5 percent in 2016 (against 2 percent expected at the time of the first review). - Support to activity expected from a de facto loosening of the fiscal stance, increased consumer and investor confidence, gradually rising real incomes, and gradual easing of credit conditions as inflation continues to fall and monetary policy can be gradually relaxed. - External conditions expected to remain a drag on growth; outlook depends crucially on strength of domestic demand. - Inflation - Inflation is projected to pick up slightly to around 13 percent toward the end of 2016, owing to the increase in gas and heating tariffs, before gradually tapering off as one-off effects subside and economic stabilization strengthens. - Balance of payments and reserves - Current account deficit expected to widen to 1½ percent of GDP in 2016 (broadly in line with earlier projections). - With limited private capital inflows but strong support from disbursements by official creditors, gross reserves projected to increase to US$16¾ billion by end-2016, and to US$31 billion by end-2018. - These reserve projections are somewhat lower than envisaged at program request and first review, reflecting some use of reserves to buffer adjustment to worsened terms of trade. Medium-term reserve adequacy will remain broadly similar given downward revision in imports. - Importantly, reserves would still surpass the 100 percent threshold of the ARA metric by the end of the program. - Risks (domestic and external) - Domestic risks: political instability (including possible early elections), policy reversals, slow program implementation, public impatience over living standards and anti-corruption results, protracted/volatile bank resolution process, potential escalation of conflict in the East. - External risks: renewed weakening of the terms of trade, weaker global recovery, slowdown in major emerging markets affecting Ukraine via trade and commodity price channels. ### Fiscal policy and the 2016 budget - 2016 budget target: general government deficit of 3¾ percent of GDP (a prior action for the review). - Despite alignment with program adjustment path, on the heels of 2015 over-performance this implies an expansionary stance; relaxation in terms of the structural primary balance is about 1½ percent of GDP, as 2015 over-performance benefited from many one-off measures. - Budget approval process revealed significant rift between government and parliament over tax policy scope; compromise reached involving a major rebalancing of the budget and a combination of revenue and expenditure measures equivalent to 6.7 percent of GDP. - Fiscal arithmetic and measures (all figures in percent of GDP): 1. 2016 budget balance on unchanged policies: -5.7 2. Lowering Social Security Contributions (SSC) rate to 22 percent: -4.0 3. Increased allocation for capital spending: -0.7 4. Approved budget balance: -3.7 5. Adjustment measures needed to close the gap (4-3-2-1): 6.7 - a. Revenue measures: 3.6 - Unify personal income tax at 18 percent with lower deductions: 1.1 - Expand the corporate income tax base from lower SSC: 0.5 - Reform the simplified tax regime for small taxpayers: 0.2 - Bring agriculture under general VAT regime (with transitional provisions for 2016): 0.2 - Increase excise taxes on alcohol, tobacco, and fuel: 0.7 - Increase property taxation: 0.3 - Increase taxation of amber mining: 0.1 - Switch gas transit from royalties to VAT: 0.1 - Additional VAT on cigarettes: 0.1 - Increase profit transfers from SOEs: 0.3 - b. Spending measures: 3.1 - Impact on government wage bill of lower SSC (lower gross wages): 0.7 - Reduce subsidies to SOEs, public transport, and cultural programs: 0.2 - Rationalize health spending (reduce hospital beds and medical staff): 0.2 - Improve targeting and efficiency of social assistance: 1.0 - Improve targeting of non-pension benefits: 0.6 - Reduce benefits to working pensioners: 0.2 - Verification of social benefits: 0.2 - Increase education spending efficiency and optimize the school network: 0.4 - Procurement and public administration reform: 0.1 - Advance part of January 2016 pension payment to 2015 (temporary): 0.6 - Supplemental budget (adopted May 2016) increased allocations for household utility subsidies (0.2 percent of GDP) and wages, pensions and social assistance (in total by less than 0.1 percent of GDP); the increase in expenditure was fully offset by higher revenues related to higher gas prices. ### Box on the 2016 Tax Reform: design, effects, and risks - Core elements of the reform: - Direct taxes: - Replaced 67 different rates of SSC (effective rate about 41 percent) with a single rate of 22 percent payable only by the employer. - Replaced personal income tax rates of 15 and 20 percent with a single, flat rate of 18 percent. - Raised marginal taxation under the simplified regime for small taxpayers (covers about 40 percent of taxpayers). - Indirect taxes: - Made agricultural sector subject to standard VAT rate of 20 percent from 2017 onward with transitional arrangement in 2016. - Raised excise rates on tobacco, fuel, beer and spirits. - Increased property taxes on residential real estate and vehicles, particularly for wealthier individuals. - Reduced royalty rates on natural gas extraction to support investments and growth in oil and gas sector. - Fiscal and implementation implications: - Deep cut of SSC rate implies significant revenue loss for social security funds (about 4 percent of GDP), requiring doubling of state budget transfers to about 7 percent of GDP. - Authorities expect SSC reduction to lower informality, create employment and support growth; international experience on SSC-informality link is mixed. - So far, social security contributions have lagged authorities’ expectations. - Successful reduction of informality depends on strengthening revenue administration and addressing corruption. - Revenue loss in 2016 budget expected to be largely compensated by higher consumption taxes. - Reform places responsibility on the State Fiscal Service to administer VAT collection from the agricultural sector and to limit increased smuggling risks from higher excises. *Italic: IMF staff country report content.* ### Box 1. The 2016 Tax Reform (concluded) ### Box 1. The 2016 Tax Reform (concluded) ### Tax reform outcomes and fiscal impact - Overall tax revenue is expected to decline to 34 percent of GDP in 2016, bringing it broadly in line with the average in the CEE. - The share of indirect taxes in total tax revenue will increase to the median of the CEE countries. - The labor tax wedge, which was about 43 percent of the total labor costs and was much higher than the OECD average of 36 percent, is expected to decline by almost 9 percentage points in 2016. - The design of the simplified regime for small taxpayers remains inadequate and provides opportunities for arbitrage between this and the general system; further reforms in this area could generate additional revenue (about 1 percent of GDP), while reducing distortions. ### Fiscal implementation and near-term commitments - Firm implementation is critical to achieve the 2016 fiscal targets (MEFP ¶27). - Authorities recognize extensive changes introduced with the 2016 budget will stretch tax administration and budget execution. - In the first seven months of 2016, revenues have been performing well, including social security contributions. - Spending has been in line with projections; authorities commit to adhere to budget ceilings and to save or invest any revenue over-performance—with a new ceiling on current spending. - Authorities are committed to hold off on further major tax policy changes or other new costly policy initiatives in view of the need for further fiscal adjustment in 2017. ### Structural fiscal reforms (progress and gaps) - Pensions (MEFP ¶29a): - Securing necessary support for pension reform proved more challenging than expected; the end-December 2015 structural benchmark was missed. - The reduction in social security contributions doubled the structural deficit of the pension system to around 6½ percent of GDP (equivalent to more than half of total pension spending), requiring large budgetary transfers. - Ratio of pensioners to contributors is about 1:1; retirement age is very low by international standards; adverse demographics and low individual pensions (eroded by high inflation). - Broader parametric reforms will be necessary to set the pension fund on a stronger footing and create space for gradually increasing pensions over time. - Authorities reduced the number of occupations eligible for early retirement (a prior action for this review). - Broader parametric pension reforms are to be implemented by end-December 2016 (a new structural benchmark) to improve affordability (Figure 7 referenced in source). - Public administration and other reforms (MEFP ¶29): - Employment in the broader budgetary sector was reduced by 3 percent and in the civil service (central and local administrations) by 16 percent in 2015. - General government total wage bill in Ukraine is 9½ percent of GDP and remains high by international standards, despite relatively low average public sector wages among civil servants. - Further civil service reform, with EU assistance, is planned to consolidate the wage bill, reduce the size of the public administration, and create room for higher wage levels to attract high quality staff and reduce corruption. - Legislation under consideration to change the basis for health care financing and to overhaul basic and professional education, as well as mandatory electronic procurement. ### Tax and customs administration overhaul (priorities and measures) - Overhaul of the tax and customs administration is a priority for 2016 (MEFP ¶27). - Progress made, but much more remains to be done: - Electronic administration of VAT was introduced on July 1, 2015. - All large taxpayers were brought under the Large Taxpayer Office (LTO) (end-December 2015 structural benchmark). - The LTO covers all large taxpayers—about 2,200, accounting for about 55 percent of government revenue. - The State Fiscal Service (SFS) now reports to the Ministry of Finance instead of to the Cabinet of Ministers, with increased operational freedom and accountability (end-December 2015 structural benchmark). - Authorities committed to revamping the SFS with a new organizational and operational structure. - SFS has nearly completed downsizing by 30 percent of its staff, and will consolidate tax and customs offices (a new structural benchmark for end-December 2016). - Planned measures: merge audit and debt management functions, reform the dispute resolution system, strengthen taxation of high-net-worth individuals and the framework for audit and investigation, and improve administrative enforcement of debt collection. - SFS to enhance its ability to detect and investigate offences by tax officers through a newly established investigation division; the tax police will be reorganized and demilitarized. - Customs reforms aim to simplify clearance procedures, tighten border controls, improve the valuation system and the audit function, and strengthen integrity policies. ### Energy sector policies (overview and link to fiscal adjustment) - Objectives: ensure a zero deficit for Naftogaz and advance broader gas market reforms. - Gas and heating tariff increases to cost recovery (MEFP ¶33): - Authorities accelerated increase in gas and heating prices to full cost recovery one year ahead of schedule (prior actions for the review; Box 2). - Committed to introducing a quarterly adjustment mechanism to keep prices aligned with import prices (a new structural benchmark for end-October 2016) until full liberalization of tariffs no later than April 1, 2017. - Price Naftogaz pays for domestically produced gas was raised to market levels to facilitate investment in domestic gas production and improve energy independence. - Targeted social assistance (MEFP ¶31): - By end-2015, some 5½ million households were receiving social assistance to help defray the cost of higher gas and heating tariffs. - Energy-related benefits envelope increased from around 1 percent of GDP in 2015 to 1¾ percent of GDP in 2016. - Reforms initiated to improve targeting and ensure fiscal affordability, including: - Streamlining energy support programs. - Updating consumption norms for the subsidy program to bring them closer to current consumption levels. - Authorities will adjust parameters of utility-related social assistance programs, including the subsidy benefits formula, to ensure spending remains within the allocated fiscal envelope (a new structural benchmark for end-September 2016). - Structural sector reforms (MEFP ¶32): - New gas market law enables unbundling of Naftogaz, including third party access to the gas transmission system. - EBRD, with inputs from other IFIs and stakeholders, developed an action plan to establish an independent and commercially-oriented transmission system operator, to be completed by 2017. - Initial steps include government approval of the unbundling model and transfer of state-owned assets (transmission system) to the new entity. - Formula for distribution accounts collecting district heating bill payments revised so Naftogaz receives a share proportional to gas cost in heating tariffs and can gradually recoup heating company arrears. - Independent audit of receivables published in September 2015; comprehensive corporate governance action plan developed with EBRD assistance. - A new supervisory board of Naftogaz with independent members was recently appointed. - With support from the EBRD and the European Commission, efforts underway to support investment in energy efficiency in the residential sector, particularly district heating systems. *Source: Box 1. The 2016 Tax Reform (concluded), IMF staff report content provided in source PDF.* ### Box 2. Gas Tariff Adjustments (concluded) ### Box 2. Gas Tariff Adjustments (concluded) ### Energy-related social assistance and gas tariffs - For 2015, sufficient resources were allocated in the budget and delivered to about 5½ million households (about one-third of the total number of households) to help cover total utility bills. - For 2016, the fiscal envelope has been increased to UAH 40.3 billion (1.8 percent of GDP), higher than the previously budgeted UAH 35 billion to help offset the advanced tariff increases. - Further steps needed to safeguard progress: - Tariffs will be fully liberalized no later than April 1, 2017. - In the meantime, the authorities will introduce a quarterly adjustment mechanism to ensure that tariffs do not deviate significantly from cost recovery should international gas prices or the exchange rate change. - Continued progress on corporate governance reforms at Naftogaz, now that the supervisory board is in place, will help to further promote transparency and good governance. ### Monetary and exchange rate policy - Authorities remain committed to maintaining a flexible exchange rate and further building up reserves (MEFP ¶5). - A flexible exchange rate will continue to support the required economic adjustment, while the NBU has been stepping up its efforts to purchase reserves through its foreign exchange auctions. - The Ministry of Finance is expected to roll over most, if not all, of the maturing domestic foreign-currency denominated bonds to support the NBU. - With conditions in the foreign exchange market improving, the NBU will gradually liberalize the foreign exchange market and further remove administrative restrictions, in consultation with Fund staff, to the extent that financial stability is maintained and reserve targets are met. - In June the NBU eased restrictions on certain external trade and financial transactions, including allowing the gradual repatriation of dividends, reducing the surrender requirement, and increasing limits on deposit withdrawals and foreign-currency cash purchases by individuals. - Monetary policy to support disinflation and financial stability (MEFP ¶6 and 7): - Any further easing of the policy stance will be gradual, provided disinflation and reserve accumulation are on track, inflation expectations are well-anchored, and monetary and financial stability are maintained. - The NBU has stepped up efforts to prepare for the eventual adoption of an inflation targeting framework and has published its medium-term monetary policy strategy, including inflation objectives for the coming years. - The NBU improved its operational framework to help monetary policy transmission and communications, including by narrowing the interest rate corridor and unifying the discount rate with the current key operational rate (on 14-day CDs). - Institutional strengthening (MEFP ¶8): - The NBU is moving forward with its modernization program to focus on core functions, improve decision-making processes, and internal controls. - A new loan management department is strengthening lending and risk-management processes, in line with the Fund’s safeguards assessment recommendations. - The NBU adopted a new ethics code for members of its decision-making bodies and for its staff. - Some reforms, such as a new Audit Committee and adoption of an internal audit charter, await the appointment of a new Supervisory Council by the president and parliament. Once a new Council is appointed, a new Audit Committee with enhanced professional qualifications will be constituted. ### Financial sector policy and banking system repair - System-wide adjustments: - The number of operating banks has declined to just over 100, from 180 institutions in early 2014. - Most of the nearly 80 resolved banks had significant shortcomings regarding liquidity, solvency, and excessive exposure to related parties. - Bank diagnostics and recapitalization: - The NBU completed the first two rounds of new bank diagnostics for the 39 largest banks (accounting for 95 percent of the system assets), focusing on sustainability of borrowers’ cash flows and quality of loan collateral. - In the review the NBU exercised new legal powers allowing it to shift the burden of proof to a bank to demonstrate that a borrower is not a related party. - Results showed material capital shortages in 28 out of the largest 39 banks. - Poor quality of collateral increased estimated levels of non-performing loans (NPLs) and provisioning requirements, underscoring the need to enhance credit risk management and loan underwriting practices. - Of the initial 20 largest banks, those needing additional capital have since brought their capital to at least zero according to the June 2016 NBU provisioning requirements, mainly by converting subordinated debt into equity, enhancing substantially loan collateral, and transferring assets to the banks’ balance sheets to settle loans or have been closed. - Banks with related-party exposures in excess of prudential limits are now required to unwind them within the next three years. - The diagnostics of the next 19 largest banks was completed in July 2016 and indicated that 12 of these banks needed additional capital. Shareholders’ efforts to recapitalize these banks are under way. - Implementation sequencing and deadlines (MEFP ¶11): - Ensuring bank recapitalization: - Deadline for recapitalization of the first largest 20 banks to reach a capital-adequacy ratio (CAR) of 5 percent of risk-weighted assets has been extended to end-September 2016. - For the next 19 largest banks the deadline to reach the 5 percent CAR is February 2017. - Encouraging loan recovery and improving collateral: - Within the recapitalization timeframe, banks can mitigate provisioning needs through effective debt collection (including foreclosing on loan collateral), enhancing problematic borrowers’ creditworthiness with new collateral, or consolidating cash flows with creditworthy affiliated companies, subject to strict valuation, documentation, and viability conditions. - Advancing plans to unwind related-party exposures: - Related-party exposures exceeding limits are being addressed with clearly-defined quarterly targets; unwinding plans may be factored into recapitalization plans if credible binding commitments are provided by shareholders (e.g., by pledging related deposits usable to repay related loans if not repaid on time). - Preventing new concentration risks: - The Related Parties Monitoring Office in the NBU reports monthly on potential related-party exposures, especially for banks under unwinding plans. - The NBU will set up a credit registry in line with international best practices. - Ensuring timely disposal of non-core assets: - Banks will be required to dispose through end-2018 non-core assets incorporated in their balance sheets (at fair market value) as part of recapitalization plans. - Addressing the high stock of NPLs (MEFP ¶19–21): - Strengthening the legal framework for private debt restructuring: - New legislation will be adopted by end-September 2016 to improve the corporate insolvency regime (a modified structural benchmark), and by end-December 2016 to improve the credit enforcement and tax regimes. - Adopting an out-of-court restructuring arrangement for corporate debt in line with international practice. - Sponsoring a voluntary approach for restructuring foreign-currency denominated mortgage loans, with safeguards for distressed borrowers and banks. Simultaneously, the moratorium on collateral foreclosure will be lifted. - Crisis preparedness and resolution principles (MEFP ¶13): - State participation in recapitalization of a problem systemic bank will be based on a technical NBU report assessing capital needs and viability, aiming to avoid losses to the State. - Public funds will be injected only after shareholders have been completely diluted and non-deposit unsecured creditors and related deposits are bailed in. - If a bank is nationalized, the Ministry of Finance will hire a well-known international firm to run the bank with a commercial business perspective. - International best practice will be followed and legal means pursued to ensure the State secures recovery from former owners of loans related to them in a timely manner. - State-owned banks (SOBs) strategy (MEFP ¶17): - Authorities adopted a strategy envisaging eventual privatization of SOBs while ensuring they operate at arm’s length of the government on sound commercial principles. - Authorities will appoint new supervisory boards for these banks with assistance from a reputable international recruitment firm. - Fiscal provision for bank restructuring: - The program includes a provision for the fiscal cost of bank restructuring—including recapitalization of the Deposit Guarantee Fund (DGF)—of around 10½ percent of GDP, out of which 9 percent of GDP remains available in case of future bank needs. ### Structural reforms: anticorruption, transparency, and judicial reform - General progress: - Progress in implementing structural reforms to strengthen the business climate and governance has been mixed. Setting up new institutions to fight corruption and preparations to reform the SOE sector have seen progress, but actual outcomes have lagged. - Authorities recognize the importance of accelerating structural reforms and have committed to an ambitious agenda. - Anticorruption (MEFP ¶36): - Progress in preventing and sanctioning corruption has generally fallen short of expectations; opinion polls indicate a large share of the population does not yet see results, with corruption perceptions particularly prevalent in SOEs and the judicial system. - The end-September 2015 structural benchmark on establishing a robust anticorruption prosecution function was missed. - Following renewed efforts, the head anticorruption prosecutor and his two deputies were appointed in December (a prior action for this review), enabling the National Anticorruption Bureau (NABU) to become operational (an end-January 2016 structural benchmark). - Amendments to strengthen the appointment process were adopted in February 2016. - Authorities plan to further enhance NABU’s investigative powers (a new structural benchmark for end-November 2016) and to create specialized anticorruption courts and recruit specialized anticorruption judges. - Transparency and asset declarations: - Legislation requiring high-level officials to declare assets and incomes was initially adopted in October 2014 and revised in February 2016, but effective implementation encountered delays. - The electronic filing system was launched on September 1, 2016. - High-level officials have 60 days to submit their information, which would become publicly available (a new structural benchmark for end-October 2016). - Preventing laundering of proceeds of corruption: - Building upon recently developed anti-money laundering supervisory tools, the NBU is implementing targeted inspections to ensure banks are not misused by corrupt officials. - Publication of comprehensive asset disclosures of high-level officials will assist banks’ efforts to identify possible proceeds of corruption and facilitate NABU investigations of illicit enrichment and associated money laundering. - Judicial reform (MEFP ¶37): - Judicial reform remains critical to address corruption and improve the business environment. - Parliament adopted a constitutional amendment and a new law on the judiciary to align organization and management of the judiciary more closely with standards vested in the European Convention on Human Rights. - Implementation is likely to be challenging; processes for disciplinary action against judges are being strengthened, and the new court fee system is contributing to court budgets and a decline in spurious litigation. *Source: Box 2. Gas Tariff Adjustments (concluded), IMF staff report excerpts.* ### Box 3. Update on Corruption and Efforts to Tackle It ### Box 3. Update on Corruption and Efforts to Tackle It ### Perceptions and impact - Perceptions of corruption remain strong, undermining public support for reforms and the business environment. - Several recent corruption indicators rank Ukraine in the lowest quartile worldwide. - Addressing corruption is the most pressing issue in the country for 94 percent of respondents to a poll published by the Kiev International Institute of Sociology in January 2016. - Corruption is reported as one of the most problematic factors for business and investment in Ukraine. ### Legal and institutional reforms undertaken - Legal frameworks have been strengthened to: - improve the criminalization of acts of corruption, - make use of anti-money laundering tools to deter the proceeds of corruption, - ensure comprehensive asset disclosure by senior officials, - establish anticorruption institutions. - Authorities recently passed legislation to improve governance in state-owned enterprises, including: - the appointment of independent supervisory boards, - mandatory audits, - transfer assets to the privatization fund and facilitate their privatization. - The independent National Anti-Corruption Bureau of Ukraine (NABU) started its work in late 2015. - The authorities launched the asset declaration system for high-level officials on September 1, 2016. - Additional planned reforms to support transparency include: - streamlining business licenses, - improving public procurement, - reducing related-party lending and improving oversight of banks, - further enhancing the privatization framework, - reducing the large public sector and ensuring adequate wages, - strengthening tax administration. ### Implementation outcomes and limitations - Results of these efforts have been limited. - So far, no high-level official has been convicted for corruption. - In 2015, the national budget only received US$4,000 of confiscated proceeds of corruption. - Notwithstanding some efforts, the prosecutors’ office and the judiciary remain weak. - Some high-level prosecutors have noted political interference in their effort to fight corruption. - Opinion polls reflect limited progress in addressing elite power structures that exert undue influence on the legislative and regulatory frameworks, as well as on public institutions and SOEs. ### NABU and enforcement developments (timing and quantities) - By end-July 2016: - 24 cases had been sent to court by NABU, - two court decisions required the restitution of US$45 million of embezzled funds, - NABU had seized more than US$175 million in financial assets. - End-August 2016: - the NBU announced having imposed fines on six banks, primarily due to breaches of compliance with due diligence requirements on political exposed persons. ### Summary implications - Authorities have expressed commitment and advanced legislative and institutional steps to tackle corruption and improve SOE governance. - Implementation challenges—weak prosecution and judiciary, political interference, lack of high-level convictions, and negligible confiscated proceeds entering the budget in 2015—indicate limited progress to date. - Continued focus on enforcement, judicial and prosecutorial reforms, and implementation of transparency-enhancing measures will be critical to translate legal and institutional changes into measurable reductions in corruption. *IMF staff summary.* ### Box 5. Exceptional Access Criteria ### Box 5. Exceptional Access Criteria ### Overall assessment - Staff is of the view that the program continues to satisfy the substantive criteria for exceptional access. - This assessment is premised on the expectation that the authorities’ policies under the program are implemented in full. ### Criterion 1: Exceptional balance of payments pressures - The member is experiencing or has the potential to experience exceptional balance of payments pressures on the current account or the capital account resulting in a need for Fund financing that cannot be met within the normal limits. - Ukraine has experienced exceptional balance of payments pressures emanating from both the current and capital accounts, requiring financing well beyond normal limits, despite expected financial support from the international community. ### External liquidity and reserve adequacy - Official reserves remain very low covering only 45 percent of short-term debt. - Official reserves are well below the 100 percent adequate benchmark of the Fund reserve metric. - A package of capital control measures is still in place to support financial stability. *Source: Box 5. Exceptional Access Criteria (content unit: _cr16319).* ### Box 5. Exceptional Access Criteria (concluded) ### Box 5. Exceptional Access Criteria (concluded) ### Criterion 2 — Debt sustainability assessment - Requirement: "A rigorous and systemic analysis indicates that there is a high probability that the member’s public debt is sustainable in the medium term." - Where debt is unsustainable ex ante: exceptional access only if financing from sources other than the Fund restores debt sustainability with a high probability. - Where debt is sustainable but not with high probability: exceptional access justified if non‑Fund financing improves debt sustainability and sufficiently enhances safeguards of Fund resources. - Non‑Fund financing may include, inter alia, financing obtained through any intended debt restructuring. - Scope: This criterion applies only to public (domestic and external) debt, but analysis will incorporate relevant contingent liabilities, including those potentially arising from private external indebtedness. - Case assessment (Ukraine): - After the successful completion of the debt operation, public debt is projected on a clearly downward path, reaching 72.8 percent of GDP by 2020. - Gross financing needs remain on average significantly below DSA higher risk benchmarks during and after the program period. - Sensitivity tests: debt remains on a non‑explosive path after a number of reasonable macroeconomic shocks. - Shift in debt composition toward official debt with longer maturity and lower cost lessens risks. - Conclusion: "Thus, staff considers the debt to be sustainable in the medium term with high probability." ### Criterion 3 — Prospects of regaining market access - Requirement: Member has prospects of gaining or regaining access to private capital markets within a timeframe and on a scale enabling it to meet obligations due to the Fund. - Assessment (Ukraine): - Program policy and financing mix address long‑standing domestic and external imbalances to stabilize the economy and revive medium‑term growth. - Measures, together with successful completion of the debt operation, expected to improve confidence, reducing Ukraine CDS and bond spreads and ultimately regaining market access. - Staff anticipates "good prospects for regaining access to private capital markets before the end of the program period" with successful implementation and continued international support. ### Criterion 4 — Prospect of program success - Requirement: Policy program provides a reasonably strong prospect of success, including institutional and political capacity to deliver adjustment. - Assessment (Ukraine): - The EFF is "broadly on track" despite delays in completing the review. - Key prior actions and important structural reforms implemented: the 2016 budget, gas market law, anti‑corruption institutions, banking resolution, and large front‑loaded increase in energy tariffs. - Risks: fragile parliamentary majority; conflict in the East remains a major challenge. - Positive signal: new authorities have recently passed long‑standing program legislation demonstrating ability to secure parliamentary support. - Conclusion: With authorities’ strong commitment and significant technical support, prospects for program success remain strong. ### C. Capacity to Repay the Fund and Risks to the Program - Baseline capacity: "Ukraine’s capacity to repay the Fund remains adequate, albeit subject to large risks." - Key statistics and projections: - Repayments to the Fund over the next five years would peak at a manageable 8.1 percent of reserves in 2018. - By the end of the arrangement in early 2019, outstanding credit to the Fund is projected at about 17.6 percent of GDP, or 59 percent of gross reserves. - Debt service to the Fund as a ratio of exports of goods and services would peak at 5 percent in 2018. - Effects of the debt operation: gross financing needs are contained during the period when the first large repayments come due to the Fund in 2018 and during the post‑program period, mitigating risks to the Fund. - Risks and uncertainties: - Main risks: domestic political situation, geopolitical developments. - Program interruption (weak performance or intensification of conflict) would adversely affect Ukraine’s ability to repay and weigh on market and investment sentiment. ### D. Exchange System - Status: Several prior exchange restrictions and multiple currency practices (MCPs) removed, but some remain; these are subject to Fund approval under Article VIII, Section 2(a) and 3. - Remaining exchange restrictions: - Absolute limits on the availability of foreign exchange for certain non‑trade current international transactions. - Partial ban on the transfer abroad of dividends received by nonresident investors from foreign investments in Ukraine. - Remaining MCPs: - Use of multiple price foreign exchange auctions conducted by the NBU without a mechanism to prevent a spread deviation of more than 2 percent between the auction and market exchange rates. - Requirement to transfer any gains from the purchase of foreign exchange to the state budget if it is unused and resold. - Eliminated measures (with dates where provided): - Requirement to provide a tax clearance certificate before obtaining authorization for import payments eliminated on September 8, 2015. - MCPs arising from (i) potential spread of more than 2 percent in NBU auction rates and (ii) use of official exchange rate for exchange transactions with some SOEs were eliminated effective July 1, and June 2, 2016, respectively. - A September 2015 regulation banning foreign exchange purchases for certain import payments resulted in nonobservance of the PC on non‑imposition of restrictions on payments and transfers for current international transactions, but this measure has since been removed. ### E. Program Monitoring - Commitments and documentation: - Attached Letter of Intent (LOI) and Memorandum of Economic and Financial Policies (MEFP) describe authorities’ progress and commitments. - Waiver requests and conditionality changes: - Authorities request waivers of non‑observance of: - End‑December 2015 PC on the NBU’s net international reserves (based also on increased foreign exchange purchases in Q2). - Continuous PC on the non‑accumulation of external debt arrears (given ongoing restructuring efforts and elimination of some arrears following restructuring agreements). - PC on non‑imposition of restrictions on payments and transfers for current international transactions (measure giving rise to restriction removed). - Modifications proposed to program conditionality, new performance criteria (PCs) and indicative targets: - PCs for end‑September 2016, end‑December 2016, and end‑March 2017. - Indicative targets for end‑June 2017. - New indicative targets on inflation and government spending. - New structural benchmarks (MEFP Tables 1–2). - Rephasing of access: - Authorities request rephasing of access and reduction in number of reviews to 11 to align purchases with reform progress and balance‑of‑payments needs (MEFP Table 3). ### Structural Conditionality (prior actions and structural benchmarks) - Selected measures and status: - Fiscal - Adopt 2016 budget consistent with the program — PA — Done - Reduce options for early retirement — PA — Done - Adopt parametric pension reform — SB — End‑December 2016 - Merge tax and customs administrations — SB — End‑December 2016 - Energy - Raise gas tariffs to cost recovery — PA — Done - Raise heating tariffs to cost recovery — PA — Done - Ensure subsidies remain within the budget ceiling — SB — End‑September 2016 - Introduce automatic tariff adjustment mechanism — SB — End‑October 2016 - Anticorruption - Appoint anticorruption prosecutors — PA — Done - High‑level officials required to complete asset declaration — SB — End‑October 2016 - Strengthen investigative powers NABU — SB — End‑November 2016 - SOE reform and business environment - Strengthen payment discipline — SB — End‑September 2016 - Strengthen corporate insolvency regime — SB — End‑September 2016 - Submit land reform legislation — SB — End‑September 2016 - Complete triage of SOEs — SB — End‑October 2016 - Amend privatization law to streamline processes — SB — End‑December 2016 - Note: "Prior actions for the second review and structural benchmarks for Sept‑Dec 2016." ### Staff Appraisal — Findings, priorities, and recommendations - Overall assessment: - "More than one year after its approval, the program is on track and delivering positive results." - Signs: activity picking up, inflation receding, confidence in the currency and banking system increasing, gross international reserves doubled. - Key accomplishments: - Significant fiscal adjustment. - Bold gas tariff increases to cost recovery ahead of schedule, eliminating Naftogaz deficits. - Banking system cleanup efforts and successful completion of debt operation with private bondholders. - Steps to reduce excessive regulations and tackle SOE finances. - Remaining challenges and policy priorities: - Accelerate reforms to convert stabilization into sustainable growth; resist entrenched vested interests and avoid stop‑and‑go reform cycles. - Continue fiscal structural reforms to ensure medium‑term sustainability: - Improve tax and customs administration. - Adopt parametric pension reforms to address large structural pension deficit. - Maintain progress on energy reforms: - Ensure continuous tariff adjustment to market levels. - Improve energy efficiency and corporate governance of Naftogaz. - Monetary and financial sector: - NBU to prioritize rebuilding international reserves while conditional easing of interest rates is considered after continued disinflation and external position strengthening. - Continue revamping monetary policy framework to set stage for inflation targeting when conditions allow. - Persist with banking sector reforms: recapitalization, unwinding related‑party lending, resolution of impaired assets. - Structural transformation and governance: - Intensify measures to combat corruption, restructure and divest state‑owned companies, and prosecute high‑level corruption cases to establish rule of law and attract investment. - External support and arrears policy: - Continued external support from multilateral and bilateral partners is important. - Private bondholders generally supported the debt operation. - Important to reach agreement on restructuring debt held by Russia in line with program parameters. - "Firm commitments of full program financing are in place for the next twelve months" and good prospects of adequate financing for the remaining program period. - Staff recommendations: - Recommendation to complete the second review and the financing assurances review under the EFF. - Staff considers that "the Fund may provide financing in line with the Fund’s policy on lending into arrears to official bilateral creditors given that the criteria underpinning the Fund’s arrears policy are satisfied." - Support for waivers requested (end‑December 2015 PC on NBU net international reserves; continuous PC on non‑accumulation of external debt arrears; PC on non‑imposition of new restrictions on payments and transfers for current international transactions). - Support for approval of retention of exchange restrictions and MCPs for a period of 12 months on grounds they are non‑discriminatory, imposed for balance of payments reasons, and temporary. - Support for rephasing of remaining access under the program to better align financing with policy implementation. *Source: IMF staff.* ### 011.8 million became effective ### _cr16319 - 011.8 million became effective ### Annex: Debt Sustainability Analysis — Overall assessment - Under the policy and financing package supporting the extended arrangement under the EFF, including the recent completion of the debt operation as per terms consistent with program targets, and conditional to a no material intensification of the conflict in the East, Ukraine’s public debt is assessed as sustainable with high probability. - Public debt is projected to remain above the 70 percent of GDP high-risk benchmark in the debt sustainability framework in the near term, and to reach below 70 percent of GDP by 2021. - Drivers of the projected downward path: successful completion of the debt operation, sustained fiscal adjustment (including elimination of quasi-fiscal losses in the energy sector), growth recovery, renewed efforts to advance structural reforms, new momentum in privatization, and real exchange rate appreciation. - Main risks to the downward trajectory: growth and real exchange rate shocks; regress to historical levels of the primary fiscal balance due to failure to implement and sustain programmed fiscal adjustment; larger-than-expected contingent liabilities emanating from the banking sector. - The average gross financing needs during the program and post-program period are forecast to remain well below 15 percent of GDP. - The shift in debt composition towards official debt with longer maturity and lower cost reduces financing risks. - External DSA: external debt would peak at 145 percent of GDP in 2016, with the historical scenario showing unsustainable dynamics; significant non-financial foreign assets provide a buffer; sustained reduction in current account deficits and voluntary private debt restructuring would place external debt on a downward path. ### A. Key assumptions in the DSA - Real GDP growth: - 2015 output decline of 9.9 percent (compared to 9 percent at time of the first review). - Real GDP growth projected at 1.5 percent in 2016. - Growth expected to reach 4 percent by 2020 (instead of 2018 as previously projected). - Exchange rate: - Stabilized around UAH24–25 per dollar. - Expectation of a small real exchange rate appreciation over the medium term supported by contained current account deficits and resumption of capital inflows. - Inflation (GDP deflator): - Peaked at 38 percent in 2015. - Projected to recede quickly in 2016 to about 13½ percent. - Gradually decrease over the medium term to a steady state of about 6 percent. - Fiscal and Naftogaz deficits: - 2015 general government budget deficit reduced to 1.2 percent of GDP (program target was 4.2 percent; 2014 outturn 4.5 percent). - Naftogaz deficit declined to less than 1 percent of GDP in 2015 (program target 3.1 percent; 2014 losses about 5.5 percent). - Combined fiscal deficits during projection period remain in line with program targets. - Cyclically-adjusted primary surplus of the general government projected to remain from 2017 onwards at about 2 percent of potential GDP — representing an adjustment of around 24.5 percentage points of GDP over 2013. - Historical context: average cyclically-adjusted primary deficit of 2.2 percent of GDP over 2004–13. ### B. Other identified debt-creating/reducing flows - Banking system support: - Fiscal costs in 2015 amounted to 2.3 percent of GDP (below a projection of about 8 percent of GDP). - Public funds for banking system support rephased and revised up to 7.3 and 1.6 percent of GDP for 2016 and 2017, respectively. - Naftogaz recapitalization: - Recapitalization bonds for a total of 1.5 percent of GDP issued in 2015 (below 6.1 percent of GDP provided in 2014). - No more fiscal support envisaged during the medium term for operational and investment purposes. - Program assumes Naftogaz would need an additional 1.4 percent of GDP of financing support to clear the stock of arrears with Gazprom in 2017. - Issuance of guaranteed debt: - Authorities issued 0.6 percent of GDP of new guarantees in 2015 (programmed envelope 1.5 percent of GDP). - Program target for 2016: 1.2 percent of GDP for new guarantees (bulk earmarked to support official financing to Naftogaz: WB loan guarantee for US$500 million and IFC loan for US$200 million). - Assumption: issuance of new guarantees over the medium term limited to 0.3 percent of GDP per year. - Privatization proceeds: - Proceeds of 0.5 percent of GDP received in 2015 (above about 0.1 percent of GDP per year in past two years). - Program assumes 0.8 percent of GDP per year for 2016–20 (below historical average of 1.1 percent during 2004–14). - Expectation: Odessa Portside Plant privatized in late 2016; regional energy distributors privatization by end-2016; power generator Centrenergo by end-March 2017. ### C. Debt operation: scope, terms, and outcomes - External liabilities eligible for the debt operation: public and publicly-guaranteed debt (sovereign and sovereign-guaranteed Eurobonds, city of Kyiv Eurobonds, and guaranteed commercial loans) and SOE debt (non-guaranteed Eurobonds and loans) with total nominal value of US$22.3 billion. - Restructuring of public and publicly-guaranteed (PPG) external debt: - PPG restructuring amounted to US$19.1 billion (including the US$3 billion of debt held by Russia). - Three completed debt exchange offers for PPG: i. Sovereign and sovereign-guaranteed Eurobonds: - Exchange offer on US$18 billion bonded debt launched on September 22, 2015. - Broad creditor participation except Russia (holds a US$3 billion Eurobond). - Collective action clauses (CACs) triggered in participating bonds leading to no holdouts but Russia. - Restructuring terms included a 20 percent haircut on the outstanding nominal amount; 0 percent haircut on capitalized accrued interest; issuance of nine broadly equally-sized new bonds maturing as bullets during 2019–27 (versus 2015–23 under existing instruments). - Coupon of 7.75 percent for all bond series (versus a pre-exchange average of 7.2 percent). - Value recovery instrument (GDP-growth warrant) providing potential upside during 2021–40 (capped at 1 percent of GDP during 2021–25) if nominal GDP is above US$125.4 billion and real GDP growth is above 3 percent during this period. - The NPV haircut (excluding VRI payments) at the exit yield of 10 percent is estimated at about 28 percent. - DSA assumes a restructuring agreement will be reached with respect to the Russian-held bond involving no nominal haircut and a repayment schedule and coupon rate consistent with program financing and debt objectives. ii. City of Kyiv Eurobonds: - On November 23, 2015, the City of Kyiv launched an exchange offer to restructure Eurobonds due 2015 and 2016 amounting to about US$0.6 billion. - The 2016 bond attracted broad creditor participation and triggered its CAC; the 2015 bond fell short of needed participation. - Scope of eligible instruments announced in Cabinet Resolution No. 318 on April 4. - Original schedule of amortization of instruments included in the debt operation presented in table (billions of U.S. dollars) and chart (pre- and post-restructuring amortization, VRI payments), with total nominal US$22.3 billion. ### Risks, scenarios, and caveats - Projected debt reduction is subject to considerable risks, particularly from growth and real exchange rate shocks, failure to implement programmed fiscal adjustment, or larger-than-expected banking contingent liabilities. - External debt peak: 145 percent of GDP in 2016 under baseline; historical scenario shows unsustainable dynamics. - Presence of significant non-financial foreign assets provides a buffer for maintaining external debt service. - In 2016, the high-risk threshold of 15 percent of GDP for gross financing needs is breached by a small amount; however, the 2016 program is fully financed, and about half of the financing needs relate to provisioning for potential bank recapitalization costs. *Source: _cr16319 - 011.8 million became effective* ### 59.5 percent tenderi ### _cr16319 - 59.5 percent tenderi ### Sovereign and guaranteed debt restructuring - 59.5 percent tendering the old bond and ultimately receiving the new bonds. A moratorium remains in place for the holdouts on the 2015 bond of the amount of US$101 million. - Restructuring terms upgraded a non-guaranteed debt to a sovereign liability and mirrored those offered for sovereign Eurobonds except for: - nominal haircut: 25 percent; - maturity extension: only taps of the 2019 and 2020 new sovereign bonds. - Resulting NPV haircut at the exit yield of 10 percent was about 35 percent (somewhat higher than the sovereign offer). - Guaranteed commercial loans: in April 2016 the Ministry of Finance, together with SOEs Ukravtodor and the Yuzhnoye State Design Office, reached agreements with Sberbank of Russia and Citibank on restructuring sovereign-guaranteed loans to the aforementioned SOEs. - The two commercial banks hold 80 percent of the restructured US$0.5 billion guaranteed loans. - Restructuring converted the guaranteed loans into sovereign bonds, mirroring sovereign Eurobond terms except for: - nominal haircut: 25 percent; - maturity extension: tap of the 2019 new sovereign bond. - All creditors received a ratable amount of all nine series of new bonds, subject to priority allocation whereby creditors holding the September and October 2015 Eurobonds were provided only 2019 new bonds; this reduced the amount of new bonds due 2019 available to other creditors and increased their share of new bonds due 2020–27. ### Restructuring of SOE debt - Selected SOEs external liabilities amounting to US$3.3 billion were restructured. - Objectives: contribute to the financing target of US$15 billion during the program period and limit contingent liabilities to the sovereign while SOEs repair balance sheets. - Deals involved Eurobonds and external commercial loans of Ukreximbank, Oschadbank and Ukrainian Railways, with broad creditor participation leading to no holdouts. - Restructuring terms: - extended maturity without nominal haircut; - repayments starting gradually after the program period; - increased coupon rates by an average of 100 basis points. - Pre- and post-restructuring amortization schedule depicted in source (USD billion). ### Financing and program debt targets - Assuming completion of remaining external liabilities restructuring as per expected terms, the debt operation is consistent with program financing and debt objectives. - Target 1: - The restructuring of PPG debt, together with rescheduling of SOEs external liabilities included in the debt operation, is estimated to reduce Ukraine’s external debt service payments by US$15.7 billion during the program period (compared to the program target of US$15 billion). - Target 2: - Under the macroframework applicable at the time of the sovereign debt exchange offer, staff projected debt/GDP in 2020 would reach 72.1 percent, exceeding the ceiling of 71 percent by a small amount. - Under the revised macroframework, the debt-to-GDP ratio by 2020 is projected at 72.7 percent, mainly as a result of the higher nominal depreciation. - In any case, the debt-to-GDP ratio would fall under 70 percent of GDP by 2021. - Target 3: - Average gross financing needs (GFNs), taking into account payments to creditors arising from the VRI under the baseline, are projected at about 9.5 percent of GDP during 2019–25, with GFNs remaining below 12 percent in any single year, thus meeting target 3. - The debt operation reduced GFNs during the program period (2015–18) from an average of 18 percent of GDP to 12 percent. ### Official financing and market access - Official financing: - Multilateral and bilateral financing provided at concessional rates (tied to Euribor/Libor and fixed annual rates below 2 percent, respectively). - Loans amortizing in the range of 10–20 years (multilaterals granting a grace period of about five years). - IMF lending under the current program is calibrated to be on EFF terms. - Market access: - Evidence points to an early return to market access in past successful pre-emptive debt operations with time to re-access at about three years from the start of the operation. - Ukraine’s time to re-access markets after its 1998 debt restructuring was also about three years. - It is expected that by late 2017 Ukraine would be able to re-access international capital markets (5-year bonds at the yield of 9 percent), supported by the improved debt profile and assuming continued de-escalation of the conflict in the East. - Low gross financing needs during the post-program period, well below the high-risk benchmark in the debt sustainability framework, would help ensure needed continuous market access. ### Public sector DSA coverage and baseline debt dynamics - Public debt coverage in this DSA includes: - (i) central government direct debt (including domestic debt held by the NBU amounting to 20 percent of GDP at end-2015); - (ii) domestic and external government-guaranteed debt extended to SOEs (with 25 percent of total guaranteed debt (excluding IMF) having been called and currently served by the central government at end-2015); - (iii) debt of local governments; - (iv) NBU’s liabilities to the IMF. - It does not contain non-guaranteed SOEs’ domestic and external liabilities. - Baseline projections indicate the debt ratio would fall below 70 percent of GDP by 2021. - Debt reached 80 percent of GDP at end-2015, a jump of 8 percentage points from 2014, driven mainly by exchange rate depreciation and a deep recession. - The increase was contained due to the nominal haircut accepted by private creditors, significant fiscal over-performance, delayed IFIs disbursements, reduced issuance of new guarantees, and lower Naftogaz recapitalization needs and banking system support than envisaged. - Another round of nominal depreciation due to BOP pressures, catch up of IFIs disbursements, and rephased and higher fiscal costs for bank restructuring and resolution would lead public debt to increase in the near term. - Thereafter, sustained fiscal adjustment and growth recovery (as well as real exchange rate appreciation and privatization receipts) would underpin gradual convergence of debt to below 70 percent of GDP by 2021. ### Risks, fan charts, and debt-sustainability indicators - Heat map and fan charts indicate significant risks to debt sustainability even after successful completion of the debt operation and assuming full program implementation; uncertainty is heightened by the sudden deterioration of the external environment. - Risk mitigants: - Reduced gross financing needs projected to average 12 percent during the program and 9.5 percent after the program. - EMBIG spread declined from a peak of 4,312 basis points in 2015:Q1 to an average below 800 basis points in 2016:Q2, reflecting de-escalation of the conflict in the East and successful completion of the debt operation. - Share of public debt held by non-residents is high (2/3 of total debt), but the shift from private to official creditors reduced implied risks (share of official debt in total debt increased by 12 percentage points in 2015). - Short-term debt ratios are very low; share of foreign currency debt is projected to decline in coming years. - Fan chart interpretations: - Symmetric fan chart: upside and downside risks to main macro variables treated as equally likely. - Asymmetric fan chart: shocks to the primary balance and REER restricted to be negative to reflect limits of fiscal effort and possibility of continued depreciation; shows risks skewed upward if fiscal consolidation and FX stabilization fall short. ### Stress-test results - Stress tests indicate considerable downside risks to the debt outlook; the projected decline in public debt remains fragile and vulnerable to: - lower growth, - continued exchange rate depreciation, - contingent liabilities from the banking system. - Growth shock: - Lower growth by one historical standard deviation in 2017–18 to -5.1 percent and -4.6 percent, respectively, leading to primary balance deteriorations to deficits of 2.5 and 5.8 percent, respectively, would push the debt-to-GDP ratio to 117 percent in 2018. - Real exchange rate shock: - Replicating half the size of FX pressures experienced in 2014 (nominal exchange rate moving from 27.5 in 2016 to 45.9 in 2017) would push the debt ratio to 116 percent of GDP by 2018. *Source: IMF staff calculations, public sector DSA and debt operation description in the provided content.* ### 2017. The combined macro-fiscal shock, an aggregation of the shocks to real growth, interest rate, ### _cr16319 - 2017. The combined macro-fiscal shock, an aggregation of the shocks to real growth, interest rate, ### Debt dynamics under shocks - The combined macro-fiscal shock, an aggregation of the shocks to real growth, interest rate, primary balance and exchange rate, produces unsustainable dynamics, sending debt above 160 percent of GDP in 2018. - Under the contingent liabilities shock: - A large associated shock to growth (10 percentage points below the baseline in 2017–18) is imposed. - Given the resulting deterioration in the primary balance together with an increase in interest rates, debt peaks at 112 percent of GDP in 2018. - The impact is mitigated by the program buffer embedded under the baseline for bank restructuring and resolution costs. - A scenario based on Ukraine’s historical variables (with flat growth and primary deficit at -0.8 and 1.7 percent, respectively) leaves debt very high and flat at about 98 percent of GDP. - The implementation of the EFF-supported program, especially the targeted fiscal adjustment and structural reforms to facilitate growth recovery, should prevent the historical-scenario outcome from occurring. ### Gross financing needs and financing-risk indicators - The shocks scenarios point to risks related to larger-than-expected financing needs, including to support the banking sector. - While the debt operation has reduced gross financing needs, in 2016 the 15 percent threshold would be marginally exceeded on the back of revised bank recapitalization needs, which leaves the classification in the heat map at high risk. - Under stress tests, only the combined shock has a meaningful impact on gross financing needs, raising it to an average of more than 20 percent of GDP during the projection period. ### External Sector DSA — baseline and risks - Baseline projections suggest external debt would drop by about 50 percentage points of GDP by 2021, while remaining high. - Gross external debt would peak at 145 percent of GDP in 2016 from slightly below 100 percent in 2014 before declining to about 100 percent of GDP by end-2021. - External adjustment underpins medium-term sustainability: - Trade balance of goods and services moves from a deficit of close to 9 percent of GDP in 2013 to an average of about 2 percent by 2020. - Debt operation impacts the primary income balance in the current account. - Expected sustained recovery of non-debt creating capital inflows supports the decline. - Non-financial sector foreign currency assets remain significant: - Net IIP contracted from 66 percent of GDP in 2015 to close to 50 percent in the medium term (projection). - Non-financial sector foreign currency assets at 99 percent of GDP by end-2015 reduce net exposure and help maintain external debt service. - Corporations engaged in voluntary debt restructuring/refinancing with increasing amounts of principal repayments deferred: 5.8 percent of GDP in 2015 versus 1.7 percent in 2014. ### External downside risks and shock magnitudes - Downside risks to external debt dynamics include macroeconomic shocks or a quick reversal of the recent external adjustment. - Specific risk scenarios and impacts: - If the current account deteriorates on average by about 1 percent of GDP per year compared to the baseline, the external debt ratio would increase by about 8 percent of GDP by 2021. - A half historical standard deviation shock from the growth path under the baseline (about 3 percentage points lower growth on average per year) increases the external debt ratio by about 21 percentage points of GDP by 2021. - Reduced FDI due to confidence effects from a prolongation or intensification of the conflict in the East would significantly affect external debt dynamics, causing a sizable upward shift in the debt adjustment path. - The historical scenario (main macro variables constant at their 10-year historical average) generates unsustainable dynamics as a result of a permanent state of recession: - Real GDP contracting 0.8 percent per year. - GDP deflator in U.S. dollar terms flat at just 2.9 percent. ### Stress-test results and scenario summaries (selected figures and outcomes) - Annex. Figure 6 summary (external debt bound tests): - Historical scenario external debt: 168 (percent of GDP) shown as historical. - Baseline external debt: 99 (percent of GDP). - Interest rate shock average shown: 103 (percent). - Growth shock average shown: 120 (percent). - Current account (noninterest) shock average shown: 107 (percent). - Combined shock average shown: 119 (percent); another combined shock entry: 146 (percent). - Real depreciation shock: 30% depreciation simulated. - Program external debt sustainability framework (selected baseline levels and changes): - Baseline: external debt (percent of GDP) by year: 2013: 79.1; 2014: 95.4; 2015: 134.6; 2016: 141.3; 2017: 136.2; 2018: 129.8; 2019: 118.4; 2020: 107.5; 2021: 98.4. - Change in external debt: 2.5; 16.3; 39.1; 6.7; -5.0; -6.5; -11.4; -11.0; -9.0 (percent of GDP by year). - Identified external debt-creating flows (4+8+9): 4.6; 32.2; 40.8; -2.9; -3.5; -4.8; -5.2; -5.2; -4.5. - Current account deficit, excluding interest payments: 3.2; -1.5; -5.8; -5.8; -5.1; -4.9; -4.0; -3.5; -3.0. - External debt-to-exports ratio (percent): 173.9; 193.0; 254.9; 275.7; 274.2; 267.3; 247.0; 227.2; 211.7. - Gross external financing need (billions of U.S. dollars): 85.5; 69.9; 48.1; 46.2; 41.7; 41.9; 45.9; 50.1; 50.1. - Gross external financing need (percent of GDP): 47.6; 52.8; 53.1; 53.0; 43.8; 39.9; 40.0; 40.0; 36.6. ### Baseline and alternative scenario assumptions (selected) - Baseline underlying assumptions (selected annual figures shown across projection years): - Real GDP growth (percent): 0.0; -6.6; -9.9; -0.8; 7.6; 1.5; 2.5; 3.0; 3.5; 4.0; 4.0 (ten-year listing includes earlier years). - GDP deflator in U.S. dollars (change in percent): 2.2; -21.1; -24.1; 2.9; 19.0; -5.1; 6.6; 6.8; 5.5; 5.2; 5.2. - Nominal external interest rate (percent): 8.0; 5.0; 4.3; 7.1; 1.4; 5.3; 5.6; 5.5; 5.1; 5.2; 5.3. - Growth of exports of goods and services (U.S. dollar terms, percent): -9.2; -19.9; -27.0; 3.9; 25.9; -6.5; 6.0; 7.5; 7.8; 7.9; 7.5. - Growth of imports of goods and services (U.S. dollar terms, percent): -6.7; -27.5; -29.9; 5.9; 31.0; -6.4; 5.9; 7.1; 9.0; 8.2; 8.2. - Current account balance, excluding interest payments (percent of GDP): -3.2; 1.5; 5.8; 0.6; 3.1; 5.8; 5.1; 4.9; 4.0; 3.5; 3.0. - Net non-debt creating capital inflows: 2.9; -0.1; 3.5; 4.4; 2.2; 2.4; 2.4; 3.0; 3.0; 3.0; 2.8. ### Program policy commitments and recommended actions (from Letter of Intent and MEFP excerpts) - Fiscal consolidation and revenue measures: - A further fiscal adjustment of about 1.5 percent of GDP in 2017 is needed. - Fiscal effort will focus on adopting permanent measures to raise revenue collection and reduce expenditures. - Policy to refrain from revenue-reducing tax policy changes not fully offset by permanent measures. - Efforts aim at improving efficiency and equity of the tax system, including broadening the tax base by eliminating existing exemptions and refraining from granting new ones, and strengthening revenue administration. - Energy sector and quasi-fiscal deficits: - To eliminate the quasi-fiscal deficit of Naftogaz earlier than previously envisaged, decisions adopted to further increase gas and heating tariffs as of May 1, and July 1, 2016, respectively, to bring them fully to cost-recovery levels. - Financial sector and banking system: - Measures to restore financial sector stability, including bank restructuring and recapitalization (program buffer exists under baseline for bank restructuring and resolution costs). - Continued efforts to rehabilitate the banking system and improve governance of state-owned enterprises. - Structural reforms and governance: - Commitments to enhance transparency, address corruption, speed up privatization, and improve the business climate. - Legislation adopted and actions taken: asset declaration requirement for high-level officials; amendments to the Law on Privatization; new Law on Corporate Governance of State Property. - Corrective actions for missed structural benchmarks, including appointments and legal amendments related to anticorruption prosecution and adjustments to pension and insolvency reform timelines. - Program financing and reviews: - Request for completion of the second review and a disbursement in the amount of SDR 716.110 million. - Request waivers of nonobservance of specific performance criteria and completion of the financing assurances review. - Expectation that the third review will be based on end-September 2016 performance criteria and that remaining amounts be allocated over the next nine purchases. *Source: IMF staff and materials as contained in the supplied content unit.* ### 2015. The economic revival has continued into 2016, with real GDP growth accelerating to ### 2015. The economic revival has continued into 2016, with real GDP growth accelerating to ### Economic performance and outlook - Real GDP growth accelerated to 1.3 percent year-on-year in the second quarter. - Agriculture, retail sales, and construction have all posted strong gains over this period. - Despite a worsened external environment, including lower commodity prices, the forecast for 2016 was revised slightly downward to 1.5 percent. - Inflation rapidly dropped to 7.9 percent in July following exchange rate stabilization, prudent monetary policy, and weak demand. - Inflation is expected to pick up because of administered price adjustments, some strengthening in demand, and waning base effects. ### Balance of payments and reserves - The overall balance of payments was broadly in line with the program in 2015, but expected to worsen in 2016 due to a more adverse external environment. - The current account is estimated to have recorded a small deficit of 0.3 percent of GDP in 2015, about 1½ percentage points of GDP less than envisaged at the time of the first program review. - Gross reserves increased to over US$13 billion at end-December 2015, more than double the level at the start of the program, but below projections largely due to delays in disbursement of some US$5 billion in official financing. - The current account deficit is projected to widen to around 1.5 percent of GDP in 2016. - The resumption of private capital inflows is expected to enable faster accumulation of reserves. ### Monetary and exchange rate policy (A) - Commitment to: maintaining a flexible exchange rate, lowering inflation, and building reserves. - NBU net FX purchases since end-February 2015: US$3.1 billion. - Swaps/credit lines arranged with central banks of Sweden and Poland equivalent to US$1.5 billion. - Since spring 2015, Naftogaz met the bulk of its FX needs from the market or by borrowing from domestic banks and bilateral creditors. - Regular FX auctions started in September 2015; administrative restrictions were gradually eased in line with the agreed roadmap. - PCs for NIR at end-September and end-December 2015 were missed due to lower-than-expected commodity prices, delays in official disbursements, and domestic political factors. - Indicative target for end-June 2016 was observed after improvements in commodity prices and banks’ FX liquidity. - Policy actions to continue: - a. Build reserves in line with available net inflows; NBU to hold daily FX purchase auctions—market conditions permitting—aiming to build reserves without triggering market instability. - b. Ease administrative FX control measures gradually and cautiously in line with the roadmap, while closing loopholes, ensuring orderly FX market conditions, and supporting reserve building. NBU, in consultation with the IMF, will further elaborate the roadmap aiming to (i) strike a balance between preserving financial stability and alleviating adverse effects of administrative measures on the economy and investment, and (ii) communicate progress with the conditions-based plan. ### Monetary framework and inflation targeting (continuation of A) - Monetary policy framework evolving toward inflation targeting with primary goal to reduce inflation to single-digit levels in the medium term. - Central bank independence enhanced via amendments to the Law “On the National Bank of Ukraine.” - NBU operational improvements: forward-looking transparent policy based on macroeconomic forecasts, regular prescheduled NBU Board meetings, enhanced communications, streamlined interest rate framework emphasizing the key policy rate (interest rate on 14-day certificates of deposits (CDs)) with a symmetric corridor bound by overnight standing facilities. - An indicative target on headline inflation has been added to reflect the monetary policy regime evolution. - NBU to consult with IMF staff on the implementation of inflation targeting. ### Interest rates and policy stance (continuation of A) - Multi-year inflation targets: 12 percent (+/- 3 pp) by end-2016 and declining to 5 percent (+/- 1 pp) by end-2019. - NDA targets for end-September and end-December 2015 and indicative targets for first half of 2016 were met comfortably; base money declined more than expected and the NBU absorbed excess liquidity mainly through 14-day CDs. - Rate adjustments: - August–September 2015: discount rate reduced by 800 bps (to 22 percent); overnight refinancing rate reduced by 900 bps (to 24 percent); 14-day CD rate kept at 20 percent. - April 2016: discount rate reduced by 300 bps and 14-day CD rate reduced by 100 bps (both set at 19 percent); corridor for overnight facilities narrowed to +/- 200 bps around the 14-day CD rate. - May, June and July 2016: discount rate reduced to 18, 16.5 and 15.5 percent, respectively. - Forward guidance: - If disinflation and reserve accumulation are on track and monetary and financial stability are entrenched, the policy rate will be gradually reduced while maintaining rates positive in real terms on a forward-looking basis. - If inflation or financial stability risks intensify, monetary policy will be tightened as needed. ### Safeguards Assessment (B) - Measures to improve NBU governance, autonomy, and internal controls in line with IMF safeguards assessment. - Legislative amendments to the NBU Law adopted; committed to implementation. - Actions include prompt re-establishment of an Audit Committee and audit charter following constitution of a new Council of the NBU (appointment stage held up). - NBU adopted a new code of ethics prepared in consultation with IMF staff. - Internal control enhancements: - Permanent senior-level credit committee established in June 2015 to oversee NBU lending to financial institutions. - New lending and credit risk management process implemented; operations shifted from banking supervision to newly created credit and risk management departments. - Quarterly data audits ongoing with timely conveyance of results to the IMF. ### Financial sector policies (C) — strategy and progress - Continued steady progress on banking sector strategy to rehabilitate the financial sector and restore confidence. - Final results of second wave of bank diagnostics and NBU verification of related-party loans for the 20 largest banks communicated to each institution. - As of late-July 2016, 79 banks, accounting for about 30 percent of the system assets, have been resolved. - Six directions of ongoing work: - making further progress with bank recapitalization and restructuring strategy; - unwinding excess related loans and enhancing post monitoring of financial institutions; - enhancing banking supervision and regulations; - strengthening governance and financial performance in the DGF and state-owned banks; - improving the existing framework for resolving non-performing loans; - reforming securities markets. ### Making progress on recapitalization and unwinding related-party exposures - NBU completed review of recapitalization plans submitted by 16 out of the 20 largest banks that require additional capital; monitoring implementation of 14 approved plans. - Where applicable, banks may use post-diagnostic loan collection and incorporation of other commercial assets subject to strict conditions as mitigating factors; resolved two banks that missed presenting a credible plan. - All other 14 undercapitalized or insolvent banks have achieved a minimum CAR of 0 percent under the June 2016 regulatory framework. - Key recapitalization and mitigation implementation requirements: - a. Ensure implementation of recapitalization plans is on track so the 20 largest banks meet a minimum CAR of 5 percent by end-September 2016; capital needs from correction of old loan provisioning practices to be addressed as part of capital injection in line with new credit risk assessment regulation. Banks unable to meet minimum CAR of 5 percent by end-September 2016 will be resolved. - b. Mitigating measures in recapitalization plans must meet criteria: - (i) Integrity: all rights on assets, including associated income, are transferred, and post-diagnostic loan repayments are well sustained; - (ii) Sound legal documentation: transfers of ownership, liens, and cash flow associations based on legally binding documentation and adequately registered in public records; - (iii) Viability test: incorporation of commercial assets and consolidation of cash flows supported by credible and sustainable financial plans; - (iv) Proper valuation: value of assets received reflects true market prices; - (v) Timely unwinding of non-core assets: if mitigating measures lead to prudential limit breaches, unwinding should be completed no later than end-December 2018. - NBU has completed verification of integrity and soundness of legal documentation for assets transferred to banks’ balance sheets; ownership registration verified where applicable. - No later than end-September 2016, NBU will complete verification of viability tests and valuation of transferred assets (valuation by internationally recognized appraisers). - c. Banks showing breakeven or negative operating income through 2017 after stress tests must submit restructuring plans by end-September 2016 with measures to be adopted in the next 12–18 months to ensure viability. - d. Related-party exposures exceeding limits per the new framework are being addressed by banks in line with quarterly targets in unwinding plans. - By end-December 2016, review of related parties for the remaining 100 banks will be completed; review of first 10 largest banks in this group completed in July 2016. - Unwinding plans may be factored into recapitalization plans if banks provide firm assurances that a source of repayment is set aside (e.g., pledging marketable assets). - Upon successful completion of first year of unwinding plans (reduction of no less than 20 percent of original stock of related loans), banks could apply to the NBU to receive up to two additional years extension for repayment of at least one-quarter of the remaining related party loans in each of the following four years, provided these loans are and remain fully performing (as defined by NBU regulations). - e. Board approved results of the next 19 banks in July 2016. These banks are required to meet zero tier 1 capital by end-November 2016 and 5 percent CAR by end-February 2017. Any bank deemed not viable or unable to meet these deadlines will be resolved promptly. - Steering committee at the NBU to submit by end-November 2016 for board approval the results for the next 21 largest banks; these banks to inject capital according to the table in the source. - Remaining 57 banks, accounting for 2 percent of system assets, will undergo a targeted viability and capital needs assessment to ensure only sound and well-run banks remain; exercise to be completed no later than end-June 2017. ### Enhancing monitoring of related-party exposures - Related Parties Monitoring Office (RPMO) fully staffed to monitor monthly the level of outstanding loan amounts of all related parties referenced above and identify a preliminary list of new borrowers in banks subject to unwinding plans. - RPMO findings to be reported to the NBU board monthly; first report issued in June. *International Monetary Fund — Ukraine staff report excerpt* ### 2016. By end-October 2016 the RPMO, with technical assistance from the IMF, will review ### _cr16319 - 2016. By end-October 2016 the RPMO, with technical assistance from the IMF, will review ### Banking sector oversight, registry, and related-party lending - By end-October 2016 the RPMO, with technical assistance from the IMF, will review and, if needed revise its internal objectives and modes of coordination with other relevant NBU departments, and define a work plan for the next 12 months. - Based on main findings from the recent review of related parties, relevant regulatory framework was refined in July 2016 to eliminate remaining gaps that may be used by banks to evade credit limits. - NBU plans to expand its current Registry of Borrowers toward establishing by end-June 2017 a credit registry at the NBU to enhance credit risk and related-party loans monitoring. - In August 2016, the NBU board approved an action plan including key steps and critical dates. - By end-September 2016 NBU will submit necessary amendments to legislation to parliament to authorize the NBU to disclose information from the credit registry to banks. - Given more than 70 banks are under liquidation, law will introduce requirements for these institutions to regularly report to the NBU their credit data and allow the NBU to share such information with private credit risk bureaus. ### Strategy and contingency planning for systemic banks (resolution framework) - Strategy and contingency planning for systemic banks completed in line with best international practice and principles agreed with IMF and WB staff. - In case of need, in close consultation with IMF staff, authorities will: - Assess all resolution options and on that basis the NBU board will timely submit to the Cabinet of Ministers a detailed report, including a resolution proposal and rationale, capital needs over a 3-year horizon, and a technical discussion on minimum assumptions under which the selected resolution option meets viability. - The selected option will aim to avoid ultimate losses to the State and will: - fully write down existing shareholders; - ensure the full and timely servicing of loans including by adequate collateralization where lacking and by not imposing any impediments on the ability to collect related-party or any other loans in a timely manner; - secure bail-in from all liabilities to related parties. - In case of bank nationalization, hire a highly recognized international firm to run the resolved bank with commercial business perspectives. - No later than 90 days since the banks’ intervention, the MoF will establish and publish a “Memorandum of Understanding” with the resolved bank in the terms described in paragraph 17 of this MEFP. - Pursue legal and commercial means to ensure recovery from former bank owners of loans they directly and indirectly owe to the bank. - Create inside the bank a special unit to manage and collect these loans, managed by an internationally recognized asset management firm (AMF) appointed by the new supervisory board within the first 60 days after the bank’s resolution started. - Ensure, through the MoF’s financial policy department (FPD), that no later than 45 days after its appointment, the AMF will complete its strategy to collect the loans, including an action plan with detailed collection targets for the following 12 months. - Ensure recipient bank accounts government bonds received to cover existing gaps between assets and liabilities and as means of capitalization on the basis of international financial reporting standards (IFRS). NBU will follow the same accounting rules if it were to purchase such bonds or receive them as means of payment of stabilization loans from the MoF. ### Legal and regulatory enhancements for program implementation - December 2015: amendments to the Law of Ukraine “On Measures Aimed At Facilitating Banks’ Recapitalization and Restructuring” approved by parliament. ### Enhancing banking supervision and regulation - Measures announced mid-November 2015 to strengthen the banking system: - Starting January 2016: conduct risk-based supervision. - By end-March 2016: all banks required to have a transparent ownership structure. - By end-June 2016: banks required to hold a minimum authorized capital of UAH 120 million. - June 2016: NBU board approved a new regulation on credit risk activities to broadly align with Basel principles; effective September 1, 2016. - By end-September 2016 banks will submit to NBU their pro-forma balance sheet showing the impact of the new rule. - Full implementation deadline: January 1, 2017. - Since December 2015: NBU board receives monthly reports on potential problem banks based on revised Early Warning System. ### Strengthening bank governance and DGF financial performance - NBU to complete assessment of regulatory and supervisory framework on sound risk governance practices against the 2015 Basel’s Guidelines for Corporate Governance for Banks by end-September 2016. - By end-October 2016 NBU will submit draft legislation to parliament to address legal loopholes and pass revised or new resolutions, with full implementation no later than end-March 2017. - By end-June 2017, with external technical support, NBU will complete assessment of collective suitability of the board and qualifications of senior management of the 10 largest banks and instruct corrective measures within 90 days where applicable. - By end-August 2017: similar assessment for the next 10 largest banks. - Remaining banks reviewed through end-March 2018 in line with a calendar to be agreed with IMF staff. - Ministry of Finance (MoF) commitments for state-owned banks (SOBs): - Principles of State Banking Sector Strategic Reforms approved by the Cabinet in early February 2016. - SOBs’ supervisory boards to have 7 members, 5 independent and appointed by selection committee; shortlist of candidates from recruitment firm due no later than end-December 2016; selections by committee by end-January 2017. - By end-October 2016 expect parliament to adopt legislation facilitating new corporate governance approach for SOBs; draft to be submitted by end-September 2016. - Business strategy action plans for the three largest SOBs completed in first half of 2016. - By mid-2018, aim to sell no less than 20 percent of interest in the two largest SOBs to reputable international financial institutions and aim to unwind current full guarantee on Oschadbank’s deposits. - Aim to divest interest in the other three SOBs by end-2017. - With IMF technical assistance, assessment of the FPD completed to identify actions to be implemented by end-September 2016. - By end-October 2016, establish memorandums of understanding between the MoF and each SOB. ### Deposit Guarantee Fund (DGF) asset management and recovery - Centralized DGF unit established to manage assets from nearly 80 resolved institutions; fully staffed and operating. - DGF asset disposal calendar with quarterly targets through 2016; working on: - Accountability: progress report on asset disposal and recovery to be published no later than 30 days after end of each quarter; first report due in July 2016. - Efficiency: new strategies including electronic data rooms and expedited sale mechanisms; Ministry of Justice passed resolution to facilitate DGF work. - By end-September 2016 submit legislation to further enhance DGF’s ability to work with assets and provide legal protection to DGF staff. - By end-November 2016 place the first batch of assets under new asset-sale modalities. - Transparency: DGF anticorruption office to deliver quarterly ex-post evaluations of asset disposal processes; first results to be published no later than end-September 2016. - Forensic review: investigations by two specialized firms into drivers of two medium-sized banks’ liquidation; executive summary targeted no later than end-September 2016. ### Non-performing loans (NPLs) resolution and insolvency reform - June 2016: Parliament adopted Law of Ukraine “On Financial Restructuring” for coordinated out-of-court restructuring of non-financial corporates. - Committee chaired by Ministry of Justice drafting amendments to Law “On Restoration of Debtor’s Solvency or Declaration of its Bankruptcy.” - Amendments to be incorporated into draft bill No. 3132; revised bill expected adopted by parliament by end-September 2016 (new completion date for structural benchmark). - Additional legislation to remove tax impediments to insolvency and strengthen credit enforcement (mortgage law, commercial code, civil procedure codes) expected adopted by end-December 2016. - Legislation to guide restructuring of foreign currency denominated mortgage loans: - Will protect individuals in financial difficulties; - Target borrowers with loans not exceeding UAH 2.5 million as of end-December 2013 (about US$150,000) who live in the mortgaged properties as primary residence; - Establish a voluntary application process for eligible borrowers; - Guide banks to restructure loans based on borrowers’ capacity to pay, possibly including debt conversion and interest and principal reduction; - Require banks to establish an independent and credible mechanism for customers’ complaints; - Will not impose a cost on the banking system estimated to exceed US$370 million (0.4 percent of GDP). - Expect legislation consistent with these principles to be adopted by end-September 2016. - Simultaneously lift the moratorium on collateral foreclosure. ### Securities market and non-bank financial regulation - Addressing challenges at the National Securities and Stock Market Commission (NSSMC) including fictitious securities issuance and insufficient supervisory powers. - Parliament to adopt legislation by end-September 2016 to allow NSSMC to: - Conduct inspections and audits without undue constraints; - Demand and access information from any natural or legal person, including exemptions from secrecy laws; - Share information with foreign authorities and provide assistance regardless of NSSMC’s independent interest; - Adopt regulations under Ukrainian securities laws without external approval; - Access larger and more stable funding; and - Provide legal protections to NSSMC and its Chairman, Commissioners, and staff. - Legislation will require NSSMC to establish confidentiality and data protection frameworks and subject staff to confidentiality requirements and administrative/criminal sanctions for undue disclosure. - Submitted draft legislation to transfer regulatory responsibilities from NCFS to NBU for several non-bank financial intermediaries; aim to implement by end-December 2016. ### Fiscal policy stance and debt operation - Determined to continue fiscal consolidation to strengthen public finances and support financial stability. - Concluded a debt operation with private creditors and advancing discussions with other creditors aiming to achieve debt sustainability. ### 2015 outturn and 2016 budget measures - 2015: general government budget performed strongly; additional cost of bringing forward pensions and wages indexation from December to September 2015 was about UAH 9.9 billion. - Re-allocated UAH 5.6 billion from ministries to defense and increased allocation for clearing VAT refunds. - 2016: parliament adopted a budget consistent with a general government deficit target of 3¾ percent of GDP (prior action). - Introduced a ceiling on state budget (general fund) current primary expenditure (new indicative target). - Indicative targets on the cash deficit of the general government for first half of 2016 were met with comfortable margins. ### Tax policy changes effective January 1, 2016 (and other tax measures) - Social Security Contributions: unified into a single rate of 22 percent payable only by the employer; cap on base raised to 25 minimum wages from 17 minimum wages. - VAT: - Special VAT regime in agriculture terminated effective January 1, 2017; transitional 2016 remittances: grain producers remit 85 percent of their net VAT obligation, livestock breeders and milk producers 20 percent, all other agricultural producers 50 percent. - Committed not to extend transitional arrangement and not to amend requirement that special VAT regime expires on January 1, 2017. - Gas transit subjected to VAT, replacing current royalty regime. - VAT refunds: projected VAT refunds no longer included in annual budget law annexes; Ministry of Finance does not include VAT refunds in monthly revenue plan (ROSPIS). - Excises: increased specific excise tax rates on ethyl spirits (by 50 percent), fortified and sparkling wines and beer (by 100 percent), tobacco (by 40 percent), and gasoline and diesel (by 13 percent). - Corporate income tax: rate unchanged at 18 percent; introduced quarterly accruals and payments to avail additional revenue from lower social security contributions in 2016. - Personal income tax: single rate of 18 percent replacing 15 and 20 percent rates; tax deduction of half of a minimum wage continued only for individuals with incomes below 1.4-times the minimum subsistence for able-bodied individuals. - Simplified tax regime: increased rates for groups III and IV and reduced qualification threshold for group III to UAH 5 million from UAH 20 million. - Property taxation: raised rate and expanded base to include luxury houses and apartments; expanded tax base for luxury vehicle tax. - Taxation on gas extraction: lowered royalty rates to 29 percent (wells shallower than 5 thousand meters) and 14 percent (wells deeper than 5 thousand meters) from 55 percent and 28 percent, respectively. - Considering further amendments by end-September 2016 to establish a flat royalty rate and introduce a corporate profit tax surcharge. - Lowered royalty rates on gas for companies required by law to supply gas for households and heating companies to 50 percent from 70 percent from April 1, 2016. - Increased sales price for companies whose gas supplies form the stock of gas for households and heating companies to UAH 4849 (about US$185), excluding VAT, effective May 1, 2016. - Other revenue measures: increased royalties on amber mining; increased dividends from state-owned enterprises by raising government’s statutory share to 75 percent. - Adopt legislation to legalize amber mining by end-October 2016 and eliminate distortive foreign exchange transaction tax for cash operations by end-October 2016. - Launched renegotiations of double taxation avoidance agreements. ### Revenue administration reform and SFS restructuring - Continued implementation of revenue administration reform plan; moved all large taxpayers to the Large Taxpayers’ Office as of end-December 2015 (structural benchmark). - SFS organizational changes started end-December 2015; staff reduced from about 58,800 to about 44,000 as of end-April, 2016. - By end-September 2016: Parliament to adopt law to introduce one-level internal dispute resolution at the SFS. - New structural benchmark: expect parliament to adopt law to merge tax and customs administration into a single legal entity by end-December 2016. - Interim step: by end-September 2016 Cabinet to adopt resolution to merge tax offices into single legal entity and parliament to adopt legislation to merge customs offices into single legal entity within SFS. - Ensure structures compatible and reorganize SFS along functional lines by end-December 2016. - Consolidate regional offices and substantially reduce administrative functions at regional/local levels by end-December 2016. - Dissolve the tax police and, in consultation with IMF staff, establish by end-October 2016 a new civil service under the Ministry of Finance for investigation of financial and economic criminal offenses; may later consider bringing new tax investigations service within SFS. - Draft legislation to identify High Net Worth Individuals (HNWIs), bring them under new audit program, and provide SFS tools including access to bank account information with safeguards—expect adoption by end-October 2016. - Allow moratorium on tax audits for taxpayers with annual turnover less than UAH 20 million to expire at end-2016 as envisaged under Tax Code. - Finalize draft legislation to strengthen administrative enforcement of debt collection and authorize SFS to use indirect measurement methods—expect adoption by end-October 2016. - Targeted compensation reform at SFS to bring salary levels comparable to other reformed agencies and ensure funding for key IT systems and customs during 2016 within current budgetary allocation. - Harmonize bases for social security contributions and personal income tax effective January 1, 2017 and offer single filing and payment; finalize plan and launch taxpayer awareness program by end-September 2016. - New internal investigation division at SFS established; activities under independent expert group with annual publication of monitoring work. ### Customs reform, trade facilitation, and ICT priorities - Aim to appoint new deputy head of SFS in charge of customs by end-September 2016. - Adopt amendments to customs code by end-September 2016 to harmonize authorized economic operator requirements with EU legislation. - Establish post-clearance audit program by end-September 2016 and implement one-stop-shop service on customs (cabinet adopted resolution in May 2016; implementation started August 2016). - Minimize physical inspections, develop and publicize customs-specific integrity action plan, and strengthen coordination with state border guard services. - Identify key ICT projects for customs and seek external funding. - Improve customs valuation procedures by applying European best practices and promote conditional release procedure from Q3 2016. - Prepare project plan for further development of risk management by end-October 2016. *Italicized source attribution: IMF staff report content from the provided PDF excerpt.* ### 016. In order to ### _cr16319 - 016. In order to ### Border, transit and inland clearance controls; tax and customs administration - Initiate a third-party inspection of weaknesses at the border, in transit and inland clearance facilities with the aim of completing at least three largest border-crossing points and inland clearance facilities by end-December 2016. - Establish key performance indicators (KPIs) for the SFS in consultation with IMF staff for 2016 and 2017 in September 2016. These targets will focus, inter alia on core performance outcomes of tax and customs administration including audits, the collection of tax debts, eliminating the stock of VAT refund arrears and the internal reorganization. - In 2016, continue reducing the stock of corporate income tax prepayments, which have accumulated over the last few years, within the space created by any revenue over-performance. - Following the shift to a new VAT refund system in 2016, delink the payments of VAT refunds and the consideration of meeting net VAT revenue targets established by monthly plans, which should allow us to entirely clear the outstanding stock of VAT refund arrears. ### Simplified tax regime reform - Recognize need for a fundamental reform of the simplified tax regime, which remains overly complex and offers opportunities for arbitrage. - By end-September 2016 develop a proposal and take action to address its abuse and lessen the concessionality and complexity of the current regime and narrow the gap in the tax burden with those under the general tax regime. ### Permanent expenditure saving measures and medium-term public service reforms - To remain consistent with the program deficit target, develop permanent expenditure saving measures as part of a medium-term reform effort to improve the efficiency and quality of public services. - Pension reform (multi-phased strategy) - Implemented first phase in 2015: eliminated special pensions for civil servants and other privileged groups; increased retirement age and qualified period of service for a number of professions eligible for early retirement; extended pension withholding for working pensioners introduced in March 2015 through end-2016; decoupled the size of the maximum pension from the minimum wage and kept it unchanged at UAH 10,740. - As a prior action for this review adopted a Cabinet of Ministers’ decree reducing the list of occupations eligible for early retirement by at least 40 percent in terms of eligible persons. - By end-December 2016 adopt legislation (a new structural benchmark) to: - (i) gradually adjust the statutory retirement age and further reduce the scope for early retirement; - (ii) tighten the eligibility criteria for the minimum pension; - (iii) consolidate pension legislation, which is now spread across about two dozen laws, and ensure a single principle for providing pensions without privileges for any occupation (with the exception of the military); - (iv) expand the base for social security contributions; - (v) ensure equitable tax treatment of pensions; and - (vi) better link benefits to contributions, also to encourage the declaration of actual incomes. - Separate various categorical pension supplements from the labor pensions, bring their financing from the pension fund to the state budget and improve their targeting starting from 2017 to make the system more equitable and free up resources for more efficient poverty alleviation. - Until all the above measures have been adopted and the pension system is set on a sustainable basis, refrain from introducing a second pillar to the pension system. - Wage bill - Budgetary sector wages will increase taking into account the minimum wage growth by 5 percent on May 1, 2016 and 10.4 percent on December 1, 2016, compensating budgetary employees for the expected inflation and to help cushion the impact of increasing gas tariffs to cost recovery earlier than targeted. - Social assistance and social insurance reform - Improve targeting and progressivity of a number of social assistance programs through better means-testing. - Streamline and consolidate programs with similar objectives. - Realign the housing utility subsidies to prevailing international market prices for natural gas. - Ministry of Finance will complete the verification of beneficiaries of pensions and social benefits and take recourse against ineligible beneficiaries by end-December 2016, and reduce the administrative costs of the social insurance funds. - Education reform (to be implemented by September 2016) - (i) Further optimize the school network through closing smaller schools and transferring students to better equipped schools; - (ii) Improve targeting of financial assistance to students through better means-testing; - (iii) Streamline research institutions; - (iv) Facilitate private funding of higher and vocational education institutions; - (v) Devolve part of vocational school funding to lower levels of government. - Healthcare reform - Undertake reforms aiming to lead to higher decentralization, increased managerial autonomy for hospitals, and transition away from funding based on the number of hospital beds to funding services. - A full reform law will be adopted by parliament by end-December 2016. - As a first step, lowered the statutory limit on the number of hospital beds per ten thousand residents to 60 from 80 with a commensurate downsizing of hospital staff by end-September 2016. - Reformed the procurement system for pharmaceuticals in line with European standards and principles; procurements are made with involvement of the specialized organizations since the beginning of 2016. - Other expenditure measures - Rationalize subsidies, including to state-owned enterprises (SOEs). - Following the adoption of the new Law on Procurement, start implementing e-procurement from April 1, 2016 at the central government and from August 1, 2016 for all other public entities. - Increase co-payments or cut costs for cultural programs and public transport by end-September 2016. - Further streamline the number of government agencies. During 2015, reorganized ten and liquidated eight government agencies. - With assistance from the EU, started developing a comprehensive public administration reform strategy and will ensure the strategy is fully aligned with the medium-term fiscal program. - Further downsizing of the public sector could provide room for targeted wage increases to support efforts in combating corruption. ### Strengthening budgetary process and public financial management - Institutionalize a spending review process in line with IMF technical assistance recommendations. - Impose hard budget constraints on line ministries to encourage identification of savings within their resource envelopes. - Use the spending review process to develop high quality expenditure saving measures. - In cooperation with the EU and other international partners develop and have Cabinet adopt by end-December 2016 a comprehensive public financial management reform plan, which will include specific, measureable and time-bound actions in the areas of: - medium-term budgeting; - cash and debt management; - financial controls; - transparency of government finances; and - fight against corruption. ### Gas and heating price increases and compensatory social assistance - Increase in gas and heating prices to full cost recovery is accompanied by significant additional social assistance, with improved targeting, to support vulnerable households. - As part of the 2016 budget, increased the envelope for energy-related benefits (privileges and HUS) from around UAH 24.4 billion in 2015 to UAH 35 billion in 2016, and issued a supplementary budget to further increase it to UAH 40.3 billion to support the advanced increase of gas prices to cost recovery. - Initiated reforms to improve targeting to support vulnerable households and help to ensure that these programs remain fiscally affordable, including by: - (i) giving energy privileges recipients the choice between the privileges and HUS programs (but not both); and - (ii) updating the consumption norms for the HUS program to bring them closer to current consumption levels. - Review and adjust the parameters of the utility-related social assistance programs, including the HUS benefits formula, to ensure that benefits remain within the allocated fiscal envelope (a new structural benchmark). - Initiated a central monitoring system of the characteristics of households participating in the privileges and HUS programs. The system contains information on number of recipients, household income, and the amount of subsidies. - By end-September 2016, expand the capabilities of the system to report benefits and consumption levels across the income distribution to improve targeting. - Regularly analyze this information to monitor whether the two existing programs deliver assistance as intended. - Mailed HUS applications to every household and taken steps to manage the surge in applications for social assistance, including by dedicating adequate budget resources and additional staffing. ### Energy sector policy and Naftogaz - Continue to make significant progress with improving Naftogaz’s finances and advancing the agreed energy-sector reforms. - The Naftogaz deficit remains within program targets. In 2015, the cumulative cash deficit reached UAH 18.2 billion. *IMF staff report excerpt contained in content unit _cr16319 - 016. In order to* ### 0.9 percent of GDP), belo ### _cr16319 - 0.9 percent of GDP), belo ### Naftogaz, gas-sector reforms, and tariff policy - Commitment to eliminate the Naftogaz deficit by end-2017. - Independent diagnostic of Naftogaz receivables completed on time by Price Waterhouse Coopers with external funding by the UK’s DFID; first section of the report was published on September 30, 2015. - Revised formula for the distribution accounts collecting district heating bill payments to ensure Naftogaz receives a share proportional to the current cost of gas in the heating tariff and reintroduced the “adjustment coefficient” to allow Naftogaz to gradually collect payments for district heating company arrears that have accumulated since September 1, 2015. Commitment to keep distribution accounts operational. - Secondary legislation adopted to facilitate the new gas market law effective October 1, 2015; allowed for below-international-parity gas pricing for a transition period until 2017 and the provision of subsidies to vulnerable consumers. - Extended allowed use of state guarantees allocated in the 2016 budget for general purposes and for Naftogaz’s borrowing to also cover at least US$700 million as well as external guarantees provided by IFIs and private parties for the benefit of Naftogaz. - Reversed parliament’s decision to extend the moratorium on collection enforcement proceedings against Energoatom and the district heating companies; will ensure moratoria abolished as part of conditionality for the first program review are not reintroduced. - Prior actions and measures to raise tariffs and ensure cost recovery: - Cabinet of Ministers published decision to unify retail gas tariffs at a level consistent with full cost recovery effective May 1, 2016 (a prior action for this review). - NEURC decision published to increase retail heating tariffs to a level consistent with gas priced at full import parity effective July 1, 2016 (a prior action for this review). - Will revise by end-October 2016 the Public Service Obligations (CMU Resolution 758) to introduce an interim mechanism to adjust retail gas and heating tariffs on a quarterly basis if tariffs deviate from full cost-recovery levels (based on import parity as defined in the TMU) by 10 percent or more (a new structural benchmark). The first price adjustment, if needed, will be effective from January 1, 2017. Interim adjustment remains until tariffs are fully liberalized, no later than April 1, 2017. - Will adjust the price of domestic gas (UGV price) quarterly starting October 1, 2016 to ensure it remains in line with import prices. - Will amend CMU Resolution 758 to separate tariffs on gas transportation and distribution from the gas commodity cost and will monetize the benefits of the HUS program by end-March 2017 so private gas traders can compete with Naftogaz. - NEURC adopted a resolution in June 2016 to introduce compensation for technical losses into heat tariffs and set targets to reduce technical losses; resolution effective by September 1, 2016. - By end-September 2016, will adopt remaining amendments (Bill 4868) needed to facilitate application of the new gas market law. ### Governance, business climate, and State-Owned Enterprise reform - Structural reform agenda advancing to address corruption, strengthen business climate, and improve governance at SOEs. ### Anticorruption: institutional framework and implementation steps - NABU operational (end-January 2016 structural benchmark); recruitment and training underway. Out of a total envisaged complement of 700, about 453 staff, including 142 detectives, have been hired and are receiving training. - Legislation adopted on the asset recovery and management office and on asset confiscation and seizure, providing NABU ability to carry out provisional measures such as freezing and seizing assets, in line with FATF recommendation 4. - Ministry of Finance produced a strategy to reform the AML reporting framework to focus reporting on suspicious transactions as defined by FATF; strategy issued after consultation and with IMF technical assistance. - NBU implemented risk-based off-site and on-site AML supervisory tools focusing on risks related to domestic politically exposed persons, incorporating IMF technical advice. - Specialized anticorruption prosecution function established; head and two deputies appointed as a prior action for this review; adequate premises allocated. - Amendments to the Law on the Prosecutor’s Office to sustain a timely, fair, and balanced appointment process for anticorruption prosecutors, including: - Selection Committee members must be persons of impeccable reputation and high professional qualities. - Nomination by the General Prosecutor is interim until the Council of Prosecutors is established; thereafter nominations by the Council. - Selection Committee to be chaired by a widely recognized expert appointed by Parliament. - Selection Committee will submit only one candidate for each of the three positions (head and two deputies of the anticorruption prosecution function). - Authority for nomination and dismissal of other prosecutorial and non-prosecutorial staff of the anticorruption prosecutor’s office is to be granted to the head anticorruption prosecutor. - Electronic system for asset and income disclosure by high-level officials launched in accordance with law 2014/49, as amended, on September 1, 2016 by the National Agency for the Prevention of Corruption (NAPC). Key features include beneficial ownership reporting, prohibition on gifts above very low value, and NABU verification powers. ### Anticorruption: forward actions and benchmarks - Will submit legislation to parliament for adoption by end-November 2016 (a new structural benchmark) to ensure: - NABU has access to a wide range of investigative techniques (including undercover operations, intercepting communications, accessing computer systems, and controlled delivery) without relying on other agencies’ infrastructure. - Registration of pre-court cases and investigative judges’ rulings pertaining to NABU protected from leakage until case completion, while preserving rights of defense. - NABU will publish statistics on acts of corruption related to high-level officials under its jurisdiction on a webpage freely available to the public, in line with the template detailed in paragraph 96 of the TMU, on a quarterly basis. Information for Q1 and Q2 2016 to be published by mid-September 2016; thereafter publication by the end of the month following each quarter. - All high-level officials required to file assets and income declarations as defined under Article 46 of law 2014/49 for the calendar year 2015 within 60 days of launch of the e-filing system; officials who filed during test mode must resubmit; disclosures to be made freely available on a single website shortly after submission (a new structural benchmark for end-October 2016). Committed to further revisions as needed in agreement with IMF staff. - NBU completed 8 targeted inspections of banks focused on customer due diligence and politically exposed persons; will publish on an ongoing basis sanctions imposed for breaches of AML/CFT requirements by banks. - Steps to implement AML reporting reform by end-2016, including adopting amendments by end-September 2016 to ensure a three tier reporting system: - (i) suspicious transaction reports as defined by FATF, - (ii) threshold based reporting of cash transactions and international funds transfers, - (iii) mandatory reporting of transactions related to high-risk jurisdictions and politically exposed persons. - Will strengthen operational capacity and integrity of the Financial Intelligence Unit (FIU), appoint its head in line with new law on government administration, and increase staff salaries closer to those of other agencies involved in tackling corruption. - NABU will publish quarterly statistics on information received from the FIU (in line with paragraph 97 of the TMU); information for Q1 and Q2 2016 to be published by mid-September 2016 and thereafter quarterly by end of the month following each quarter. - Will adopt a law ensuring establishment of a specialized anticorruption court as provided in the new law on the judiciary, following review of such courts in other European countries, in line with European standards and best practices. - Will adopt by end-November 2016 a Law on the Business Ombudsman including clauses on adequate authority, immunities consistent with international practices, authority to impose administrative penalties, and access to information. ### Judicial reform and related measures - Parliament passed a constitutional amendment in June 2016 implementing structural changes to judicial organization and judge status; a prior draft received favorable opinion of the Venice Commission (October 26, 2015). Amendment abolishes probationary period for judges, introduces objective recruitment standards and procedures, and strengthens management by judges. Parliament enacted a new Law on the Judicial System and the Status of Judges. Will establish civic integrity councils within three months from publication as provided by that law. - Progress on specified benchmarks: - Orders of Payment and Garnishment: Draft laws providing for electronic submission of order for payment claims to be enacted by end-September 2016 (modified structural benchmark). These laws will amend relevant parts of the Code of Civil Procedure and the Code of Commercial Procedure. - Private Enforcement Profession: Parliament adopted in June 2016 a law establishing a profession of private enforcement agents, as set out in the February 2015 and July 2015 MEFPs. - High Council of Justice and High Qualification Commission: Will provide adequate financing so they can commence routine publication of statistical data by end-November 2016. Data will include number of cases closed, entered and pending for each time period, and sanctions applied for each case closed, if any. First data set will cover Q1, Q2 and Q3 of 2016 up to and including September 30, 2016. Thereafter data to be published quarterly throughout the period of the arrangement. - Court Fees: Reference to May 2015 law on increase in court fees (end-May 2015 structural benchmark) envisaged implementation beginning by September 1 (text cuts off). *Source: _cr16319 - 0.9 percent of GDP), belo* ### 2015. In this ### _cr16319 - 2015. In this ### Business climate and deregulation - Action plan to remove regulatory and legislative impediments to a growth-conducive business climate is being implemented, with some delays; the plan is being updated to reflect achievements and incorporate additional deregulation initiatives. - Monthly implementation reports are published on the State Regulatory Service’s and the Cabinet of Ministers’ websites following submission to the cabinet. - Looking ahead: - The Cabinet of Ministers will ensure full implementation of the plan, including publication of monthly implementation reports. Priority actions 1, 2, and 5 aimed at streamlining clarifying business registration and operation procedures were adopted by the Cabinet. - The Cabinet will cooperate with Parliament to ensure adoption of legislation necessary to implement actions 2, 5, 50, 54, and 62 from the plan by end-September 2016. - The Cabinet approved an updated methodology for regulatory impact assessment (RIA) in December 2015, which included mandatory quantitative regulatory impact analysis for all new and amended draft legislation. - A full-scale revision of regulatory norms is being prepared, including (i) review of all norms that influence businesses; and (ii) preparing recommendations on whether the norm should be eliminated, revised or maintained. This review is expected to be finalized by end-December 2016 together with a roadmap for implementation. - The Cabinet will ensure full functionality of the Law "On Licensing of Types Economic Activity." To date, the Cabinet has approved 13 licensing conditions (out of 30); the remainder will be adopted by end-September 2016. Delays in submission or approval of these rules and conditions will not serve as a basis for denying a license or for prohibition of business activities. - The Cabinet, in consultation with the IMF, will submit a draft law on agricultural land circulation to parliament by end-September 2016 (a new structural benchmark). Parliamentary approval of the law is expected by end-December 2016. ### State-owned enterprise (SOE) reforms - Strategy elements: (i) improving budgetary oversight by enhancing SOEs fiscal-risk assessment; (ii) improving governance of SOEs; and (ii) implementing transparent privatization, restructuring, or liquidation of identified SOEs in the medium run. - Near-term measures: - SOE fiscal risk assessment: - An inter-departmental working group established to improve methodology for assessing fiscal risks from SOEs liabilities. - Identified list of the 10 SOEs posing the biggest fiscal risks that will be subject to restructuring. - Reporting template developed, extended reporting coverage to include all arrears of the 50 largest companies, and reports on the stock of these arrears prepared. - A fiscal risks management unit will be established in the Ministry of Finance to put in place SOE fiscal risks monitoring and analysis framework, inform budget preparation, and provide expected fiscal impact on the budget. The unit will be responsible only for monitoring and analysis and will not interfere in SOE management. After establishment, a comprehensive statement of fiscal risks from the SOE sector will be prepared for inclusion in budget documentation and publication on the Ministry of Finance website. Analysis will later expand to broader fiscal risks such as macroeconomic and commodity price risks. - SOE governance: - Law “On Amendments to Some Legislative Acts of Ukraine on Corporate Governance of State Property” adopted, allowing supervisory boards at fully state-owned enterprises and making external audits obligatory for these enterprises. - The Cabinet will adopt, by end-September 2016, a decision regulating establishment of supervisory boards, member selection, and procedural matters. - Appointment targets: independent supervisory boards in at least five large SOEs by end-October 2016 and in at least 10 more large SOEs by end-December 2016. - First audit reports based on end-2015 financial results to be completed by end-October 2016. - Independent supervisory board of Naftogaz appointed: five members, with three independent members and two appointed upon nomination by the President and the Cabinet of Ministers. - Cabinet adopted decree establishing criteria for auditor selection in SOEs based on SOE size. Plan to have audit reports of 20 large SOEs completed and published by end-October 2016, and audit reports of at least 30 more large SOEs published by end-December 2016. - MEDT, in consultation with IMF staff, to develop by end-September 2016 a time-bound action plan for the single national Holding Company’s corporate governance structure and steps required to establish the Holding Company. - Triage of all SOEs: - Committed to triage all SOEs to classify them to: keep under State management (strategic commercial SOEs and SOEs performing regulatory, social, defense functions, and those in territories not under government control), sell (privatization), or liquidate (liquidation or bankruptcy). - MEDT, in consultation with IMF staff, will complete a preliminary triage of all SOEs and reconcile it within the Cabinet by end-September 2016; will review the list of “strategic” companies and assess their proper qualification. - Legal framework under review to allow triage implementation, including significant reduction of the non-privatization list, establishment of a special unit within the State Property Fund of Ukraine (SPFU) for liquidation of non-operating SOEs, and streamlined liquidation procedures. - Aim to adopt legislative amendments to allow triage implementation; complete triage in consultation with IMF staff and other ministries; approve by Cabinet resolution; transfer to the SPFU SOEs incorporated in the privatization plan for 2016 except those banned from privatization. Cabinet adoption and publication in the MEDT website of the triage and transfer of SOEs to the SPFU will be completed by end-October 2016 (a new structural benchmark). An action plan for privatization and liquidation of SOEs, including phased schedule for transfers to SPFU, is being developed. - Restructuring and liquidation: - Detailed restructuring action plans for five companies on the list of largest fiscal risks were prepared as an end-January 2016 structural benchmark; relevant line ministries together with MEDT and Ministry of Finance will ensure implementation. - Government plans to centralize liquidation of non-operating SOEs in one governmental body. SPFU, in consultation with ministries and IMF staff, is preparing a draft law enabling SPFU to liquidate certain SOEs (zero assets or assets smaller than liabilities) under streamlined procedures. Analysis of bankruptcy law for SOEs will be conducted and necessary changes introduced. Parliament adoption of this law expected by end-October 2016. Secondary legislation regulating transfer of non-operating SOEs between government bodies will be revised by end-October 2016 to simplify transfers to SPFU for liquidation. Ensure SPFU has sufficient institutional capacity, including financial and human resources. - Privatization: - Cabinet adopted a resolution identifying a list of SOEs subject to priority privatization with advisors. Cabinet also adopted action plans for these companies defining key parameters, timeline, method, and intermediate steps. Shares of all SOEs on the priority privatization list have been transferred to the SPFU; privatization will be initiated. - Parliament adopted amendments cancelling mandatory sale of 5–10 percent of shares on stock exchange. Cabinet will adopt by end-September 2016 secondary legislation establishing criteria for selection of advisors for large SOEs (Group G). - By end-September 2016, Cabinet will adopt the 2016 Privatization Plan. Parliament will adopt by end-September 2016 legislation to reduce the list of companies banned from privatization, notably to remove seaports and agricultural SOEs from the list; Cabinet will adopt necessary decisions to transfer shares of companies in the 2016 Privatization Plan to the SPFU. Transfer of these shares will be completed by end-October 2016. - MEDT and SPFU, in cooperation with the MoF, are preparing additional amendments to the privatization law to improve transparency and safeguards, and to streamline privatization, including: - i. Measures to prevent asset stripping in SOEs selected for privatization by limiting management’s right to enter long term contractual obligations (in excess of 6 months) and transactions exceeding specific value limits; personal liability of SOE managers for breaches and right to unwind affected contracts post-privatization; exception only with prior written consent from the SPFU. - ii. Streamlined procedures for privatization of small- and medium-sized SOEs. - iii. Comprehensive procedures for privatization of large-scale SOEs in line with international best practices. - iv. Improved cooperation between SPFU, law enforcement agencies, and regulatory authorities for verification of information about interested buyers. - These amendments will be completed in consultation with IMF staff, submitted to parliament by end-September 2016 and expect Parliament adoption by end-December 2016 (a new structural benchmark). - Progress on specific privatizations: - Significant progress on robust and transparent privatization of PJSC Odessa Portside Plant: engagement of advisors, information packages prepared and submitted to SPFU, financial audits based on end-December 2015 results according to IFRS and environmental audits completed. Cabinet approved conditions for sale requiring at least two bidders, at least one foreign. Expect SPFU auction by end-October 2016. - By end-2016, aim to undertake contest sales of JSC Kharkivoblenergo, OJSC Zaporizhyaoblenergo, PJSC Mykolayivoblenergo, PJSC Khmelnytskoblenergo, OJSC Ternopiloblenergo, following Odessa Portside Plant procedures. - Aim to launch privatization contest for PJSC Centrenergo and aim to complete its sale by end-March 2017, following same procedures as for PJSC Odessa Portside Plant. ### Program monitoring and conditionality - Implementation will be monitored through prior actions, quantitative performance criteria, indicative targets, continuous performance criteria, structural benchmarks, and quarterly reviews as envisaged in the Memoranda of Economic and Financial Policies dated February 27 and July 21, 2015 and this Memorandum. - Request to establish new indicative targets for the inflation rate. The attached Technical Memorandum of Understanding (TMU) defines quantitative performance criteria and indicative targets. - Prior actions and structural benchmarks are set out in Table 1. Quantitative targets for end-September and end-December 2016 and end-March 2017, continuous quantitative performance criteria, and indicative targets for end-June 2017 are set out in Table 2b and the TMU. ### Key prior actions and structural benchmarks (selected items and completion dates as listed) - Prior actions met: - Parliamentary approval of the 2016 budget and new tax code (Met). - Appointment of the Head Anticorruption Prosecutor and two deputies (Met). - Adoption and publication of Cabinet decision to unify and increase retail gas tariffs to 100 percent of cost recovery based on import parity effective May 1, 2016 (Met). - Adoption and publication of decisions to increase retail heating tariffs to 100 percent of level consistent with gas priced at full import parity effective July 1, 2016 (Met). - Adopt a Cabinet decree reducing lists 1 and 2 of occupations eligible for early retirement by at least 40 percent in terms of eligible persons (Met). - Proposed new structural benchmarks and dates: - Adjust utility-related social assistance parameters to ensure benefits remain within the allocated fiscal envelope (¶31a). End-September 2016. - Submit law on agricultural land circulation to parliament (¶38d). End-September 2016. - Revise Public Service Obligations (CMU Resolution 758) to introduce an interim mechanism to adjust gas and heating tariffs quarterly if tariffs deviate from full cost-recovery levels by 10 percent or more (¶33a). End-October 2016. - Ensure all high-level officials filed assets and income declarations for calendar year 2015 and full disclosures publicly available on a single website shortly after submission (¶36c). End-October 2016. - Cabinet approval and publication in MEDT website of completed triage of all SOEs and transfer to SPFU of those incorporated in the privatization plan for 2016 (¶39c). End-October 2016. - Parliamentary approval of legislation strengthening NABU investigative powers and protecting registration of pre-court cases and investigative judges’ rulings from leakage (¶36a). End-November 2016. - Parliamentary approval of comprehensive pension-related reforms (¶29a). End-December 2016. - Parliamentary approval of amendments to privatization law to improve transparency and streamline process (¶39e). End-December 2016. - Adopt legislation to merge customs and tax administration into a single legal entity (¶27a). End-December 2016. ### Quantitative performance framework (selected figures preserved exactly as in source) - From Attachment I. Table 2a (end-of-period; millions of Ukrainian hryvnias, unless otherwise indicated): - Ceiling on the cash deficit of the general government (2015 targets and actuals listed in Table 2a; see source for full schedule). - Floor on cumulative change in net international reserves (in millions of U.S. dollars) sample values include: -284, -471, -638, 2,098, 575, -576, 2,224, 127, -987, 2,545, 809, 1,084. - Ceiling on cumulative change in net domestic assets of the NBU sample values include: 84,571; 87,856; -1,924; 57,720; 81,731; 11,892; 54,520; 87,577; 9,595; 69,445; 96,817; 2,362. - Ceiling on publicly guaranteed debt sample values: 30,000; 30,000; 0; 30,000; 30,000; 12,758; 20,000; 20,000; 0; 20,000; 20,000; 0. - From Attachment I. Table 2b (selected targets for 2016–2017, end of period): - Ceilings and floors (PC/IT columns): - Ceiling on the cash deficit of the general government: 35,000 (September PC), 84,900 (December PC), 15,000 (March PC), 29,000 (June IT). - Ceiling on the cash deficit of the general government and Naftogaz: 30,500; 90,000; -1,100; 25,400. - Floor on cumulative change in net international reserves (in millions of U.S. dollars): 1,776; 2,317; 2,288; 3,498. - Ceiling on cumulative change in net domestic assets of the NBU: -2,886; 9,923; 22,584; 32,075. - Ceiling on publicly guaranteed debt: 28,200; 28,200; 15,000; 15,000. - Indicative targets: - Ceiling on cumulative change in base money: 25,123; 46,452; 58,655; 87,233. - Inflation (mid-point, percent): n.a.; 12.0; 12.0; 12.0. - Ceiling on current primary expenditure of the state budget (December PC): 526,000. - Memorandum items: - Naftogaz deficit (sample values): -4,500; 5,100; -16,100; -3,600. - External project financing (sample values): 8,965; 15,858; 4,000; 8,000. - Government bonds issued for banks recapitalization and DGF financing: 166,000; 166,000; 6,000; 12,000. - Program accounting exchange rate, hryvnia per U.S. dollar: 15.7686 (repeated for reporting periods). - Schedule of purchases under the Extended Arrangement (Attachment I. Table 3): - Total: 12,348 SDRs; 17,185 US$; 614 percent of quota. - Individual availability dates and amounts include: - March 11, 2015: 3,546.000 SDRs; 4,872.00 US$; 258.45 percent of quota. - June 15, 2015: 1,182.100 SDRs; 1,650.00 US$; 86.16 percent of quota. - September 15, 2015: 716.110 SDRs; 1,000.00 US$; 52.19 percent of quota. - November 15, 2016: 952.487 SDRs; 1,330.88 US$; 47.35 percent of quota. - February 15, 2017: 1,418.479 SDRs; 1,985.90 US$; 70.51 percent of quota. - Further scheduled purchases through November 15, 2018 (see source table for full list and exact amounts). - Note: For 2015–18, the average USD/SDR rates used are: 1.402, 1.397, 1.400, and 1.400, respectively. Ukraine's previous quota of SDR 1,372 million applies for 2015; Ukraine's new quota of SDR 2,011.8 million became effective in February 2016. The second purchase took place on August 4, 2015. ### Technical Memorandum of Understanding (TMU) — reporting and definitions (selected) - TMU dated September 1, 2016 sets out definitions of variables subject to quantitative targets for the Extended Arrangement under the Extended Fund Facility and describes methods for assessing program performance and information requirements. - Prior actions and structural benchmarks listed in Table 1 of the MEFP, with definitions in Section I of the TMU. Quantitative performance criteria are shown in Table 2 of the MEFP. Official exchange rate defined in Section II. Reporting requirements specified in Section III. - For program purposes, all exchange rates used to evaluate reserve levels and monetary aggregates are (i) the official exchange rate of the Ukrainian hryvnia to the U.S. dollar of [text continues in source]. *Source: IMF staff and Ukrainian authorities, as presented in the Memorandum of Economic and Financial Policies and Technical Memorandum of Understanding (September 1, 2016), extracted from the provided PDF content.* ### 15.7686 set by the NBU as of December 31, 2014; and (ii) reference exchange rates of foreign ### _cr16319 - 15.7686 set by the NBU as of December 31, 2014; and (ii) reference exchange rates of foreign ### Accounting and Program Exchange Rates - Program accounting exchange rates (kept fixed over the program period): - Hryvnia to dollar: 15.7686 set by the NBU as of December 31, 2014. - Swiss Franc: 0.9904 per dollar. - Euro: 1.2141 dollars. - Pound Sterling: 1.5587 dollars. - Australian dollar: 0.8187 U.S. dollars. - Canadian dollar: 0.8633 dollars. - Chinese Yuan: 0.1611 U.S. dollars. - Japanese yen: 119.6195 per dollar. - Norwegian Krone: 0.1343 dollars. - SDR: 0.690224 per dollar. - Official gold holdings valued at 1,206.00 dollars per fine ounce. - Note: These accounting exchange rates differ from actual market exchange rates. Setting a program exchange rate for computing monetary aggregates does not imply a policy target exchange rate. ### GDP Definition for Program Purposes - Gross domestic product compiled as per the System of National Accounts 2008 and excludes Crimea and Sevastopol. ### Net International Reserves (NIR) — Definition and Composition - NIR defined as dollar value of difference between usable gross international reserve assets and reserve-related liabilities to nonresidents, evaluated at program exchange rates. - Usable gross international reserves comprise all readily available claims on nonresidents denominated in convertible foreign currencies (consistent with BPM6 and SDDS). - Exclusions from usable reserves include, inter alia: - any assets denominated in foreign currencies held at, or claims on, domestic institutions; - all foreign currency claims of the NBU on domestic banks, and NBU deposits held at the Interbank Foreign Currency Exchange Market and domestic banks for trading purposes; - any precious metals or metal deposits other than monetary gold and gold deposits; - assets that correspond to claims of commercial banks in foreign currency on the NBU and any reserve assets that are (i) encumbered; or (ii) pledged as collateral; or (iii) frozen; - reserve assets not readily available for intervention in the foreign exchange market. - Reserve-related liabilities comprise: - all short-term liabilities of the NBU vis-à-vis nonresidents denominated in convertible foreign currencies with an original maturity of one year or less; - the stock of IMF credit outstanding; - the nominal value of all derivative positions (including swaps, options, forwards, and futures) of the NBU and general government implying the sale of foreign currency or other reserve assets; - all foreign exchange liabilities of the NBU to resident entities excluding foreign exchange liabilities to the general government or related to deposit guarantees. ### NIR/NDA Assumptions and Adjustment Mechanism - Assumptions in line with authorities’ commitments: - Rollover of central government’s domestic foreign exchange debt liabilities of 110 and 82 percent in 2016 and 2017, respectively. - Rollover achieved through issuance of new central government foreign exchange bonds with maturity of at least one year. - No early repayment of domestic foreign exchange bonds. - Footnote: Notional value of derivative commitments is used (not market value). - NIR target adjustments: - Adjusted upward (downward) by the full amount of cumulative excess (shortfall) in program disbursements relative to baseline (Table B). - Adjusted by cumulative excess (shortfall) in net issuance (gross issuance minus debt service) of central government domestic foreign exchange debt relative to baseline (Table C). - Symmetric adjustor applied for conversion of non-reserve currency from central bank swap agreements into reserve currency via outright sale (adjusted at time of conversion and on NBU repayment). - Adjusted upward (downward) by full amount of cumulative excess (shortfall) in net financing from debt operations relative to baseline (Table D). ### Projections for NIR/NDA Adjustment (selected figures as presented) - Attachment II. Table B. Eurobond Placements and Disbursements from IFIs and Official Sources (cumulative flows from end-December 2015, millions of U.S. dollars at program exchange rate): - End-September 2016: Eurobond placement 1,000; World Bank 30; EU 0; Others (Japan, Sweden, Switzerland, Turkey) 309; Total 1,339. - End-December 2016: Eurobond placement 1,000; World Bank 40; EU 930; Others 434; Total 2,404. - End-March 2017: Eurobond placement 1,000; World Bank 40; EU 930; Others 559; Total 2,5293,28 3 (text presents concatenated figures). - Attachment II. Table C. Net Issuance of Central Government Domestic FX Debt (cumulative flows from end-December 2015, millions of U.S. dollars at program exchange rate): - End-September 2016: 455 - End-December 2016: -38 - End-March 2017: -99 - End-June 2017: -156 - Attachment II. Table D. Net Financing from Debt Operations (cumulative flows from end-December 2015, millions of U.S. dollars at program exchange rate): - End-September 2016: 1,237 - End-December 2016: 2,467 - End-March 2017: 2,199 - End-June 2017: 2,470 ### Net Domestic Assets (NDA) and Monetary Base — Definitions and Adjustment Mechanisms - NDA defined as difference between monetary base and NIR (excluding conversion of non-reserve currency to reserve currency through outright sale under swap). NIR valued at program exchange rates and expressed in hryvnia for NDA computation. - NDA adjustment mechanisms: - Adjusted downward (upward) by full amount of cumulative excess (shortfall) in program disbursements relative to baseline (Table B) evaluated at program exchange rates. - Adjusted upward by full amount of cumulative excess in total NBU loans to the Deposit Guarantee Fund (DGF) and NBU purchases of government bonds issued for DGF financing and bank recapitalization (combined up to limit of UAH 166 billion in 2016 and UAH 12 billion in 2016 and January through June 2017), relative to baseline and evaluated at program exchange rates (Table E). - Symmetric adjustor for use and repayment of hryvnia by another central bank under swap agreement. - Adjusted downward (upward) by full amount of cumulative excess (shortfall) in net financing from debt operations relative to baseline (Table D) evaluated at program exchange rates. - Adjusted by full amount of cumulative excess (shortfall) in rollover of central government’s domestic foreign exchange debt liabilities relative to baseline (Table C). - Attachment II. Table E. NBU Net Loans to DGF and Purchases of Government Bonds Issued for DGF Financing or Banks Recapitalization (cumulative flows from end-December 2015, millions of hryvnia): - Net NBU loans to DGF and purchases of government bonds issued for DGF Financing: - End-September 2016: -635 - End-December 2016: -635 - End-March 2017: 455 - End-June 2017: 1,607 - NBU purchases of government bonds issued for Bank Recapitalization: - All reported periods: 0 - Monetary base (indicative target) definition: - Monetary base comprises domestic currency outside banks and banks' reserves, including cash in vault of commercial banks, and funds of customers at the NBU. - Currency outside banks defined with specific NBU account references and minus cash in vault at deposit money banks (DMBs). - Banks’ reserves defined as cash in vault at DMBs plus DMB correspondent account deposits at the NBU (NBU liabilities accounts 3200, 3203, 3204) plus funds of customers at the NBU in hryvnia (NBU liabilities accounts of groups 323, 3250, 4731, 4732, 4735, 4736, 4738, 4739, and 4750), plus accrued interest on time deposits (NBU accounts 3208L) and accrued interest on client current accounts. - Monetary base targets adjusted upward by cumulative excess in NBU loans to DGF and purchases of bonds for DGF/bank recapitalization up to limits and adjusted for swap usage symmetrically. ### Headline Inflation (Indicative Target) - Headline inflation defined as year-on-year rate of change of the Consumer Price Index as measured by Ukraine’s State Statistics Service. - Indicative target met if headline inflation falls within a range of +/- 3 percentage points around the mid-point target in 2016 and 2017. ### Cash Deficit of the General Government — Definition and Adjustors - General government comprises central (state) government including the Road Fund (UkrAvtoDor), all local governments, and all extra budgetary funds including the Pension Fund, Unemployment Fund, Fund for Social Insurance of Ukraine. - Cash deficit measured by net financing flows excluding valuation changes and composed of: - total net treasury bill sales (in hryvnias and foreign currency) as recorded in NBU registry (net treasury bill sales defined as cumulative funds realized from primary auction sales and government securities issued for recapitalization less cumulative redemptions), excluding bonds issued to recapitalize Naftogaz and other SOEs; - other net domestic banking system credit to general government as per NBU monetary statistics (all non-treasury-bill financing less change in government deposits) and any other financing not reflected in monetary statistics; - total receipts from privatization received by State Property Fund and local governments and proceeds from uncompensated seizures; - difference between disbursements and amortization on any bond issued by general government or NBU to nonresidents for deficit financing; - difference between disbursements and amortization of foreign credits to general government (including on-lent project loans); - net sales of SDR allocation in SDR department; - net change in general government deposits in nonresident banks; - net proceeds from any promissory note or other financial instruments issued by general government. - All foreign currency flows to/from the budget accounted in hryvnias at official exchange rate as of date of transaction; valuation changes excluded. - Adjustors to cash deficit ceiling: - Automatic adjustor for deviations in external project loans (disbursements to consolidated general government for project expenditure) from program projections (Table F): ceiling adjusted upward by 100 percent of excess or downward by 100 percent of shortfall (external project financing evaluated in hryvnia at actual exchange rates). - Automatic adjustor for budget support grants: ceiling adjusted downward (upward) by 100 percent of amount of budget support grants received in excess (shortfall) of program amounts (Table F). - Automatic adjustor for government bonds issued for banks recapitalization and DGF-financing up to cumulative maximum of UAH 166 billion in 2016 and UAH 42 billion in 2017 (amount included in targets is zero; indicative cumulative amounts in MEFP Table 2). - Automatic adjustor on stock of budgetary arrears on social payments (wages, pensions, social benefits) defined as payments not made thirty days after due date; excludes unpaid pensions to individuals resident in territories temporarily outside government control. - Automatic downward adjustor corresponding to full savings on budgetary interest bill resulting from any restructuring or reprofiling of existing government debt to NBU as of end-2015 (projected payments presented in Table G). - Attachment II. Table F. External Financing of General Government Projects and Budget—Adjustment (cumulative flows from January 1, 2016, in millions of hryvnia): - External project financing (technical assumption): - End-September 2016: 8,965 - End-December 2016: 15,858 - End-March 2017 1/: 4,000 - End-June 2017 1/: 8,000 - 1/ Cumulative from January 1, 2017. - Budget support grant (technical assumption): - End-September 2016: 0 - End-December 2016: 5,057 - End-March 2017 1/: 0 - End-June 2017 1/: 0 - Attachment II. Table G. Projected Payments of Interest on Government Bonds held by NBU (cumulative flows from January 1, 2016, In billions of hryvnia): - End-September 2016: 36.1 - End-December 2016: 49.3 - End-March 2017 1/: 10.6 - End-June 2017 1/: 22.9 - 1/ Cumulative from January 1, 2017. ### VAT Refund Arrears and State Budget Expenditure Ceilings - Ceiling on stock of VAT refund arrears set to UAH 0 billion. - VAT refund arrears defined as claims not settled within 74 days after submission in 2016 and 2017. - Ceiling on state budget current primary expenditure defined as current cash expenditure of general fund of central government net of interest payments on domestic and external debt plus payments of any past expenditure arrears; based on monthly treasury report (Kv_1ek) adjusted for Ukravtodor debt repayment. - Automatic downward adjustor on accumulation of new budgetary arrears on wages and social benefits (defined as payments not made thirty days after due date). ### General Government and Naftogaz Combined Cash Deficit - Cash deficit of General Government and Naftogaz equals cash deficit of General Government plus cash deficit of Naftogaz. - Naftogaz cash deficit measured from below-the-line as cumulative of: - net domestic banking system credit to company less change in company deposits; - disbursements minus amortization of private foreign loans (including private placements); - disbursements minus amortization of official foreign credits (including project loans); - disbursements of trade credits to import gas; - disbursements minus amortization on any bonds issued by Naftogaz; - net change in deposits of Naftogaz in nonresident banks; - net proceeds from promissory notes or other financial instruments issued by Naftogaz; - net receipts from sale of financial assets (including recapitalization or treasury securities issued to Naftogaz); - any other forms of financing not identified above. - Foreign currency flows for Naftogaz measured in hryvnias at official exchange rate as of transaction date; arrears outstanding valued at official exchange rate on test date. - Adjustors applicable to general government component also apply to combined ceiling. - Additional adjustors: - Adjusted upward by loan financing by multilateral institutions and official bilateral creditors disbursed to Naftogaz for investment projects. - Adjusted downward by net transfers made by Gazprom (advance transit fee) measured cumulatively from calendar year start. - Adjusted by net amount of accumulated domestic arrears by Naftogaz to Ukrgazvydobuvannya and Ukrtransgaz measured cumulatively from beginning of 2015. ### Continuous Performance Criteria and Publicly Guaranteed Debt - External debt payment arrear defined as payment by general government to non-residents not made within seven days after falling due (including grace period). Arrears from agreed clearance frameworks or ongoing restructuring negotiations excluded. Applies continuously throughout program. - Ceiling on publicly guaranteed debt applies to amount of guarantees issued in 2016 by central government; official exchange rate applies to non-UAH denominated debt. New state guarantees in 2016 limited to no more than UAH 28.2 billion. Excludes guarantees for NBU borrowings from IMF. ### Other Continuous Performance Criteria - During Extended Arrangement, Ukraine will not: - impose or intensify restrictions on payments and transfers for current international transactions; - introduce or modify multiple currency practices; - conclude bilateral payments agreements inconsistent with Article VIII; - impose or intensify import restrictions for balance of payments reasons. ### Official Exchange Rate Determination - NBU to set official rate daily as weighted average of interbank market deals on same day. - All deals concluded until 5:30pm on the day considered regardless of settlement date (including tod, tom and spot (T+2) deals). - NBU to make public its official exchange rate no later than 18:00 of the day preceding the one for which it is set. ### Cost Recovery of Gas and Heating Tariffs - Threshold deviation from cost recovery (import parity) to trigger quarterly tariff adjustment applies to commodity gas price defined as weighted monthly average of Naftogaz import prices (inclusive of transportation and entry costs) from date of last adjustment to date of calculation, multiplied by spot US$/euro and UAH/US$ exchange rates on date of calculation. - Date of calculation two months prior to effective date of adjustment (example: November 1, 2016 for January 1, 2017 adjustment). - Retail tariffs add transmission costs (Ukrtransgas), distribution costs (oblgases), provider mark-up, and VAT in effect at date of calculation as officially published by regulator. ### Reporting Requirements — National Bank of Ukraine (selected obligations and frequencies) - Monthly sectoral balance sheets for NBU and other depository corporations (SRFs) no later than the 25th day of following month. - Daily: stock of net and gross international reserves at both actual and program exchange rates; full breakdown of NBU accounts included in net international reserves; obligatory, voluntary and total foreign exchange sales; approved foreign exchange demand in interbank market (including Naftogaz purchases); official foreign exchange interventions and intervention quotations; results of any foreign exchange auctions; balances in analytical accounts 2900. - Daily publication on NBU website of daily holdings of treasury bills at primary market prices at current exchange rates with breakdowns and auction reports; monthly treasury bill report in agreed format to IMF. - Daily information on secondary market treasury bills transactions (volumes and yields) including OTC and breakout for NBU transactions. - Monthly NBU financial statements and projections if available as approved by NBU’s Council; immediate notification of updates. - Daily and monthly data on NBU financing operations (including swaps/refinancing) and mopping up operations; weekly bank-by-bank info on outstanding amount and weighted-average interest rates of loans from NBU by type of lending; monthly collateral information by bank and loan type, collateral type, haircut and currency. - Monthly report on banking sector indicators in format agreed with IMF no later than 30 days after reporting month; core and expanded FSIs for aggregate and individual banks in State Participation Group, Foreign Banking Group and Group 1. - Daily and monthly depository corporations surveys including net domestic assets, NBU loans and liabilities with banks, detailed loans provided to general government, balances of funds of government held at NBU (account 3240 A and 3513 A) and DGF. - Monthly projections for external payments falling due in next 12 months; quarterly data on actual settlement of external obligations (separately principal and interest, public and private) within 80 days after quarter end. - Quarterly stock of short- and long-term external debt (including arrears) for public and private sectors. - Daily data on foreign exchange export proceeds, obligatory foreign exchange sales, import transactions for goods and services, foreign exchange transfers and cash sales/purchases by individuals, T+n verification system summary, weekly noncash foreign exchange purchases on behalf of banks’ clients and banks (form N 538). - Daily data on foreign assets and liabilities of overall banking system (excl. NBU), banks’ open FX positions, deposits and loans breakdowns; weekly foreign assets/liabilities by bank for State Participation Group, Foreign Banking Group and Group 1; monthly foreign assets by type and liabilities by type, holder and maturity and rollover rates for credit lines and securities. - Daily bank-by-bank data for largest 35 banks and aggregates for bank groups on liquidity ratio, cash and cash equivalents, available funds in NBU accounts, correspondent accounts with well-known international banks, deposits from customers. - Daily aggregated currency flows including government foreign receipts and payments by currencies and interbank market operations by currencies; daily exchange market transactions including exchange rate. - Provision of reserve requirements information. - Monthly bank-by-bank average interest rate on deposits to customers for State Participation Group, Foreign Banking Group and Group 1; weekly average interest rate on interbank borrowings. - Bi-weekly data on risk-weighted assets and other risk exposures, total regulatory and core capital, capital adequacy ratio, loan maturities, deposits maturities, FX open position split on- and off-balance sheet. - Monthly data on loans and claims by currency, maturity, loan classification categories, collateral, provisions, large exposures, refinanced and restructured loans, average interest rate on outstanding loans, accrued interest on loans; securities holdings by category and currency. - Monthly bank-by-bank data on related-party exposures and deposits, collateral, provisions and largest 20 related-party loans counterparty names and amounts. - Monthly aggregates and bank-by-bank data on loans, provisions, deposits and due from banks by currency and classification categories. - Monthly cumulative income statements and related items for entire banking sector and bank groups. - On request, two-week bank-by-bank cash flow projections for large bank groups. - Bi-weekly reporting on increases in regulatory capital bank-by-bank with disclosure of instruments/transactions used. - Monthly notification of regulatory and supervisory measures against banks violating NBU regulations and decisions on declaring a bank problem or insolvent. - Quarterly balance of payments data within 80 days after quarter end. - Monthly data on credit to nongovernment units guaranteed by NBU no later than 25 days after month end. - Notification if Treasury does not pay interest or principal on domestic government bonds due to NBU or other entities; provide outstanding interest and principal. - Inform IMF staff of changes to reserve requirements. - Communicate changes in accounting and valuation principles applicable to balance sheet data and notify before introducing changes to Charts of Accounts and reporting forms. - NBU Internal Audit Department to provide assurance report to Fund no later than six weeks after each test date confirming monetary data accordance with program definitions and no changes to chart of accounts or valuation methods impacting data reporting. - Provide copy of annual management letter from external auditor within six weeks of completion of each audit for duration of arrangement and while credit outstanding. - Monthly data relative to interest income and principal received from January 1, 2016 on portfolio of government bonds and monthly coupons and principal to be paid (in hryvnia and foreign currency separately) on outstanding stock of government securities held by NBU and public no later than 15 days from end of reporting period. ### Reporting Requirements — Deposit Guarantee Fund (DGF) - Monthly data on total number and volume of household deposits broken down by deposit size, bank-by-bank for largest 35 banks and aggregate for remaining banks. - Monthly bank-by-bank reporting of insured deposits and total household deposits by domestic and foreign currency. - Monthly bank-by-bank reporting of total insured deposits and remaining insured deposits to be paid by DGF for banks under liquidation and provisional administration. - Monthly reports on financial position of DGF including cash balance, bond holdings, credit lines and loans. - Monthly reporting on financing arrangements of DGF including contracted financing from MoF. - Monthly one-year forecast of financial resources DGF expects to receive from MoF, NBU and other entities; amount DGF expects to pay to insured depositors in banks in liquidation; amount of asset recoveries expected by DGF. ### Reporting Requirements — Ministry of Finance (selected obligations) - Monthly consolidated balances (end-month) of other non-general government entities holding accounts at Treasury no later than 25 days after month end. - Daily operational budget execution indicators, daily inflow of borrowed funds by currency, expenditures related to debt service, weekly Treasury cash flow balances and forecasts including government FX deposits; 10-day execution data on revenue side and social security contributions; monthly data on funds deposited with Single Treasury Account and related registration accounts and inflows from Treasury liabilities to households and redemptions. - Monthly and quarterly treasury reports in electronic form no later than 25 and 35 days after period end respectively; final fiscal accounts at end of fiscal year no later than March of following year. - Monthly report on public wage bill (excluding SOEs) per agreed template; monthly reports on UrkAvtoDor borrowing (disbursements, interest, amortization); monthly information on municipal borrowing and amortization. - Monthly, no later than 15 days after month end, cash deficit of general government with details: privatization receipts, disbursements of external credits and amortization, net domestic borrowing including net t-bill issuance and change in government deposits. - Monthly stock of all budgetary arrears no later than 1st day of second subsequent month with separate line items for wages, pensions, social benefits, energy, communal services, other arrears; monthly accounts payable for state and local budgets; Pension Fund monthly reports on net unpaid pensions to individuals in territories temporarily outside government control. - Monthly information no later than 25 days after month end on amounts and terms of all external debt contracted or guaranteed by central government. - Monthly electronic provision of (a) outstanding stock of domestic and external debt of state and local budgets; (b) standard files planned and actual external debt disbursement, amortization and interest payments broken down by creditor categories; (c) report on external debt amortization and interest payments by days and currencies; report accumulation of any budgetary arrears on external and domestic debt service. - Monthly debt amortization schedules updated weekly. - Monthly data on external and domestic credit to key budgetary spending units and non-government units guaranteed by government including Naftogaz, State Mortgage Institution, DGF, Agrarian Fund (amount of sovereign guarantees effectuated; total outstanding guarantees and recipient list) no later than 25 days after month end. - Quarterly (no later than 50 days after quarter end) approved budgets and operational data and balance sheets for Pension Fund, Fund for Social Insurance, Employment Fund and other extra-budgetary funds; monthly reporting for Pension Fund. Within-year amendments reported within a week after approval. Annual financial statements of these funds no later than April following year. - Semi-annual data on number of employees of budgetary institutions financed from central and local budgets starting from January 2010; after any public sector wage increase provide cost estimates for current and two subsequent fiscal years for state and local government budgets. - Monthly data no later than 15 days after month end on budgetary costs associated with recapitalization of banks and SOEs including upfront cash impact and interest payment costs and changes due to supplementary budgets. - Monthly data on expenditure plans (ROSPIS) for state budget. ### Reporting Requirements — State Fiscal Service (SFS) - Monthly data on tax arrears inclusive of deferred payments, interest and penalties in specified format (beginning stock, netting out during month, deferrals, write-offs, collections, new arrears, ending stock; totals and breakdown principal, interest, penalties). - Quarterly listing of all tax exemptions granted no later than two months after quarter end specifying beneficiary, duration, and estimated revenue loss for current fiscal year. - Monthly information on VAT refunds no later than 25 days after month end in format: beginning stock of refund requests; refund requests paid in cash; refunds netted out; denied requests; new refund requests; end-of-period stock; stock of VAT refund arrears (claims submitted more than 74 days before end of period). - Monthly reports 1.P0 on actual tax revenue and 1.P6 on tax arrears no later than 25 days after month end. - Quarterly information no later than 25 days after quarter end on number of tax appeals and disputed amounts, internally resolved appeals and outcomes. ### Reporting Requirements — Ministries and Agencies (selected) - Ministry of Economy: quarterly information on communal service tariffs in all regions for major services and level of cost recovery; quarterly consolidated information from financial statements of 50 largest SOEs (excluding Naftogaz) no later than 80 days after quarter end including gross profit/loss, net financial results, subsidies, budget guarantees, stock of debt by domestic/foreign, taxes and dividends paid, wage arrears, other payment arrears; report on number of SOEs profit/loss/balanced. - Ministry of Energy and Coal Industry, Ministry of Housing and Municipal Economy, NCSREU and Ministry of Economic Development and Trade: monthly electronic reporting (no later than 25th of following month) on financial indicators in gas and heating sectors in agreed format (“Ukraine: The Financial Position of Gas Sector”) including prices and volumes of domestically produced and imported gas, sales, tariffs, arrears, payments to budget, subsidies, debt; Naftogaz to provide monthly updated financial liabilities schedule. - Ministry of Economic Development and Trade (based on Naftogaz): monthly electronic report on cash flows and deficit of Naftogaz; monthly break down of total cash outlays for gas imports from Gazprom by month in separate table. - Monthly reporting on domestic gas used by Naftogaz for sales to households, heating utilities, budget institutions and industries including gas produced by SC “Ukrgasvydobuvannya,” and OJSC “Ukrnafta.” - Ministry of Housing and Municipal Economy: quarterly information on quantity of building-level heating energy meters installed and ratio to applicable buildings no later than 25th of following month. - NCSREU: information on tariffs for heat energy for households, centralized heating services and centralized hot water supply by licensee in event of changes, average tariff levels net of VAT and VAT included; advance notice 10 days before meeting about amendments to distribution accounts regulation; inform following day on adoption of Register of norms for transfer of funds for heat/utilities in electronic format. ### Additional Reporting and Transparency Requirements - Ministry of Economic Development and Trade to report weekly on Naftogaz daily market purchases of foreign exchange. - State Statistics Service to provide revised quarterly GDP data and components no later than 10 days after revisions. - Ministry of Social Policy to provide monthly data on HUS and privileges for energy consumption in agreed excel format with specified breakdowns no later than agreed deadlines. - National Anti-Corruption Bureau (NABU) to publish quarterly on public website (no later than end of month following quarter) detailed statistics on indictments and convictions by Penal Code articles and categories and on FIU reports received related to suspicions of laundering of proceeds of corruption, in specified tabular formats, including fines (total value in UAH) and jail (total months and suspended jail). ### Program Implementation and Statement Excerpt - Statement by Oleksandr Petryk, Alternate Executive Director for Ukraine (September 14, 2016): - After sharp recession in 2014 and first half of 2015, economy started to recover. - Geopolitical conflict in East continues to hold back pace of recovery and create uncertainty. - New government appointed April 2016 following political tensions in late 2015. - Authorities implemented measures to strengthen fundamentals, restore sustainable growth and financial stability: pursue price and financial stability under flexible exchange rate, establish prudent strong banking system, sound public finances, fight corruption, implement structural reforms in public sector and SOEs. - All performance criteria and prior actions met except those on NIR for end-December 2015, non-accumulation of external debt payment arrears, and non-imposition of exchange restrictions. - Progress: economic growth picked up, inflation drastically reduced, banking system recovered, international reserves doubled relative to beginning of program, 2016 fiscal deficit and current account deficit in line with program objectives following significant over-performance in 2015, and debt operation with private bondholders completed. - Authorities committed to reach agreement on broader sovereign debt restructuring in good faith and in line with program objectives. - Authorities remain committed to program implementation and recognize risks and need for comprehensive and timely reforms. - Ex-Post Evaluation of Exceptional Access Under the 2014 SBA assessed 2014 SBA; authorities share main findings that intensification of conflict and loss of confidence led to unattainable program goals; replacement with EFF provided more financing for a longer period to support deeper reform plans. ### Macroeconomic Outlook (excerpt) - Q1 2016: for the first time since Q4 2013, real GDP increased in annual terms and is projected to grow by [text ends here in supplied content]. *Source: IMF technical memorandum and related sections contained in the provided content unit.* ### 1.5 percent in 2016. However, this is somewhat weaker than expected, predominantly due to ### _cr16319 - 1.5 percent in 2016. However, this is somewhat weaker than expected, predominantly due to ### Economic performance and external sector - Real GDP growth was 1.5 percent in 2016. - Industrial production recovered more slowly than expected: 1.7 percent in the first seven months of 2016 compared to the same period last year, because of difficulties in the mining and steel industries. - Foreign trade is the main driver of economic growth, despite the intensification of restrictions in trade with Russia. - Domestic investment increased in the first half of 2016 while private consumption remained subdued. - Labor market: recovering real wages, but unemployment remained high at around 10 percent. - Inflation slowed to 8.4 percent in August 2016 due to moderate aggregated demand, prudent monetary policy, stabilization of the foreign exchange market and ample supply of food products. - Current account: returned to a surplus in Q2 2016 of around US$1.0 bln. and remains in line with the program. - International reserves increased to US$14.1 bln. in August 2016, almost double the amount of end of 2014. - For some time, imports remained in line with the program assumptions. - The current account balance improved noticeably due to climbing grain export and higher-than-expected commodity prices. ### Fiscal policy, tax and pension reforms - The government budget performed well in 2015 and 2016, as the authorities controlled spending. - Debt interest payments declined following the debt restructuring. - Revenues increased and fiscal targets were met with large margins. - Parliament approved the 2016 budget in line with the program, supported by a new tax code as agreed with staff as a prior action. - Parliament adopted a comprehensive package of tax policy reforms as required under a prior action for this review. - A new electronic system of government procurement makes procedures more transparent and efficient, and public investment and services less expensive. - Significant progress has been made with improving the tax and customs administration. - Pension reform is the cornerstone of the structural reform agenda and critical for fiscal sustainability due to a rapidly aging population and a pension fund with a structural deficit. - Prior actions taken on pensions: - Eliminated special pensions to privileged groups. - Extended withholding pension for people that continue to work after reaching the retirement age. - Reduced the number of people eligible for early retirement (based on their occupation) by at least 40 percent (a prior action). - As a new structural benchmark, the authorities will further reform the pension system and social security contribution. ### Monetary and exchange rate policy and financial stability - In June 2015, the parliament amended the NBU law, increasing the NBU’s institutional and financial independence to secure monetary and financial stability, reduce inflation and build up reserves. - The flexible exchange rate helps adjust to domestic and foreign shocks. - The NBU intends to continue with foreign exchange auctions to further increase its reserves. - The NBU has built up reserves of around US$3 bl. on a net basis since the end of February of 2015. - The NBU agreed on temporary swap/credit lines with the Riksbank and National Bank of Poland equivalent to US$1.5 bln. - The NBU, together with the IMF, developed a road map for further gradual and controlled removal of the administrative restrictions; the optimal strategy is a trade-off between control of foreign currency outflow to ensure financial stability and the negative effects of administrative restrictions. - Strengthened communication with market participants is key to anchor expectations. - Inflation-targeting strategy: - The NBU board defined and announced a path of disinflation to reach in the medium term an inflation target of 5 percent associated with price stability. - The NBU set up a decision-making system based on a regular macroeconomic forecast, switched to a new operational framework with key policy rate as main instrument, and launched regular and systemic communications aimed at anchoring inflationary expectations. - Inflation is now an indicative target of the program. The authorities propose, on the occasion of the next review, the inflation as an indicative target of the program and propose switching to inflation-based conditionality under the EFF program for the next review. - Monetary transmission improvements: - Gradual narrowing of the interest rate corridor and ensuring interbank rates remain close to the targeted policy rate. - The NBU keeps the policy interest rate in positive territory and stands ready to absorb excess liquidity if necessary. - Banking system reform and stability: - Important progress with rehabilitation of the banking system; confidence was restored. - Second stage of diagnostics for the 20 largest banks was completed; recapitalization plans were submitted by the 16 banks which require additional capital. - The NBU is currently monitoring the implementation of 14 plans. - Capital requirements were increased and non-viable banks have been resolved. - New legislation introduced to limit lending to related parties and ensure transparent ownership of the banks. - The Related Parties Monitoring Office (RPMO) has been staffed to monitor outstanding loans to related parties and reports regularly to the NBU Board. - Non-performing loans (NPLs) and restructuring: - Authorities are working on strengthening the legal framework for private debt restructuring, adopting an out-of-court restructuring arrangement for corporate debt, and sponsoring a voluntary approach for the foreign currency denominated mortgage loans restructuring. - Banking regulation and supervision improvements: - More risk-based supervision and new regulation on credit-risk activities. - The NBU started to work with a Registry of Borrowers which allows monitoring credit risks and related-party loans. - Since December 2015, the NBU introduced monthly reports on potential problem banks, based on a revised Early Warning System (EWS). - The Ministry of Finance, as the main shareholder of the state banks, committed to run these banks on a commercial basis. - The authorities developed the Principles of State Banking Sector Strategic Reforms to provide a framework for transparency, improvement in management and a sound financial position of these institutions. ### Structural reforms and anticorruption program implementation - Energy sector reforms: - Significant progress reforming the energy sector; Naftogaz’s finances were improved and its cumulative cash deficit reached 0.9 percent of GDP in 2015, better than the program target. - The authorities remain committed to eliminate Naftogaz’s deficit by end-2017. - Retail gas tariffs were unified at the full-cost recovery level since May 1, 2016, as were the heating tariffs since July 1, 2016 (a prior action). - Anticorruption and judicial reforms: - The National Anti-Corruption Bureau of Ukraine (NABU) finalized the recruitment process for competent staff and has started to operate. - NABU management is implementing an action plan prepared by and agreed upon with foreign specialists, and supported by donors. - A specialized anticorruption prosecution function was established; the head of the anticorruption prosecutors and two deputies have been appointed in a transparent procedure (a prior action). - Parliament adopted a law requiring high-level officials to report their assets and income in an electronic declaration system; this information will also be publicly available online. - Administrative reforms launched with the traffic police and other public services; many institutions underwent a clean-up procedure. - The Ministry of Finance is implementing a framework for AML reporting and the NBU introduced risk-based off-site and on-site AML supervisory tools. - Political influence in the judicial process remains a challenge. Parliament proposed amendments to the Judges’ Organization; the preliminary draft was supported by the Venice Commission. These amendments will enhance judicial independence, introduce standards and procedures for recruitment, and strengthen management of the judiciary. - Public administration and SOE reforms: - Public administration reform has reduced the size of state working places and the civil service reform will reduce the wage bill and the size of public administration to enable higher wage levels, attract higher quality staff and reduce corruption. - The authorities continue with reform of state-owned enterprises. A privatization schedule for the 10 biggest SOEs was adopted. - The government initiated a review of the existing portfolio of SOEs to identify non-operating ones for subsequent liquidation. ### Final remarks - Despite external and internal challenges, the Ukrainian authorities remain committed to continue with difficult but necessary reforms. - The new government is determined to reform the economy and lay the foundation for sustainable growth and prosperity. - There is broad support and agreement that reform is the only way forward. - The authorities are grateful for the cooperation with and support from the Fund, other IFIs and the international community. *Source: IMF staff report excerpt provided in the content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16319.pdf_