Transcript of a Conference Call on the Extended Fund Facility Arrangement with Ukraine

March 18, 2015

Washington, D.C.
March 12, 2015

Thanos Arvanitis, Deputy Director, European Department
Nikolay Gueorguiev
, Mission Chief for Ukraine, European Department
Olga Stankova
, Senior Communications Officer, Communications Department

MS. STANKOVA: Good morning to everyone and thank you for joining the conference call on the release of the Extended Fund Facility arrangement with Ukraine. Following the Executive Board decision On March 11, we published a set of documents yesterday evening. They are available under embargo until 10:30 a.m. today, Washington time.

This conference call is to give you an opportunity to ask questions about those documents. The speakers at today’s conference call are Thanos Arvanitis, Deputy Director in the European Department of the IMF and Nikolay Gueorguiev, Mission Chief for Ukraine, also in the European Department.

With this I will turn the microphone over to Thanos and Nikolay who will say a few words about the program and then we will take your questions.

MR. ARVANITIS: Thank you, Olga. Good morning to all. As Olga said, here we are to give any further information that you need or explanations about the program. You have seen statements from the IMF, including from the Managing Director, from February 12 that the Executive Board approved the program yesterday. This is an ambitious program. It’s a comprehensive program. It’s a difficult program in some respects, but it’s absolutely necessary to restore stability and lay the basis for some growth in Ukraine over the medium term.

So the Board approved it last night. You have seen the set of documents. The total amount of financing under the Fund program is $17.5 billion over a four-year period. Of this, $5 billion was released yesterday and $10 billion will be disbursed, expected to be disbursed, during 2015.

Now Nikolay and I are open to answering questions in details.

QUESTIONER: Oh, hi. Thanks for doing this and taking my question, two good questions. Can you elaborate on the timing of the debt restructuring? I think in both letter of intent and the report it says that the debt operation will be concluded by mid-June, the timing of the first review. Can you clarify what that means? I mean does that mean that the rules for how the debt restructuring will unfold will be concluded by then, or does that mean that you expect an agreement to have been reached and any haircut to have been imposed by then?

MR. ARVANITIS: Thanks for the question. Look, you’re right to quote the staff report. We note that we expect the debt operation to be concluded by the time of the first review. This is around the time of June. As you may have seen, the authorities have called for a press conference tomorrow, Friday, in the afternoon. I think that they will be in a position to give you the full timeline of how they see these unfolding over the next few months. Certainly, they want -- with this conference call, they want to initiate the process. We understand that over the next several weeks there will be extensive consultations with all creditors before they finalize the instruments that are necessary to reach the targets under the program and also to gain support by your creditors.

I don’t have anything more to add on the timeline, but I’m sure that the authorities tomorrow will give you much more detailed information of how they see the next step between now and then.

QUESTIONER: And a quick follow-up on your GDP projection. I notice that it calls for a contraction of 5.5 percent this year. I believe the government not too long ago put out a forecast of a contraction of 11.9 percent this year, and I’m just wondering what accounts for that. I mean is it apples to oranges or why is your forecast more optimistic?

MR. GUEORGUIEV: At the moment, the government’s projection for GDP growth this year is the same at -5.5 percent and the budget, the revised budget, for the year is based on the same forecast. Now, what you’re probably referring to were various scenarios that were put out in the public space about a month ago. Indeed, they had different underlying assumptions and, indeed, one of them had such a big drop. I don’t quite remember the exact assumptions behind that scenario, but from what I remember they were much more averse than what we expect now and then what the government expects now.

QUESTIONER: Okay, thank you.

QUESTIONER: Great. Thank you for doing this. First of all, I’m curious about how you are able to approve a program on a policy that, as you all have regularly said, is purely speculative. The program is based purely on the assumption of a $15 billion debt relief, or as you say restructuring. Those negotiations haven’t yet happened. The agreement is a purely voluntary one and no creditors have agreed to that. How can you rely on a program that’s so speculative first of all?

Secondly, you say that it requires a high participation rate. Does that high participation rate include the 3 billion euro Russian debt that’s due at the end of this year?

And also on the 5.5 percent growth, does that include all of the areas, including Crimea and the Donbass region?

And, finally, is there any concern that you have about the replacement of an old set of oligarchs with a new set of oligarchs, the corruption -- well, I think that’s sufficient for now.

MR. ARVANITIS: Okay, let me take your questions one at a time. The debt operation and moving it back in the program while the operation is unfolding, this is standard in some programs, many such programs, that needed a debt operation. This has been the case that they were initiated and concluded during the program. I can give you an example of Uruguay where this also was the case. So for us to --

QUESTIONER: And you approved cash tranches before the debt operation took place?

MR. ARVANITIS: Yes. So that’s not unusual for some programs. I think you have seen the way that we deal with it is to define the objectives, to define targets for the debt operation together with the authorities. So for us what is very important that at the end of the debt operation, when it’s finalized, the debt is sustainable, the public finances become stronger, and the economy can grow again. I think that this operation at this moment is in the best interest of Ukraine, but also its creditors to make sure that the debt is sustainable and serviceable.

QUESTIONER: What’s the difference between a debt operation and a debt restructuring? You keep using the word debt “operation,” but in the actual program documents you actually say “restructuring.”

MR. ARVANITIS: I think we use the word debt “operation,” but this is all semantics. I don’t think that there is much to be read behind it. I think it’s a general way to describe it.

QUESTIONER: But it is a restructuring, yes?

MR. ARVANITIS: I think any kind of potential when debt replaces one set of instruments with a different set of instruments is a debt restructuring. It’s going to be an exchange of instruments -- old instruments for new instruments.

QUESTIONER: Okay, thank you.

MR. ARVANITIS: High participation rate? Of course, this is the goal, it’s the goal of the authorities to get high participation rate. I think the authorities are committed to this consolidated process.

You asked about the GDP growth and no, it does not include Crimea. National accounts data, as you know, exclude Crimea starting in 2014. And I think this answers your questions.

QUESTIONER: Actually, there’s the issue about Donbass. It does include the Donbass region? And secondly, you all raised the issue of high participation rate, acquiring a high participation rate. In that assumption is that a certain number, an amount, of creditors that must participate. So you all have outlined that parameter. So that’s why I’m trying to get clarity from you whether that requires the Russian 3 billion euro bonds.

MR. ARVANITIS: Thanks for reminding me the two questions. On the Donbass area, as you know, the reporting from the Donbass area is becoming more spotty, and I think to the extent that things are not reported because small- and medium-size enterprises are not reporting data back, these are not going to be included in the national accounts. As I said, the regional Crimea is excluded from national accounts and then reporting from the Donbass area is declining. There is less reporting of data from that region.

Now, on the specific claim that they’re going to be included in the debt restructuring, as you know what claims are going to be included in the restructuring is up to the authorities and their financial advisers to decide. We don’t specifically include one claim or the other. I think the universe of claims that are eligible for restructuring includes all euro bonds, including euro bonds maturing between now and 2018. Now, which ones are going to be included and the trade-offs to get the participation rate that is required for the debt operation, I think this is up to the authorities and the financial advisers to decide.

QUESTIONER: Thank you.

QUESTIONER: Hi, thanks very much for holding this call. I just have a few questions, one on the GDP assumptions or the macroeconomic assumptions. Are they based on the current, sort of semi-T-slope scenario? In other words, you have some references in there, the exceptional risks to the slant of the conflict potentially posing a greater risk to the economy. But is that 5.5 percent figure based on now, today, the ceasefire holding? So that’s my first question.

Second question is on the banking sector. You talked about the recapitalization plan that the government is working on. Can you just tell us a little bit more about when that might be coming? And also in the discussion of the banking sector, you talked about Non-Performing Loans, they’re at 19 percent now, but likely to rise further. Do you have an estimate for how high they might rise?

And finally, in the document that you made reference to on vested interest, are you worried about a new set of oligarchs emerging in Ukraine?

MR. ARVANITIS: Okay, let me take a couple of questions and I think I could ask Nikolay to get the more specific ones. On the assumptions of the GDP growth, this is essentially what we’re using for our assumptions for GDP growth for 2015, but also beyond. This means, of course, this prior agreement that has been in place since February 12, but it doesn’t -- what we want to give the view is that it does not require a normalization of relations. This was an assumption under the 2014 standby arrangement. We think with the current situation as of February 12, the rest of the country can gradually delink and the economy that would not be affected by the conflict can start growing again.

And, of course, we expect as you can see certainly a continuing recession, a continuing contraction in GDP in 2015 reflecting the impact of the conflict early on, but also the drag from the uncertainty and the weak confidence in the economy. But gradually from the second half of the year and most likely into 2016, we see growth returning and becoming more widespread in 2017 and beyond, particularly supportive with external financing that’s expected to be starting and leased and locked after the Board approved one other program and also the reforms that the authorities are undertaking. So these are the assumptions and the growth projections, which we think are fairly conservative, reflecting the current circumstances in Ukraine.

On the vested interest, I think the authorities have shown the determination to start addressing the governance issues. Governance issues, as you know, have been a longstanding issue in Ukraine. I think the authorities have tried to set up a new framework of reforms, trying to tackle these issues both with establishment of an anti-corruption bureau and giving it powers. Also moving much more on Anti-Money Laundering kind of legislation, but also trying to address issues of related lending in the financial sector as well. So there are many areas where the government is moving ahead trying to improve governance, trying to improve creditor rights, trying to create a business climate that is favorable to private activity because they understand that without strong growth in private activity, they cannot get the objectives that they want.

Let me turn now to Nikolay to answer the two questions that you asked on the recap of banks as well as on the Non-Performing Loans side.

MR. GUEORGUIEV: Basically, these two questions are related. Indeed, in the paper we do say that we expect the number of NPLs to keep increasing. This is done by two processes. First, recognition of losses that have already occurred and are just not shown. This is now the process of banks trying to figure out the borrower’s ability and willingness to repay before going along nonperforming. And then the second process is what’s ahead of us, how will the macroeconomic situation evolve from now on.

I would not move on to venture-specific number or guesses where the NPLs will end up. But let me say that a rise in the NPLs does not necessarily mean a hit on the banks’ capital to the same standard. The big banks or most of the banks are now busy making provisions against these NPLs, so part of the hit will be absorbed by these provisions and the need for capital will be less, if any, than the increase in the number from NPLs. Nevertheless, as you may have seen, the program has sacrificed nearly 4 percent of GDP to absorb additional amounts of public costs stemming from the bank restructuring process.

QUESTIONER: Just in terms of timing on the recapitalization plan?

MR. GUEORGUIEV: Well, it is a process with several stages. The recapitalization based on the diagnostic value that was in place last year, this has to be finished by June this year. But, meanwhile, additional diagnostics will be performed to ascertain an update of the banks’ capital needs based on recent developments. By recent developments I mean the updated macroeconomic situation, including exchange rate and depreciation. So the results of these diagnostics will be available later this year and then there will be another round of bank recapitalization.

If you have followed Ukraine for a while, this process is not dissimilar to what happened after the 2008-9 crisis. There were also several rounds, I think, two major rounds of bank recapitalization, followed by a couple of smaller rounds. That also took two or three years to complete.

QUESTIONER: Thanks a lot for arranging this call. I’m afraid I’m going to be annoying as well and ask two questions. The first has to do with the protections that you have in terms of the primary balance of the general government and natural gas prices combined. Now, you’re kind of hoping I think in looking at these figures, which if anyone has page 49, that by next year the primary balance of the general government and natural gas prices will be positive. Now, depending on which way you sort of question it, the adjustment that you have in mind is kind of roughly similar to what Greece has gone through in the last kind of four or five years. With that in mind, is there any bit of concern within the Fund that the adjustment plan as is proposed is too severe? That’s my first question.

And the second question, which is kind of related, is about the sort of social protection measures that you’re planning on implementing. And this may sound like a redundant question, but it’s actually probably important. On page 26 you have a box, which is talking about households during the crisis. And towards the bottom you sort of talk about what the government was doing to help the most vulnerable, including increasing social assistance programs by 30 percent. Various things are going up by a certain amount with some going up by 15 percent, some going up by six-fold. I just wanted to know in that box when you talk about increases, are we talking in nominal terms who it is spending? Are we talking in nominal terms dollar spending, potentially GDP? It’s not at all clear from the box when you talk about increases in social assistance what you actually mean. So I was wondering if you might be able to clarify that for me.

MR. ARVANITIS: Thanks. I’ll try to very quickly give you an answer and then Nikolay may want to add more details. First on your question about the pace of fiscal adjustment under the program: You need to separate two things to have a clear picture of this. You need to separate the term “government” and “natural gas prices.” As you can see, the general government at the cities moving very slowly, gradually, to under 3 percent from about, at this moment about 5 percent. And I think this gradual reduction of the deficit is really intended to ease the drag of the fiscal adjustment on growth. This gradual adjustment underlying it also has two major components: One is the increase in social assistance and I’ll come back in a second, and also the reduction in current outlays to leave space for capital increases, increases in capital spending, and necessary spending on infrastructure. So you see the path of the general government is steady, but it’s gradual, essentially trying to make sure that the adjustment is not severe. What is happening, though, is that the adjustment in natural gas prices is very fast. I think the government has decided that energy subsidies are unaffordable. They are untargeted. They are helping more the well-off than consumer energy, and energy subsidies of 7 percent of GDP are unsustainable in the long run. And they want to move very fast into bringing energy prices or gas prices to cost recovery, and they want to do it in serious time. If you saw last week, they announced very large increases in both gas prices and heating inventories. And they’re prepared to do the same both in April 2016, and eventually bring prices to full cost recovery by April 2017. So this is really what makes a big adjustment.

Now, we want under the program to make sure that the support remains for discussed increases and the reason that we have made allocations for social support. The authorities are moving with the World Bank to revamp the social assistance programs that they have, and we in the program here at least, the allocation for that is a percent of GDP. So I think it’s better to look at it in terms of percent of GDP rather than nominal figures and there is an increase. All the social assistance programs are going to increase to 4.1 percent of GDP in 2015, and I think this is part of the effort to make sure that we defray the cost to a viable level and support for this rapid pace of increases is maintained.

Now, did I answer both of your questions?

QUESTIONER: Well, I don’t want to get bogged down in details too much, perhaps if I could just follow up with you afterward. But just in terms of the actual figures that you quote, you quote a variety of percentages of increase. So, therefore, I guess what you’re saying is I’m to assume that’s an increase of say 30 percent as a proportion of GDP, that’s the increase that we’re looking at.

MR. GUEORGUIEV: Actually, it’s not, no. Let me clarify. Those percentages -- the increase for social assistance for all kinds of uses is about 0.4 percent of GDP, but that percentage is nominal. But the more number is in the next one, which says social assistance with energy bills will more than double. In fact, we just got revised numbers from the government for last year, and the increase in social assistance with energy bills is going to be much larger -- in nominal terms about four times, and in percent of GDP from 0.4 to 1.3 percent of GDP. So this is three times. That will be the more important number I would say.

QUESTIONER: Thank you. That’s great.

QUESTIONER: Thank you. Most of my questions have been asked, but a couple of quick ones. The support for the program has been described as strong in the Board. Can you describe it as unanimous?

And number two, the country is in a civil war. What is to prevent the government from using the money from the program mostly for military purposes? Thanks.

MR. GUEORGUIEV: As you can see in our public statement, the Board approved yesterday the program. The exact record is confidential, and as you know the Board operates on a consensus basis.

I think you can read the report and you can see all the objectives of the program. And you can see certainly the big importance that we pay on building up the position of the Central Bank. This is certainly of paramount importance to strength and confidence in the national currency. We seek all the financing from multilateral and bilateral creditors that are going to support reforms. And you can see certainly the adjustment that is happening in the program on the fiscal accounts with adjustments as discussed.

So I think that we are very confident, the Board is very confident, to support this and seek adjustment reform program that the authorities just put in this paper. And you can see the very strong prior actions that they passed last week to start this program. So as you can see, we are very comfortably supporting this program and disbursing already $5 billion.

MS. STANKOVA: Thank you, Thanos, Nikolay, and everybody for joining us today.


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