Transcript of a Conference Call on the First Review under the Stand By Arrangement with Ukraine and the Diagnostic Study on Governance Issues Pertaining to Corruption, Business Climate, and the Effectiveness of Judiciary in Ukraine

September 3, 2014

Washington, D.C.
September 2, 2014

Nikolay Gueorguiev, Mission Chief for Ukraine, European Department
Ceda Ogada, Deputy General Counsel, Legal Department
Olga Stankova, Senior Communications Officer, Communications Department

MS. STANKOVA: Good morning and welcome to the conference call on the release of the staff report on the first review under the Stand By Arrangement with Ukraine as well as the Diagnostic Study on Governance Issues Pertaining to Corruption, Business Climate and the Effectiveness of Judiciary in the Ukraine. The Study was prepared by the authorities of Ukraine with the assistance of the Legal Department of the IMF.

The call will be held by Nikolay Gueorguiev, Mission Chief for Ukraine and Ceda Ogada, Deputy General Counsel of the IMF. I will pass the microphone now to Nikolay and Ceda for their opening remarks.

MR. GUEORGUIEV: Thank you, Olga. I will say a few words about program implementation, about the risks that have materialized meanwhile and about what compensatory measures have been taken by the authorities to keep the program on track.

Program policies have essentially been implemented as planned. The authorities have persisted in taking difficult decisions despite the volatile political situation. In view of the implementation problems that plagued previous Fund supported programs with Ukraine, the authorities' perseverance and ownership are encouraging.

This augurs well for the authorities’ ability) to continue to keep the program on track amid a much more adverse environment than envisaged when the program was launched.

I think, unfortunately, the economic environment is indeed much more challenging than envisaged at the time of the program approval. A number of risks have materialized including first and foremost intensification of the conflict in the Eastern Ukraine. And an escalation of the dispute between Ukraine's gas company Naftogaz and Gazprom of Russia. The materialization of these risks led to a notable deterioration in the economic outlook, budget performance, the balance of payment flows.

MR. GUEORGUIEV: Yeah, okay. The noise here -- the sound here changed so I thought maybe I got disconnected but if not, great. So I was saying that some temporary deviations from the initial program have been temporarily accommodated while compensatory measures, specifically accumulation of reserves, fiscal adjustment, and Naftogaz bill collections have been put in place to ensure that key program objectives are met.

I think this is what I wanted to say what by way of introduction. Back to you, Olga.

MS. STANKOVA: Thank you, Nikolay. Ceda, would you have any introductory remarks on the Diagnostic Study?

MR. OGADA: Yeah, let me just make four points on this diagnostic study.

The first is that the diagnostic study on governance issues pertaining to corruption, the business climate and the effectiveness of the judiciary was called for under the program as a structural benchmark for the first review. And this is in realization of the fact that the authorities recognize that these are areas that need to be addressed under the program.

Second, we are very pleased by the thorough and comprehensive nature of this diagnostic study which has been done by the authorities with the assistance of the legal department.

Third, we welcome very much the openness and forthcoming nature of the report. And fourth, we think it sets a very, very hopeful stage for beginning to address these issues that are critical for economic recovery in Ukraine.

MS. STANKOVA: Thank you, Ceda. Now we will take your questions.

QUESTIONER: I was wondering how unusual would you say is it to finance a country that is practically at war? To have a full scale IMF program of such a significant amount with so much uncertainty, thanks.

MR. OGADA: Basically, the Fund does and has lent to countries that are based in some kind of armed conflict or the other. We basically would follow the same rules that we follow for any other country. And if the member meets those criteria, then we go ahead and lend.

MS. STANKOVA: And next question, please.

QUESTIONER: Thank you, good morning. Could you elaborate a little more on the situation in the East? Just reading through the review that you've put out this morning, I see that agriculture, you mentioned, is a bright spot with the harvest increasing its yield. But it would seem to me clearly that the East of Ukraine is, and these are my words, dragging down the economy. Could you elaborate a little bit on that?

MR. GUEORGUIEV: Indeed, the situation in the East is serious. The economic situation is very serious. In the report we make a clear distinction between the East and the rest of the country. In the East, basically, we expect much bigger decline in economic activity than in the rest of the country. GDP decline in the East is expected to be in the 15-20 percent range while for the rest of the country in the mid-single digits. And putting these together, we arrive at our six and a half percent decline for the year.

Basically, as you know, the East is heavily industrialized. So the decline in industrial production there is greater. And also, other economic activity - now not only in industrial sector but in the other sectors as well - the economic activity is now very, very impaired. And this gives rise to deterioration in (inaudible) people in the East. Basically, the decline in the overall tax revenue in the East is in the 10 to 18 percent range relative to last year. This is for June 2014 to June 2013.

In the rest of Ukraine revenue is growing by 6 to 7 percent based on the June data. Of course, the conflict in the East affects the economy not only directly but also indirectly namely through the balance of payments. It makes it more difficult -- -- the uncertain situation makes it more difficult for everyone to invest in Ukraine, both domestic investors and international investors, which is affecting activity. Thank you.

QUESTIONER: Thank you, sir. Could I just take your name? The call broke up earlier for me. Could I just take your name?

MR. GUEORGUIEV: Yeah, this is Nikolay Gueorguiev. I am the mission Chief for Ukraine.

QUESTIONER: Thank you. I appreciate your answer.

QUESTIONER: I have two questions. First, can you confirm when the next two payments will be made? I think you've agree to combine the next two payments. When will you make a decision on those?

MR. GUEORGUIEV: Yes, the next two reviews are planned to be combined in one and the payments will be made when the combined review is completed. We expect this to happen (audio skip).

QUESTIONER: Sorry, I missed that.

MR. GUEORGUIEV: We expect the next review which will make the two combined payments to be completed in December this year.

QUESTIONER: Okay, thank you. And then a second question, in this report you are sticking to your July forecast of a decline in GDP of minus 6.5 percent. And is there anything that has happened in the last few days since you've or in the last couple of weeks since you've written that report that would make you move towards the most adverse scenario that you sketch out?

MR. GUEORGUIEV: Now, clearly the risks are on the downside. We don't have high frequency data for the last weeks, let alone the last days to be able to quantify those risks. For now, though, as I mentioned in my long answer to one of the previous questions we expect this combination of a big GDP decline in the East and the moderate decline in the rest of Ukraine. So the overall economy remains with six and a half. But of course, it depends -- this very much depends on how the situation will evolve in the next weeks and months. And once again, I would certainly agree with anybody who says that there are big risks on the downside here.

QUESTIONER: Hi, yes, forgive me. I missed the first 10-12 minutes. So if I ask anything that's repetitive, please forgive me. I'm kind of skeptical that there is no need for any additional external financing at this point. Given even with the risks that you say are there, tell me why I should be wrong? Why I'm wrong to be skeptical?

MR. GUEORGUIEV: Well, once again, this is our assessment based on the available information up to now. But what --

QUESTIONER: Up to now or up to when you wrote the report?

MR. GUEORGUIEV: Well, basically up to now. I explained that we don't really have quantitative information for the last couple of weeks when the report was presented to the Board. But anyway, what happened if you follow the evolution of the program, was that the initial program had some buffers built in. In reserve accumulation, in fiscal, fiscal policy and now, given that the shocks on the economy have proven larger than expected and given that significant risks have materialized, which I already explained, namely the intensification of the conflict and escalation of the gas problem.

What the authorities have done is to use some of these available buffers, so that the program -- the targets have been reduced. The program targets of the (inaudible) relation have been reduced in particular for this year. And this is why we believe for now the available financing in the next months remains adequate.

Because the buffers on the balance of payments have been utilized to absorb the shocks. (Inaudible) once again let me repeat that the risks to the balance of payments are also on the downside. And basically, we’ll have to continue to keep assessing the situation.

QUESTIONER: With your downside scenario, how much more external financing, financial assistance do you estimate would be needed in the next 12 months if the downside scenario materializes?

MR. GUEORGUIEV: Well, that's -- they'll be a combination -- first of all, we have a range of scenarios. We do present one in the report but there will be a combination of measures that would address potential financing gap including additional adjustment on the fiscal and external side.

Let me also mention there is some exchange rate depreciation will, if sustained, will probably result in large current account adjustment or smaller current account deficit than currently envisaged. But I think it's too early to speculate about these large uncertainties on the horizon. We keep monitoring the situation and as I said, we will assess -- we are assessing it constantly and taking into account and preparing for the next review.

QUESTIONER: Finally, for now, there's been a major use of cash to recapitalize banks with open market positions. Are you, one, can you quantify how much cash has been used there? And two, are you comfortable with the oversight and accountability of the use of those cash -- that cash?

MR. GUEORGUIEV: I am not quite sure I understood the question. If you're talking about the recapitalization of the banks, the diagnostic studies for the first group, they have been completed but the results are still to be assessed and verified. So for the moment, we're not in a position to say how much will be needed.

QUESTIONER: Well, it was my understanding that the Central Bank was able to tap some of the funds through the government budget to help temporarily recapitalize banks who had open market FX positions. Is that not the case? And I thought that you all had tried to institute some safeguards to protect the misuse of those funds?

MR. GUEORGUIEV: No, that's -- I -- if we're talking about the open bank foreign currency positions --


MR. GUEORGUIEV: -- what the National Bank did last Friday was to reduce the limit that they allow from five percent of capital to one percent of capital. But this has nothing to do with recapitalizing the banks per se.

QUESTIONER: Well, it's a liquidity position, wouldn't it?

MR. GUEORGUIEV: Liquidity, the National Bank has provided a substantial amount of liquidity indeed. But this is in the form of loans and this liquidity -- this particular liquidity rather took place mainly between February and April and it was related to the withdrawals of (inaudible) deposits in this period. Since mid-April, hryvnia deposits have basically stabilized and, in fact, over the summer they have been increasing. So the National Bank has not increased its liquidity provision anymore.

Just rolling over whatever is extended. But once again, it's a loan. It's not recapitalization and the National Bank is not the one that can recapitalize the banks.

QUESTIONER: Okay, so I'm confusing the two issues then. So then, to clarify, do you have a quan -- have you quantified how much potential recapitalization needs and does the IMF bailout cover those recapitalization estimates and secondly, you're -- the IMF is comfortable with the practices that the Central Bank is using in terms of liquidity operations for the banks that have open market positions?

MR. GUEORGUIEV: On the first issue, the program envisages two sets of diagnostic studies as we call them. They are akin to the asset quality reviews in Western Europe. So the first was for the biggest 15 banks, this was completed by the end of July. But the results are still being finalized and verified. So at the moment, we do have an answer on how much is needed.

In the report, actually, we report the results of a stress test that we did during the mission. So on this stress test indicates that the banks, the whole system, would need something between three and a half to five percent of GDP in additional capital. Now, this is total capital need and much of it is expected to be provided by the banks private owners, certainly the foreign banks are expected to provide funds to meet the needs of their Ukrainian subsidiaries if there are such needs.

Also, liquidity provision we do see now in the report that the National Bank has taken certain risks and we are calling for them being a bit more conservative in this regard. But other than that, I am not aware of other specific issues.

QUESTIONER: I have a follow-up question to those of my colleagues. It's about the adverse scenario that you sketch out in the report. My colleague asked about what additional financing, external financing needs that might possibly incur. You didn't really answer that question even though the box on page 28 says, "Meeting these external pressures … would require additional external financing of about US 19 billion by the end of 2015 relative to the baseline scenario."

And is there something wrong with that information or am I understanding it wrong? Could you explain that for me? Thanks.

MR. GUEORGUIEV: Oh, that's -- yes, I see now what the confusion may be. This is basically the difference between the two scenarios. The difference in National Bank reserves between the baseline scenario and this adverse scenario. But it's just -- this can be covered from a number of sources. It doesn't necessarily mean the whole 19 billion have to be provided in additional financing. Maybe the language was a bit loose there.

There could be additional adjustment, less reserve accumulation. This includes the same reserve accumulation in 2015 as under the baseline. So one possible source would be that this accumulation could be reduced a little. I mentioned additional adjustment, yes, if need be and let me say that this is a relatively steep adverse scenario with significant capital outflows. To finish my thought, yes, there would possibly be need for additional external financing as well.

But as of now, we have not broken this down into specific components. This would depend on how it's -- how the situation evolves in the next few months. It's too early for us to do this. It's just a signal of a potential need If the negative assumptions embedded in the adverse scenario were to materialize.

QUESTIONER: Thank you. I’m sorry if you answered this earlier but I wasn't clear on how much the third and fourth amounts of money would be worth all together.

MR. GUEORGUIEV: Can you repeat that please?

QUESTIONER: How much will the next installment be worth?

MR. GUEORGUIEV: Yeah, the two, since we are combing two purchases, it would be US$1.8 billion SDR which in dollars, depending on the exchange rate at the time, something like US$2.7-2.8 billion.

QUESTIONER: That's together?


QUESTIONER: And did you -- I heard the Ukrainian Government had made a request to bring this payment forward to September. Did you consider that?

MR. GUEORGUIEV: They haven't -- just to clarify, I was talking about the purchase, the disbursement after the completion of the next review. After the completion of this review, you may have seen the number in the press release. It's 900 million SDR or US$1.4 billion.

Now, to go back to your question, the authorities have not requested to bring the purchase to September.

QUESTIONER: Okay, thank you. And just finally, just for me, please, could you clarify the US$19 billion figure on your adverse scenario because I still don't understand exactly where that comes in. And are you saying that the IMF may have to put forward this money or not?

MR. GUEORGUIEV: No. This is just -- let me see if I can -- the difference between the level of gross reserves in the end of 2015, the difference between this number for the baseline and the number for the adverse scenario. So if you look at, I think there is a table there, trying to find it. Yes, there is a small table there that has the indicator gross reserves end of the period. So under the -- and for 2015, you see two numbers. Under the current revised program the number is US$23.4 billion and under the adverse scenario it's US$4.4 billion.

So the US$19 billion is just the difference between these two numbers; the difference between the level of reserves under the baseline and under the adverse scenario. Let me also explain once again that this is just an analytical device, an analytical device to show the pressures on the balance of payments under the adverse scenario.

In reality, things would not develop even if the risks materialize of the adverse scenario, things would not develop like this because the economy, the exchange rate would adjust by more, the current account would adjust by more. Additional policy measures will be introduced as well. In reality, the level of reserves at the end of 2015 even under the adverse scenario would probably be higher. But for analytical and expositional convenience, it's instructive to present the matters this way.

Let me also mention that the exchange rate is kept the same under the baseline and under the adverse scenario. Not because we believe that this would be the case but not to cloud the exposition with the effects of additional exchange rate moves.

QUESTIONER: Okay, thank you.

MS. STANKOVA: Since those were clarifications from previous questions, if there is another question, we can take it.

OPERATOR: We have no further questions.

MS. STANKOVA: Thank you, everybody, for joining us today. Thank you, Nikolay. Thank you, Ceda. Good-bye.


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