Category Archives: Ukrainian economy

18/2/15: IMF Package for Ukraine: Some Pesky Macros

Ukraine package of funding from the IMF and other lenders remains still largely unspecified, but it is worth recapping what we do know and what we don't.

Total package is USD40 billion. Of which, USD17.5 billion will come from the IMF and USD22.5 billion will come from the EU. The US seemed to have avoided being drawn into the financial singularity they helped (directly or not) to create.

We have no idea as to the distribution of the USD22.5 billion across the individual EU states, but it is pretty safe to assume that countries like Greece won't be too keen contributing. Cyprus probably as well. Ireland, Portugal, Spain, Italy - all struggling with debts of their own also need this new 'commitment' like a hole in the head. Belgium might cheerfully pony up (with distinctly Belgian cheer that is genuinely overwhelming to those in Belgium). But what about the countries like the Baltics and those of the Southern EU? Does Bulgaria have spare hundreds of million floating around? Hungary clearly can't expect much of good will from Kiev, given its tango with Moscow, so it is not exactly likely to cheer on the funding plans… Who will? Austria and Germany and France, though France is never too keen on parting with cash, unless it gets more cash in return through some other doors. In Poland, farmers are protesting about EUR100 million that the country lent to Ukraine. Wait till they get the bill for their share of the USD22.5 billion coming due.

Recall that in April 2014, IMF has already provided USD17 billion to Ukraine and has paid up USD4.5 billion to-date. In addition, Ukraine received USD2 billion in credit guarantees (not even funds) from the US, EUR1.8 billion in funding from the EU and another EUR1.6 billion in pre-April loans from the same source. Germany sent bilateral EUR500 million and Poland sent EUR100 million, with Japan lending USD300 million.

Here's a kicker. With all this 'help' Ukrainian debt/GDP ratio is racing beyond sustainability bounds. Under pre-February 'deal' scenario, IMF expected Ukrainian debt to peak at USD109 billion in 2017. Now, with the new 'deal' we are looking at debt (assuming no write down in a major restructuring) reaching for USD149 billion through 2018 and continuing to head North from there.

An added problem is the exchange rate which determines both the debt/GDP ratio and the debt burden.

Charts below show the absolute level of external debt (in current USD billions) and the debt/GDP ratios under the new 'deal' as opposed to previous programme. The second chart also shows the effects of further devaluation in Hryvna against the USD on debt/GDP ratios. It is worth noting that the IMF current assumption on Hryvna/USD is for 2014 rate of 11.30 and for 2015 of 12.91. Both are utterly unrealistic, given where Hryvna is trading now - at close to 26 to USD. (Note, just for comparative purposes, if Ruble were to hit the rates of decline that Hryvna has experienced between January 2014 and now, it would be trading at RUB/USD87, not RUB/USD61.20. Yet, all of us heard in the mainstream media about Ruble crisis, but there is virtually no reporting of the Hryvna crisis).

Now, keep in mind the latest macro figures from Ukraine are horrific.

Q3 2014 final GDP print came in at a y/y drop of 5.3%, accelerating final GDP decline of 5.1% in Q2 2014. Now, we know that things went even worse in Q4 2014, with some analysts (e.g. Danske) forecasting a decline in GDP of 14% y/y in Q4 2014. 2015 is expected to be a 'walk in the park' compared to that with FY projected GDP drop of around 8.5% for a third straight year!

Country Forex ratings are down at CCC- with negative outlook (S&P). These are a couple of months old. Still, no one in the rantings agencies is rushing to deal with any new data to revise these. Russia, for comparison, is rated BB+ with negative outlook and has been hammered by downgrades by the agencies seemingly racing to join that coveted 'Get Vlad!' club. Is kicking the Russian economy just a plat du jour when the agencies are trying to prove objectivity in analysis after all those ABS/MBS misfires of the last 15 years?

Also, note, the above debt figures, bad as they might be, are assuming that Ukraine's USD3 billion debt to Russia is repaid when it matures in September 2015. So far, Russia showed no indication it is willing to restructure this debt. But this debt alone is now (coupon attached) ca 50% of the entire Forex reserves held by Ukraine that amount to USD6.5 billion. Which means it will possibly have to be extended - raising the above debt profiles even higher. Or IMF dosh will have to go to pay it down. Assuming there is IMF dosh… September is a far, far away.

Meanwhile, you never hear much about Ukrainian external debt redemptions (aside from Government ones), while Russian debt redemptions (backed by ca USD370 billion worth of reserves) are at the forefront of the 'default' rumour mill. Ukrainian official forex reserves shrunk by roughly 62% in 14 months from January 2014. Russian ones are down 28.3% over the same period. But, you read of a reserves crisis in Russia, whilst you never hear much about the reserves crisis in Ukraine.

Inflation is now hitting 28.5% in January - double the Russian rate. And that is before full increases in energy prices are factored in per IMF 'reforms'. Ukraine, so far has gone through roughly 1/5 to 1/4 of these in 2014. More to come.

The point of the above comparatives between Russian and Ukrainian economies is not to argue that Russia is in an easy spot (it is not - there are structural and crisis-linked problems all over the shop), nor to argue that Ukrainian situation is somehow altering the geopolitical crisis developments in favour of Russia (it does not: Ukraine needs peace and respect for its territorial integrity and democracy, with or without economic reforms). The point is that the situation in the Ukrainian economy is so grave, that lending Kiev money cannot be an answer to the problems of stabilising the economy and getting economic recovery on a sustainable footing.

With all of this, the IMF 'plan' begs two questions:

  1. Least important: Where's the European money coming from?
  2. More important: Why would anyone lend funds to a country with fundamentals that make Greece look like Norway?
  3. Most important: How on earth can this be a sustainable package for the country that really needs at least 50% of the total funding in the form of grants, not loans? That needs real investment, not debt? That needs serious reconstruction and such deep reforms, it should reasonably be given a decade to put them in place, not 4 years that IMF is prepared to hold off on repayment of debts owed to it under the new programme?

Note: here is the debt/GDP chart adjusting for the latest current and forward (12 months) exchange rates under the same scenarios as above, as opposed to the IMF dreamt up 2014 and 2015 estimates from back October 2014:

Do note in the above - declines in debt/GDP ratio in 2016-2018 are simply a technical carry over from the IMF assumptions on growth and exchange rates. Not a 'hard' forecast.

12/2/15: IMF’s Latest Ukraine ‘Package’… It’s Political

As expected, the IMF announced a revised package of loans for Ukraine today. Below is the statement with some comments.

Top line conclusions:

  1. IMF Extended Fund Facility Arrangement gives Ukraine more breathing space (three years at a shorter end of debt repayments) and avoids significant repayments due this year under the old arrangement.
  2. Nonetheless, the new package is still too short in its maturity - Ukraine will need closer to a decade to rebuild the East and own economy, and to implement reforms, while allowing reforms to take hold and start delivering on growth. 
  3. IMF funding comes with expectations of European funding and will probably (at this time it is uncertain as no details have been released yet) imply Fund participation to 2/3 of the total package.
  4. Ukraine needs not more loans, but a Marshall Plan with loans:grants ratio of 1:1 or close and total package volume of USD60 billion and duration of at least 10 years. In ignoring the grim realities of Ukrainian economy, the IMF has once again gone for a political compromise instead of a real solution.

IMF statement (select quotes):

"February 12, 2015: Nikolay Gueorguiev, Mission Chief for Ukraine, issued the following statement today in Kyiv: “The mission has reached a staff-level agreement with the authorities on an economic reform program, which can be supported by a four-year Extended Fund Facility, in the amount of SDR 12.35 billion (about $17.5 billion, €15.5 billion), as well as, by considerable additional resources from the international community. The staff level agreement is subject to approval by IMF Management and the Executive Board. Consideration by the Executive Board is expected in the next few weeks, following the authorities’ implementation of decisive front-loaded actions to achieve program goals."

So the total package extended to Ukraine is now in the region of USD40 billion. This might be enough, if the hostilities in the East end in the next month or so, and assuming post-hostilities ending, Ukraine regains the regions as a part of at least some Federal structure. Barring that, if the regions gain significant autonomy from Kiev, it is hard to see how the Ukrainian economy can sustain a loss of ca 15-20 percent of its GDP and still fund the debt it will be carrying.

“The policies under the new arrangement, developed by the Ukrainian authorities jointly with Fund staff, are designed to address the many challenges confronting the Ukrainian economy. Economic activity contracted by around 7-7½ percent in GDP in 2014, weighed down by the conflict in Eastern Ukraine, which  has taken a significant toll on the industrial base and exports, undermined confidence and ignited pressures on the financial system. The economic reform program focuses on immediate macroeconomic stabilization as well as broad and deep structural reforms to provide the basis for strong and sustainable economic growth over the medium term."

It is worth noting that in October 2014 WEO, IMF estimated 2014 GDP decline of 6.5% and forecast growth of 1% in 2015, followed by 4% in 2016 and 2017. At an upper reach of the latest estimate, the Ukrainian economy was shrinking at an annual rate of 1.5 percent in Q4 2014. Which is quite surprising as prior to that it was falling by 2.0-2.2 percent per quarter. Meanwhile, EBRD and others are forecasting for Ukrainian economy to shrink 5% in 2015 (a swing of difference of 6 percentage points compared to the IMF dreaming).

Ukraine's “…2015 budget initiates an expenditure-led adjustment to strengthen public finances within the availability of resources. This required bold, but necessary, measures, including keeping nominal wages and pensions fixed. The budget is supported by revenue reforms, including increasing the progressivity of the personal income tax and streamlining the tax system. The authorities are committed to medium term reforms of the civil service and the important health and education sectors, aiming to improve quality and efficiency, as well as widening the tax base and improving customs and tax administration. Fiscal consolidation would continue over the coming years which together with the debt operation envisaged by the authorities will strengthen debt sustainability."

All of this sounds benign, until you think about the impact of these reforms on Ukrainian power base (oligarchs), and foreign investment (sensitive to taxation regime). In addition, behind the 'widening of the tax base' rests a push to increase effective tax burden on general population. Now, consider this: inflation is running at close to 13% pa, hrivna is devaluing, taxes are rising (both in terms of enforcement and rates and breadth of applications), while nominal wages are fixed. And that in a country with GDP per capita (adjusting for PPP) at $8,240.4 in international dollar terms (for cross-referencing, comparable figure is $24,764.4 in Russia). So how soon will there be social unrest boiling up?

Again from the IMF release: “The authorities are firmly committed to deep and decisive measures to reform the critical energy sector. They have developed a comprehensive strategy aiming to foster energy efficiency and independence, increase domestic gas production, and restructure Naftogaz. As part of this strategy, and to rehabilitate Naftogaz while eliminating its drain on the budget, the authorities have decided to implement frontloaded gas and heating price adjustments aiming to reach full cost recovery by April 2017, while protecting the poor through revamping social protection schemes and allocating sufficient budgetary resources. At the same time, efforts are under way to improve Naftogaz’s corporate governance, as well as the framework for payment compliance and recovery of receivables."

What the above means is that cost of energy to middle classes and above will rise and it will rise dramatically. Note two things in the above: one part of this increase will come from eliminating energy subsidies these classes currently receive.  But another shock will come from "eliminating [Naftogaz] drain on the budget" which means that supports for low income earners and the poor in the form of subsidies will have to be loaded onto the rest of the population if Naftogaz were to be a cost-recovery vehicle.

“Monetary policy will be geared toward returning inflation to single digits in 2016 within a flexible exchange rate regime. To strengthen confidence in banks and improve their ability to intermediate credit and support economic activity, the authorities are moving ahead with a multi-pronged strategy to rehabilitate the banking system. The regulatory and supervisory framework will be upgraded, including through measures to address above the limit loans to related-parties; banks’ balance sheets will be strengthened, where needed, following a prudential review of banks; and measures will be undertaken to enhance banks’ asset recovery and resolution of bad loans."

Banking reforms are desperately needed in the Ukraine, as banks are running non-performing loans to the tune of 20 percent and that is before any losses taken on Eastern Ukrainian operations and before we take out foreign lenders who face lower NPLs due to more selective lending to larger enterprises and foreign companies. But driving inflation down to single digits by 2016? Any one can pass the IMF folks a reality pill? Driving inflation down to these levels will require a massive deflation of demand and money supply. Which will cut across bot the above reforms in taxation and wages moderation, and across the banks reforms too.

“Structural reforms will aim at improving business climate, attracting investment and enhancing Ukraine’s growth potential. To this end, the authorities are advancing efforts toward deregulation and judicial reform and implementation of the anti-corruption measures.  They will also proceed with state-owned enterprise reforms, to minimize fiscal risks and improve corporate governance structures and de-monopolization."

All is fine. Except we have no idea what any of it really means. Still, major risk to Ukraine on this front is what will it do replace lost Russian (and other CIS) investments and remittances?

In short, so far, we have very little to go on the IMF latest package fundamentals, but plenty indications that Ukraine is in for some serious, serious social and economic pain in years to come. This pain is necessary. But what is highly questionable is whether this pain is feasible over the 4 year horizon of the new programme. Should Ukraine get some real help: a Marshall Plan with, say at least 50:50 grants to loans ratio and a package worth around USD60 billion over 10 years instead of 4 year loans that only shore up redemptions of other debts?