Проф. Иван Ангелов
член-кор. на БАН
Programme of the IMF for Economic Reforms in Ukraine
This article is a summary of the IMF programme for economic reforms in Ukraine, approved by the Board of the IMF on 30 April 2014. All figures and facts in the article are taken from official documents on the site of the Fund – the section on Ukraine.
А. Overall characteristics of the programme for reforms:
1. The Board of the IMF approved a two year programme for economic reforms in Ukraine, prepared by the European Department of the Fund, jointly with Ukrainian officials and experts.
2. „Major objectives of the programme are recovery of the macroeconomic stability, improving the macroeconomic management, increasing the transparence and setting the foundations for stable and balanced economic growth”. This is stated explicitly in the prgramme.
3. The programme is for $17,1 bill. or 800 per cent of the Ukrainian quota. After the approval of the programme $3,19 bill. were transferred to the Government of Ukraine. It is expected that additional $15 bill. will be provided by the international community, but they are not guaranteed. Most of the additional resources are credits. At the same time Ukraine owes $5 bill. to the IMF on previous tranches, which must be repaid during 2014-2015. The amount due to Gazprom for delivered but unpaid gas from the beginning of 2014 to the end of April 2014 was over $3,5 bill. Therefore, the secured net amount of secured resources at the disposal of Ukraine is $8,6 bill.
4. The programme covers the territory of Ukraine as of 31 December of 2013. If Ukraine government loses control over Crimea (3-4 per cent of the national GDP), and of the eastern regions (around 23-25 per cent of the national GDP) the programme will be revised accordingly. This was stated by the Managing director of the IMF Christine Laggard in early May 2014. They already lost Crimea irreversibly and the developments in the eastern provinces are unpredictable for the time being. This introduces even more uncertainty in the content, scope and fate of the programme.
B. Some macroeconomic indicators of the programme:
1. The Ukrainian economy is in recession since the middle of 2012. For 2014 is expected decline of GDP by 5 per cent. For 2015 the programme expects growth of 2 per cent, and for 2016-2017 – growth of 4,0-4,5 per cent per annum. This, in my view is not feasible due to the sharp decrease of domestic demand, reduced export opportunities, low competitiveness, confused economic ties with the Russian economy, the total destabilization and insecurity in the country, and the lost confidence of the global financial markets.
2. The programme expects the 2014 inflation to reach 16 per cent, and to decline to 6 per cent the following year. Based on experience in Bulgaria and other Central and East European countries, I believe this is not possible, having in mind the forthcoming massive sharp increases of prices. The true inflation will be higher both for 2014 and 2015. It will remain relatively high and for the following years. The programme calls on the National Bank of Ukraine to maintain 3-5 per cent inflation in the medium term. This is also very difficult to achieve.
3. The debt of Ukraine is expected to reach almost 100 per cent of GDP this and the next year. At the present complicated domestic and external environment the changes of the debt in the medium term are very difficult to predict. Even larger gross debt is not to be precluded due to total destabilization of the economy.
4. It is written in the programme that unemployment, which is 8,5 per cent now is expected to fall to 7,5 per cent in 2016. The true present unemployment is and during the following years will be higher, both due to the internal socio-political chaos in the country, declining domestic demand, limited opportunities for exports to the West, collapsing economic ties with Russia and the restrictive macroeconomic policies, which always inhibit growth and employment.
5. The programme expects higher than 6 per cent annual growth of exports during 2015-2016. This is not feasible owing to many reasons, part of them already mentioned above.
6. The deficit in the current account is expected in the programme to fall in 2014 to the bearable level of 4,5 per cent of GDP, and to go on declining in the medium term. This is hardly feasible. This deficit will be higher in the medium term, while for the long term is premature to talk.
C. Wages, salaries, pensions, social programmes:
1. The average monthly salary in Ukraine is 164 euro, in Bulgaria – 333 euro, in Belarus – 353 euro, Rumania – 395 euro, Russia – 554 euro, Poland – 681 euro. The average monthly pension in Ukraine is $160, and in Russia - $285. The poorest 10 per cent of the population in Ukraine get 3,4 per cent of total income, and the richest 10 per cent – 25,7 per cent, according to 2006 data. More recent data are not available, but it is known that income polarization is growing. Ukraine is among the European countries with the lowest incomes and the largest income polarization. This is not a favorable social environment for shock economic reforms.
2. The programme states that salaries and wages will be frozen at their nominal level of 1 January 2014 until the end of 2014. This freezing will probably be extended over the following year. New appointments in the public sector are blocked. Employment will be reduced through layoffs and retirements. Pensions are also frozen at their January 2014 level. Indexation of pensions with inflation is terminated. Taking into consideration that accumulated inflation for 2014-2015 г. envisaged by the programme is expected to be 22-23 per cent (the actual one even higher) the real incomes and the purchasing power of the households will decline drastically over the two years. All social funds are curtailed: for healthcare, education, support for people with disabilities, etc. Deterioration will certainly continue during 2016-2017.
D. Subsidies:
The programme adopts a policy of severe restrictions on subsidies for public enterprises, aiming at their elimination during the following years, as well as for equally severe restrictions on resources earmarked for social and other programmes. This will generate multiple economic, social and other implications. Investment programmes will also be reduced drastically.
E. Energy policy:
1. Ukraine is among the European countries with the highest energy intensity of output. According to quoted in the programme data for 2012 for the generation of a unit of GDP they spend 10 times more energy than the average for the OECD countries. The Russian Gazprom and the Ukrainian Naftogaz signed 10-years agreement in 2009 for supply of natural gas, which none of the partners published so far.
2. The programme calls for total comprehensive reform of the energy sector. One learns from the programme that energy subsidies have been 7,5 per cent of GDP in 2012. One also learns that the reach strata of the population were obtaining the largest portion of the energy benefits. This is a dangerously high degree of subsidization, which should not have been allowed in the past. A focal point of the energy reform is the drastic reduction of subsidies for the Naftogaz. The objective is to reduce this deficit down to 3,25 per cent of GDP in 2014 and to pay the accumulated debt to Gazprom. The deficit of Naftogaz should be further reduced to 1,9 per cent in 2015 and eliminated by 2018. This will be achieved through drastic increases of domestic prices of the gas and other energy sources, and thus reducing the gap between them and the international supply prices. The reduction of energy intensity, improvement of payment discipline, restructuring of Naftogaz should also contribute to this end. International audit of Naftogaz is also planned.
3. The present domestic prices of gas are as an average $85 per 1000 cubic meters. The programme calls for drastic increases of these prices over the following years to reduce the gap with the external supply prices of the gas, which vary now between $300 and $400 for 1000 cubic meters. Tolerating such a huge gap in the past has been a bloomer. A new mistake is being committed now by imposing a forceful approximation of domestic and international prices, which can’t be borne by the prevailing majority of the population. The authors of the programme underestimate the economic and social implications of such an approach. Particularly, within the present tense Ukrainian social and political environment.
4. Sharp price increases will affect tens of millions of consumers in the households, as well as the production sector. Expenditures for gas and heating are now 3-7 per cent of the household’s budgets. With the new prices they will grow to 5-11 per cent and after achieving normal collection of heating fees from the consumers (now around 50 per cent) – even more. The programme envisages energy assistance for the poorest 27 per cent of the consumers. This is a good idea. However consumers will hardly get them as planned due to the shortage of funds and the adopted highly restrictive fiscal policy. The reduction of the enormous gap between domestic and international prices of gas is unavoidable, but must be done gradually and cautiously, by helping the most vulnerable, who are now more than 50 per cent of the population. With the already accumulated very high social tension the adopted drastic price increases may alienate the population from the very idea of reforms and could provoke social explosion with unpredictable consequences.
5. As of May 1st 2014 the prices of gas for the households were increased by 56 per cent on average. On July 1st 2014 the heating fees will grow by 40 per cent. In 2015 the prices of gas and heating fees will grow by another 40 per cent, while in 2016 and 2017 with additional 20 per cent for both of them each year. If the authorities stick to this schedule gas prices would grow nearly threefold for 2014-2017. However, even with these drastic price increases at the present importing prices the budget of Naftogaz can’t be balanced by 2018, as stated in the programme. If the authorities are firm in sticking to this objective they need even higher price increases of gas for the final consumers. This would exceed the limits of social affordability for a large portion of the population with unpredictable consequences.
6. The programme announces that as of 7 April 2014 the gas prices for industry and public consumers have been increased in accordance with actual supply prices, without providing figures. This will affect negatively the competitiveness of industrial and other output of Ukraine, would further boost prices on the domestic market and would restrict export potentials with the resulting negative consequences.
F. Financial sector reform:
1. The programme provides for improving financial stability through constant monitoring, support for liquidity of the banks, assessment of their financial elasticity, restructuring and recapitalization of requiring banks, reviews and improvements of regulating and supervisory mechanisms, removing obstacles and increasing the potential of the banks to handle bad credits.
2. The programme informs that the IMF expert group had carried stress tests for banks, along with local personnel, which will be extended during the following review missions. There will be permanent monitoring and independent diagnoses of all banks and particularly for the 35 largest banks, possessing 82 per cent of the assets of the system. There will be specific measures with deadlines for the 15 largest banks, including utilization of public funds for their stabilization. Part of the banks will probably not pass the stress tests with the resulting consequences for the shareholders and depositors. The programme does not say if Ukraine has a guarantee fund for deposits. If not millions of depositors will face heavy losses.
G. Fiscal policy:
1. The deficit in the total government budget was 4,8 per cent of GDP in 2013. The programme projects 5,2 per cent for 2014, 4,2 per cent in 2015, 3,1 per cent in 2016. Along with operational deficit of Naftogaz the deficit should be 8,5 per cent in 2014, 6,1 per cent in 2015, and 4,4 per cent in 2016. Such speedy improvement is hardly feasible in poor country, torn by internal conflicts, loaded with huge risks. Of course, reduction of the budget deficit is indispensable, but it should be done gradually to be successful for obvious reasons. This is a lesson to be learned from the transition experience of the other Central and East European countries.
2. The budget expenditures of Ukraine in 2013 were 50% of GDP, similar to the pattern of the West European EU countries. The programme calls for drastic reduction of these expenditures by cancelation of salaries’ and pension’s increases, planned by the previous government for 2014 and 2015, restriction of employment in the public sector, freezing of new appointments, reductions of all kinds of public expenditures. Public guarantees for new loans are also restricted.
3. The programme provides for higher budget revenues through improved tax collection, introduction of unified higher excise rates on fuels, sharp increases of excises on alcohol and tobacco products, reduction of VAT frauds, reduction of illegal exports of fuels, of illegal production of alcohol, etc. Higher excises will, in turn provoke higher domestic prices
4. The zero VAT for export of grain and other products is terminated. 7 per cent VAT will be introduced for medicines and other medical products. The basic VAT remains 20 per cent, but the planned reduction of this tax by the previous government is repealed.
H. Foreign exchange policy:
1. At the end of February 2014 the foreign exchange reserve of Ukraine was reduced to $15,5 bill., covering only two months imports. The National bank of Ukraine was no longer able to defend the pegged rate of the national currency (Hryvnia) and shifted to a floating rate. This was considered to be one of the priorities of the programme. And rightly so. Under an exceptionally complicated economic, social and political environment the depreciation of the Ukraine currency began and will go on during the following years. No administrative measures can stop this process. This will be an additional source of inflation with its multiple implications. Nevertheless, this was a right step. It will support the competitiveness of the economy, will facilitate the maintenance of modest foreign exchange reserves and will serve as a cushion against domestic and external shocks, which will be abundant over the following years.
2. According to the programme an exchange rate of around 10,5 Hryvnia per US dollar would not generate serious challenges for the balances of the largest 22 banks, however at 12,5 Hryvnia per $ (50 per cent depreciation compared to the end of 2013) would require substantial capital injection (around 5 per cent of GDP) for those banks. On 18 May 2014 the rate was 11,76 Hryvnia per dollar – depreciation of 40 per cent compared to the end of December 2013.
J. Curbing Corruption:
The programme has a special section on curbing corruption. This however is not very convincing, as almost all present highest ranking officials have been in the highest corridors of power during the last 20 years: prime ministers, ministers, members of parliament, etc. Starting with the most likely forthcoming new president Poroshenko (oligarch, possessing $1,6 bill.) and follow down the administrative ladder, including the newly appointed regional governors, are oligarchs or people from their entourages. If they wanted, they were in a position to suppress corruption a long ago, but they didn’t. Where is the guaranty they will make it now?
I. Risks facing the programme:
- Risks for macroeconomic prospects:
1. The programme warns that tension in relations with Russia could lead to significant reduction in the nonenergy trade between the two countries, which are almost entirely duty free. More than 25 per cent of exports are towards Russia. Ukraine imports 50 per cent of the consumed gas from Russia. Between 12 and 15 per cent of the consumed by Europe Russian gas passes through Ukraine. Russian banks posses around 12 per cent of the assets of the Ukrainian banking system. In 2013 Ukraine got $2,7 bill. transfers of Ukrainian guest workers in Russia. Disruptions of trade between the two countries will produce negative economic shocks hurting more Ukraine than Russia.
2. Some people hope that the forthcoming association agreement of Ukraine with the
EU will help to fill the gap, but the programme admits that “this would not compensate the interruption of the traditional close relations with Russia”. Moreover, one should bear in mind that with its present quality and production costs most of the Ukraine output would not sell easily to the European markets. The ongoing drastic price increases for natural gas and other energy sources will further reduce the competitiveness of the Ukraine goods. Ukraine would need huge investments and many years of efforts for substantial upgrading of the relatively low technological level of the economy and the modest quality of output. But what to do in the meantime? It is explicitly stated in the programme, that the total collapse of trade with Russia will extend and deepen recession in Ukraine and further devaluation of the national currency. This may require serious revision of the programme and major changes in policies.
3. Alarming disturbances are expected in energy trade and energy prices with Russia. Price increases from $386 to $485 for 1000 cubic meters of gas would augment the deficit with $1,5-2,0 bill. per annum. Possible delivery of gas from the West at price below $400 per 1000 cubic meters could alleviate the situation; however the programme does not consider it as feasible alternative in the foreseeable future. Unless a speedy agreement was achieved with Russia even termination of deliveries of gas is possible at the beginning of June 2014. Taking into consideration that Ukraine gas storage facilities are half-empty this would bring the country and may be some European countries in the phase of severe problems in the coming winter. This is understood well enough both in Kiev and in Brussels and one should expect quick and efficient precautionary measures.
- Geopolitical risks, connected with Crimea. With its 4 per cent of GDP Crimea is no longer part of Ukraine, and this is irreversible. The inclusion of Crimea in this programme is done by the IMF for political courtesy only. The behavior of Ukraine towards Crimea terminating one-sidedly the supply of irrigation water through the Crimea channel, will cause great damages to the Crimea agriculture this and the next year until alternative supplies of water were found.
- Broader geopolitical risks, related to possible separation of the industrial eastern region of Ukraine. One learns from the programme, that in 2013 the Donetsk, Lugansk and Kharkov regions have produced 21,5 per cent of the GDP of Ukraine, and 30 per cent of industrial output. They have provided 28 per cent of exports and generated 11 per cent of imports. In the least unfavorable scenario there will be a decline of budget revenues and reduction of investments. This would contribute to higher budget deficit of Ukraine and would worsen trade and payment balances. The present situation in the region with the ongoing military activities there seems to lead to separation of this region from Ukraine sooner or later and hence to the pessimistic scenario.
- Risks in the financial sector. There is a probability of stronger than expected weaknesses of the banks and of other financial institutions. One may expect larger panic withdrawal of deposits from the banks, deterioration of the credit portfolio, and growing pressure on the banking system.
- Other risks. Under the present circumstances there would be an increase of military expenditures of Ukraine at the expense of civil development programmes. The access to the international capital markets will be more difficult. One may expect weakening of political support and of confidence of the population in the reform programme. The resistance of powerful vested interest groups against reforms may grow stronger. The implementation of the programme may be delayed during May - September 2014 in connection with presidential elections and their outcome, as well as of military confrontation in some regions of Ukraine. It is not excluded some time after elections the new government to request modifications in the reform programme. Political, economic and social uncertainties and insecurities may last longer, be deeper and more destructive than expected, with large negative effects on employment, incomes, consumption, savings, investments, lending, trade, may boost the black economy and corruption. All this will make more difficult the implementation of the programme
К. Monitoring of implementation:
Monitoring of implementation will be executed by the IMF at the beginning by reviews every two months and afterwards – each quarter. The first review will take place on 25 July 2014; the second – on 25 September 2014 and the third – on 15 December 2014. Afterwards reviews will be made every three months
L. Overall assessment of the programme:
1. The programme has been developed, following the well known pattern of the IMF, implemented over recent decades throughout the World, including Central and East European countries (CEEC), including Bulgaria. Its fundamental characteristic is “RESTRICTION”. The authors of the programme did not learn the pressing lessons of the implementation of this approach in CEEC over the last 25 years, as well as from the recent global crisis. Hard times await tens of millions of Ukraine citizens, whose quality of life, one of the lowest in Europe, will be further reduced. If this programme was implemented strictly as planned, the already miserably low domestic consumption in Ukraine would fall by another 35-40 per cent during the following years. This would introduce additional tensions in the society, which would be added to the existing sharp social, ethnic, cultural, political and other conflicts. The implications of these challenges are hard to predict in details, but obviously they will be very serious. What we witnessed in Bulgaria and in other CEEC during the so called “transition” will be repeated in Ukraine in degraded version.
2. The programme is too optimistic and ambitious. This makes it unrealizable. To be more specific I have in mind the expectations for GDP growth, employment, incomes growth, exports, inflation, budget deficits, balance of payments, and payment of debts to Gazprom, reduction of gross debt. It is unrealistic to expect that Ukraine will settle regularly with creditors and will attract easily resources from private foreign investors. It is also unrealistic to expect the stated price for gas, an exchange rate of 10,9546 Hryvnia per US dollar until the end of this year, substantial suppression of corruption.
IMF does a disservice to Ukraine with this brutally restrictive and unrealistic programme. The authors of the programme did not exercise the indispensable prudence concerning potential social consequences of the requested very restrictive measures. Particularly bearing in mind the present critical situation in Ukraine: the ensuing social fatigue in society from the long-lasting, wrongly designed economic reforms and the acute deficit of social justice in the country, generating degrading poverty at one pole of society and extraordinary wealth on the other. The Government has limited options to assist the most vulnerable sections of the population. This will be a source of economic, social, political instability and prolongation of social agony. The citizens of Ukraine will be cruelly deceived. They will pay again the price for somebody else’s mistakes.
This conclusion could be summarized in the following table:
Summary of the most important indicators of the programme
Indicators/Years |
2013 |
2014 |
2015 |
2016 |
2017 |
2018 |
2019 |
1.Growth of GDP - % |
0,0 |
-5,0 |
2,0 |
4,0 |
4,0 |
4,5 |
4,5 |
2. Growth of domestic demand-% |
0,9 |
-8,2 |
2,0 |
4,6 |
4,8 |
5,3 |
5,3 |
3.Growth of net exports -% |
-1,0 |
3,2 |
0,0 |
-0,6 |
-0,8 |
-0,8 |
-0,8 |
4. Unemployment (ILO) - % |
7,2 |
8,5 |
8,0 |
7,5 |
7,0 |
6,5 |
6,5 |
5. Consum.prices-aver. annua. % |
0,5 |
8,3 |
12,9 |
6,3 |
5,4 |
5,0 |
4,6 |
6. Growth of nominal salaries - % |
8,0 |
4,7 |
14,0 |
9,5 |
9,1 |
8,7 |
8,5 |
7. Savings - % оf GDP |
6,5 |
5,0 |
7,1 |
10,1 |
12,0 |
14,1 |
16,1 |
8. Investments - % оf GDP |
15,7 |
9,5 |
11,4 |
13,9 |
15,9 |
17,9 |
19,9 |
9. Governm. budget -% оf GDP |
-4,8 |
-5,2 |
-4,2 |
-3,1 |
-2,9 |
-2,5 |
-2,4 |
10. Public debtг -% оf GDP |
40,9 |
56,5 |
62,1 |
61,2 |
57,9 |
51,9 |
45,3 |
11. External debt – % оf GDP |
78,6 |
99,5 |
99,3 |
95,4 |
91,0 |
87,1 |
81,5 |
Source: Programme for economic reforms in Ukraine. IMF site. Section on Ukraine.
Even a cursory look at the table shows that in 2016 the situation in the Ukraine economy would be normal: 4,0 per cent growth of GDP, 4,6 per cent growth of domestic demand, only 7,5 per cent unemployment, 6,3 per cent inflation, 9,5 per cent increase of salaries, 10,1 per cent increase of savings, 13,9 per cent growth of investments, only 3,1 per cent of GDP budget deficit, only 61,2 per cent of GDP public debt. Most of the EU member countries would be pleased with such macroeconomic indicators. Ukraine would have set a world record for quick recovery from total chaos and at the brink of economic catastrophe, as it is at the beginning of 2014, to economic and social normality in 2016, as the above table is telling us.
I repeat – with such programme the IMF does not provide a good service to Ukraine! Even the authors of the programme will understand soon that it is not realistic and would initiate a major revision. With the present version of the programme one could generate illusions in Ukraine society for quick exit from the crisis. This however is not feasible and the illusions will develop soon into alienation and despair. The most convincing language in carrying such complex economic reforms and in presenting them to the public is the language of sincerity, realism and truth.
18 May 2014