Ukraine: New IMF deal sealed to escape cash crunch
On 19 October, Ukraine and the IMF reached an agreement for a new 14-month USD 3.9 billion Stand-By Arrangement (SBA). The breakthrough was reached when the government finally gave into the Fund’s demands and hiked up household gas tariffs by 23.5% effective 1 November. The SBA replaces the USD 17.5 billion arrangement under the Extended Fund Facility (EFF) which had been frozen since April 2017 due to the slow implementation of reforms such as the establishment of an anticorruption court, liberalizing the agricultural land market and removing energy subsidies for households. The EFF was also set to expire in March 2019. The SBA should allow Ukraine to maintain financial stability and credibility in the eyes of investors in the run up to elections next year. The agreement should help President Petro Poroshenko stand firmer in his re-election bid and in turn help to keep the country on a stable course after 2019.
The new IMF deal should help Ukraine navigate through the upcoming challenging election year by providing the government with financial support to meet its heavy debt repayments and, in turn, mandating needed structural economic reforms. While the full details of the agreement are still outstanding, it should reinforce fiscal consolidation, help speed up tax reform and focus on reducing economic vulnerabilities. While tough economic reforms, including likely gas price hikes, could put a damper on consumption in the near-term, structural reforms should boost the sustainability of the economy’s recovery in the longer-term and strengthen the business environment. The SBA will also help to replenish the county’s foreign exchange reserves and allow Ukraine to receive additional financial support from both the EU and World Bank. Furthermore, the agreement has opened doors for the country to again sell international bonds to finance its debt—the standoff with the IMF had killed creditors’ appetite for Ukrainian debt. On 25 October, the government raised USD 2.0 billion which is set to be used for repayments and public spending.
While the agreement is overall good news for Ukraine’s economy, there is a chance that it could fall off track similarly to the previous IMF deal if reform momentum loses traction. This risk appears rather significant, given next year’s election. The possibility of a delay or even a reduction in financing will continue to loom large well into 2019, until the current government’s willingness to implement reforms before the elections and the new government’s willingness to remain committed to reforms are tested. Moreover, despite the tentative agreement for the SBA in place, the deal could still fall through in the coming weeks as it is conditional on the Ukrainian parliament passing a 2019 budget consistent with IMF recommendations and approval is still pending from the Ukrainian parliament and the Fund´s executive board. Commenting on the agreement’s outlook, Economists from Investment Capital Ukraine (ICU) elaborate:
“We see two major remaining threats to the approval of the budget. The primary one is the Capital Exit Tax (CET), which should replace the Corporate Profit Tax. The IMF sees it as a threat to financial stability, since income tax revenues amount to 2.3% of GDP. We believe that the compromise solution will suggest gradual replacement of the income tax with CET. The other possible problem might be lack of parliamentary support of a budget with spending, which does not satisfy MPs’ election-year appetites due to the IMF criteria. We believe that such a scenario is possible, but not plausible. In our base-case scenario, Parliament supports the deal.”
While risks to successful implementation of the deal as well as to the economic outlook remain, the emerging scenario appears more optimistic than in recent months. The SBA should guarantee economic stability in the coming year and encourage the government to pursue needed economic reforms.
Ukraine GDP Forecast
Economic growth is expected to moderate slightly next year; however, it should gather momentum over the medium-term.