6 Reasons to Support the IMF Agreement

The obvious reason to support the IMF Agreement is that it provides vital relief to the critical state of foreign reserves of Ukrainian central bank. The foreign reserves of the country have fallen to a crisis level of $5.6 billion (as of end-February 2015) as foreign currency has drained away under the pressure of debt repayments, trade imbalances and speculative outflow of hard currency. However, an even more important aspect of the IMF Agreement are the conditions imposed which relate to the reform of Ukraine’s economy.

On March 11, the Board of the IMF is meeting to ratify the Agreement reached between Ukraine and the IMF mission to provide extended funding in the amount of $17.5 billion. This Agreement would then see the release of an additional $7 billion in funding promised by the EU, the US and other international lenders. Furthermore, the Agreement opens the door for the restructuring of another $17 billion in Eurobonds, a substantial portion of which would be coming due in the coming year. Beyond this, an upcoming donor conference may again lead to further financing, possibly at a level of an additional $10 billion.

Reason 1: Vital relief to the critical state of foreign reserves

The obvious reason to support the IMF Agreement is that it provides vital relief to the critical state of foreign reserves of Ukrainian central bank. The foreign reserves of the country have fallen to a crisis level of $5.6 billion (as of end-February 2015) as foreign currency has drained away under the pressure of debt repayments, trade imbalances and speculative outflow of hard currency. This situation has resulted in the massive devaluation of the Hryvnia whose exchange rate value had fallen from 8 UAH per US$ in end-2013 to the level of over 30 UAH to the US$ in mid-February 2015. With the IMF Agreement it is expected that around $5 billion in foreign currency would be forthcoming very shortly as the initial tranche. The effect of such a currency infusion is already being felt in the interbank currency market which saw a recent strengthening of the Hryvnia to the 21 UAH/US$ level (with monetary tightening and the introduction of temporary administrative measures also playing a role.)

However, an even more important aspect of the IMF Agreement are the conditions imposed which relate to the reform of Ukraine’s economy. As a lender, the IMF invariably imposes terms and conditions which must be met by the borrower in order to receive funding. While all of the details of the Memorandum of Agreement have not been made public prior to formal Board approval, the main elements are obvious from the actions of the Government and amendments introduced to the 2015 Budget. The central demands of the IMF can be summarized as follows: a reduction in the budgetary deficit, a movement to market pricing in energy, a curtailment of excessive pension expenditures, improved management of the banking sector and the reduction of corruption.

These conditions constitute the essential elements for the reform of Ukraine’s economy. Over the past year, working within the Economic Advisory Council to the Ministry of Economic Development and Trade, I and my fellow members have repeatedly put forth position papers strongly advocating just such reforms. Such reforms have also been advocated by numerous specialists and observers of the Ukrainian economy. That the IMF would impose such conditions is far from radical but rather reflects the opinion of a wide range of observers. In this regard it must be seen that the financing being offered by the IMF would prove ineffective and ultimately totally wasteful if the imposed economic reforms were not implemented.

Reason 2: Reduction of the budgetary deficit

The terms and conditions being imposed by the IMF are not without pain but must be seen as the steps needed to heal an economy which is severely ill and without which there can be no recovery. The large budget deficit, which cannot be financed by tapping capital markets, has led to high levels of inflation and currency devaluation. Reducing budget deficits, even as the expenditures to support the military efforts to ward off aggression must rise, implies restrictions in numerous other spending areas.

Reason 3: Movement to market pricing in  the Energy sectror

There is never popular as the current beneficiaries of that spending will be negatively affected. This is clear, for example, in the imposition of market pricing for energy with the requirement for a substantial initial rise in the cost of communal services including natural gas, heating and electricity. However, the continuation of the massive government support of Naftogaz deficits to cover gas price subsidies (amounting to 7.5% of GDP in 2014) is both economically absurd and unsustainable.

Reason 4: Getting rid of excessive pension expenditures

Similarly, the reduction in special pensions which benefited a small privileged group at the expense of the general public is both appropriate and unavoidable in the difficult financial position of the government and the massive amounts (17% of GDP) which pension costs imposed.

Reason 5: Improved management in the Banking sector

The banking sector which currently finds itself in a massive crisis requires major reform and cannot be simply maintained through indiscriminate central bank support. In the past (chiefly during 2008-2009), very significant levels of funding was being provided to banks which were illiquid and, in fact, insolvent due to gross mismanagement. Such lending had a very negative impact on government expenditures and contributed in a major way to the sizable emissions of currency and total deficits. These practices need to be stopped and closure and restructuring of the banking sector (which has begun) needs to be continued.

Reason 6: Reduction in corruption

Finally, no knowledgeable observer of Ukraine’s economy would fail to recognize the essential need to fight corruption. As is well known from the experience of other transitional economies, the elimination of corruption is a prime requirement for the establishment of a properly functioning economy which can provide growth. Without an all-out assault on corruption, investment in the economy will continue to stagnate and any hopes for foreign capital inflow will be unrealized. Under such conditions, the economic growth which would provide jobs and wellbeing to the people of Ukraine cannot materialize.

Conclusion

At this critical juncture, the people of Ukraine must show maturity and understanding. It is very important to avoid the siren calls of populists among the politicians who would have you believe that difficult measures are not required. Such messages may be tempting but are being uttered by false prophets who will only lead the country into a financial abyss. Ukraine today has an opportunity to embrace a serious path toward economic reform with the financial support which provides a lifeline to avoid a total meltdown. More funding will be required and embracing the acknowledged difficult path of reforms is the only way to move forward and to realize on the dream of European integration.