IMF Program: Summary before the Review

Ukraine looks set to receive the next round of IMF funding after accomplishing most of the 100 reforms stipulated by the IMF Memorandum for spring 2015

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Ukraine looks set to receive the next tranche of IMF funding after accomplishing most of about 100 reform measures stipulated by the IMF Memorandum signed in February 2015.  However, as long as the country relies on external pressure to generate the political will, comprehensive action on reforms will remain elusive.

On February 27, 2015, Ukraine signed a Memorandum of cooperation with the IMF that may soon be characterized as “money in exchange for reforms”. In their “First 100 days in the Office Report” government officials named the IMF agreement one of their main achievements. Indeed, without the IMF loan, Ukraine would not have been able to pay out its external liabilities and stabilize its exchange rate. More details about the IMF program can be found here, here and here.

The reforms envisaged by Memorandum can be summarized as follows:

  • Monetary and banking policy: flexible exchange rate, transfer to inflation targeting, further “cleaning” of the banking system, establishing fair rules of the game and enforcing them;
  • Fiscal policy: elimination of the Naftogaz deficit, raising tax compliance, and providing social safety net for vulnerable groups;
  • Deregulation, judicial reform and the fight against corruption – the “three pillars” of a healthy economy. Ukraine’s Western partners often stress that the combatting corruption must be the foundation of reforms in Ukraine. No wonder that it received significant attention in the Memorandum.

As we can see, nothing is new here – these are the measures that have been discussed by experts and government officials for at least the last decade. Now they have to be implemented.

Importantly, the Memorandum contains not only the reforms outlined above, but, unlike the Ukrainian government program, also a very clear schedule for their implementation. The majority of reform activities will be carried out with technical assistance from the IMF, the World Bank and other international organizations.

The Memorandum also calls for the Government to conduct communication campaigns to inform the public about reform efforts – particularly regarding energy price increases. Unfortunately, this requirement is quite vague and, perhaps because of that the Government does not pay sufficient attention to the informational component of their work.

In May, the IMF mission arrived in Ukraine to assess the implementation of Ukraine’s key performance indicators. The decision on additional funding for Ukraine by the IMF’s Executive Board, which is due in early July, will hinge on the mission’s findings. Judging from the press release issued by the mission, there is a high probability that the Board will decide in Ukraine’s favor. Although some have been delayed, the majority of “structural benchmarks” – that is specific activities with clearly defined terms – were met. The reforms planned in the Memorandum, and their execution, are detailed below (note that we don’t know which measures were included into the Memorandum at the IMF’s request, and which of them were proposed by the Ukrainian government officials).

Note: areas marked in green denote measures that were implemented in time, orange – implemented partially or with a delay, red – measures for which the deadline has passed.

Reform of the monetary and exchange rate policy

Despite the formal announcement about the transfer to a flexible exchange rate policy and a number of periods of significant (over 10%) devaluation of the Hryvnia, the National Bank of Ukraine (the NBU) had actually been pursuing a fixed exchange rate until February 2015. This policy, coupled with the structure of Ukrainian exports, consisting primarily of raw materials, resulted in Ukraine’s over-sensitivity to the world economic crises with alternating periods of deceptive stability and outright panic (read more here). Now the NBU is targeting price stability because the majority of people earn and spend in Hryvnia. The following measures were included into the Memorandum:

Reform area Actions Deadline Outcome
Monetary policy Limit the money supply while maintaining a positive real refinancing rate Next 12-18 months In process – the key interest rate increased to 30% and administrative constraints imposed
Foreign exchange market Draft a plan to remove foreign currency and capital flow restrictions End of May 2015 NBU weakened three restrictions (resolution 354, 355), a plan was developed but not published
Naftogas will buy currency on the market, and not from the NBU Undefined Done
Extend a swap line with the Bank of China Undefined Done
Strengthen the NBU independence Prepare draft amendments to the NBU Law End of February 2015 Draft law was approved in the first reading
Amend the Budget code making it impossible to transfer NBU revenue to the budget prior to the completion of the financial audit of the NBU Undefined Draft law was approved in the first reading
Reform the NBU structure and internal procedures Transform Board of Directors into Executive Committee. Extend the Board competences, form a Monetary Policy Committee, publish regular reports on inflation and financial stability Undefined Monetary Policy Committee was formed, 1st Inflation report published

 Banking system reform

There are several problems in the Ukrainian banking system. First, there is a large number of “pocket” banks in Ukraine and thus a high level of related party lending. Second, there is insufficient capital, which raises risks of bank insolvency in case of exchange rate fluctuations or deterioration of assets. Third there is high amount of non-performing loans, which often became non-performing back in 2008, after a sharp Hryvnia devaluation.

It’s no secret that almost every financial-industrial group had its own “pocket” bank not only for operational purposes, but also for preferential lending to companies belonging to this financial-industrial group – and the source of these loans were personal deposits, often attracted at above the market interest rates. When needed, one could empty this kind of bank in a few days by withdrawing the assets and shifting the cost of deposits redemption to the Deposit Guarantee Fund, i.e., to the other banks which contribute to the Fund and, in case of the insufficiency of such funding, to the taxpayers. Before the adoption of the relevant law on increasing the bankowner responsibility, dishonest owners were not held responsible for engaging in such schemes. Although there were legal restrictions to related party lending, they were easily bypassed via complicated structures of financial-industrial groups. The recently adopted law obliges enterprises, including banks, to disclose the information on the final beneficiaries, but it has not come into full force yet. To eliminate the above schemes and clean up the banking system, the following actions are planned:

Reform purpose Measures Deadline Outcome
Reduce related party lending Adopt relevant legislation and revise the NBU documents to close the loopholes allowing restrictions on related party lending to be bypassed End of March 2015 On May 12, 2015 the NBU adopted a resolution on related parties criteria and reporting
Banks have to provide the information on the volume related party lending End of May 2015 – 10 biggest banks, end of July – 20 next banks, end of September – the rest of the banks In process
The NBU will audit the banks and together with them develop plans to reduce the volume of related party lending Audit 20 biggest banks within a 6 month period, audit the rest of the banks during a 9 month period
Reduce the volume of related party lending. If a bank violates the plan for reduction of related party lending two times, it will be withdrawn from the market. Starting from June 2016, all banks will have a plan in place to reduce the volume of related party lending
Create a specialized department at the NBU to supervise reduction of related party lending.Create plans for all the financial-industrial groups End of September 2015 Head of department was appointed
Improve banking standards, especially treatment of non-performing loans Full transition of banks to IFRS Since July 2015
Legal investigation of cases of banks bankruptcy to identify the causes of bankruptcy (the investigator will be chosen through a tender) Beginning of investigation – June 2015
Adopt a law to extend the bank liquidation period from 3 to 5 years (to raise the recovery rate of the assets’ economic value) End of May 2015 A draft law has been submitted
Create a system of pre-court loan restructuring that corresponds to international practices By the end of June 2015
Submit the draft law on private debt restructuring (personal bankruptcy law) to parliament By the end of July 2015 A draft law has been submitted by MPs (People’s Front and the Radical Party of Lyashko)
Forced conversion of foreign currency loans into Hryvnia will not happen; NBU will not interfere in negotiations between the banks and FX borrowers but will issue a Code of Conduct regulating such negotiations By the end of March 2015 A Memorandum was issued
Bank recapitalization Amendments to the law on measures helping bank recapitalization Law was adopted on Dec 28, 2014
Additional capitalization of the banks based on the results of the 2014 stress test 9 of the 15 largest banks should have been recapitalized by the end of January 2015, next 20 banks – by the end of February, other banks – by the end of June 2015 In process
Updated stress test and evaluation of the banks’ asset quality, if necessary conduct another recapitalization 10 largest banks – end of July 2015, next 10 banks – end of September 2015 In process

 Fiscal policy

The main fiscal policy problems that Ukrainian governments have faced have been revenue-expenditure mismatch and spending inefficiency due to both corruption and “social state” inherited from the Soviet times. Until recently Ukraine had a “Russian-type” social contract, which implies that people let officials enrich themselves, and in return receive “crumbs from the table”, mainly in the form of low tariffs, an ineffective system of privileges and supposedly free healthcare system.

Under such a setup, the middle class representatives, and particularly entrepreneurs, had to pay for both the palaces of the ruling class, and the “guaranteed minimum” of others. Obviously, this model of social relations could not last for long. From now on both the government and households will have to engage in the long-term planning and economizing. For this purpose the following measures are envisaged:

Reform Measures Deadline Outcome
Budget cuts “Freezing” minimum wage and official subsistence level, cutting special pensions (except for the army pensioners) from 70-80% to 60% of salary, cancelling subsidies to the coal mining industry. Thus, public sector payroll (except for the army) in 2015 compared with 2014 will not increase. The number of people getting paid from the budget would drop by 3% (or about 105,000) by September 2015. Of those 67,000 will be civil servants, whose number will decline by 20%. The salaries of public servants will grow accordingly. In the medium term the public sector payroll will be reduced to 9% of GDP 2015-2018 Included in Budget-2015
Healthcare:Submit to the parliament the draft law on medical reform. The law will foresee financing of hospitals depending not on the number of beds, but on the services provided By the end of March 2015 A draft law on medical reform has not been submitted
Adopt a law on drug procurement through international organizations. By the end of March 2015 The law was adopted
Education:Reduce the number of higher educational institutions from 802 to 317, reduce the number of students paid for by the state, reduce the number of schools by 5% (more than 900 schools), as a result in 2015 the expenditures on education will be reduced by at least UAH 300 million By the end of May 2015 Foreseen in the State Budget-2015
Submit to the parliament the draft law on education reform By the end of May 2015 A draft law has not been submitted
Social safety net: replace subsidies with a guaranteed minimum income (GMI) program. Merge utility privileges and subsidies, convert privileges into subsidies.By 2017 introduce a single program of cash transfers (poverty protection mechanism) – completely monetize privileges. By the end of March 2015 Some privileges remain
Reduce Pension Fund expenses and its budget financing For some occupations, in which the workers have the right for early retirement, the retirement age will be gradually increased by 5 years, which will save UAH 1.6 billion in 2015. Undefined The law was adopted
Pensioners who did not receive pensions on the occupied territories will be paid after they resettle Ongoing Pensions are being paid
Preventing the rollback of the pension reform. Ongoing The law that rolled back the reform was vetoed
Submit a new version of the law on pension provision, which will come into effect from Jan 1, 2016 (indexation of pensions, lowering the threshold of nontaxable pension, gradual unification of the rules for calculation of general and privileged pensions) By September 15, 2015 A draft law was submitted, but returned for a complete review by the parliamentary Committee
The single social tax (SST) rate will be reduced in line with the reduction of pension expenditures Undefined The law on SST rate reduction was adopted (certain eligibility criteria were introduced, particularly, salary increases)
Simplification of tax compliance Develop a plan of the State Fiscal Service modernization (improve tax administrative procedures, lay off inefficient staff, introduce automatic customs procedures, make State Fiscal Service subordinate to the Ministry of Finance) in order to start the implementation of the plan of Jan 1, 2016 By the end of April 2015 No plan
Tax reform, transfer pricing, electronic system for VAT administration By the end of 2015 The respective laws were adopted (1, 2)
Entrepreneurs using simplified taxation system will have to use cash registers Since July 1, 2015 The law was adopted, but entrepreneurs oppose the cash registers
All large taxpayers will be transferred to the single Large Taxpayers Inspection. By Jan, 1 2016  Transferred
The agricultural sector will pay VAT on the general basis From Jan 1, 2016
To submit to the parliament amendments to the Tax Code aimed at tax base expansion, making PIT more progressive, expansion of the base and raiding property tax rates, new taxation regime for extraction industry By July 1, 2015 Tax reform is under way, however currently there is only a collection of ideas
Budget process reform Implement medium-term budgeting Since 2018
Review accounts of state entities in commercial banks, close unnecessary accounts and create a payments planning unit within the Ministry of Finance or State Treasury Undefined
Eliminate the differences between protected and unprotected budget items Undefined
Limit the newly issued state guarantees of commercial debt to 5% of the sum of state debt increase Undefined The 5% limit was included into the Budget Code

Except the internal reforms, the Memorandum envisages restructuring of the state foreign debt as well as external liabilities of the state-owned enterprises. The government actively negotiates with investors, but for now only the restructuring of the state-owned Ukreximbank bonds has been agreed upon. To strengthen the government bargaining position, the law was adopted providing the government with the right to impose a moratorium on external debt payments.

Energy sector

Today Ukraine is one of the most energy inefficient countries in the world. For example, according to the World Bank data, Ukraine produces 2.8 times less GDP per unit of energy use than Poland, and 3.7 times less than Germany. This can be partially explained by the high share of the shadow economy in GDP. However, a more important reason for this is a complete mess in the energy sector, where a large part of energy resources are not accounted for, are lost during transportation, or simply wasted. As we don’t value things what we get cheaply, the majority of people do not realize the true price of the “cheap energy”. For example, in 2014 Naftogas financing exceeded the Defense Ministry budget by 3.5 times and the Health Ministry budget by 10 times. In 2013, subsidies for the coal mining industry were equal to the financing of all higher educational institutions.

The energy sector reform plan includes three components – market tariffs, with no hidden subsidies, strict accounting, and targeted support of the poor. The need to raise energy tariffs has been explained by the [broad] Government on numerous occasion – for example, see a recent interview of the Naftogas Head. Planned energy sector reforms are primarily concerned with the gas sector:

Measure Deadline Outcome
Adopt the gas sector reform plan (Split Naftogas into gas transportation, storage and sales, audits of regional gas distributors, installation of gas meters along the entire supply chain) By March 1, 2015 The plan was approved in March
Cancel the decree that ordered 170 companies to buy gas exclusively from Naftogas, avoid such decisions in the future End of February 2015 Cancelled
Submit to the parliament legislation amendments aimed at improving the collection of payments by Naftogas (remove the moratoria that protect energy companies from mandatory collection procedures, disconnect the consumers that do not pay for gas) By March 31, 2015 The law was signed on June 3, 2015
By April, 2017 retail prices on gas and heating will be raised to the level of import prices.At the first stage, prices were raised to UAH 3,600 per 1,000 cubic meters for those who consume less than 200 cubic meters per month and to UAH 7,178 for those who consume more, and also use gas only for cooking and water heating (i.e. in apartment buildings). Average increase was 280%. From April 2015 National Commission for State Energy and Public Utilities Regulation raised the tariffs for gas (1, 2) and electricity (1, 2)
Publish the Naftogas audit: for 2012 – 2013 – by the end of March 2015, for 2014 – by the end of July 2015; audit of Naftogas accounts receivable – by June 30, 2015. By the end of July, 2015 Naftogas published consolidated financial statements for 2012 -2013, however they are not very informative
A law on natural gas market should be adopted (free access to pipelines, rules for tariffs setting by the regulator, liberalization of prices) By the end of April 2015 The Law “On natural gas” market was adopted
Install gas and heat meters in all households (now only 36% of households have heat meters installed, and gas meters are installed mostly by large consumers), pay for the gas and heat based on actual rather than normative consumption. By the beginning of 2016
Make legislative changes that will allow funds to be invested in installation of meters and individual heating of apartment buildings (with the help of IFC and USAID) Undefined
To introduce international management standards into state energy companies (Ukraenergo, Naftogaz, Energoatom, etc.). To privatize Centrenergo and other key producers. Undefined

Business climate and fight against corruption

There is no doubt that corruption is the main problem in our country. Moreover, as repeatedly noted, corruption in Ukraine is not episodic, as in developed countries, but rather systemic. In current conditions an optimal strategy for a Ukrainian citizen without informal connections is to give a bribe and quickly get a service from the state, or avoid punishment. The alternative is not to give a bribe and be kicked from one office to another for months or, for example, pay a fine that exceeds the size of the bribe.

The high priority of fighting corruption was acknowledged in the previously mentioned government program, Strategy of reforms – 2020. It is also acknowledged in a more detailed strategic document that is currently under development.

It is clear that it is impossible to place a policeman next to every civil servant. That is why the most effective method of fighting corruption is reduction of state functions, aka deregulation. For this purpose such measures are planned:

Measure Deadline Outcome
Implement the actions foreseen by the anti-corruption Strategy for 2014-2017 and the State program for the implementation of this strategy, including:
  • National corruption perception survey
Every year in March, starting in 2015 Only the level of perception of corruption by business was surveyed
  • Create Anti-corruption Agency
March 2015 The government decree was adopted
  • Appoint its head so that the Agency starts working by Jan 1, 2016
June 2015 Competition is in process
  • Submit to the parliament the new versions of the Laws “On the State service” and “On service at local self-government bodies” in order to adopt them in May 2015
April 2015 Draft laws (1, 2) adopted in the first reading
  • Draft the law on political parties financing (to adopt it in December 2015)
June 2015 Draft law was submitted to the parliament
  • Draft a judicial sector reform strategy to be implemented by 2019
May – June 2015 Ukrainian and European experts are working on the document
  • Adopt the draft law on the State Bureau of Investigation
June 2015 Adopted in the first reading
  • Adopt the law on raising transparency of Verkhovna Rada and local councils
August 2015
Adopt legislation on disclosure of information on final beneficiaries. By the end of March 2015 The law was adopted but the deadline for information disclosure was moved to September 2015
Forbid high-level officials to accept the gifts (except those with nominal value) or to receive any salary except what is stipulated by the Constitution. Undefined  
Adopt an action plan on deregulation and publish quarterly reports on its implementation and the regulatory effect evaluations By March 11, 2015 Action plan was approved, the first report was published  action
Adopt the law on investors rights protection By the end of March 2015 The Law was adopted and will come into effect on May 1, 2016
Organize National Anti-corruption Agency (appoint its head and provide a budget and an office) By the end of April 2015 The Head of Anti-corruption Agency was appointed on April 16, 2015, office was provided (3, Surikova Str.)
To adopt the amendments to the law on Anti-corruption Agency providing for:

  • External supervision (publication of annual report, monitoring of activity by experts with international experience)
  • The right to pursue investigation against all high-level officials, including former presidents, to get all information, including confidential information about bank accounts without a warrant
  • Careful selection and high salaries for workers of Anti-corruption Agency
Undefined Amendments were adoptedThe law that secures financing of the National Anti-Corruption Bureau and anti-corruption Committee was adopted
To take action on money laundering (make the appropriate changes to the law on the National Bank of Ukraine, to conduct trainings for financial institutions on identification of politically significant persons, to organize a permanent exchange of information between national anti-corruption bureau, NBU and the Sate Financial Monitoring Service of Ukraine On a regular basis

 Judicial system

Apparently, there is no need to stipulate the importance of a properly working judicial system for the existence of a democratic state guided by the rule of law – for the laws that are not enforced are useless – as well as the court orders which are not executed. However, judicial reform is perhaps most difficult because formally it is not subordinate to the government. Nevertheless, some measures for the legal system reform have been included into the Memorandum:

Measure Deadline Outcome
Adopt a law on the court system and status of judges. Submit it to the Venice Commission for evaluation By February 28, 2015By March 31, 2015 A new version of the law was adopted, and received a generally positive feedback from the Commission
Adopt a law on the selective increase of the court fees to double the annual revenue By the end of May 2015 The Law was adopted
Adopt a law on streamlining and easing the procedure and of bank accounts arrest By the end of August 2015
Adopt the law on the private execution agent By the end of September2015

Restructuring of state-owned enterprises (SOE)

Of Ukraine’s nearly 3,400 state-owned enterprises only a little over a half are operating and the majority of those are unprofitable. In 2014 the subsidies to state-owned enterprises (without Naftogas) amounted to 2,5% of GDP, and dividends from them were only to 0,2% of GDP (data from the Memorandum). Therefore, it makes sense to sell the underperforming companies, except for those important for the national security – at the least to reduce state subsidies to loss-making SOE. To remove this “deadweight” from the state budget the following measures are foreseen:

Measure Deadline Outcome
To create a department within the Ministry of Economic Development and Trade that would be responsible for drafting the SOE reform strategy and development of the system of fiscal risk management.Strategy must be approved by the end of March By the end of February 2015 Strategic directions for reform are presented here and here
Prepare a list of the largest 50 state-owned enterprises and their main financial indicators (revenues, profit/loss, payroll, budget subsidies, dividends etc.). By the end of March2015 Report on the Top-100 state-owned companies and their financial statements were published
Prepare the assessment of fiscal risks of state-owned enterprises; introduce a monitoring and reporting system on them. Define Top-30 state-owned enterprises by fiscal risk (Ministry of Finance and Ministry of Economy) By the end of April 2015 Fiscal risk assessment is provided in the Top-100 SOE report
Define 30 “pilot” state-owned enterprises for restructuring By the end of April 2015 Not defined
Adopt a plan for improvement of SOE-related legislation By the end of May 2015 No plan
Create a database of the 50 largest state-owned enterprises and a comprehensive report on their economic performance.Later, create a database of all state-owned enterprises and publish annual reports on their economic performance By the end of June 2015
Make a list of all state-owned enterprises breaking them down into commercial and non-commercial ones By the end of July 2015
State property inventory: to make a list of real estate owned by state authorities (Ministry of Economy and State Property Fund of Ukraine) By the end of August 2015

Conclusion

Ukraine implemented the majority of measures foreseen by the Memorandum. However, these reforms are only a necessary minimum that will “keep Ukraine afloat”. The “shock therapy” experience of other Eastern European countries suggests that to switch into a stable economic growth path, one should implement more rapid and sweeping reforms. It would not only improve the life of Ukrainians already in a year or two, but also attract a new wave of foreign investment. Current pace of reforms induces “weariness from Ukraine” syndrome abroad and “nothing has changed” position within the country.

The article was published also by Ukrainska Pravda.

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