The International Monetary Fund has been working with Ukraine for years, but recent talks about a new $5.5 billion credit tranche have already stretched out to half a year. The tranche, which is supposed to dole out funds to Ukraine over the course of three years, is seen as necessary for the Ukrainian economy to keep growing – and without it, Ukraine may face economic issues.
Ukraine’s last credit programme with the IMF ended on February 18, 2020. And Ukrainian president Volodymyr Zelenskyy believes that continuing cooperations between Ukraine and the IMF is not just needed for funding – it is a sign of stability to international investors. He says that a bill intended to assist with getting Ukraine that IMF loan is in the works.
Hromadske looks into why IMF credit is so important for Ukraine and the risks involved in working with the IMF.
Why does Ukraine need to take on credit?
When government spending (on education, roads, pensions, and so on) exceeds tax revenue, what occurs is a budgetary shortfall. This shortfall – a normal feature of most developed countries – amounted to 2% of GDP ($3.8 billion) in the 2020 budget. According to orthodox economists, this deficit of funds can result in a government being unable to cover its budgetary obligations, though other economic theories, like modern monetary theory (MMT) consider government deficits to be a tool for regulating inflation and unemployment.
Filling in the deficit can be done in a number of ways:
- Printing money (which can result in inflation)
- Cutting government spending (austerity)
- Raising additional tax revenue
- Selling government-owned assets (privatization)
- Raising funds (via borrowing, selling bonds)
A popular method for decreasing government deficits, at least in Europe, has been austerity – cutting government spending. However, austerity has failed, in many countries, to provide the economic benefits that its proponents espouse, and states have turned to alternative methods to raise funding.
As for privatization, another popular tool for raising funds, it has likewise failed implementation in Ukraine – less than 5% of planned privatizations over the last few years have taken place.
As a result, Ukraine has relied on credit to shore up its deficit.
What is IMF credit spent on?
IMF credit, unlike other sources of borrowed government funds, does not actually cover the deficit. Instead, it’s added to Ukraine’s gold reserves, held at the National Bank of Ukraine. The IMF has only twice in Ukraine’s history transferred funds directly into the government budget.
These reserves are then used to shore up sudden spikes or falls in the price of the Ukrainian national currency, the hryvnia, in relation to the U.S. dollar. Reserves are spent to stabilize the hryvnia, and the government can also purchase IMF gold reserves from the National Bank in order to pay currency debts (by spending budgeted hryvnias).
How does the IMF work?
In order for the IMF to cooperate with a country, that country has to hold itself to requirements set by the Fund itself. These requirements, a mix of ideological and economic policy preferences, are then tracked by the Fund. Common IMF requirements include lowering deficits, creating market economies, and instituting rule of law, among other factors. The IMF views these requirements as “medication”, and the Fund believes that countries that meet their requirements can “be cured” of poor finances.
International investors often rely on IMF assessments of economies in order to determine the credit-worthiness of countries. International finance organizations, investment banks, and finance corporations all look for IMF cooperation as a sign that the country is on the road to implementing reforms, creating markets, and is generally cultivating a business-friendly atmosphere. This means that IMF cooperation lets them believe that investment risks in the country are minimized.
What cooperation is Ukraine looking for now?
Right now, Ukraine is hoping for $5.5 billion spread over 3 years from the Fund. And a 500 million euro loan from the European Union is hanging on that programme, as well as a $1 billion loan from the World Bank. Unlike IMF tranches, these loans can be directly used to cover Ukraine’s deficit.
Private investors, as mentioned previously, are also waiting to see an announcement of new IMF-Ukrainian cooperation. Private investors often buy bonds and other forms of government debt that can help in financing government spending. IMF cooperation lowers the risk of these instruments, letting Ukraine sell bonds at lower percentages, meaning that servicing that debt can come more cheaply than it would otherwise.
How has Ukraine worked with the IMF before?
Ukraine has been a member of the IMF since 1992. Ukraine took its first credit from the IMF in 1995-1996.
Ukraine has participated in 10 credit programmes from the IMF in its history. However, as Ukraine has yet to meet all of the Fund’s requirements, Ukraine has received less than half the promised funds from the IMF – around $31.5 billion, out of a promised $74 billion.
The last cooperation programme with the IMF, known as the “stand-by”, was meant to transfer $3.9 billion to Ukraine in tranches over the course of 14 months. The programme was signed in late 2018, and the first tranche of $1.4 billion was transferred to the country. Ukraine did not receive the rest of the tranches, due to the change in government and the non-fulfillment of some of the IMF’s requirements.
Ukraine has often turned to the Fund during economic crises (in the late ‘90s, in 2004-2005, in 2008, and in 2014-2015), but has never filled all of the IMF’s requirements.
Some of those requirements have been met, some haven’t been met to the IMF’s liking, and some are still in the works: while Ukraine has succeeded in cleaning up the banking sector and creating an independent national bank, it has yet to create a land market, and there’s still work to be done in optimizing the gas market. But because of these obstacles, the IMF has not transferred the promised funds to Ukraine.
Why are negotiations with the IMF for a new programme taking so long?
Preliminary agreements on a new IMF programme were reached on December 7, 2019. But in order for the programme to be finalized, the IMF Board of Governors has to sign off. But they have yet to do so, despite the fact that Ukraine is on its way to meeting most of the IMF’s requirements – Ukraine’s gas market is set to launch May 1, 2020, and the Ukrainian parliament is working on finalizing a law on the creation of a land market.
Oleksiy Honcharuk, the first prime minister in Zelenskyy’s administration – now replaced by Denys Shmyhal – had been working with the IMF to finalize an agreement for his entire six-month tenure. Ukraine has played host to IMF missions numerous times, and Ukrainian officials have visited the IMF in Washington DC several times. IMF head Kristalina Georgieva has even met with President Zelenskyy. But that still hasn’t led to an agreement.
A big reason for this failure has been the non-adoption of bill number 2571, nicknamed the “anti-monopoly” bill. The IMF requires Ukraine to pass that bill in order to receive funds, but parliamentary opposition has so far stalled that effort.
The bill is intended to solve the program of so-called “zombie banks” – banks that are unable to pay their debts, yet whose owners are still, via the courts, attempting to bring them back onto the market. The zombie appellation comes from the fact that these banks, despite formally existing on paper, cannot engage in banking activists, nor can they be traded on the market.
The bill also tackles two big issues connected to bank nationalizations – in particular, the nationalization of PrivatBank. The bill would ban former owners of banks from regaining control of nationalized banks, though it does allow the former owners to receive monetary compensation if a court rules the nationalization illegal. The bill sets the Supreme Court of Ukraine as the only with jurisdiction over bank nationalization cases.
In practice, this would mean that the former owner of PrivatBank – oligarch Ihor Kolomoisky – would be barred from taking back the bank, even if one of the many currently open court cases is ruled in his favor. If bill 2571 passes, all those cases would be combined into one, and it would be referred up to the Supreme Court. PrivatBank would remain government-owned in any case.
As Parliament is currently busy with coronavirus emergency measures and land reform, it cannot currently consider bill 2571, and thus cannot fill that IMF requirement at this time.
Managing Director of the International Monetary Fund Kristalina Georgieva (center) and World Bank president David Malpass at a joint press conference at IMF headquarters in Washington D.C., U.S.A. March 4, 2020. Photo: EPA-EFE/ERIK S. LESSER
Why does Ukraine need those IMF funds right now?
In 2019, when Ukraine was in the stand-by program, it expected to receive two tranches from the Fund. However, there was no pressing crisis at that time that would have given those tranches a sense of urgency, since international markets seemed to be warming to Ukraine.
In fact, Ukraine’s finances were steadily improving – thanks to cheap energy prices and cheap imports, Ukraine’s spending turned out to be lower than usual. And Ukraine was even able to increase its exports thanks to a record grain harvest. The hryvnia stabilized in relation to the dollar, and stopped falling.
This was a sign for international investors to buy into Ukraine: they began to actively purchase Ukrainian bonds and debts. This let the Ministry of Finance cut the interest rate on those bonds, from 20% to 9-10%. At the start of 2020, the Ministry of Finance launched eurobonds at the lowest rates in Ukrainian history – 4.375% (though that was still higher than IMF credit rates.)
But now the global economic outlook has radically changed. Developing countries, like Ukraine, have become unattractive to foreign investors, who are withdrawing their money. Markets are panicking due to the coronavirus, which has caused immense turmoil in major economies like China.
As a result, Ukraine is finding it even harder to finance its deficit. And the deficit is growing due to lower than expected tax revenues.
The lack of an IMF programme further exacerbates the situation, as the recent government reshuffle caused a major international investment bank, Morgan Stanley, to recommend for its clients to sell Ukrainian bonds and buy Egyptian ones. A new IMF programme would calm investors and would let Ukraine receive further funding from other international organizations. That would be enough to cover this year's budget deficit almost in full.
What is the IMF criticized for?
Despite all the seeming positives that IMF cooperation brings to a country, the Fund still faces harsh criticism both from member governments and private commentators. A common feeling in IMF-borrowing countries – and Ukraine as well – is that the IMF is butting its head into domestic policy. And some critics feel that IMF policies would lead to a cheapening of Ukrainians bonds to worthlessness.
Other criticisms stem from the lack of “success stories”: among countries who have borrowed from the IMF – as Norwegian economist Erik Rainert pointed out, few IMF-borrowing countries, even ones who have met IMF requirements, have significantly improved their economic status or raised their citizens' quality of life. Instead, Rainert claims, IMF requirements have often hurt those countries' trade balances – making them even more reliant on the Fund to smooth over currency spikes.
Rainert also points out that most of the world’s developed countries reached that status not by following IMF recommendations, but from policies of trade protectionism – meaning, loosely, that domestic products become more attractive to domestic buyers than imports. The United States, the United Kingdom, and Germany had previously all adopted strict import restrictions (aside from raw resources) in order to stimulate domestic production and exports. But the IMF requires developing countries to adhere to free trade rules and open up their markets to foreign goods, which can squeeze out domestic production in favor of multinational producers.
At the moment, Ukraine’s most productive sectors are agriculture and services (though services are typically only aimed at the domestic market and are thus very vulnerable to economic shakes.) Industrial production has been in freefall for the past few months – though not due to free trade agreements, in this case. Instead, the situation has been caused by China’s economic freeze due to the coronavirus – Chinese imports of Ukrainian metallurgical products has fallen drastically, sending Ukrainian heavy industry into crisis.
/Adapted by Romeo Kokriatski