Blog Post

Eastern promises: The IMF-Ukraine bailout

Ukraine is in a dire economic situation. In 2013, its twin deficits – which have persisted for several years – reached a new record. The budget deficit increased to about 8 percent of GDP and the current account deficit reached almost 9 percent of GDP. Economic growth has been practically zero in the last two years. Access to foreign capital markets is closed. And the hryvnia devalued by about 20 percent in the first two months of this year.

By: and Date: March 27, 2014 Topic: European Macroeconomics & Governance

Read our comments on Ukraine and Russia Eastern promises: The IMF-Ukraine bailout‘, ‘Interactive chart: How Europe can replace Russian gas‘, ‘Can Europe survive without Russian gas?‘, ‘The cost of escalating sanctions on Russia over Ukraine and Crimea‘, ‘Russian roulette‘ and ‘Gas imports: Ukraine’s expensive addiction

The International Monetary Fund has announced a $14-18 billion rescue package for Ukraine. The country has considerable economic potential. It possesses the second-largest area of fertile soils in Europe after Russia, important natural gas resources, and has a significant industrial backbone, important transit routes and a well-educated population of 45 million. Nevertheless, Ukraine is in a dire economic situation. In 2013, its twin deficits – which have persisted for several years – reached a new record. The budget deficit increased to about 8 percent of GDP and the current account deficit reached almost 9 percent of GDP. Economic growth has been practically zero in the last two years. Access to foreign capital markets is closed. And the hryvnia devalued by about 20 percent in the first two months of this year.

But how did Ukraine get there? When Yanukovich became president in 2010, his administration envisaged a project of fiscal consolidation and structural reform. The budget deficit halved between 2009 and 2011 and a progressive tax-code reform was adopted. Access to financial markets allowed his administration to issue Eurobonds. But ahead of the 2012 parliamentary elections, the government moved from long-term economic stabilisation to short-term populism. Even before the elections, from 2010 to 2012, the administration shied away from the main steps needed to tackle macro-economic imbalances: adjusting domestic energy prices and allowing for more exchange rate flexibility. In an attempt to demonstrate strength and stability, the hryvnia was fixed at 8 hryvnia per dollar by a non-independent National Bank. As a consequence, the hryvnia appreciated strongly between 2011 and 2014 compared to other currencies in the region, for example by 10 percent compared to the Polish zloty or 20 percent compared to the Turkish lira. As a result of unfavourable agreements with Russia, gas import prices increased from about $250 per thousand cubic meters in 2010 to about $400 in 2013, but gas and heat tariffs for the population were not adjusted accordingly. This tariff deficit was ultimately financed from the state budget and amounted to about 6 percent of GDP per year.

The clearly unsustainable macro-economic policy of the Yanukovich administration implied first, that Ukraine was unable to issue fresh debt on the international financial market from May 2013. Cut off from financial markets, Ukraine tried to secure an IMF programme. But as the government was unwilling to tackle the exchange rate and energy price issues, the talks stalled. By that stage, in late 2013, Russia was the only creditor that proposed financing for Ukraine without requiring unpopular measures until the regular presidential elections in 2015. But the 30 percent gas price discount and the $15 billion credit offered by Russia would have only increased the adjustment need after the elections. Furthermore, the population was highly suspicious that there was a political price for this ‘gift’ that was supposed to assist Yanukovich’s re-election. Since then, of course, the deal with Russia has fallen apart and the macroeconomic crisis is acute again.

The National Bank of Ukraine has been forced to allow the hryvnia to devalue substantially and introduce capital controls. The banking sector is under severe stress. The devaluation, deposit withdrawals and an expected increase in non-performing loans have caused a blow to the balance sheets of several banks, which might have to be recapitalised. But worse is to come. The government has to service $9.7 billion in foreign-currency debt in 2014. If Russia returns from the preferential gas price of $268 granted in December last year to the more than $400 it demanded in 2013, it will imply a 2 percent of GDP hike in the current account deficit. If Russia imposes trade restrictions, the short-term impacts on Ukraine could be severe. Switching from the current free trade regime to most-favoured-nation tariffs would imply a loss of 1.7 percent of GDP. Non-tariff measures, as applied in August last year, could further deteriorate the situation.

However, it is not impossible for Ukraine to overcome its macroeconomic crisis. In the context of an IMF programme, the country could significantly reduce the twin deficits in the medium term, accompanied by the necessary funds to finance the deficits in the short term. Additional funds from the EU and the USA are certainly welcome. A key issue in this respect is the price of energy for the population, which in some cases covers only 16% of the import and distribution costs. A gradual but decisive increase in energy prices is a necessary condition for fiscal consolidation in the short term, but also for current account sustainability in the medium term. Such a move would also reduce dependence on Russia and decrease the widespread corruption in the energy sector. But stabilisation of the banking sector is also crucial, including liquidity support and recapitalisation for systemic banks. A strong push for institutional reform should also be initiated, including the strengthening of key institutions such as the National Bank and the energy regulator, in order to avoid the mistakes of the recent past. Finally, decisive structural reforms are needed to reinstall the rule of law, improve tax administration, reduce bureaucracy and fight corruption.

One might wonder if it is realistic to achieve these multiple tasks in the short- and medium terms. In fact, while the current situation is very critical, it also provides a great opportunity for sweeping reform. First, it became evident to large parts of the population that the “old ways” according to which the country has been managed no longer work. The country needs a new economic management approach. Second, members of the new government have put aside personal interests and decided to take over responsibility, despite risking becoming unpopular. They are ready to change the country and create a better future for the Ukrainian people. Third, the EU and the USA are ready to support the country in this difficult situation, both in technical and financial terms. Seen from this angle, Ukraine might have a unique opportunity for decisive reform. 

The German Advisory Group in Ukraine, of which the two authors are members, just published its ‘Government Reform Agenda


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read about event More on this topic

Upcoming Event

Apr
25
12:30

Central banking in turbulent times

This event will look at fundamental questions about the central banking systems and how the Great Recession might have prompted a reassessment of the old central banking model.

Speakers: Maria Demertzis, Paul De Grauwe, Marianne Nessén and Francesco Papadia Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Apr
26
16:30

Youth UP Europe: Future of democracy in Europe

Bruegel and the European Youth Forum are teaming up to organise an event series in which young people, researchers and policy makers debate policy issues relevant to the future of Europe.

Speakers: Alice Mary Higgins, Luis Alvarado Martinez, Thodoris Georgakopoulos and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author

Podcast

Podcast

Director's Cut: EU risks US tariff pain in standing by the WTO

As global trade war continues to unfold, Bruegel director Guntram Wolff is joined for this Director's Cut of 'The Sound of Economics' podcast by Bernd Lange MEP, chair of the Committee on International Trade (INTA), to discuss Europe's options.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: April 18, 2018
Read article More on this topic

Blog Post

The European Globalisation Adjustment Fund: Time for a reset

It is only in the last decade that the EU has had an active policy to reintegrate workers who lost their jobs as a result of globalisation, through the European Globalisation Adjustment Fund (EGF). In this blog, the authors assess the performance of the Fund and make three recommendations to improve its effectiveness. To be more successful, the Fund should improve its monitoring and widen the scope of its usage.

By: Grégory Claeys and André Sapir Topic: European Macroeconomics & Governance Date: April 11, 2018
Read article More by this author

Opinion

How Should the EU Position Itself in a Global Trade War?

It is high time for the EU to work on more than just wishful thinking in response to the US challenge to global trade. With the first cracks appearing in the multilateral system, it will be difficult for the EU to maintain a middle course between the US and China.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: April 5, 2018
Read article More by this author

Podcast

Podcast

Director's Cut: Developing deposit insurance in Europe

In this week’s Director’s Cut of ‘The Sound of Economics’ podcast, Bruegel director Guntram Wolff talks with Nicolas Véron, senior fellow at Bruegel, about the implementation of a European Deposit Insurance Scheme (EDIS), one of the three pillars needed for the completion of banking union.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: April 3, 2018
Read article More on this topic

Blog Post

Do wide-reaching reform programmes foster growth?

With growth gathering momentum in the eurozone, some have claimed this is the proof that structural reforms implemented during the crisis are working, re-opening the long-standing debate on the extent to which reforms contribute to fostering long-term growth. This column employs a novel empirical approach – a modified version of the Synthetic Control Method – to estimate the impact of large reform waves implemented in the past 40 years worldwide.

By: Alessio Terzi and Pasquale Marco Marrazzo Topic: European Macroeconomics & Governance Date: March 28, 2018
Read article More on this topic

External Publication

Europe in a new world order

The EU is a relatively open economy and has benefited from the multilateral system. We argue that the EU should defend its strategic interests. The Singapore ruling has offered a useful clarification on trade policy. Addressing internal imbalances would also increase external credibility. Finally, strengthening Europe's social model would provide a counter-model to protectionist temptations.

By: Maria Demertzis, Guntram B. Wolff and André Sapir Topic: European Macroeconomics & Governance Date: March 26, 2018
Read article More on this topic More by this author

Blog Post

The Brexit Transition Deal

Michel Barnier, the European Union’s Brexit negotiator, and David Davis, Britain’s Brexit secretary, announced a transition deal on March 19. We review recently published opinions about the deal and its implications.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: March 26, 2018
Read article More on this topic More by this author

Opinion

Greece must capitalise on its growth momentum

Better-than-expected growth performance reflects the underlying positive changes in the Greek economy – but net investment is in fact negative, while Greece has various institutional weaknesses. Further improvements must be made regarding Greece’s attractiveness to foreign direct investment. A new (at least precautionary) financial assistance programme would improve trust in continued reforms and also address eventual public debt financing difficulties.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: March 26, 2018
Read about event More on this topic

Past Event

Past Event

Could uncertainty derail the European recovery?

It is a contradictory time for Europe. The economy is recovering but the political climate is uncertain. There is excitement about common projects but also rifts and increasing nationalism and populism.

Speakers: Franco Bruni, Maria Demertzis, Zsolt Darvas and Marietje Schaake Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 22, 2018
Read article Download PDF More on this topic

Policy Contribution

The European Globalisation Adjustment Fund: Easing the pain from trade?

With the European Globalisation Adjustment Fund (EGF), the EU now has an instrument to help workers negatively affected by trade find new jobs. However, only a small proportion of EU workers affected by globalisation receive EGF financing. How to improve the EGF? Revising the eligibility criteria to qualify for EGF assistance, enlarging the scope of the programme beyond globalisation and collecting more and better data to enable a proper evaluation of the programme.

By: Grégory Claeys and André Sapir Topic: European Macroeconomics & Governance Date: March 22, 2018
Load more posts