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.

View comments
Read about event

Upcoming Event

Jan
28
09:30

A post-Brexit agreement for research and innovation

What is the future of EU's and UK's relationship on research and innovation?

Speakers: Gina Dowding, Michael Leigh, Adrian Hayday, Clare Moody, Martin Muller, Joe Owen, Jaroslaw Pietras, Uta Staiger, André Sapir, Beth Thompson and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic

Blog Post

A European anti–money laundering supervisor: From vision to legislation

In fighting anti-money laundering, the European Commission should act fast toward creating a central supervisory authority.

By: Nicolas Véron and Joshua Kirschenbaum Topic: European Macroeconomics & Governance Date: January 24, 2020
Read article More on this topic More by this author

Blog Post

How could net balances change in the next EU budget?

The gap between payments into the EU budget and EU spending in a particular country has importance when EU spending does not constitute European public goods, or there are risks for their improper use. I estimate that the Juncker Commission’s proposal for the next seven-year budget would lead to big reductions (as a share of GNI) in the net payments to most central European countries, while the changes for other countries seem small

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: January 23, 2020
Read article

Blog Post

Incorporating political risks into debt sustainability analysis

DSA applies to crisis countries only, but an early warning system identifying vulnerabilities is relevant for all countries. A more general, less stringent, debt vulnerabilities analysis (DVA) could be used to assess countries’ debt management policies and identify vulnerabilities, without leading immediately to policy consequences. A more general framework could also incorporate political risks that are significant determinants of debt dynamics

By: Stavros Zenios and Andrea Consiglio Topic: European Macroeconomics & Governance, Global Economics & Governance Date: January 22, 2020
Read about event

Past Event

Past Event

The state of health in the EU and the digitalisation of health promotion

The panellists at this event reviewed the general state of health as well as the digitalisation in the industry.

Speakers: Stefania Boccia, Caroline Costongs, Katarzyna Czabanowska, Zsolt Darvas, Guillaume Dedet, Martin Dorazil, Josep Figueras, Joanna Kokot, Martin Seychell and Michael Strübin Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 22, 2020
Read article Download PDF More on this topic

Policy Contribution

Market versus policy Europeanisation: has an imbalance grown over time?

This Policy Contribution tests the hypothesis that an imbalance has grown in Europe over the last few decades because markets have integrated to a greater extent than European-level policymaking, potentially creating difficulties for the democratic process in managing the economy. This hypothesis has been put forward by several authors but not so far tested empirically.

By: Francesco Papadia and Leonardo Cadamuro Topic: European Macroeconomics & Governance Date: January 9, 2020
Read article More on this topic More by this author

Opinion

Understanding populism

Political identity is a group stereotype. As no camp corresponds exactly to our expectations, we choose the one to which we are closest and which is also the most distant from the ideas we reject

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: January 2, 2020
Read article More by this author

Blog Post

2019 on #econtwitter, in a million tweets

What did academic economists talk about in 2019? I collected one million tweets from popular academic economists over the year, and analysed the topics discussed.

By: Enrico Bergamini Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Date: December 19, 2019
Read article More on this topic More by this author

Podcast

Podcast

The Sound of Margrethe Vestager

Will AI exacerbate the gap between big companies and small ones? Do ordinary Europeans gain anything from having European tech giants? This week, Nicholas Barrett and Guntram Wolff went to the Berlaymont to interview Margrethe Vestager, the Executive Vice President of the European Commission for a Europe Fit for the Digital Age.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: December 19, 2019
Read article Download PDF More on this topic More by this author

Policy Contribution

Can EU competition law address market distortions caused by state-controlled enterprises?

The distortive effects that foreign state-owned or state-supported companies can have on European markets and on the European Union’s economic autonomy are starting to worry policymakers

By: Mathew Heim Topic: European Macroeconomics & Governance Date: December 18, 2019
Read article More on this topic More by this author

Blog Post

How much will the UK contribute to the next seven-year EU budget?

This post estimates the United Kingdom’s net contribution to the 2021-2027 EU multiannual budget at close to €20 billion, taking into account the most significant items of the financial settlement according to the October 2019 EU27-UK draft withdrawal agreement.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 16, 2019
Read article Download PDF More on this topic More by this author

Working Paper

A new look at net balances in the European Union's next multiannual budget

Whenever the European Union’s budget is discussed, much of the political focus is on net balances – whether countries pay in more than they receive – rather than on the broader overall positive effects of EU spending. The largest net contributor countries have sought to limit their contributions, leading to the build-up of an ad-hoc, complex, opaque and regressive system of revenue corrections.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 12, 2019
Load more posts