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 More on this topic

Past Event

Past Event

Public finance - time for a quality check

Is the quality of fiscal expenses and revenues more important than the budget deficit?

Speakers: Maria Demertzis, Boris Cournede, Sven Langedijk and Francesco Papadia Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 16, 2019
Read article More on this topic More by this author

Opinion

Brexit and Finance: Brace for No Impact?

Amid the daily high drama of Brexit, it is easy to lose track of the structural shifts, or lack thereof, that may be associated with the UK’s possible departure from the European Union. One of them, and not the least, is the potential impact on the European and global financial system.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: October 14, 2019
Read article More on this topic

Blog Post

Cross-border, but not national, EU interregional development projects are associated with higher growth

Our calculations reveal that places where EU regional development projects bind together participants from different countries experience higher economic growth. Purely national interregional projects, on the other hand, are not associated with such benefits. The results hold across regions of different levels of income and consider the effects of other growth-determinants. Cross-border projects might bring efficiency gains, unlock synergies and provide knowledge transfers, boosting activity, with gains going beyond the projects’ scope. Cross-border projects could provide perhaps the only rationale for the continued cohesion/regional funding of more developed regions.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: October 14, 2019
Read about event

Upcoming Event

Nov
4
08:30

What industrial policy for the European Green Deal?

This event will be a workshop, aiming to look into the design and implementation process of the European Green Deal. Each session will be introduced by three short presentations aimed at launching the discussion among all workshop participants.

Speakers: Jos Delbeke, Bertrand Déprez, Markus Hess, Kerstin Jorna, Laura Piovesan, Megan Richards, Simone Tagliapietra, Kurt Vandenberghe and Reinhilde Veugelers Topic: Energy & Climate, European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Podcast

Podcast

Brexit: a European Odyssey

Nicholas Barrett and Guntram Wolff talk to Kalypso Nicolaïdis, author of Exodus, Reckoning, Sacrifice: Three Meanings of Brexit. Together they discuss the mythology that binds Britain to continental Europe

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: October 11, 2019
Read article Download PDF More on this topic More by this author

Policy Contribution

With or without you: are central European countries ready for the euro?

The debate on euro adoption by central European EU countries has intensified in the last years. In this Policy Contribution the author does not review all the complex aspects of euro-area enlargement, but analyse a particularly important issue: the build-up of macroeconomic vulnerabilities and the subsequent adjustments.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 10, 2019
Read article More on this topic More by this author

Blog Post

Long term real interest rates fell below zero in all euro area countries

The 10-year real government bond yield, which is the nominal yield deflated by expected inflation, has fallen below zero in Italy and Greece, boosted by increased market confidence for their new governments. Romania is the only remaining EU country with a positive real interest rate. Negative real interest rates vastly help fiscal sustainability and provide a great opportunity to invest in much needed infrastructure and the transition to a carbon-neutral economy.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 8, 2019
Read article More on this topic More by this author

Opinion

Europe: en finir avec la politique en silos

Projetée dans un monde de rapport de force dont les principaux protagonistes ne séparent pas géopolitique et économie, l’UE va devoir conduire un changement de logiciel culturel, une mutation organisationnelle et un rééquipement opérationnel, explique l’économiste Jean Pisani-Ferry.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: October 8, 2019
Read article More on this topic More by this author

Opinion

The Case for Intelligent Industrial Policy

Although national industrial policies have a bad reputation, there is a strong case for government support to sectors that will increasingly rely on artificial intelligence. In this regard, the German government’s plan to promote production of electric-car batteries may accelerate an industrial renaissance in Europe.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: October 7, 2019
Read about event More on this topic

Past Event

Past Event

A fresh perspective on EU-Turkey relations: still a possibility?

Examining the mutual benefits of a EU-Turkey customs union.

Speakers: Zeynep Bodur Okyay, André Sapir, Sinan Ülgen and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 3, 2019
Read article More by this author

Blog Post

Why structural balances should be scrapped from EU fiscal rules

A prominent team from DG ECFIN of the European Commission challenged some of the criticisms of the EU’s methodology for estimating potential output and output gaps, as well as their role in the EU fiscal framework. In this post, I conclude that their responses to the criticisms they considered are questionable. More importantly, they overlook serious problems with the EU’s potential output methodology.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: October 1, 2019
Read article More by this author

Blog Post

Questions to the High Representative and Vice-President-designate Josep Borrell

Josep Borrell, the incoming High Representative and Vice-President-designate must explain how von der Leyen’s ‘geopolitical Commission’ intends to adapt to a global landscape dominated by an intensifying rivalry between Washington and Bejing.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 30, 2019
Load more posts