Ukraine: Government passes economic reforms in desperate push to halt economic collapse
March 10, 2015
The Ukrainian government approved a number of amendments to the 2015 budget on 2 March in an effort to secure desperately needed financial aid. The International Monetary Fund (IMF) had announced a new USD 17.5 billion Extended Fund Facility Arrangement on 12 February to replace the existing Stand-By Arrangement. The IMF will now review the country’s progress on implementing reforms and is widely expected to announce its approval of the bailout package on 11 March. If approved, Ukraine could receive the first tranche of approximately USD 5 billion within the subsequent days.
The amendments included in the revised budget are part of the government’s desperate push to halt Ukraine’s downward economic spiral. The military conflict has had a devastating impact on the economy and the country’s finances have been depleted. According to a preliminary estimate released by the State Statistics Service of Ukraine, GDP contracted a massive 15.2% in Q4 2014, which was a notable deterioration from Q3’s 5.3% fall. Further, the sharp contractions in economic activity have been coupled with skyrocketing inflation and a drastic plunge in the value of the hryvnia. The enacted reforms contain many unpopular measures designed to overhaul the country’s finances. Specifically, the measures include cuts to pensions, increases in taxes and a large decrease in energy subsidies. The Ukrainian government has historically subsidized gas prices and beginning in April consumers will be faced with an almost triple increase in price. In addition to the government’s reform push, the Central Bank decided to hike the discount rate from 19.5% to 30.0% and introduced a number of currency controls in an attempt to stabilize the hryvnia and fulfill its part of the IMF’s requests.
Despite the likelihood of receiving additional aid, Ukraine’s outlook is bleak. The IMF funds will help shore up the Central Bank’s reserves, which have fallen below three months of imports, but will do little to address other economic obstacles. Ukraine’s banking sector is in shambles, over 40 banks have been declared bankrupt since the war began including Delta Bank, Ukraine’s fourth largest lender, on 3 March. In addition, many of Ukraine’s industries are uncompetitive; they are focused on traditionally-outdated sectors and corruption is rampant.
The military conflict is centered in the eastern regions of Luhansk and Donetsk, Ukraine’s industrial heartland, which represent over 15% of the nation’s GDP and the country’s economy is unlikely to be able to turn around without a lasting resolution. While fighting appears to have eased since the new Minsk peace agreement was signed on 12 February, the current ceasefire is fragile. The Ukrainian government and pro-Russia rebels still remain deeply divided on the country’s territorial future, and the dire state of the economy combined with unpopular reforms could erode political support from the Ukrainian government. Peter Attard Montalto and Dmitri Petrov, Economists at Nomura comment that:
“In our view, the separatists and Moscow still have substantially different views from Ukraine on constructional reform as well as on the degree and practicalities of autonomy. The difference in the interpretation of these very vague concepts creates substantial medium-term risks to the implementation of the agreement. Even if some of the preliminaries have been agreed upon, there may still be substantial resistance from the hawkishly-minded Ukraine parliament, where some of the more populist forces may try to block any incoming legislation as part of the ongoing domestic political battle. Change in political power in Kiev, which could see further erosion of electorate support as a result of growing economic difficulties and austerity, would add further substantial risks to the process.”