Ukraine: IMF approves USD 17.5 billion bailout for Ukraine, difficult debt restructuring talks begin
April 14, 2015
The International Monetary Fund (IMF) approved a new USD 17.5 billion Extended Fund Facility Arrangement for Ukraine on 11 March, immediately releasing a desperately-needed USD 5.0 billion in aid to the cash-strapped country. The announcement was widely expected and followed the Ukrainian government’s approval of a number of IMF-instructed reforms intended to overhaul the country’s finances. The agreement is designed to fill part of the larger USD 40.0 billion financing gap the country faces over the next four years. International donors have pledged an additional USD 7.2 billion in aid and the country aims to generate the remaining funds through a debt restructuring operation. The debt operation, as outlined by the IMF, will focus on three objectives: generating approximately USD 15.0 billion in funds throughout the program period, reducing the public debt (% of GDP) to below 71% by 2020 and keeping the government’s gross financing needs to an average of 10% of GDP between 2019 and 2025.
The Ukrainian government has already begun negotiations with bond holders, but reaching an agreement will not be easy. The government is aiming to conclude negotiations with creditors by May before the IMF’s first review in June, which leaves just a short window to reach an agreement. Complicating matters, Russia is the second-largest holder of Ukrainian debt and holds a USD 3.0 billion Eurobond due in December. Russia has stated that it refuses to participate in joint restructuring talks and uncertainty remains whether a deal can be reached between the two countries.
On top of the country’s financing woes, the economy continues to show no signs of recovery. Industrial production recorded the largest contraction since August 2009 in February and inflation skyrocketed to over 45% in March. In addition, a number of the reforms included in the 2 March revised budget are likely to further dampen private consumption. Specifically, a large reduction in the state energy subsidy and hefty reductions in state employment and benefits will hurt Ukraine’s already-struggling households. On the external front, prospects are also bleak. Almost a quarter of the country’s exports originate from Donbas, one of the areas at the heart of the military conflict, and Ukraine’s largest export partner, Russia, is struggling with its own economic crisis. Ivan Tchakarov, Head of Russia/CIS Economics at Citi, adds:
“The assumptions laid out in the adopted 2015 budget underscore the insurmountable challenges faced by the government. Even if the fiscal envelope appears robust (planned budget deficit at just 4.0% of GDP), the assumption of a 40% increase in revenues (following a mere 4% increase in 2014) suggests that revenues will likely undershoot, leading to a much-higher fiscal deficit that will most likely be financed by money-printing by the NBU, with grave consequences for the currency.”
Going forward, Ukraine’s economy is not likely to turn around without a lasting resolution to the military conflict. While some progress has been made since the 12 February peace agreement, a number of obstacles remain. In particular, the government must amend the constitution before year-end and include some degree of decentralization of power to the eastern regions. A large amount of uncertainty remains regarding whether the Ukrainian government and pro-Russia rebels can reach an agreement over the country’s territorial future and establish a framework for elections. Adding to the political risks, the dire state of the Ukrainian economy combined with unpopular reforms could erode political support from the government.