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Ukraine: IMF returns to Ukraine amid daunting outlook for 2015

January 13, 2015

The IMF returned to Ukraine on 8 January to resume a review of the country’s progress before releasing the next desperately-needed tranche of aid from the USD 17 billion bailout program. Two tranches of funding, which were due last year, had been postponed as a result of the country taking one month to form a coalition government following the 26 October parliamentary snap elections and another month to pass a budget for 2015. The IMF will now review the country’s progress on implementing reforms and is expected to conclude its assessment by the end of January. The next tranche of funding, the third to be released in the program, is for USD 2.8 billion in aid. The fourth tranche (USD 2 billion) that is scheduled for March 2015 it is expected to be released early, in conjunction with the third tranche, given Ukraine’s grave financial situation.

Looking ahead, Ukraine’s outlook for 2015 is grim. The military conflict between the government and pro-Russia separatist rebels has had a devastating impact on the country and a resolution seems far off. Since the onset of the conflict the economy has entered into a downward spiral as it has faced sharp contractions in economic activity coupled with skyrocketing inflation. It is widely expected that the country will need additional financing on top of the current IMF program to stay afloat. In addition, the hyrvnia has skyrocketed and lost almost half its value against the dollar during 2014. The Central Bank’s reserves have hit an over-nine-year low in November, falling below USD 10 billion and Ukraine’s main exports (food, minerals and metals) are all facing reduced demand and falling prices, which is contributing to the deteriorating outlook.

The government’s budget for 2015, which was passed on 29 December 2014, reflects these new realities that Ukraine is facing. The budget was drafted on the assumption of 13% inflation and an economic contraction of 4.3% for 2015. Moreover, the budget includes many economic reforms that were agreed upon as a contingency of the IMF’s bailout program, including new tax legislation and increased duties on imports. Additional notable changes include a drastic increase in military spending and large cuts to social spending. A mandatory review of the budget will be conducted before 15 February, following meetings with Ukraine’s international creditors to allow for additional reforms if required.

Despite the government’s commitment to economic and fiscal reform, Ukraine’s economy is unlikely to turn around without a resolution to the military conflict. The conflict is centered in the eastern regions of Luhansk and Donetsk, Ukraine’s industrial heartland, which combined represent over 15% of the nation’s GDP. Furthermore, the conflict has weighed heavily on consumer and business confidence and economic activity has declined in other areas of the country. Dan Buc?a, Economist at UniCredit comments that:

“While we expect a frozen conflict in Donbas, Ukraine’s recovery requires an agreement with the breakaway republics of Donetsk and Luhansk and, implicitly, with Russia. A comprehensive deal would entail concessions from Ukraine. Larger autonomy for the Donbas could “restart” ties with the rest of Ukraine’s economy and could set the stage for a long-term truce in the East. This would help business and consumer confidence recover, lifting consumption and investment in 2016, albeit from a very low base.”

At this point, a resolution to the conflict is unclear. Tensions between Ukraine and Russia, a key-player in the negotiations, remain high following the Ukrainian parliament’s decision to renounce their “non-aligned” status—a move which opens the door for potential NATO membership in the future. Further, talks between the foreign ministers of Ukraine, Russia, Germany and France concluded on 12 January without any significant progress on how to resolve the conflict and no date has been set for future talks.

Amidst this political turmoil and Ukraine’s dire financial situation, FocusEconomics panelists have downgraded Ukraine’s 2015 economic outlook for the eighth month in a row. Panelists now expect GDP to contract 2.2% in 2015, which is down 0.4 percentage points from last month’s forecast. For 2016, panelists expect the economy to rebound to a 2.2% expansion.


Author: Angela Bouzanis, Senior Economist

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