At the forthcoming Ukrainian official donors’ meeting scheduled for September, one has to hope that G-7 policymakers stop pretending and face up to the questions that they should have been asking at the time that Ukraine’s US$17 billion IMF stand-by program was approved last May. Should the IMF, as opposed to the official donors, continue to be the primary source of Ukraine’s external financing at the risk of further undermining the IMF’s credibility as a conditions based lender and as a provider of a seal of good house-keeping? Should the private sector continue to be given a free ride at the expense of the international taxpayer by forestalling debt restructuring, thereby compounding the moral hazard problem currently plaguing the global financial system?
These questions would appear to be all the more pertinent now that Ukraine’s IMF program is veering seriously off course, its external financing needs are continuing to increase, and its domestic and external political situation is becoming all the more difficult. For particularly in light of the IMF’s recent unfortunate Greek lending experience, policymakers should be pondering the appropriateness of using the IMF as a convenient slush fund to achieve understandable geopolitical ends, without appropriate parliamentary oversight of the use of taxpayers’ money and at the cost of seriously undermining the IMF as a lending institution.
While arguably last May one could have given Ukraine’s IMF stand-by program the benefit of the doubt, this can no longer be the case. Largely due to more serious hostilities in Eastern Ukraine than was anticipated, it now appears that Ukraine’s GDP will decline by more of the order of 10 percent in 2014 rather than by the 5 percent that initially had been assumed in the IMF program. Also in question has to be Ukraine’s prospects for economic recovery in 2015.
At the same time, as capital flight has accelerated, the country’s official international reserves have been depleted and the Ukrainian currency now has depreciated by more than 30 percent since the start of the year. This has brought the currency to a level that the IMF itself considers to be dangerous for the solvency of the Ukrainian banking system.
A slumping domestic economy and a weakening currency have highly compromised the country’s public finances and have increased its external borrowing needs. So too have rapidly rising non-performing bank loans and delays in domestic natural gas price increases. As a result, it now appears that the overall budget deficit could be as high as 12 percent of GDP in 2014, the public debt to GDP ratio could rise to over 85 percent by 2018, and the country’s external financing needs might have increased by more than US$10 billion.
As if the country’s present economic plight were not bad enough, two basic considerations cloud its longer-run outlook. The first is Russia’s attitude towards Ukraine where Vladimir Putin has amply demonstrated that his country has both the political willingness and the means to destabilize the Ukrainian economy. Short of actually invading the country, Russia can do so by turning off Ukraine’s natural gas supply, by closing its all important market to Ukrainian exports, and by insisting on early repayment of its loan now that Ukraine’s public debt to GDP ratio has exceeded 60 percent.
The second factor clouding Ukraine’s economic outlook is its compromised domestic political situation that could impede the adoption of the economic reforms needed to put the country on a better long-term growth path and to keep it in compliance with its IMF program. This is particularly the case now that for understandable reasons of needing to confront the Russian external threat in the East, President Petro Poroshenko has had to strike a deal with those same oligarchs who have impeded meaningful economic reform to combat corruption in the past.
As official donors gather next month to map out their Ukrainian policy approach, there can be little question that for obvious geopolitical reasons Ukraine has to be kept economically afloat. However, what does need to be questioned is how this might be best done without making yet another end-run around domestic parliaments, without further compromising the IMF as a lending institution, and without letting private sector lenders off the hook with use of international taxpayers’ money.
At a minimum one has to hope that the main burden of additional external financial support to Ukraine be borne by official bilateral creditors rather than by the IMF and that this is done with explicit approval of the respective elected legislatures. One also has to hope that a meaningful part of additional external support to Ukraine is provided by a rescheduling of its external private sector obligations.