Press Release No. 98/38

Press Release: IMF Approves Three-Year Extended Fund Facility for Ukraine

September 4, 1998

The International Monetary Fund (IMF) today approved a three-year credit for Ukraine, equivalent to SDR 1,645.55 million (about US$2,226 million), under the Extended Fund Facility (EFF)¹ to support the government’s 1998-2001 economic program. Of the total, SDR 190 million (about US$257 million) is available immediately.

Background

Ukraine made considerable progress in stabilizing its economy under its 1996 economic reform program, supported by a Stand-By Arrangement from the IMF. Inflation fell rapidly and a measure of stability was achieved, even though real GDP continued to decline. Progress was made on the structural front in privatization, tax reform, and price and trade liberalization.

In August 1997, Ukraine continued its stabilization efforts with the support of the IMF under a new 12-month Stand-By Arrangement. Despite some progress, overall performance under the program was less than aimed for, owing mainly to an inability to contain expenditures, to slow progress in structural reforms, to adverse developments in international capital markets, and to unsettled domestic politics. On the positive side, progress was made in reducing inflation and in halting the decline in output. In the first six months of 1998, real GDP rose by 0.2 percent, the first increase since independence, reflecting output increases mainly in construction and agriculture.

In the wake of adverse regional developments in mid-August 1998, the economic situation has suffered and the authorities have taken a number of steps to respond. On August 18, the National Bank of Ukraine increased interest rates and allowed the exchange rate to depreciate at a faster rate. Nevertheless, despite continued tight monetary policy, the foreign exchange market remained under pressure and gross international reserves declined. A new exchange rate band of hryvnia 2.5-3.5 to the U.S. dollar will take effect from September 5, 1998. A voluntary rescheduling scheme for treasury bills held by residents was initiated, excise taxes were raised, and some VAT exemptions were eliminated and payroll taxes reduced.

Medium-Term Strategy

The key objectives of Ukraine’s program are to strengthen public finances and implement ambitious structural reforms to promote economic growth and improve the population’s living standard. At the same time, measures are being taken to counter the negative effect of the recent regional shocks. The macroeconomic objectives during 1998-2001 are expected to achieve

4 percent growth in GDP by 2001 from -0.3 percent in 1997; to bring inflation down to 7 percent by 2001 from 10 percent in 1997; and to achieve gross international reserves equivalent to 7 weeks of import cover in 2001 from 6.3 weeks in 1997.

As a result of regional shocks and the deteriorated outlook for external financing, the program includes implementation of tighter fiscal policies, debt restructuring, and the adoption of a new exchange rate band. Inflation is expected to pick up in the last few months of the year as a result of the widened band for the hryvnia, but with full program implementation, inflation for 1999 should be contained to about 7 percent on an end-of-period basis. With imports more expensive, tight monetary policy, and the more inflationary environment, projected real GDP growth in 1999 has been modified in recent weeks to 1 percent from about 3 percent.

Strengthening the financial position of the government will be given the highest priority. The fiscal package adopted under the program calls for a wide range of revenue and expenditure measures during 1998 and the remainder of the program period, most important of which are a substantial reduction in payroll taxes (by 10 percentage points), public administration reform, and scaling down of subsidy programs. Revenue targets will be met through continued improvements in tax administration. Expenditure control will also be forcefully pursued, including through the introduction of the expenditure limits system and efforts to ensure that expenditure adjustments are made on a regular basis, taking into account revenue developments. Debt restructuring is expected to have a positive fiscal impact, with lower domestic interest payments in 1998, offset somewhat, however, by higher payments on external debt. As a result, the budget deficit in 1998 is expected to be held to 2.8 percent of GDP, and the budget for 1999 to be based on a deficit of 1 percent of GDP. With a stronger fiscal stance, the authorities should be able to continue to implement a tight monetary policy to keep inflation under control.

As under the previous Stand-By Arrangement, monthly monitoring should provide early warning signals for any adjustments needed, while quarterly reviews will provide for a continuous dialogue between the Ukrainian authorities and the IMF.

Structural Reforms

Stabilization gains alone will not lead to a resumption of growth and fundamental systemic reforms are crucial. Structural reforms envisaged under the program are far reaching. Strengthening of fiscal and monetary institutions, especially the Ministry of Finance and the tax and customs administration, are necessary to enhance the authorities’ implementation capacity. Reductions in the size of the government and its intervention in economic activities, as well as progress in privatization, deregulation, and administrative reforms, and reforms in the energy and agricultural sectors are essential for promoting private investment and economic growth, and will be vigorously pursued. Accelerated reform in the coal sector will lessen expenditure pressures on the budget.

Addressing Social Costs

The social protection system will be rationalized and streamlined to eliminate general subsidies and to improve targeting of assistance to the truly needy. The government intends to eliminate most budgetary privileges and to review the benefits provided by the Chernobyl Fund, the Social Insurance Fund, and the Employment Fund. The authorities aim to establish a pension system that will be financially sustainable and provide adequate social protection, to include the introduction of personal savings accounts and nonstate pensions.

The Challenge Ahead

In the near term, Ukraine will continue to be vulnerable to unexpected fluctuations in capital markets that could undermine the fiscal situation and put renewed pressure on the exchange rate and international reserves. It will be critical to monitor developments closely and respond quickly if necessary. As progress in structural reform makes Ukraine less vulnerable to the type of financing problems it is now facing, increased efforts to avoid borrowing with short-term maturities should help alleviate short-term liquidity problems associated with unexpected developments in capital markets.

Ukraine joined the IMF on September 3, 1992; its quota² is SDR 997.3 million (about US$1,349 million). Its outstanding use of IMF credit currently totals SDR 1,807 million (about US$2,444 million).