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9 October, 2015

«Economic populism is always tempting during periods of hardship, but it has not served Ukraine well in the past»

The IMF's assessment of Ukraine's reforms and outlook

Interviewed by Lyubomyr Shavalyuk

On September 22, the International Monetary Fund mission came to Kyiv for the second review of the Extended Fund Facility program. The Ukrainian Week spoke to Jerome Vacher, the IMF Resident Representative in Ukraine, about the IMF’s assessment of the reform process, the progress in fulfilling the Extended Fund Facility conditions by the Ukrainian government, and the restructuring of Ukraine’s foreign debt.

How would you assess the progress Ukraine’s government has made in reforms and in the meeting of conditions for the EFF program?

The Mission is precisely here to assess the performance under the program. The mission will look at the performance criteria and structural benchmarks in the fiscal and monetary areas, as well as at the economic situation. This is basically the backward-looking part of the discussion. We also have a forward-looking part which is to discuss our economic forecasts but more importantly the policies and reforms that can be put in place.

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Because of the timing of the mission, a lot of the discussion focuses on the 2016 Budget and how the Ukrainian authorities see it. There are also other important areas to discuss.

We have seen progress on macroeconomic stabilization, there are some early signs of bottoming out. I will also note the good handling and execution of 2015 Budget and a prudent fiscal policy. We have seen stabilization of deposits in the banking sector, mostly in hryvnia, but these are still early signs.  The foreign exchange market was stabilized as well. The cleanup of the financial sector has started in a decisive manner.

One of the most important questions is the increase of social benefits. We have heard the Premier’s statements about increase in salaries and pensions starting in September, the President mentioned a significant rise next year. Does the IMF support this policy?

The government decided to move the indexation which was initially scheduled for December 1, 2015, forward to the September 1. We were indeed consulted on this, as per the commitment of the Ukrainian authorities under the Letter of Intent and the Memorandum of Economic and Financial Policies to discuss actions affecting the EFF program. We have given our advice and opinion.

In that context we discussed fiscal performance so far, as well as the prospects for 2015 as we and the Minister of Finance saw them. We agreed with the government that even though there is not much room in the budget, it was sufficient to proceed with this important move thanks partly to prudent management of the budget so far.

Yulia Tymoshenko has stated that we need a 73% increase in social benefits. How would you assess this suggestion and options for the implementation of such policy?

We are well aware, that the Ukrainian population faces a difficult situation in the context of high inflation, even though it should be coming down partly thanks to the NBU’s focus on price stability.

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The increase which was moved forward from December to September was based on available resources in the budget. But the fiscal situation remains tight. It is easy to promise an increase even above the rate of inflation without taking into account the fiscal consequences. Economic populism is always tempting during periods of hardship, but ithas not served well Ukraine in the past. Some real thinking needs to be done on how to do better with the same envelope. It has already started in some areas with cuts of staff. Other important steps would be civil service reform and the fight against corruption.

What do you think of the debt restructuring deal Ukraine has managed to strike?

The agreement is a result of long negotiations between the main holders of Eurobonds and the Ukrainian government. The first step was to persuade the creditors to sit at the negotiation table — that took some time, but the whole process was done in good faith. Negotiations showed that Ukraine can be a strong and responsible partner. In my opinion, this is the best deal that could be achieved in those difficult circumstances and it satisfied both parties. We supported the deal because it fulfills the conditions that allow us to continue to lend. It allows us to see clearly how the available financing can support the needs of Ukraine over the years. In addition it improves debt sustainability in the medium term. There was a good discussion in the parliament about the agreement and I am glad that Ukrainian members of Parliament supported it.

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What is the IMF’s official stance on Ukraine’s debt held by Russia? Does it qualify as private or public debt?

It’s quite a complex and unique issue. The determination of whether the debt should be considered public or private has to be made by the IMF executive board. This has not been done yet, because Ukraine has been doing its coupon payments on time. However, the principle payment is due in December. The intention of the Ukrainian authorities has been to offer the holders of these bonds to participate in the restructuring deal. So, it is not determined yet.

Ukraine is in the process of drafting tax reform. Few options are on the table. Which one does the IMF consider a better one?

There are indeed a lot of different proposals and many ideas are floating around. It is clear that everybody – including ourselves - wants to see a modern tax system which would be less distortive.

But that has also to be discussed in the context of the 2016 budget. It is important to understand that the room for maneuver will be limited with the budget for the next year. There are some sources of revenue which were temporary in 2015 and will not be available in 2016. These are mostly the extraordinary NBU profits that went to the budget and the temporary import surcharge. The combination of these two is 2 ½  percent of GDP*. This will not be available next year. Moreover, there will be important expenditures that everybody wants to see. These include increased subsidies to compensate the rising energy tariffs. Plus, the government has defense and security priorities.

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As a result, the discussion about the tax reform should take that into account. The authors have to pay attention to what is affordable in the current situation. However, there are opportunities to simplify the tax system and reduce distortions caused by it, including the ones created by the level of social security contributions. There is also room to expand the tax base in some areas and to improve compliance in terms of tax revenues, including from some large taxpayers.

Many experts assume that administration of taxes is the key problem in Ukraine’s tax system, so the reform should be based on changes in the tax system and the customs. Does that meet the IMF’s perspective?

There is no doubt that a lot of changes are to be made in tax administration. It is an important issue for business and households. At the same time, tax compliance is currently not what it should be in Ukraine  and we see a lot of governance issues in the tax and customs areas. That’s where everybody, including the IMF, would like to see improvements. It’s not only  a matter of fiscal revenues, but also an important matter for the business environment and level of corruption in the country.

The reform of the tax system takes a lot of efforts, just as the reform of justice and prosecutorial system. The State Fiscal Service employs a lot of people and needs a comprehensive reform. We have been providing technical assistance for a few months already to prepare the reform of this service. It has already been agreed with the head of the State Fiscal Service and with the government. We hope to see it put in place.

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One of the ideas of the reform is to make the State Fiscal Service more efficient and accountable, and to make sure that there are checks and balances in the taxation system which would avoid abuses of power. We also want to see a reduction of corruption in the tax police and the customs services. Anything that can make the system more transparent and relying less on manual management would be a significant progress.

Clearly there are a lot of things that can be done in terms of institutional framework. We certainly expect more progress on that front in the next few months.

There have been talks in Ukraine about changes in political arrangements: changes in the parliament coalition are taking place and some experts speak of early parliamentary elections in 2016. Could that be a threat to the cooperation between Ukraine and the IMF?

Of course, election periods can occasionnally lead to some delays and changes in the schedule of  IMF programs, but what matters to us is the dialogue with the Ukrainian authorities and the capacity and willingness to commit to the necessary macroeconomic policies and reforms. These are the important aspects that are taken into consideration by the IMF Board. Ukraine gets exceptional access to IMF resources, therefore the commitment of the authorities is particularly important. 

BIO

Jerome Vacher has acted as IMF Resident Representative in Ukraine since May 2013. Born in France, he graduated from the Paris Institute of Political Studies, Pantheon-Sorbonne University and the Kiel Institute for the World Economy. Mr. Vacher joined the IMF in 2002. Over the time of his service there, he gained extensive experience in cooperation with Spain, Lithuania, Belarus, South Africa, United Arab Emirates, as well as Ukraine.

 

*The print version of the interview published in The Ukrainian Week #10(92) wrongly states the rate at 0.5%. We apologize for this error.


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