The IMF test

13 November 2019, 02:14

Like other populists, Volodymyr Zelenskiy is increasingly different as real President from the image elected by 73% of the voters. Cooperation with the IMF offers one of the best illustrations. While his character in the Servant of the People kicked the IMF out to protect the state and the citizens, the real Zelenskiy is trying hard to develop cooperation with it. In his recent meeting with the IMF, Zelenskiy assured it of “full support for structural reforms in the economy, independence of the National Bank of Ukraine and full investigation of fraud in the banking sector.” Meanwhile, the government has been busy drafting laws and preparing public opinion for the fulfillment of long-standing requirements from the IMF: abolition of the ban on the sale of land, market gas prices, restriction of public spending and a number of other steps, such as the law on concession or privatization of attractive government-owned objects. 

In late September, however, news emerged that the IMF mission left Ukraine after two weeks with no intentions to recommend a new credit program for Ukraine to the administration, counter to what the Ukrainian Government expected. Allegedly, the trigger was not the usual issues of budget, land or gas, but the scandal caused by Premier Honcharuk’s interview for the Financial Times referring to the readiness for a compromise with oligarch Ihor Kolomoiskiy. While the IMF mission was in Kyiv, Kolomoiskiy said at the YES 2019 forum that he did see a window of opportunity for an agreement with the new government on the reimbursement of $2bn to him, even if this compensation comes via return of the nationalized PrivatBank. 

The new government is thus learning the difficulty of dealing with specific financial interests of the key sponsors, not just with public policy towards them. It is far more difficult to ignore their interests than it is to take other steps, even if unpopular with the majority of the population. 

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While Premier Honcharuk tried to persuade the audience that his words were misinterpreted and the government was not negotiating anything with Kolomoisky, few seemed reassured. If the new government decides to satisfy the claims of its key sponsor in the election, a good portion or half of the IMF’s money will be spent on reimbursement to Kolomoiskiy. With this approach, the rest can be used to plug the hole created by the privileges that Kolomoiskiy’s business has been enjoying since the first months of Volodymyr Zelenskiy’s presidency – including in the energy sector, and may continue to enjoy as attractive objects go under control of the entities associated with him during the great privatization at discounted prices announced by the government. 

The influence of Kolomoiskiy on decision making by the team in power is obvious both in Ukraine and abroad. The resignation of Oleksandr Danyliuk, Secretary of the National Defense and Security Council, confirms the scale of that influence. He said in Savik Shuster’s Freedom of Speech talk show on September 20 that his task was to do everything to prevent Ihor Kolomoisky from getting a lot of power in Ukraine only to resign a week later. Therefore, the likelihood of decisions favoring Kolomoiskiy in issues that are high on the IMF’s agenda is high. Moreover, Kolomoiskiy himself speaks openly about his attitude towards the IMF, the acceptability or desirability of a default for Ukraine, and the resulting refusal to service its debt further. 

In order to continue cooperation with Ukraine, the IMF insists on guaranteed red lines. One to not be crossed is reimbursement for PrivatBank to Kolomoiskiy. Kyiv, however, is yet to say yes or no to this. Meanwhile, the Commercial Court of Kyiv has postponed the session on the lawsuit whereby PrivatBank ex-shareholders Ihor Kolomoiskiy and Triantal Investment Ltd. want the purchase of PrivatBank by the state declared invalid from October 1 to October 8. And this may not be the last postponement. 

The IMF’s demands do not necessarily benefit long term development of the country it works with, while its lending mostly pushes the country further into a debt spiral rather than fixing the reasons of its economic problems – albeit most of the IMF’s demands for Ukraine are fair and reasonable. But it is something different that matters now: it is not unacceptable demands for Ukraine’s economic interests, the prospects of its development or life quality of its citizens that may freeze relations with the IMF. Ukraine’s new government hardly cares about that despite the image the new President portrayed in his film. Freezing relations with the IMF would send the only signal – that it is Kolomoiskiy’s interests that have prevailed, not those of Ukraine or the lobbyists of cooperation with the IMF. Furthermore, the losses caused by freezing cooperation with the IMF would not mean that the government would use this to fix its economic policy in Ukraine’s interests when freed from its obligations to the IMF. Quite on the contrary, Ukrainians would pay for the negative impact of such a move without even potentially benefiting from freezing cooperation with the IMF. The price of this would grow further as Ukraine would have to pay dividends to Kolomoiskiy for his sponsorship of “Zelenskiy presidency” and “Servant of the People” projects, starting with an equivalent of $ 2bn via stocks of PrivatBank.    

Meanwhile, Ukraine is entering the three-year period of peak debt repayment. According to the 2020 draft budget submitted to Parliament, the public debt servicing and repayment is projected at UAH 438.1bn, including UAH 185.6bn for external debt and UAH 252.2bn for the national debt. Ukraine plans to borrow another UAH 361.1bn, including UAH 119.1bn externally and UAH 242.1bn domestically. This shows that the Government is in fact planning to refinance or reborrow the debt on the domestic market, while paying out UAH 66.5bn (or $ 2.3bn according to the exchange rate projected by the Government) over what it borrows as external debt. This will materialize provided that the Government manages to reborrow the rest of the UAH 119bn external debt (or $ 4.25bn under the projected exchange rate). 

In this, much depends on the IMF’s funds. Firstly, they are three-fourfold cheaper compared to the cost of borrowings on the international financial market. Secondly, cooperation with the IMF will define the readiness of private lenders to buy Ukrainian bonds and the price they are willing to pay for them. Finally, the payment of $ 2.3bn of external debt which the Government does not plan to reborrow will force it to buy foreign currency. It will have to do so on the interbank market in Ukraine or to use the NBU’s reserves. Cooperation with the IMF is thus important in supporting a stable exchange rate on Ukraine’s market.   

The recent rise of the hryvnia and the high appetite for hryvnia-denominated Ukrainian government bonds are misleading and will vanish soon. The Ministry of Finance started issuing five-year hryvnia bonds in April 2019. It sold over UAH 60bn-worth of these bonds by May while the hryvnia rose from UAH 26.8 to UAH 24.1 per US dollar. In late September, foreign investors poured UAH 100bn into Ukrainian bonds. On October 1, the Ministry of Finance managed to sell a mere UAH 77mn-worth of the bonds, compared to the sale worth UAH 13.2bn in one day just a week before. This sharp decline of sale matched steep devaluation of the hryvnia to UAH 24.93 per US dollar on October 2 from around UAH 24 per US dollar as of September 30. By October 3, the NBU’s official rate was UAH 24.98 per US dollar. It looks like the outflow of speculative capital that boosted hryvnia exchange rate in the past months is starting.

There are no fundamental reasons for the revaluation of the hryvnia or for Ukraine’s hryvnia-denominated bonds to become more attractive. Its trade deficit for goods rose to $ 5.01bn over January-August 2019. Export barely grows lately while trade balance improves only marginally, mostly thanks to the temporarily cheaper fuels. Imports in June amounted to $ 4.65bn compared to $ 3.57bn of exports; and $ 5.48bn compared to $ 4.28bn in July. Despite active exports of this year’s harvest, Ukraine still imported more than it exported ($ 4.28bn). As a result, trade deficit was $ 1.08bn in June 2019 compared to $ 0.67bn in June 2018, and $ 1.3bn in July 2019 compared to $ 1.42 in July 2018. Even the August trade balance at – $ 0.76bn was just marginally better this year compared to the same month in 2018 at $ -0.84bn.   

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It is obvious that the positive factors are mostly temporary while further downturn on commodity markets will threaten Ukraine’s exports revenues from raw materials and semi-finished goods more than it benefits it by shrinking spending on imports. The 2020 draft budget projects trade deficit at $ 12-12.5bn by the end of 2019 and $ 14bn in 2020. Net growth of FDI is projected at just $ 4-4.5bn in 2020 which is not very optimistic compared to the actual growth of FDI in the past years.

The overall state of the economy and of the key export-oriented sectors is worsening too. The sharp rise of agricultural output in July was followed by a visible decline by 11.8% in August. Industrial output has been declining in the past months, mostly coming from the processing industries. While the output was 5% higher in March 2019 compared to March 2018, and 7.4% in April, the following months saw either stagnation (a growth of nearly zero – growth was a mere 0.7% and 0.3% in May and July 2019 compared to the same months of 2018) or loss of output at a much faster pace (by 6.1% in June and 4.1% in August). 


Translated by Anna Korbut 

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